Commerzbank Finance & Covered Bond S.A.

Transcription

1 CREDIT OPINION Update Commerzbank Finance & Covered Bond S.A. Update following rating alignment with Commerzbank AG Summary We assign a Baa1 long-term issuer rating as well as an A2(cr)/P-1(cr) Counterparty Risk (CR) Assessment to Commerzbank Finance & Covered Bond S.A. (CFCB). Michael Rohr VP-Sr Credit Officer michael.rohr@moodys.com Alexander Hendricks, CFA Associate Managing Director alexander.hendricks@moodys.com Carola Schuler MD-Banking carola.schuler@moodys.com The bank's baa3 BCA -as well as its baa3 Adjusted BCA- is aligned with the BCA and Adjusted BCA of its parent Commerzbank AG (A2 stable / Baa1 stable, baa31). We consider CFCB to be a highly integrated and harmonized subsidiary of Commerzbank, because of its limited proprietary franchise, the magnitude of its management integration and its role as a group service provider being a fully integrated part of its parent's treasury operations, as well as the influence of the parent on CFCB's financial profile, in particular its asset risk and funding profile. This view is further supported by the letter of comfort provided to CFCB by its parent as well as several service level agreements between Commerzbank and CFCB, supporting the bank's operational stability. Exhibit 1 CFCB - Key financial ratios CFCB (BCA: baa3) Median baa3-rated banks 40% 80% 35% 70% 30% 60% 25% 50% 20% 40% 15% 30% 10% 5% 20% 1.5% 33.5% 75.6% 52.9% 0% 10% 0% -0.1% -5% Asset Risk: Problem Loans/ Gross Loans Capital: Tangible Common Equity/Risk-Weighted Assets Solvency Factors (LHS) Source: Moody's Financial Metrics Profitability: Net Income/ Tangible Assets -10% Funding Structure: Market Funds/ Tangible Banking Assets Liquid Resources: Liquid Banking Assets/Tangible Banking Assets Liquidity Factors (RHS) Liquidity Factors Solvency Factors Analyst Contacts CFCB's long-term issuer rating reflects (1) the bank's baa3 Baseline Credit Assessment (BCA) and its baa3 Adjusted BCA; (2) the results of our Advanced Loss Given Failure (LGF) analysis, which takes into account the severity of loss faced by the different liability classes in resolution, resulting in one notch of rating uplift for CFCB's issuer rating; and (3) a moderate probability of CFCB receiving government support in case of need, resulting in one additional notch of rating uplift. The LGF notching uplift and government support uplift mirror the rating uplift factored into the long-term senior unsecured debt ratings of Commerzbank AG, CFCB's ultimate parent.

2 Credit strengths Modest liquidity risk owing to refinancing support from Commerzbank AG Solid and strongly improved capital ratios CFCB is a fully integrated part of Commerzbank, specifically with regards to its parent's treasury operations and risk controls, thereby benefitting from the parent's stronger credit profile Credit challenges High exposure to legacy public finance portfolios that may exert pressure on the bank's capital adequacy metrics Very modest earnings-generation capacity Rating outlook The outlook on CFCB's issuer rating is stable, mirroring the outlook on its parent's long-term ratings and reflecting the absence of any directional pressure on Commerzbank AG's fundamental credit metrics nor on the results of our Advanced LGF analysis. Factors that could lead to an upgrade An upgrade of CFCB's long-term ratings would likely follow (1) an upgrade of Commerzbank's BCA; or (2) an increase in rating uplift resulting from our Advanced LGF analysis. Upward pressure on Commerzbank's BCA could result from (1) a further significant improvement of its asset risk metrics, including a further meaningful reduction of sector concentrations or significantly improved problem loan coverage; combined with (2) a sustained and pronounced improvement of its fully phased-in capital ratios and balance sheet leverage; and (3) a persistent strengthening of the bank's recurring earnings power. Our Advanced LGF analysis could result in higher notches of rating uplift if the volume of subordinated instruments significantly increases relative to the bank's tangible banking assets. This could result in one additional notch of rating uplift for the bank's senior unsecured debt ratings and, thus, CFCB's long-term issuer rating resulting from our Advanced LGF analysis. Factors that could lead to a downgrade A downgrade of CFCB s issuer rating could result from (1) a downgrade of Commerzbank s BCA; (2) fewer notches of rating uplift as a result of our Advanced LGF analysis; (3) signs that CFCB returns to a lower level of integration within Commerzbank; or (4) a reduction in our government support assumptions for Commerzbank and, thus, CFCB. Downward pressure on Commerzbank's BCA could result from (1) a weakening of the bank's Strong+ Macro Profile, (2) renewed pressure on its asset quality and capital adequacy metrics; and (3) failure to improve its risk-return profile in the medium term. CFCB's long-term issuer rating could also be downgraded if, at the parent group level, the volume of senior unsecured or subordinated debt was to decrease significantly, leading to fewer notches of rating uplift under our Advanced LGF analysis. In addition, CFCB's ratings could be downgraded if our assumption of CFCB as a highly integrated and harmonized subsidiary of Commerzbank AG is undermined by Commerzbank (1) no longer being committed to orderly unwinding CFCB's legacy portfolios; (2) reducing funding support or separate CFCB from its treasury operations; or (3) withdrawing the letter of comfort or existing service level agreements with CFCB. 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. 2

