CREDIT OPINION Pfandbriefbank (Oesterreich) AG Update Following Review for Upgrade of Ba1 Update Summary Rating Rationale RATINGS Pfandbriefbank (Oesterreich) AG Domicile Austria Long Term Rating Ba1 Type Senior Unsecured - 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. Contacts Andrea Wehmeier 49-69-70730-782 VP-Senior Analyst andrea.wehmeier@moodys.com Alexander Hendricks, 49-69-70730-779 CFA Associate Managing Director - Banking alexander.hendricks@moodys.com Carola Schuler 49-69-70730-766 Managing Director Banking carola.schuler@moodys.com On 23 May 2016, we placed on review for upgrade the Ba1 backed senior unsecured debt ratings of Pfandbriefbank (Oesterreich) AG's (Pfandbriefbank), following an announcement for a renewed and improved buyback offer by the Austrian government, which is more likely to be accepted. During the review period, we will seek clarification if and when the buyback offer will be accepted and will monitor the development of other legal uncertainties around Heta Resolution AG (Heta, Ca, review for upgrade)1. The Ba1 rating assigned to Pfandbriefbank reflects our assessment of the creditworthiness of Austrian Landeshypothekenbanken and their ability to service their senior long-term obligations. Pfandbriefbank's ratings are purely based on the member banks' creditworthiness and include no uplift from public-sector entities or government support. Our view is based on the lack of explicit commitment by several federal states to honour their own obligations under the existing joint and several liability framework. Pfandbriefbank's liabilities benefit from the multi-recourse statutory liability scheme of its member banks: the joint and several liability obligation of the Austrian regional mortgage banks (Landes-Hypothekenbanken) and of the Austrian federal states.
Credit Strengths The announced buyback offer for the liabilities of Heta is providing a potential for declining credit pressured on Austrian LandesHypothekenbanken and more clarity on the potential burden related to the resolution process Pfandbriefbank's liabilities benefit from a multi-recourse statutory liability guarantee from its member banks and their statutory guarantors, but several Austrian states have undermined the reliability of the support scheme A track record of liquidity support provided by the member banks has being built up Honouring guarantee obligations for Pfandbriefbank would have limited impact on the federal states' risk-bearing capacity Credit Challenges The application of resolution tools to Heta negatively affects Pfandbriefbank's asset profile Pfandbriefbank's strategic fit in its member banks' funding strategies is diminished, while the bank's future as a LandesHypothekenbanken funding vehicle is uncertain Rating Outlook Pfandbriefbank's ratings are on review for upgrade, reflecting upward pressure on the credit fundamentals of the key supporting member banks. Factors that Could Lead to an Upgrade An upgrade could result from (1) a strengthening of the member banks' credit profiles; (2) a clarification of the legal obligations of the Austrian federal member-states under the guarantee framework, to the extent that this removes any doubts over the full, unconditional liability of all parties to support Pfandbriefbank in a timely fashion. At the same time, the Ba1 rating remains underpinned by the agreed 1.2 billion support measure that fully covers Pfandbriefbank's Heta exposure, thereby eliminating immediate liquidity and solvency concerns for the entity. Factors that Could Lead to a Downgrade Though currently unlikely, negative rating pressure could arise if (1) any of the member banks opt out of the agreed support measures for Pfandbriefbank, in the absence of which the bank could be at risk of insolvency; and (2) the member banks' credit profiles weaken. 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 www.moodys.com for the most updated credit rating action information and rating history. 2
