German Savings Banks Finance Group: A Forward-Looking and Differentiated Rating Approach

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1 13 October 2016 Financial Institutions German Savings Banks Finance Group: German Savings Banks Finance Group: A Forward-Looking and Differentiated Rating Approach This report explains Scope s approach for rating member institutions of the German Savings Banks Finance Group (S-Group) focusing on the over 400 savings banks, seven Landesbank groups and the Deka Group. This approach is based on, and consistent with, Scope s existing bank rating methodology (latest version from May 2016). Although we do not currently have public ratings on S- Group members, various market participants including investors and issuers have long expressed interest in our view on this important market segment in Germany. We note that market participants may find our rating approach for S- Group members differs to those of other rating agencies. In summary, Scope s rating approach is the following: 1. Savings banks and Deka Group: A rating floor should be applied to savings banks that are members of the S-Group. Based on our analysis, Deka Group (Deka) would be included in this approach. Under normal circumstances, this approach means that the rating of a financially weaker group member would not fall below the rating floor. Conversely, the rating should be higher than the floor level when the fundamental strength of the respective S-Group institution warrants it bearing in mind that financially stronger members could one day be called to support financially stressed members, most likely via mergers. A rating floor would be underpinned by i) the relative cohesiveness (but not uniformity) of German savings banks business and financial models, ii) intragroup cooperation across the savings banks sector and with Deka (as the S-Group s asset management institution) and iii) the reassuring solidity of existing intragroup support mechanisms (see section: S-Group s joint liability scheme ). Our report explains why we do not consider it appropriate to apply a group rating, i.e. the same rating for all S-Group members, as opposed to the contemplated rating floor. 2. Landesbanken: For the seven Landesbank groups within the S-Group, we consider that a bottom-up rating approach is more justified. Specifically, these banks ratings would be based on their own business models and credit fundamentals which can differ materially from bank to bank. The business strategies of several Landesbanken have changed materially over the past decade, especially with regard to the integration of the banks in the savings banks sector, as well as with the respective economies of a Land (German federal state) or group of Laender via retail banking, SME lending, and infrastructure and other types of project financing. In our view, the strength of this integration is material to a rating which to an extent also guides the possibility of support via the Landesbank s owners should the need arise. With respect to the latter aspect, we note that the Landesbanken s majority owners are generally Laender. In this context, the evolving political dynamics across Europe, including in Germany, are not reassuring for the timely support of a financial institution such as a Landesbank public-sector-owned but operating commercially within market terms and competing with other firms. In actual terms, any assistance by a public-sector owner would fall under the European Union s state-aid rules. In light of the political and procedural realities of these rules, the timeliness of state-related support could be of concern for debt investors. This is especially the case for Landesbanken whose presence in the local economy (retail and SMEs) is less mainstream, which weakens the political argument for their timely support. These elements are a core part of our forward-looking rating and analytical approach for Landesbanken, and also explain why the likelihood of state support should be closely linked with how well the respective Landesbank is embedded in the local economy. Analysts Michaela Seimen Howat m.seimenhowat@scoperatings.com Sam Theodore s.theodore@scoperatings.com Related Research Bank Rating Methodology May 2016 Scope Ratings AG Suite Angel Square London EC1V 1NY Phone Headquarters Lennéstraße Berlin Phone Fax info@scoperatings.com Bloomberg: SCOP 13 October /11

2 In the report we also point out that, in the case of Landesbanken, we see hurdles to an ironclad application of the S-Group s joint liability scheme, especially after the scheme was reorganised in 2015 to satisfy new EU regulations. In this respect, the Landesbanken s cooperation with, and importance to, the local savings banks should be very relevant. The uncertainty around future support for Landesbanken from the joint liability scheme is also based on the chequered record of unquestioned support within the group for Landesbanken. Consequently, our current approach is to provide an uplift of at least one notch to the Landesbank s rating on account of intragroup support mechanisms. A wider notching uplift could occur if and when we are convinced that institutional commitment within the S-Group is strong enough to provide financial support to an ailing Landesbank. The S-Group The S-Group displays total assets of around EUR 2.2trn (year-end 2015), thus ranking among the largest banking groups worldwide. We recognise the generally and relatively close-knit network and the multi-layered cooperation within the group, which is sustained by a common brand and the S-Group s joint liability scheme, noting nonetheless that the member institutions are legally and economically independent. The individual institutions are managed in a decentralised and self-reliant way, and do not act as entities of a fully consolidated group as is the case, for example, with mutualist groups in France or the Netherlands. Many S-Group members pursue differentiated business models with uneven risk profiles. The S-Group comprises around 580 member institutions: 403 savings banks (as of September 2016) Seven Landesbank groups Deka Group Nine Landesbausparkassen (regional building societies) Public insurers, leasing and factoring companies, equity capital providers and consultancies Service providers, e.g. in IT, securities settlement, payment services and publishing Our rating approach is currently focused on the savings banks, Landesbanken and Deka. Table of Content The S-Group... 2 S-Group s joint liability scheme... 4 A. Savings banks and Deka 7 B. Landesbanken October /11

