Landesbank Baden-Wuerttemberg

Transcription

1 CREDIT OPINION Landesbank Baden-Wuerttemberg Semi-annual update Update Summary Rating Rationale We assign Aa3/P-1 long- and short-term deposit ratings and A1 long-term debt ratings to Landesbank Baden-Wuerttemberg (LBBW). We further assign Baa2 subordinated debt ratings and an Aa3(cr)/P-1(cr) Counterparty Risk Assessment as well as a baa3 baseline credit assessment (BCA) and a baa1 adjusted BCA. RATINGS Landesbank Baden-Wuerttemberg Domicile Germany Long Term Rating Aa3 Type LT Bank Deposits - Fgn Curr Outlook Stable Please see the ratings section at the end of this report for more information.the ratings and outlook shown reflect information as of the publication date. Analyst Contacts Andrea Wehmeier VP-Senior Analyst andrea.wehmeier@moodys.com Alexander Hendricks, CFA Associate Managing Director - Banking alexander.hendricks@moodys.com The long-term ratings reflect (1) the baa3 BCA; (2) its baa1 adjusted BCA, incorporating two notches of rating uplift reflecting affiliate support from Sparkassen-Finanzgruppe (S-Group; Aa2 stable, a2)1; (3) the result of our Advanced Loss Given Failure (LGF) analysis, which takes into account the severity of loss faced by the different liability classes in resolution and which provides two and three notches of rating uplift to LBBW's debt and deposit ratings, respectively; and (4) a moderate likelihood of LBBW receiving government support, resulting in one additional notch of rating uplift. The baa3 BCA reflects (1) LBBW's improving and strong capitalisation; (2) significant concentrations risks and exposure to market risk; and (3) exposure to confidence sensitive market funding, mitigated by access to sector funds and strong liquidity. It also reflects its modest profitability, as well as LBBW's high exposures to domestic and international corporate and commercial real-estate (CRE) portfolios, which might exert pressure on the bank's profitability and, potentially, capital ratios in a highly adverse scenario. Exhibit 1 Rating Scorecard - Key Financial Ratios Carola Schuler Managing Director Banking carola.schuler@moodys.com Source: Moody's Banking Financial Metrics

2 Credit Strengths LBBW's strongly improved capital ratios benefit from de-risking A low and improving problem loans ratio Liquidity profile and liquidity management are sound Credit Challenges Despite de-risking, concentrations remain Profitability and efficiency metrics are stabilising at a low level Confidence-sensitive market funding dependence is balanced by access to sector funds Rating Outlook The outlook on the bank's long-term debt and deposit ratings is stable, capturing (1) its sound asset profile despite concentration risks; (2) stable capitalisation; and (3) low, but stable profits. The outlook also captures the result of our LGF analysis. Factors that Could Lead to an Upgrade An upgrade of LBBW's long-term debt and deposit ratings would be likely in the event of a pronounced upgrade of the bank's BCA. LBBW's senior unsecured debt ratings could also be upgraded if the volume of its subordinated instruments increases meaningfully relative to the bank's tangible banking assets, which could result in one additional notch of rating uplift from our LGF analysis; LBBW's deposit ratings already benefit from the highest possible rating uplift from our LGF analysis. Upward pressure on LBBW's baa3 BCA could result from (1) a continued improvement of asset quality within the bank's loan portfolios, consisting of exposures to CRE and cyclical industry sectors such as automotives and construction, displayed through a reduced problem loan ratio, and coupled with further reduced single-name credit concentrations and a faster-than-anticipated full reduction of higher-risk secondary market investments; and (2) a marked and sustainable improvement in risk-adjusted profitability and efficiency. Factors that Could Lead to a Downgrade A downgrade of LBBW's long-term debt and deposit ratings could be triggered following (1) a downgrade of its BCA; (2) weakening cross-sector support assumptions; and/or (3) a reduction in rating uplift resulting from our LGF analysis. Downward pressure on the bank's BCA could result from (1) a deterioration in the bank's Macro Profile; (2) deterioration of the bank's financial strength, especially if followed by an unexpected and sustained weakening of its capital adequacy metrics; and (3) a material deterioration in asset quality, evidenced by a strongly rising problem loan ratio. In addition, LBBW's debt and/or deposit ratings could be downgraded if their volume, or that of its subordinated instruments, decreases relative to the bank's tangible banking assets. This could result in fewer notches of uplift resulting from our LGF analysis. 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 Landesbank Baden-Wuerttemberg (Consolidated Financials) [1] Total Assets (EUR billion) Total Assets (USD billion) Tangible Common Equity (EUR billion) Tangible Common Equity (USD billion) 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 (%) Avg [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] Compound Annual Growth Rate based on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - fully-loaded or transitional phase-in & IFRS reporting periods have been used for average calculation Source: Moody's Financial Metrics Detailed Rating Considerations LBBW'S STRONGLY IMPROVED CAPITAL RATIOS BENEFIT FROM DE-RISKING AND CONTINUED SUPPORT BY ITS OWNERS LBBW's reported fully loaded CET1 ratio stood at 15.6% at end-215, an increase of 2 basis points from year-end 214, and its total capital ratio increased to 21.4% as of 31 December 215 (214: 18.9%). The ratios were supported by the bank's accelerated balance sheet clean-up and resulting lower risk-weights, and are significantly above the required regulatory ratio of 9.75%, which the regulator determined following the Supervisory Review and Evaluation Process (SREP) in November 215. Our assigned Capital score for the bank remains constrained by the remaining risk-weighted asset relief from continued guarantees. Combined with our expectations regarding the potential negative impact of upcoming regulatory changes, we assign a Capital score of a1. These changes include stricter risk-weighted asset calculation requirements and updated accounting standards. The bank's reported capital ratios continue to benefit from support measures initiated by the bank's owners in 29, providing relief to the risk-weighted assets at LBBW. Following the sale of the guaranteed structured credit portfolio, remaining guaranteed tranches (relating to the Sealink loan) exempt from risk-weighting stood at 4. billion as of end-215. LBBW's fully loaded Basel III CET1 ratio is calculated at levels around 15% when excluding the remaining guarantee's ratio-positive risk-weighted asset effects. LBBW's 'underlying' capital ratios are approaching reported levels, thereby making its capital ratios more comparable with those of peers. LBBW HAS SIGNIFICANTLY DE-RISKED, BUT SOME CONCENTRATIONS REMAIN LBBW has achieved strong progress in reducing non-core investments, such as its structured credit portfolio and exposures to euroarea periphery sovereigns. However, its single-name and risk concentrations to highly cyclical industries within its corporate loan book, as well as exposures to financial institutions, remain high. LBBW's net corporate credit exposures amounted to 7.9 billion as of 31 December 215; the CRE sector, the automotive industry and the construction industry together accounted for 34% of total corporate exposures, at 7.4 billion, 11.1 billion and 5.7 billion, respectively. The aforementioned exposures could trigger large losses in a highly adverse macroeconomic scenario. Despite improving non-performing loan ratios, dropping further to 1.8% of gross loans as per year-end 215, we are currently at a very benign point of the credit cycle in Germany in general. 3

