Credit Opinion: DEPFA ACS BANK

Transcription

1 Credit Opinion: DEPFA ACS BANK Global Credit Research - 24 Mar 2015 Dublin, Ireland Ratings Category Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Ult Parent: Germany Country Ceiling: Fgn Currency Debt Country Ceiling: Fgn Currency Bank Deposits Parent: DEPFA Bank plc Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Senior Unsecured Subordinate -Dom Curr Moody's Rating Rating(s) Under Review *Baa3/*P-3 Aaa/P-1 Aaa/P-1 Rating(s) Under Review *Baa3/*P-3 ***Baa3 **Caa3 * Rating(s) within this class was/were placed on review on March 17, 2015 ** Placed under review for possible upgrade on March 17, 2015 *** Placed under review for possible downgrade on March 17, 2015 Contacts Analyst Phone Katharina Barten/Frankfurt am Main Michael Rohr/Frankfurt am Main Carola Schuler/Frankfurt am Main Maximilian Denkmann/Frankfurt am Main Key Indicators DEPFA ACS BANK (Unconsolidated Financials)[1] [2]6-14 [3]12-13 [3]12-12 [3]12-11 [3]12-10 Avg. Total Assets (EUR million) 30, , , , ,722.0 [4]-19.0 Total Assets (USD million) 41, , , , ,876.6 [4]-18.6 Tangible Common Equity (EUR million) [4]0.5 Tangible Common Equity (USD million) [4]1.0 Tangible Common Equity / Risk Weighted Assets (%) [5]28.6 Net Interest Margin (%) [6]0.2

2 PPI / Average RWA (%) [5]-0.9 Net Income / Tangible Assets (%) [6]0.1 Cost / Income Ratio (%) [6]95.4 Market Funds / Tangible Banking Assets (%) [6]61.2 Liquid Banking Assets / Tangible Banking Assets (%) [6]13.2 Gross Loans / Total Deposits (%) [6]172.9 Source: Moody's [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] Basel III - fully-loaded or transitional phase-in & IFRS reporting periods have been used for average calculation [6] IFRS reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE On 17 March, we placed on review for downgrade the Baa3/Prime-3 debt and deposit ratings of DEPFA BANK plc (DEPFA) and its fully owned subsidiary DEPFA ACS BANK (DEPFA ACS), and placed on review for upgrade the banks' caa2 baseline credit assessments (BCAs), and the Caa3 rating for DEPFA's senior subordinated debt. Our preliminary indication of the expected rating outcome for the banks' long-term debt and deposits is Ba2/Not-Prime. The review for downgrade was prompted by our decision to reduce our current assumptions for support from the German government (Aaa stable), which is the banks' ultimate owner. The expected downward revision of our government support assumptions will likely result in two notches of rating uplift for senior unsecured debt and deposits - down from eight notches currently - and takes into account that DEPFA group is subject to the European resolution regime (Bank Recovery and Resolution Directive, or BRRD) which the Irish government has implemented with effect from 1 January In addition, the review reflects changes arising from the implementation of our new methodology for rating banks globally, which is mildly positive for DEPFA's and DEPFA ACS's senior debt and deposit ratings. This positive effect stems from the introduction of our advanced Loss Given Failure (LGF) analysis, which takes into account the severity of loss faced by the different liability classes across the liability structure should the banks enter resolution. This positive effect will partly offset the downward pressure on the debt and deposit ratings. The review for upgrade of the caa2 BCA was prompted by expected benefits for DEPFA's weak financial profile from liquidity support provided by the banks' new owner, the German Government's unwinding vehicle FMS Wertmanagement (FMS-WM, Aaa stable). In addition, FMS-WM's proposed plan to purchase up to EUR1.2 billion of DEPFA's outstanding hybrid capital at roughly 60% of the nominal value may help DEPFA to optimise its lossabsorption capacity and regulatory capital. We understand that this transaction remains subject to regulatory approval. Following the acquisition of 100% of DEPFA's equity from Hypo Real Estate Holding AG (HRE, unrated) in late December 2014, FMS-WM's proposed tender on 14 January 2015 to purchase DEPFA's hybrid capital indicates the government's expectation of an intrinsic value of these instruments near or above 60%. By implication, FMS- WM does not expect losses for senior unsecured bondholders in DEPFA's unwinding process. We see upgrade potential of up to three notches (to b2) for the BCA, although this will depend on greater transparency of DEPFA's unwinding plan and our scenario analysis of DEPFA's ability to maintain adequate capital levels during its unwinding. Following the review, DEPFA's and DEPFA ACS's BCA will remain constrained by (1) financial opacity in the context of the ongoing unwinding of the banks; and (2) the vulnerability of their capital position to accruing operational losses as well as macroeconomic stress or market shocks in the context of DEPFA's exposure concentrations to economically weaker euro area countries. DEPFA's RATINGS ARE SUPPORTED BY ITS `STRONG' MACRO PROFILE DEPFA Group has a regionally very diversified asset base, and only less than 5% of its assets originate in Ireland. Its largest exposures are to Germany (26%) and the United States (21%) whose Macro Profiles are Very Strong-. The remainder of its total exposure is diversified across Europe. The Weighted Macro Profile for DEPFA is

