Credit Opinion: Deutsche Hypothekenbank AG

Transcription

1 Credit Opinion: Deutsche Hypothekenbank AG Global Credit Research - 25 Mar 2015 Hannover, Germany Ratings Category Moody's Rating Outlook Rating(s) Under Review Bank Deposits *Baa1/P-2 Baseline Credit Assessment b1 Adjusted Baseline Credit baa3 Assessment Senior Unsecured **Baa1 Subordinate -Dom Curr Ba1 Other Short Term -Dom Curr Parent: Norddeutsche Landesbank (P)P-2 GZ Outlook Negative Bank Deposits Bkd Bank Deposits A3/P-2 Aa1/P-1 Baseline Credit Assessment ba2 Adjusted Baseline Credit baa3 Assessment Issuer Rating A3 Senior Unsecured A3 Subordinate Commercial Paper Ba1 P-2 Other Short Term -Dom Curr (P)P-2 * Rating(s) within this class was/were placed on review on March 17, 2015 ** Placed under review for possible upgrade on March 17, 2015 Contacts Analyst Phone Bernhard Held/Frankfurt am Main Katharina Barten/Frankfurt am Main Carola Schuler/Frankfurt am Main Maximilian Denkmann/Frankfurt am Main Key Indicators Deutsche Hypothekenbank AG (Unconsolidated Financials)[1] [2]6-14 [3]12-13 [3]12-12 [3]12-11 [3]12-10 Avg. Total Assets (EUR million) 29, , , , ,921.9 [4]-4.5 Total Assets (USD million) 40, , , , ,190.7 [4]-4.0 Tangible Common Equity (EUR million) [4]3.7 Tangible Common Equity (USD million) 1, , , [4]4.2 Problem Loans / Gross Loans (%) [5]3.3

2 Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) [5]66.4 Net Interest Margin (%) [5]0.6 PPI / Average RWA (%) Net Income / Tangible Assets (%) [5]0.1 Cost / Income Ratio (%) [5]36.0 Market Funds / Tangible Banking Assets (%) [5]59.0 Liquid Banking Assets / Tangible Banking Assets (%) [5]44.0 Gross Loans / Total Deposits (%) [5]110.2 Source: Moody's [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; LOCAL GAAP [3] Basel II; LOCAL GAAP [4] Compound Annual Growth Rate based on LOCAL GAAP reporting periods [5] LOCAL GAAP reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE On March 17, we placed Deutsche Hypothekenbank AG's (Deutsche Hypo) Baa1 long-term debt and deposit ratings on review for upgrade. Deutsche Hypo's Prime-2 short-term debt and deposit ratings, its b1 standalone baseline credit assessment (BCA) and its Ba1 rating for subordinated debt were unaffected. The review was prompted by the expected effects on Deutsche Hypo's various debt and deposit ratings resulting from the implementation of our new global bank rating methodology, as well as considerations on public sector support. For Deutsche Hypo, we expect the combined rating impact from the new methodology and the revised support assumptions to be at least neutral for its debt and deposit ratings. The rating review reflects the possibility of an upgrade, which we would expect to be limited to one notch. The review will focus on the analysis of the bank's liability structure within the broader resolution perimeter of Norddeutsche Landesbank GZ (NORD/LB, deposits A3 negative, BCA ba2) group, Deutsche Hypo's owner. Most notably, we will focus on the expected waterfall within NORD/LB's deposit and debt classes in resolution and the respective volume of each debt class. During the review, we will also determine the extent to which Deutsche Hypo can benefit from public-sector support within the framework of the Bank Recovery and Resolution Directive (BRRD). Deutsche Hypo`s b1 BCA remains unchanged under the new rating methodology. DEUTSCHE HYPO'S RATINGS ARE SUPPORTED BY ITS STRONG+ MACRO PROFILE The bank's BCA benefits from its Strong+ Macro Profile, largely determined by the German environment with very high economic, institutional and government financial strength and very low susceptibility to event risk. Operating conditions for the German banking system are, however, constrained by high fragmentation in an over-saturated market, low fee income generation and intensifying competition for domestic business. Deutsche Hypo`s Strong+ Macro Profile also captures foreign exposures predominantly within the Euro area, which we assign to Macro Profiles lower than the domestic environment. Rating Drivers - CRE-focused business model and asset tail risks limit the bank's solvency score - Good asset quality from core on-balance-sheet lending compared with peers - Vulnerable capital ratios in a stressed economic environment - Recognised covered bond issuer with well-established domestic investor base - Senior creditors benefit from the broader NORD/LB group's large volume of outstanding debt, as well as subordinated instruments in the unlikely event of resolution Rating Outlook