3 Key Indicators Exhibit 2 Commerzbank Finance & Covered Bond S.A. (Consolidated Financials) [1] Total Assets (EUR million) Total Assets (USD million) Tangible Common Equity (EUR million) Tangible Common Equity (USD million) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross Loans / Due to Customers (%) ,599 18,562 1,287 1, ,676 21, , ,259 28, , ,935 31, , CAGR/Avg.4 20,471 26, [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [3] Basel II; IFRS [4] May include rounding differences due to scale of reported amounts [5] Compound Annual Growth Rate (%) based on time period presented for the latest accounting regime [6] Simple average of periods presented for the latest accounting regime. [7] Simple average of Basel III periods presented Source: Moody's Financial Metrics Detailed credit considerations CFCB fully repositioned within Commerzbank group Based in Luxembourg, CFCB is a wholly owned subsidiary of Commerzbank. Within its very limited local franchise, it plans to extend its business within the remits of a covered bond bank in Luxembourg, also offering syndicated loans and fiduciary notes to its clientele. We align CFCB's BCA (and Adjusted BCA) with those of its German parent based on our rating approach for highly integrated and harmonised subsidiaries. This reflects CFCB's close integration in and dependence on the group with regard to funding and capital support as well as key controlling and risk management functions: The majority of CFCB's unsecured funding is sourced from its German parent; CFCB relies on capital support from Commerzbank in order to meet regulatory requirements; CFCB's legacy public finance portfolio is managed centrally within Commerzbank, and the majority of CFCB's assets are centrally monitored as part of the parent's treasury operations; Smaller and usually higher-risk or lower-liquidity exposures are held and managed within Commerzbank's asset and capital recovery (ACR) unit and will be unwound over time. These considerations, together with the existence of a letter of comfort and various service level agreements in favour of CFCB, support our view that CFCB s probability of failure as measured by the BCA is similar to that of its parent. CFCB resulted from the merger of two former Luxembourg-based Commerzbank subsidiaries: (1) EEPK, which held a portfolio of publicsector loans; and (2) Hypothekenbank Frankfurt International S.A., a wind-down entity that used to be a subsidiary of Hypothekenbank Frankfurt AG (the former Eurohypo AG), managing the bank's international public finance portfolio in Luxembourg. Both entities used Lettres de Gage (covered bonds) to refinance their large portfolios of public-sector loans. 3

4 On 4 July 2016, Julius Baer Group Ltd. (JBG, issuer rating A3 stable) acquired selected parts of Commerzbank's Luxembourg private banking and wealth management business (former Commerzbank International S.A. (CISAL), renamed Bank Julius Baer Luxembourg S.A.). As part of the deal, some of former CISAL's assets and liabilities as well as certain businesses from Commerzbank's Luxembourg branch were transferred to CFCB or were reintegrated into Commerzbank, thereby finalising the restructuring of Commerzbank's Luxembourg operations. CFCB's high exposures to legacy public finance portfolios may exert pressure on the bank's capital adequacy metrics in an adverse scenario CFCB s balance sheet size accounts for less than 4% of Commerzbank's consolidated asset base, so that the asset exposures held at the level of CFCB are generally large in comparison to its stand-alone risk-bearing capacity. As a result, CFCB continues to display larger tail risks stemming from public sector exposures to the United States (Aaa stable), United Kingdom (Aa1 negative), Italy (Baa2 negative) and Spain (Baa2 stable). As of 31 December 2016, CFCB held a public-finance portfolio with a nominal value of 11.1 billion, down 7% or 0.9 billion from yearend As of end-2016, the portfolio mainly comprised exposures to public sector entities in the US ( 5.4 billion or 47% of the total), the UK ( 2.4 billion or 21%), Italy ( 1.3 billion or 11%) and Spain ( 0.8 billion or 7%). Unrealised losses on CFCB's public sector portfolio amounted to 1.5 billion as of year-end 2016, or 136% of its balance-sheet equity. These hypothetical losses mainly arise from the bank having almost fully hedged its long dated interest-only loans to British local authorities with maturities of years (so-called Lobo loans) that were subscribed at a time of meaningfully higher interest rates. Together, the aforementioned exposures constitute significant tail risks for CFCB if the portfolio rundown cannot be performed in a value-preserving manner. Strongly improved capital metrics, but profitability is set to remain modest The bank's common equity Tier 1 (CET1) ratio of 29.1% increased significantly during 2016 (2015: 17.9%), driven by a 291 million capital injection from Commerzbank and the full retention of 2016 net profits. Lower credit risk-weighted assets (RWA) supported the strong increase in CFCB's stand-alone capital metrics. For some parts of its public-sector portfolio, CFCB continues to benefit from a zero risk-weight for public-sector exposures. Owing to the recent capital injection, leverage is not a constraint for CFCB any longer (equity as a percentage of total assets was 6.1% as of 31 December 2016). Given the further run-down of selected legacy portfolio parts and the recent asset and liability transfers within Commerzbank's Luxembourg operations, we believe the bank's intrinsic earnings generation capacity to remain subdued. Additional earnings pressure may arise from provisioning needs on the aforementioned exposures in an adverse scenario. Particularly, the UK's decision to leave the Eurozone as well as the uncertainty around the future economic policy of the US may adversely influence Europe's economic recovery. This, in turn, may have negative effects on bond spreads in the bank's public-sector portfolio and widen the gap between equity and unrealised losses further. In addition, lower government bond ratings, e.g. on CFCB's large exposures to the UK, may increase credit RWA and thus pressure the bank's capital adequacy metrics. For 2016, CFCB reported a net profit of 59 million (2015: 79.4 million; 2014: net loss of 67.5 million). Significantly lower year-overyear one-off gains from the buyback of 18.3 million of own bonds ( 11 million positive effect; 2015: buyback of 2.2 billion with a positive effect of 138 million) were partially offset by valuation gains on trading as well as financial assets. Modest liquidity risk owing to refinancing support from Commerzbank The bank ceased its funding with 'Lettres de Gage' in October 2015 due to changes in the Capital Requirements Directive (CRD IV) that excluded 'Lettres de Gage' from the European Central Bank's repo program. Instead, CFCB aims to reduce funding needs by further reducing its asset base and fill any potential gaps by tapping senior funding from Commerzbank going forward. The 10.0 billion liabilities towards Commerzbank at year-end 2016 (2015: 10.5 billion) make up 60% of the bank's total liabilities (excluding equity) and stand against 1.0 billion of related intragroup assets (2015: 1.3 billion), unveiling the close integration of CFCB into Commerzbank's group treasury, thereby benefitting from its parent's now lower funding costs, as funds are passed through to CFCB on favourable terms. Because CFCB is currently not seeking to replace maturing covered bond funding, the proportion of parental funding will likely increase further from here, specifically if group funding can be sourced to CFCB at favourable conditions. As of 31 4