4 Albeit largely driven by LBBW's client-oriented capital markets business and its role as the central bank for the regional savings banks (e.g. money market and hedging activities), we take account of LBBW's relatively high proportion of trading assets as a percentage of total assets, and the declining, but still relatively high share of net interest income generated from trading derivatives. These considerations lead us to assign an Asset Risk score of baa2, four notches below the indicated historic scorecard ratio. PROFITABILITY AND EFFICIENCY METRICS ARE STABILISING AT A LOW LEVEL For 215, LBBW reported a 11% higher pre-tax profit of 531 million ( 477 million in 214), despite the sharp decline in net interest income of 12% resulting from the low-interest rate environment. The decline was compensated by lower-than-expected loan loss provisions of 55 million, half of the 14 million reported in 214, as a reflection of benign economic conditions in LBBW's core markets. Also, a positive fair-value gain from financial investments ( 226 million compared to a negative 12 million in 214 and a 369 million gain in 213) compensated the 224 million decline in net interest income, as the volatile markets in 215 led to more customers hedging their foreign-currency and interest rate risks. The costs relating to the aid measures provided by the bank's owners in 29 remain, but on a lower level ( 121 million) compared to the previous year ( 191 million in 214). The sale of LBBW's guaranteed structured credit portfolio (excluding the fully-guaranteed loan provided to Sealink, which was reduced to 5.3 billion at end-215) slightly enhanced LBBW's earnings capacity, owing to the easing burden of related state-aid costs. However, the group's earnings will continue to appear low relative to its overall risk profile for the next two to three years, and therefore modest by global standards. Our assessment reflects our anticipation of persistent earnings pressure resulting from the low interest-rate environment, a potential slight increase in retained earnings is already captured in our b1 Profitability score. LIQUIDITY PROFILE AND LIQUIDITY MANAGEMENT ARE SOUND LBBW is partially dependent on wholesale funding for a part of its lending business. The bank's ample liquidity and good access to sector funds are key credit strengths that mitigate potential funding challenges. Given the stabilisation of LBBW's balance sheet size after the work-out of most of the structured portfolio and the maturing of most of the grandfathered debt, we expect that the bank's funding needs will stabilise at around 1 billion per annum. Funding costs are set to continue to be supported by good access to funds from regional savings banks (and their retail clients), as well as LBBW's own retail client base and a strong covered bond franchise. Nevertheless, LBBW is not entirely immune to market shocks, given its large derivatives book, the related risk of volatile collateralisation requirements, and its sizeable deposits from institutional clients. The above considerations lead to a one-notch positive adjustment of the Funding Structure score to b1. Our consideration of encumbered assets in our Liquid Banking Assets ratio results in a two-notch downward adjustment of the Liquid Resources score to a1. LBBW'S LARGELY DOMESTIC EXPOSURES DETERMINE ITS VERY STRONG- MACRO PROFILE LBBW is predominantly active in Germany, aligning its Macro Profile with that of its home country. The very high economic, institutional and government financial strength and very low susceptibility to event risk therefore support the bank's BCA. However, operating conditions for the German banking system are constrained by high fragmentation in an over-saturated market, low fee income generation and intensifying competition for domestic business. Overall, LBBW's Macro Profile stands at Very Strong-. A deterioration of the bank's Macro Profile may negatively affect its financial profile, all other things being equal. 4