3 therefore `Strong`, somewhat above the `Moderate' Macro Profile for Ireland. Rating Drivers - DEPFA's franchise is impaired and the group will be unwound - DEPFA will likely remain structurally loss-making - Capitalisation remains vulnerable to unexpected losses and erosion from loss-making operations - DEPFA has adequate liquidity as a result of past large-scale support from Germany's support fund (SoFFin) - DEPFA benefits from past and continued government support Rating Outlook DEPFA's and DEPFA ACS's senior unsecured debt and deposit ratings are on review for downgrade and the caa2 BCA is on review for upgrade. The review for upgrade of the caa2 BCA will focus on (1) the extent to which liquidity support from FMS-WM will translate into benefits for the group's weak financial profile; and (2) the benefits of FMS-WM's proposed purchase of the majority of DEPFA's hybrid instruments (and the negotiated change of terms for these instruments) for DEPFA's scope to manage its capital. The review of the Baa3 long-term ratings will materially depend on the positioning of the BCA and will include a validation of the results of our LGF analysis. This analysis indicates that DEPFA's Preliminary Rating Assessment (PRA) may benefit from additional uplift above the Adjusted BCA. Our support assessment will focus on the scope that FMS-WM has to provide further assistance to DEPFA during its unwinding. Based on our understanding of respective options available to FMS-WM at the current stage, the upgrade potential for the BCA to b2 and the benefits from the LGF analysis for junior deposits and senior long-term debt, we expect DEPFA's debt and deposit ratings to be positioned at Ba2, two notches below the current ratings. The short-term ratings are likely to be Not-Prime. What Could Change the Rating - Up There is no upward pressure on the long-term ratings, as indicated by the review for downgrade. We see upgrade potential for the caa2 BCA of up to three notches. We do not rule out further upgrade potential in case of specific beneficial measures beyond current expectations (like capital injections), but consider them unlikely. The debt and deposit ratings, albeit on review for downgrade, could benefit from an increase in subordinated liabilities relative to the group's total banking assets. Any explicit commitment by FMS-WM to provide capital support could result in higher systemic support being factored into DEFPA's ratings. What Could Change the Rating - Down The upward pressure on the caa2 BCA of up to three notches will be subject to greater clarity of the group's unwinding strategy and a satisfactory capital plan. In the absence of relevant information, the review may result in an upgrade below the potential three notches or in no upgrade, which would imply additional pressure on DEPFA's debt and deposit ratings. Further downward pressure on the Baa3 long-term ratings under review could result from a reduction in the volume of subordinated instruments at a pace faster than the reduction of the balance sheet. This could result in a higher loss-given-failure for senior bondholders and therefore lower uplift from our LGF analysis. In addition, any signs of the government withdrawing the level of support we have identified could result in a reduction or exclusion of system support. DETAILED RATING CONSIDERATIONS DEPFA'S FRANCHISE IS IMPAIRED We consider DEPFA's franchise impaired, as its operations are restricted to managing the run-down of its asset pool, as required by the European Commission, following the German government's decision in May 2014 not to privatise the bank. The opacity of this process, in particular regarding the scope of future losses, constrains