5 December 2016, CFCB had 4.6 billion of outstanding covered bonds, a 23% year-over-year decline from 5.9 billion as of year-end As a result, we regard funding and liquidity risks similar to that of its parent, even when considering CFCB's business-modelinherent high asset encumbrance. Notching considerations Loss Given Failure (LGF) analysis CFCB is subject to the EU Bank Recovery and Resolution Directive (BRRD), which we consider an operational resolution regime. We perform our LGF analysis on the consolidated financials of the German parent, based on the assumption that resolution would be addressed for the German parent bank and its Luxembourg subsidiary at the same time. Common resolution with the parent is likely given that CFCB is strongly interconnected with its parent, as illustrated by its funding reliance for the majority of its balance sheet. Such interconnectedness implies limited options for a subsidiary s ring-fencing in resolution. Our LGF analysis follows the new insolvency legislation in Germany that subordinates non-structured ('plain-vanilla') senior bonds and notes to deposits in resolution (the respective law took effect on 1 January 2017). For CFCB, this is based on our understanding that the BRRD leaves sufficient flexibility to subordinate debt instruments to other liabilities in resolution, even in EU countries where no such subordination of debt instruments has been formally introduced. In-line with our standard assumptions, we further assume residual tangible common equity of 3% and losses post failure of 8% of tangible banking assets, a 25% run-off in junior wholesale deposits, and a 5% run-off in preferred deposits. As a result, for CFCB's issuer rating, our LGF analysis indicates a low loss-given-failure, leading to one notch of rating uplift from its baa3 Adjusted BCA. Government support As a result of the Luxembourg-based bank s close integration with that of its Germany-based parent, we would also expect any potential German government support to be available for the benefit of CFCB's creditors in case of need. Such support from the government of Germany (Aaa stable) would likely be made available to and through Commerzbank AG in the event of stress. Therefore, CFCB's issuer rating benefits from one additional notch of rating uplift from government support, mirroring our moderate support assumption at the level of its parent. Ratings Exhibit 3 Category COMMERZBANK FINANCE & COVERED BOND S.A. Outlook Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating -Dom Curr Moody's Rating Stable baa3 baa3 A2(cr)/P-1(cr) Baa1 PARENT: COMMERZBANK AG Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating Senior Unsecured Subordinate Commercial Paper -Dom Curr Other Short Term Stable A2/P-1 baa3 baa3 A2(cr)/P-1(cr) Baa1 Baa1 Ba1 P-1 (P)P-1 Source: Moody's Investors Service 5

6 Endnotes 1 The ratings shown are Commerzbank's deposit ratings and senior unsecured debt ratings together with their corresponding outlooks, as well as the bank's Baseline Credit Assessment (BCA). 6

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8 Contacts Christina Holthaus Associate Analyst 8