3 Deutsche Hypo's long-term debt and deposit ratings are under review for upgrade. Ba1 subordinated debt ratings carry a negative outlook, and in line with the BCA and hybrid/preferred securities will not carry an outlook after the review process under the new methodology. What Could Change the Rating - Up As indicated by the review for upgrade, the affirmation of NORD/LB's long-term debt and deposit ratings puts upward pressure on the long-term debt and deposit ratings of its closely integrated subsidiary Deutsche Hypo. Deutsche Hypo's BCA would be subject to upward pressure in case of (1) a continued improvement in the bank's profitability without compromising its liquidity profile; and (2) a reduction in non-lending credit risk exposures in its securities portfolio. Given the significant rating uplift from parental support assumptions, a modest BCA increase of Deutsche Hypo would not directly translate into higher long-term debt and deposit ratings. What Could Change the Rating - Down Downward pressure on Deutsche Hypo's BCA could arise if (1) Deutsche Hypo's monoline CRE exposures showed signs of material asset quality deterioration; (2) risks embedded in its securities portfolio materialised to a greater than currently expected degree; and/or (3) NORD/LB's capital cushion jointly available for NORD/LB and Deutsche Hypo came under increased pressure. We do not expect Deutsche Hypo's long-term debt and deposit ratings to experience downward pressure at this stage. DETAILED RATING CONSIDERATIONS CRE-FOCUSED BUSINESS MODEL AND ASSET TAIL RISKS LIMIT THE BANK'S SOLVENCY SCORE Deutsche Hypo's leveraged business model, with considerable exposure to CRE and a more limited presence in public sector finance, exert pressure on its franchise. We believe that the bank is vulnerable in an adverse economic scenario and, therefore, may have to apply adjustments to its current business profile. To reflect these risks, we perform a qualitative downward adjustment of one notch to Deutsche Hypo's BCA, based on the limited diversification of its business model. We caution that tail risks associated with unexpected losses persist in the bank's securities portfolio, for which Deutsche Hypo may require capital support from its parent NORD/LB under the domination and profit and loss transfer agreement with Deutsche Hypo. To underpin Deutsche Hypo's role as the group-wide competence centre for CRE, NORD/LB transferred until end 2013 CRE assets from its own balance sheet to Deutsche Hypo. This has changed Deutsche Hypo's asset mix from the previous high concentration in public sector exposures (two thirds of total assets) to a more CRE-driven loan book. As of June 2014, CRE loans (EUR12.0 billion) and public-sector bonds and loans (EUR10.8 billion) accounted for more than one third of the bank's total assets each. Deutsche Hypo's primary driver for asset quality arises from its EUR12.0 billion real estate loan portfolio at 30 June 2014, which continued to shift focus towards the domestic market (64% of overall exposure), while legacy exposures to Spain and the US declined to EUR0.6 billion from EUR0.8 billion during the first six months of Deutsche Hypo focuses on prime locations with a particular portfolio focus on offices (39.1% as of YE2013), retail (30.4%), multi-family housing (11.7%) and hotels (7.7%). We believe that the performance of international CRE markets in particular will remain dependent on overall economic and liquidity conditions, posing potential credit quality and liquidity risks in case of weaker-than-anticipated economic growth. The increasing focus on domestic mortgage lending has however led to an improvement in the bank's overall asset quality. The credit quality of the bank's public sector finance business has started to stabilise, particularly as a result of the stabilising credit profile of some European peripheral sovereigns. In 2013, Deutsche Hypo's exposure to European peripheral countries amounted to EUR3.2 billion, excluding EUR320 million CRE lending activities in these countries. These exposures are concentrated in Italy (EUR1.4 billion) and Spain (EUR1.2 billion). Whereas unrealised fair value losses in the bank's securities portfolio reduced to EUR111 million as of June 2014 (year-end 2013: EUR201 million), these unrealised losses can still negatively affect the bank's financial position, as demonstrated by the bank's announced decline in 2014 full-year profits. This decline results from an impairment charge on Deutsche Hypo's EUR245 million exposure to Heta Asset Resolution AG (Carinthian stateguararanteed senior unsecured debt rated Ca, negative) which represents a large 29% of Deutsche Hypo's EUR852 million of Tangible Common Equity as of June 2014.