3 Figure 1: The S-Group 11.3% Savings banks finance group Total business volume EUR 2,880bn DSV-Gruppe (Deutscher Sparkassenverlag) 403* Savings banks Total assets EUR 1,145.3bn 39.8% Deka-Bank Deutsche Girozentrale Total assets EUR 108bn 4% Deutsche Leasing Group Acquisition values EUR 27.4bn 1% 4 Factoring companies 3 Additional leasing companies Finanz Informatik 7 9 Landesbausparkassen 11 Public primary insurance groups 7 Equity investment companies of the Landesbanken Landesbank groups Total assets EUR 1,145.3bn 40.9% Total assets EUR 65bn 2.3% Gross premium income EUR 21.3bn 0.7% 8 Company/municipal advisory companies 9 LBS real estate companies Source: DSGV, Scope Ratings *Note: DSGV information, as of ; numbers rounded. % amounts for illustration purpose only 13 October /11

4 S-Group s joint liability scheme Overall, all members of the German Savings Banks Finance Group benefit from an exclusive guarantee scheme, the so-called joint liability scheme, which comprises two elements: 1. A voluntary institutional guarantee 2. A statutory deposit guarantee To assess the credit quality of the individual entities, it is important to incorporate these support factors in the respective ratings. The primary objective is to safeguard the solvency and liquidity of member institutions The voluntary institutional guarantee aims to safeguard the solvency and liquidity of member institutions. This fallback/safeguarding system of the S-Group focuses on the continued operation of each institution by providing support or initiating a merger with another institution. Support measures could further consist of the following: Recapitalisation Guarantees or letters of comfort Satisfying claims of third parties The statutory deposit guarantee aims to safeguard customer deposits up to EUR 100,000. The joint liability scheme encompasses 13 separate guarantee schemes/funds (Figure 2): Eleven regional savings bank guarantee funds A guarantee fund of the Landesbanken and Girozentralen (central savings banks) A guarantee fund of the Landesbausparkassen. These individual guarantee schemes are interconnected. If resources of the respective funds are insufficient for the support required, these can be supplemented by resources from other guarantee funds (Figure 3). We note, however, that no public data is available on the size of and available moneys in the individual funds. 13 October /11

5 Figure 2: S-Group individual support fund members S-Group members of the 13 individual support funds 11 regional savings banks guarantee funds Guarantee fund of the Landesbanken & Deka Guarantee fund of the Landesbausparkassen Hanseatischer SGV Ostdeutscher SV Rheinischer SGV SGV Hessen-Thüringen SGV Schleswig-Holstein SV Baden-Württemberg SV Bayern 7 Landesbank Groups DekaBank Berlin Hyp AG, Berlin DEG Deutsche Hypothekenbank Frankfurter Bankgesellschaft Landesbank Berlin Holding Portigon Sparkassen Broker Weberbank LBS Hessen-Thüringen LBS Schleswig-Holstein-Hamburg LBS Bayern LBS Baden-Württemberg LBS Rheinland-Pfalz LBS Saar Norddeutsche LBS Ostdeutsche LBS Westdeutsche LBS SV Niedersachsen SV Rheinland-Pfalz SV Saar SV Westfalen-Lippe Source: DSGV, Scope Ratings Note: SV = Sparkassenverband; SGV = Sparkassen- und Giroverband 13 October /11

6 Figure 3: Individual support funds and linkage under the Joint Liability Scheme Sequence of actions to support a savings bank Sequence of actions to support a Landesbank Liquid funds from the regional fund concerned Liquid funds from Landesbanken guarantee fund Subsequent capital contributions from the regional fund concerned Obligation of the Landesbanken guarantee fund Liquid funds from the other regional funds (supra-regional compensation) Liquid funds from the joint liability scheme (savings banks and Landesbausparkassen) Subsequent capital contributions from the other regional funds (supra-regional compensation) Obligation of the joint liability scheme (savings banks and Landesbausparkassen) Funds from the Landesbanken and Landesbausparkassen (joint liability scheme) The same sequence of actions is adopted to support a Landesbausparkasse. Source: DSGV, Scope Ratings Member institutions have no legal claim to receive institutional support Importantly, we point out that by-laws of the joint liability scheme clearly state that member institutions do not have a legal claim on institutional support. Equally relevant is that a majority of at least 75% of member institutions is needed to decide on providing assistance to a member institution. In our view, this could become a potential hurdle for institutions that are less integrated within the S-Group, and/or those displaying an excessive risk profile. Based on the aspects highlighted above, and while on balance we see the joint liability scheme as beneficial for member institutions, we consider that group support for larger and more complex member institutions, such as, potentially, Landesbanken, may be a difficult process that is especially incapable of guaranteeing timeliness. This situation was evidenced in recent years. These analytical considerations underpin our differentiated rating approach for Landesbanken as opposed to the one for the S-Group s savings banks and Deka. 13 October /11