4 DEPFA's ratings and leads us to apply a qualitative adjustment of -1 notch to the calculated scorecard outcome. DEPFA WILL LIKELY REMAIN STRUCTURALLY LOSS-MAKING We expect DEPFA to remain loss-making in the medium term, although there may be potential to reduce losses. In particular, we expect that FMS-WM will assist in optimising DEPFA's liability management and funding costs with positive effects on results. If FMS-WM intends to pass on gains from repurchasing DEPFA's hybrid capital to the bank, such gains (i.e., from buying own subordinated liabilities from FMS-WM deeply below par) may partly offset operating losses in coming years. The Profitability score is caa3, reflecting the limited leeway DEPFA has to improve its poor profitability. DEPFA is structurally loss-making, as the bank's recurring revenues are insufficient to cover its cost base. Positive results during were only possible because of a combination of positive extraordinary effects from the buy-back of the bank's own liabilities below par, or tax rebates. Given negative (underlying) operating revenues, we believe that - absent outside assistance - DEPFA group has limited scope to sustainably turnaround even if it swiftly manages to further run down its cost base. DEPFA reported negative operating revenues of EUR58 million for the six months to June 2014 (under IFRS, unaudited), which include a EUR35 million valuation loss on its own credit spreads, and a net loss of EUR94 million. CAPITALISATION REMAINS VULNERABLE TO UNEXPECTED LOSSES AND EROSION FROM LOSS- MAKING OPERATIONS Whilst DEPFA's capitalisation is adequate from a regulatory perspective, the total costs of the group's unwinding are difficult to predict, and therefore how capital ratios will evolve over time. Despite the low transparency at the current stage, we base our review for upgrade of the caa2 BCA partly on the assumption that existing capital will be sufficient for the next four to five years in order to facilitate DEPFA's unwinding without resorting to the bail-in of (senior) creditors. DEPFA reported a Tier 1 ratio of 28.2% (based on unaudited results) as of September 2014, under the rules of the Capital Requirements Regulation and the fourth Capital Requirements Directive (CRR/CRD IV). The ratio reflects the low risk weight associated with the bank's public finance book and includes almost EUR700 million (or 47%) in hybrid instruments. The Common Equity Tier 1 (CET1) ratio under the rules of CRR/CRD IV, which excludes hybrid capital, was considerably lower at 14.8% as of September We consider the economic capitalisation of the group to be modest and risks to capital considerable. We base our assessment on the following three considerations: (1) the prospect of accruing losses from operations which will gradually diminish capital; (2) DEPFA's high leverage, which under CRD IV is around 3.2% based on Tier 1 capital, but a low 1.7% based on its EUR800 million CET1 capital (based on our calculations); this implies limited tolerance for unexpected losses that may arise on the bank's relatively concentrated exposures (but also on market, litigation, operational or other risks); and (3) a high EUR5.5 billion exposure to several pressured (sub-) sovereigns in the euro area (in addition to EUR300 million cash held with the Irish central bank), i.e., Ireland (Baa1 stable), Italy (Baa2 stable), Spain (Baa2 positive) and Slovenia (Baa3 stable), as of June 2014, representing a high 3.4x Tier 1 capital. More than half of the total exposure (i.e., EUR3.3 billion) is to sub-sovereigns in these countries. Major exposure concentrations are to Spanish sub-sovereigns (EUR2.8 billion book value, mostly with maturities over five years). DEPFA reported a negative difference of EUR1 billion in the fair value of assets compared with their book value as of June To highlight the bank's high leverage and considerable risks to capital, we adjust DEPFA's Capital score to b1. DEPFA HAS ADEQUATE LIQUIDITY AS A RESULT OF PAST LARGE-SCALE SUPPORT FROM GERMANY'S SUPPORT FUND (SOFFIN) We do not expect that the bank will need any senior unsecured funding in our central scenario given its positive cumulative liquidity position of EUR5.3 billion as of year-end As a result of the asset offloading transaction with FMS-WM in October 2010, DEPFA has a largely matched funding profile, and the prospect of continued government ownership will make it easier for DEPFA to effect vital transactions. Should DEPFA face difficulties in accessing secured funding markets, we expect that FMS-WM will step in and provide the required funding. In addition, FMS-WM will probably reinstate unsecured funding facilities it cancelled in early 2014, to assist in the bank's unwinding. Notching Considerations LOSS GIVEN FAILURE DEPFA Group is subject to the EU Bank Resolution and Recovery Directive, which we consider to be an

5 advanced Operational Resolution Regime. We therefore apply our LGF analysis, considering the risks faced by the different debt and deposit classes across the liability structure should the bank enter resolution. We base our analysis on consolidated financials and assume residual tangible common equity (TCE) of 1.98% and losses postfailure of 8% of tangible banking assets, a 25% run-off in "junior" wholesale deposits, a 5% run-off in preferred deposits, and assign a 25% probability to deposits being preferred to senior unsecured debt. Except for the reduced TCE at failure (normally at 3.0%), these ratios are in line with our standard assumptions. For DEPFA's senior unsecured debt and deposits, our LGF analysis indicates that the PRA for these liability classes may benefit from additional uplift above the Adjusted BCA. The Tier 1 preferred securities of DEPFA Funding II, III and IV LP are rated C(hyb). These instruments are underperforming and were unaffected by the 17 March rating action. No coupons were paid in respect of the financial years We do not expect DEPFA to pay any coupons on these non-cumulative, perpetual instruments in the future, given the prohibition of distributions until 2015 by the European Commission and DEPFA's negative distributable reserves. More importantly, the payment of distributions is discretionary. GOVERNMENT SUPPORT Although European banks operate in an environment of materially weakened prospects for financial assistance from the government, we will likely continue to maintain two notches of rating uplift in our senior unsecured debt and deposit ratings, reflecting a high support assumption. This assumption takes into account (1) that DEPFA will remain under indirect government ownership and be gradually wound down; and (2) that FMS-WM has some leeway to assist DEPFA Group in treasury operations and capital management, although the latter falls short of capital injections. Whilst it is not clear at this stage to what extent such assistance will translate into benefits for DEPFA's weak credit profile, we expect short-term funding from FMS-WM and similar options to somewhat ease the group's losses, thereby protecting the banks' capital position. Support during was mostly provided through Germany's financial market stabilisation fund (Sonderfonds Finanzmarktstabilisierung or SoFFin) and FMS-WM which is the public sector wind-down vehicle into which DEPFA offloaded non-strategic assets, which helped the group to address its previous funding mismatch. 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. 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. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES ( MIS ) ARE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY S ( MOODY S PUBLICATIONS ) MAY INCLUDE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY

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