4 GOOD ASSET QUALITY FROM CORE ON-BALANCE-SHEET LENDING COMPARED WITH PEERS Deutsche Hypo's problem loans, which are to a large extent a function of the bank's international CRE exposures, improved to EUR374 million as of year-end 2013 (2012: EUR566 million). However, given the current economic environment, we expect that (1) the performance of its loan books will remain volatile; and (2) the decreasing, yet high level of CRE-related loan-loss-provisions (2013: EUR65 million, 2012: EUR71 million, 2011: EUR75 million), will continue to negatively affect Deutsche Hypo's risk-adjusted earnings. The bank's problem loans ratio as a percentage of gross loans improved to 2.1%, down from 2.6% in 2012, and compares favourably to other banks with significant CRE exposures. Although Deutsche Hypo's specific loan loss reserves decreased to EUR152 million (2012: EUR165 million), we positively note its improved 41% coverage ratio. While we recognise the availability of collateral, very often from first-lien loans, we remain cautious regarding the potential volatility in the stock of problem loans as a result of rating migrations and market value volatility, which may fall short of expectations when needed. VULNERABLE CAPITAL RATIOS IN A STRESSED ECONOMIC ENVIRONMENT We consider Deutsche Hypo's capitalization equivalent to that of its parent NORD/LB and therefore apply NORD/LB's Capital score also in Deutsche Hypo's scorecard. Deutsche Hypo has been exempt from compliance with regulatory solvency requirements since 2013 as a result of a waiver granted by the German Federal Financial Supervisory Authority (BaFin). The bank's parent NORD/LB discloses a transitional CET1 ratio of 10.6% as of September 2014, which translates into an 8.3% fully phased-in CET1 ratio. We consider NORD/LB's capitalisation adequate but add that it remains vulnerable to macro-economic stress. We expect loan impairments in the highly cyclical shipping industry loan portfolio to remain at elevated levels in In addition, the continued appreciation of the US dollar against the euro exerts upward pressure on loan loss provisioning and risk weighted asset amounts in its foremost USDdenominated ship loan book. RECOGNISED COVERED BOND ISSUER WITH WELL-ESTABLISHED DOMESTIC INVESTOR BASE Deutsche Hypo's access to cost-efficient funding is a key requirement for the bank's business model. With a EUR30 billion balance sheet as of June 2014, almost two-thirds of total assets are funded through covered bonds. Deutsche Hypo is among the specialised covered bond issuers with the highest level of asset encumbrance and as a consequence, we adjust the bank's Liquid Resources score down to ba1. We take comfort from the fact that the bank pursues a strategy of largely matched funding, facilitated through a domestically and internationally diversified funding franchise in terms of funding tools and regions, including German savings banks and Asian sovereigns. We also note, however, that the transformation of the entity into a more CRE-focused lender has rendered its asset-liability matching tasks more complex than in the past due to the higher extension risk embedded in CRE loans in comparison to public sector exposures. Deutsche Hypo ensures that it maintains a liquidity cushion that allows it to meet all obligations over at least six months without having to access debt capital markets. The bank's portfolio of liquid assets remains highly rated and largely repo eligible with the ECB. In cases of emergency, Deutsche Hypo also has access to short-term liquidity lines with its parent bank NORD/LB. However, we view Deutsche Hypo's funding structure in general geared towards confidence-sensitive wholesale funding sources that render the bank susceptible to changes in investor sentiment and market risk appetite. Notching Considerations AFFILIATE SUPPORT Based on the profit and loss transfer agreement of Deutsche Hypo with its parent NORD/LB and based on the high degree of integration, including a BaFin exemption from regulatory capital reporting granted for Deutsche Hypo, we consider Deutsche Hypo to be "affiliate backed" by NORD/LB, resulting in its adjusted BCA being equalized to the baa3 adjusted BCA of NORD/LB. LOSS GIVEN FAILURE