7 A. Savings banks and Deka S-Groups internal risk systems apparently differentiate between the credit strengths of member institutions Rating floor more appropriate than group rating When we rate member institutions of a financial group with a material degree of intragroup cohesion (cooperative groups, savings banks groups, or savings banks associations), we may apply either a group rating or a rating floor. The former, which means that, under normal circumstances, all group members receive the same rating, is for highly cohesive groups such as French or Dutch cooperative groups. The latter is applicable to less-cohesive groups or associations, and is characterised by the fact that the rating of a financially weaker member of the respective group would normally not fall below the floor. We believe that, in the case of the S-Group s savings bank members (and Deka), the rating-floor approach should apply, in light of the group s relatively looser cohesiveness. On the one hand, we point out the clear advantage and power of the S brand for German savings banks, as well as to strategic group cohesiveness, intragroup financial links, and risk management and control processes. On the other hand, there remain important differences between regional and operational approaches, due, among other things, to variations in business models, sizes and regional/local footprints, and due to the impact of local management s cooperation with the municipal owner. Normally, the rating-floor approach means the rating of a financially weaker savings-bank member of the S-Group would not fall below the rating floor. Conversely, the rating should be higher than the floor when the fundamental strength of the respective savings bank warrants it. We add, however, that within the context of intragroup support which underpins the rating-floor concept our analysis has to take into account that a financially strong savings bank may one day be called on to support a financially stressed peer member. Deka is strongly linked to savings banks via its ownership structure and business integration Deka included in the rating-floor approach Due to historical reasons, Deka is part of the Landesbanken support fund. However, Deka is different to the Landesbanken, not only because it is fully owned by the savings banks, but also because it enjoys a unique standing within the S-Group. Indeed, Deka is the central asset management institution for the entire S-Group, in addition to offering essential funding and liquidity access to the savings banks. Its business model thus entails strong cooperation and integration with the S-Group s savings banks, as well as strong mutual interdependence. The integrated strategic and operational approach strengthens the scenario that highly predictable and timely financial support will be provided within the joint liability scheme. 13 October /11

8 B. Landesbanken A differentiated bottom-up rating approach In the case of the S-Group s seven Landesbank groups, Scope considers that a differentiated rating approach is warranted, based on a bottom-up analysis of each institution. The rating-floor approach would not apply, as the analysis of group integration and solidarity, including the safeguard from the joint liability scheme, is different to that of the savings banks. Specifically, Landesbankens ratings would be based on their own business models and credit fundamentals which can differ materially from bank to bank. The business strategies of several Landesbanken have changed materially over the past two decades, especially with regard to their integration into the savings banks sector, as well as in their respective Land s (or group of Laender s) economies via retail banking and/or SME lending, and infrastructure and other forms of project financing. In our view, the viability and sustainability of such organic integrations, or visible shortcomings in this respect, are and should remain a material rating factor. Based on the above considerations, we believe rating levels could differ materially between Landesbanken depending on the specific credit fundamentals of each institution. We are fully aware that many market participants, including some rating agencies, continue to look at public-sector banks in Germany as one single block as one of the three pillars of the German banking sector, alongside private and cooperative groups. The predominance of market funding for Landesbanken unlike the savings banks also makes them more vulnerable to changing market sentiment. As a consequence, it remains that, by extension, negative market sentiment on a specific Landesbank can have a ripple effect on the sector and, one step further, on German public-sector banks. Against this view, however, our belief is that German Landesbanken should no longer be painted with the same broad brush. Indeed, following the loss of its previous stateguarantee structures (Anstaltslast and Gewährträgerhaftung) in 2005, the Landesbanken sector has become increasingly diversified in terms of business models and risk profiles. Through consolidation and attrition, it has also become less oversized both within the S-Group and the German banking sector in general. Nevertheless, the sector is still quite significant, and we especially note that the areas of risk within the S-Group remain largely clustered with the Landesbanken as opposed to the savings banks and other member institutions. Correlating local economy integration with state ownership and support The majority owners of Landesbanken are generally Laender (see Figure 4 in the Appendix). In past years including the crisis years Laender were faced with the possibility that their Landesbank might collapse financially, and some ended up providing financial support to keep these institutions from falling behind with servicing their financial commitments. Such support, however, has been increasingly accompanied by political headwinds, as voters have manifestly turned against bank bailouts, even when the state is the majority owner. Our forward-looking analysis is that the evolving political dynamics across Europe, including in Germany, are not reassuring for the timely support of a financial institution such as a Landesbank, which is owned by the public sector but operates commercially within market terms and competes with other firms. Importantly, we also add that any form of state assistance to a public-sector bank that operates on commercial terms, like a Landesbank does, now falls under the European Union s state-aid rules. In our view, the political, jurisdictional and procedural realities of these rules can create uncertainty around the timeliness of public-sector support for ailing banks which can be a material factor of concern for debt investors. Here again we turn to the above-mentioned aspect of a Landesbank s integration in the local economy of a 13 October /11