5 Notching Considerations AFFILIATE SUPPORT LBBW benefits from cross-sector support from S-Group. Cross-sector support reduces the probability of default, as such support would be available to stabilise a distressed member bank, and not just compensate for losses in resolution. The "high" support assumption, assigned to LBBW and also most Landesbanks, reflects its cross-liability scheme membership and only partial ownership by S-Group members. As a result, cross-sector support provides two notches of rating uplift to LBBW's debt, deposit and subordinated instrument ratings. LOSS GIVEN FAILURE (LGF) ANALYSIS LBBW is subject to the German Bank Recovery and Resolution Directive, which we consider to Operational Resolution Regime. We therefore apply our Advanced LGF analysis, considering the risks faced by the different debt and deposit classes across the liability structure at failure. We revised this analysis to reflect changes in protection resulting from the subordination of certain senior unsecured debt obligations relative to other senior liabilities, including deposits. We continue to 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, a 5% run-off in preferred deposits and - following the legislative changes - a 1% probability to certain deposits being preferred to senior unsecured debt, according to our EU Full Deposit Preference waterfall. For LBBW, our revised LGF analysis indicates an extremely low loss-given-failure for deposits and a very low loss-given-failure for senior unsecured debt. Therefore, deposits and senior debt instruments benefit from three and two notches of rating uplift, respectively, above the bank's baa1 adjusted BCA. Further, our LGF analysis continues to indicate a high loss-given-failure for subordinated debt classes, leading us to position those instruments one notch below the bank's baa1 adjusted BCA. Subordinated debt instruments do not benefit from any government support. GOVERNMENT SUPPORT Given its size on a consolidated basis, we consider S-Group as domestically systemically relevant. We therefore attribute a "moderate" probability of German government support for all members of the sector, in line with support assumptions for other systemically relevant banking groups in Europe. For LBBW, this results in one notch of government support uplift for its senior debt and deposit ratings. 5

6 Rating Methodology and Scorecard Factors Exhibit 3 Landesbank Baden-Wuerttemberg Macro Factors Weighted Macro Profile Very Strong - 1% Financial Profile Factor Historic Ratio Macro Adjusted Score Credit Trend Assigned Score Key driver #1 Key driver #2 Solvency Asset Risk Problem Loans / Gross Loans 2.4% a1 baa2 Sector concentration Market risk Capital TCE / RWA 17.% aa2 a1 Risk-weighted capitalisation Expected trend Profitability Net Income / Tangible Assets.2% b1 b1 Return on assets Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets Liquid Resources Liquid Banking Assets / Tangible Banking Assets Combined Liquidity Score Financial Profile Business Diversification Opacity and Complexity Corporate Behavior Total Qualitative Adjustments Sovereign or Affiliate constraint: Scorecard Calculated BCA range Assigned BCA Affiliate Support notching Adjusted BCA Instrument Class Counterparty Risk Assessment Deposits Senior unsecured bank debt Dated subordinated bank debt a2 baa2 58.8% b2 b1 Market funding quality 4.5% aa2 a1 Asset encumbrance Intragroup restrictions Government Support notching Local Currency rating Aa3 (cr) Aa3 A1 Baa2 Foreign Currency rating -Aa3 A1 Baa2 baa3 Loss Given Failure notching Additional notching baa3 baa2 Aaa baa1-baa3 baa3 2 baa1 Preliminary Rating Assessment a1 (cr) a1 a2 baa2 Source: Moody's Financial Metrics 6

7 Ratings Exhibit 4 Category LANDESBANK BADEN-WUERTTEMBERG Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Senior Unsecured Subordinate Commercial Paper -Dom Curr Other Short Term Moody's Rating Stable Aa3/P-1 baa3 baa1 Aa3(cr)/P-1(cr) A1 Baa2 P-1 (P)P-1 Source: Moody's Investors Service Output of the Baseline Credit Assessment 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. 7

8 Endnotes 1 The ratings shown are S-Group's Corporate Family Rating and outlook, and its baseline credit assessment 8

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10 Analyst Contacts Andrea Wehmeier VP-Senior Analyst 1 CLIENT SERVICES Mira Carey Associate Analyst Americas Asia Pacific Japan EMEA