5 Deutsche Hypo is subject to the EU Bank Resolution and Recovery Directive, which we consider to be an Operational Resolution Regime. We expect Deutsche Hypo to be included in the resolution perimeter of its parent entity NORD/LB and in accordance with our methodology, we therefore apply NORD/LB's LGF analysis, considering the risks faced by the different debt and deposit classes across the liability structure at failure. Our NORD/LB LGF analysis indicates a very low loss-given-failure for deposits and senior unsecured debt, leading us to position their Preliminary Rating Assessment two notches above the Adjusted BCA. This is supported by the substantial senior debt volume, which in particular consists of backed senior debt expiring until year-end Our NORD/LB LGF analysis indicates a high loss-given-failure for subordinated debt instruments. Accordingly, Deutsche Hypo's subordinated debt is rated at Ba1, which is one notch below the bank's baa3 adjusted BCA. We assign a Ba3 (hyb) rating, on non-cumulative preferred securities ("Charlottenburg Capital International S.àr.l. & Cie"), which is three notches below the bank's baa3 adjusted BCA, reflecting their deeply subordinated claim in liquidation and non-cumulative coupon skip mechanism tied to the breach of a balance sheet loss trigger. GOVERNMENT SUPPORT The implementation of the BRRD has caused us to reconsider the potential for government support to benefit certain creditors. We now expect a moderate probability of government support for NORD/LB's senior debt and deposits, resulting in a one-notch uplift to the PRA. We expect this support to be available as well for Deutsche Hypo and hence expect to assign a long-term debt and deposit rating of A3 to Deutsche Hypo. ABOUT MOODY'S BANK RATINGS About Moody's Bank Scorecard Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecard may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong divergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Deutsche Hypothekenbank AG Macro Factors Weighted Macro Profile Strong + Financial Profile Factor Historic Ratio Macro Adjusted Score Solvency Asset Risk Problem Loans / Gross Loans Credit Trend Assigned Score 2.7% a2 ba1 Sector concentration Capital TCE / RWA 10.7% baa2 b1 Expected trend Profitability Net Income / Tangible Assets Combined Solvency Score Liquidity 0.1% b1 b1 baa2 ba3 Key driver #1 Key driver #2 Non lending credit risk

6 Funding Structure Market Funds / Tangible Banking Assets Liquid Resources Liquid Banking Assets / Tangible Banking Assets Combined Liquidity Score 47.4% b1 b1 42.3% aa3 ba1 Asset encumbrance baa3 ba3 Financial Profile ba3 Qualitative Adjustments Adjustment Business Diversification -1 Opacity and Complexity 0 Corporate Behavior 0 Total Qualitative Adjustments -1 Sovereign or Affiliate constraint Scorecard Calculated BCA range Aaa ba3 - b2 Assigned BCA b1 Affiliate Support notching 4 Adjusted BCA baa3 Instrument Class Loss Given Failure notching Additional notching Preliminary Rating Assessment Government Support notching Local Currency rating Deposits Baa1 RUR Possible Upgrade Senior unsecured bank debt Dated subordinated bank debt Baa1 RUR Possible Upgrade -1 0 ba1 0 Ba1 Foreign Currency rating Baa1 RUR Possible Upgrade Baa1 RUR Possible Upgrade This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved.

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