9 Land or Laender. In this respect, we find that some Landesbanken are more tightly integrated in the local economy than others. This shows through both a retail presence (savings-bank networks, which can be extensive) and an SME lending presence. We believe that, if financial support is needed, a Land has a stronger sociopolitical argument for assisting a Landesbank that is more tightly integrated with, and essential to, the local economy as opposed to a Landesbank with a more marginal presence in the local economy and whose risk concentrations lie elsewhere. Based on these considerations, our rating approach for Landesbanken would include integration in the local economy within the credit fundamentals underpinning our analysis, and would also take into account the predictability and reliability of a state owner s timely support when needed. Reliability of the joint liability scheme for Landesbanken In our view, in the case of Landesbanken, there may be hurdles to an ironclad application of the S-Group s joint liability scheme, more so than in the case of the savings banks and Deka, as mentioned above. This is even more the case following the scheme s 2015 reorganisation to satisfy the new EU regulations. To reflect savings banks concerns over the potentially negative impact of supporting large firms in the group, the adjusted bylaws of the joint liability scheme state that member institutions do not have a legal claim on institutional support. We also note that the decision to provide support to an S-Group member in need requires a majority of at least 75% of member institutions. In our view, this may be another hurdle for the predictability and reliability of support under the joint liability scheme. In this respect, the Landesbanken s cooperation with, and importance to, the local savings banks should be a very relevant factor. The uncertainty around the future support for Landesbanken from S-Group s joint liability scheme is also based on a chequered record of unquestioned support within the group for Landesbanken, and also on some Landesbanken s willingness to solicit it. In this context, we note that, in order to accept the provision of support to an ailing Landesbank, the central body of the S-Group, Deutsche Sparkassen und Giroverband (DSGV), which manages the joint liability scheme, has the power to intervene in the respective institution s strategy and operations, and can initiate a merger with a healthier member institution or may ask for other transformational steps (e.g. senior management changes). Understandably, some management teams of stressed Landesbanken would have chosen in the past to turn to their state owners for support rather than call for the application of joint liability scheme provisions, which for them would have entailed undesired consequences. Rating uplift of at least one notch Consequently, our approach provides an uplift of at least one notch to the Landesbank s rating, on account of intragroup support mechanisms. A possibly wider notching uplift can occur if and when we assess there to be strong institutional commitment within the S- Group to provide timely financial support to an ailing Landesbank. 13 October /11

10 I. Appendix. Figure 4: Landesbanken ownership structures Norddeutsche Landesbank ship in % Land Niedersachsen 5.57 Sachsen-Anhalt Sparkassenverband Niedersachsen Sparkassenbeteiligungsverband Sachsen-Anhalt Sparkassenbeteiligungszweckverband Mecklenburg- Vorpommern ship in % Bremer Landesbank 41.2 Freie Hansestadt Bremen Nord LB 3.97 Niedersaechsischer Sparkassen- und Giroverband Note: ship change in process from Nord LB ship in % HSH Nordbank AG Freie und Hansestadt Hamburg Land Schleswig-Holstein HSH Finanzfonds AoeR Gemeinsame Anstalt der Laender Sparkassen- und Giroverband Schleswig-Holstein Neun Trusts (J.C. Flowers & Co. LLC) Bayerische Landesbank Landesbank Baden-Württemberg Landesbank Hessen-Thüringen ship in % ship in % ship in % Freistaat Bayern Sparkassenverband Bayern ship in % Landesbank Berlin AG Erwerbergesellschaft der S- Finanzgruppe mbh & Co. KG Beteiligungsgesellschaft der S- Finanzgruppe mbh & Co. KG Land Baden-Württemberg* Stadt Stuttgart ship in % Sparkassenverband Baden- Württemberg Landesbank Saar Land Saarland Sparkassen-verband Saar 8.10 Land Hessen 4.05 Freistaat Thüringen Sparkassen- und Giroverband Hessen-Thüringen Rheinischer Sparkassen- und Giroverband Sparkassenverband Westfalen- Lippe 4.75 FIDES Alpha GmbH 4.75 FIDES Beta GmbH Source: Individual Landesbank institutions, Scope Ratings *Note to Landesbank Baden-Württemberg: Land Baden-Württemberg (Land) 24,988379% + Landesbeteiligungen BW 15,545739% 13 October /11

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