Detailed Rating Considerations THE RECENTLY ANNOUNCED BUYBACK OFFER INCORPORATES POTENTIALLY DECLINING CREDIT RISKS FOR PFANDBRIEFBANK MEMBER BANKS On 18 May 2016, the Austrian Ministry of Finance announced the signing of a memorandum with Heta's creditors, including a buyback offer for Heta's liabilities, thereby providing some clarity on the potential impact on the involved Austrian Landes-Hypothekenbanken. The buyback offer, if accepted, indicates a recovery rate of around 90% of the face value of Heta s senior unsecured liabilities, significantly above provisioning levels at Pfandbriefbank member banks. If implemented, the buyback offer would lead to the release of loan-loss provisions, impacting profitability and capital generation capacity of member banks positively. However, legal uncertainties around the resolution of Heta remain a risk factor. Given the proved liquidity support by the Austrian Landes-Hypothekenbanken, their increasing risk provisioning levels for Heta-related obligations and the additional visibility provided by the May 2016 announcement of the buyback offer for Heta's liabilities, we evaluate diminishing tail risks for the entities. The Austrian Financial Market Authority imposed resolution measures on Heta on 1 March 2015, leading to a temporary payment moratorium on Heta's liabilities until 31 May 2016. The moratorium was taken in accordance with the Federal Banking Restructuring and Resolution Act. The moratorium affected Heta's 1.2 billion liability as of March 2015 towards Pfandbriefbank, which is backed by deficiency guarantees from Carinthia. The Austrian Constitutional Court declared on 28 July 2015 that unconstitutional legislation (the Hypo Reorganisation Act, HaaSanG) was introduced in August 2014, signalling that, in hindsight, the value of the deficiency guarantee cannot be fully eliminated by law by isolated measure. Persisting uncertainties are linked to the extent to which the State of Carinthia (B3 negative) will honour its deficiency guarantee, given (1) the Court's ruling that guaranteed bondholders cannot be selectively discriminated against in order to give preference to other senior Carinthian creditors; and (2) the continued unwillingness of the Austrian government to provide financial support that Carinthia could use to honour the guarantees. PFANDBRIEFBANK'S LIABILITIES BENEFIT FROM A GUARANTEE FROM ITS MEMBER BANKS AND THEIR GUARANTORS, BUT SEVERAL AUSTRIAN STATES HAVE UNDERMINED THE RELIABILITY OF THE SUPPORT SCHEME Pfandbriefbank's liabilities benefit from a multi-recourse statutory liability scheme by its member banks, a joint and several liability obligation of the Austrian regional mortgage banks (Landes-Hypothekenbanken) and of the Austrian federal states. Given its business profile as a poorly capitalised issuing vehicle for its member banks (the Austrian Landes-Hypothekenbanken or their legal successors), Pfandbriefbank relies fully on the performance of its concentrated assets to service its liabilities. The Heta moratorium in March 2015 therefore impaired its liquidity and solvency. Since April 2015, the member banks and the majority, but not all, of the Austrian Federal states have reliable support measures in place which fully cover Pfandbriefbank's Heta exposure, eliminating the entity's immediate liquidity and solvency concerns. In the meantime, the supporting entities provided approximately 0.8 billion in liquidity support, thereby building a track record of timely and credible support and reducing tail-risks related to the future support needs of 0.4 billion. However, the Austrian states' individual contributions were not uniformly provided, although Pfandbriefbank's liabilities are grandfathered under a statutory joint and several guarantee from member banks and their former guarantors (the relevant Austrian federal states), according to Austrian federal law. Consequently, Pfandbriefbank's Ba1 backed senior unsecured rating is derived from our assessment of the creditworthiness of Austrian Landes-Hypothekenbanken, as indicated by our assessment of their ability to service senior long-term obligations. Pfandbriefbank's ratings do not incorporate any likelihood of public-sector support, reflecting our view of a considerable risk that guarantors, including the Austrian federal states, will not agree on additional timely support for Pfandbriefbank, if it is required again. 3
PFANDBRIEFBANK'S STRATEGIC FIT IN ITS MEMBER BANKS' FUNDING STRATEGIES IS DIMINISHED, WHILE THE BANK'S FUTURE AS A LANDES-HYPOTHEKENBANKEN FUNDING VEHICLE IS UNCERTAIN Pfandbriefbank is an issuing vehicle for member banks, including Heta, and subject to provisions of the Austrian Banking act. As of 2015, Pfandbriefbank has legally assumed all of Pfandbriefstelle der osterreichischen Landes-Hypothekenbanken's (Pfandbriefstelle; unrated) business operations and liabilities. Pfandbriefstelle completely transferred its banking business to Pfandbriefbank while remaining its sole owner. The transfer was based on the Austrian Banking Act by way of universal succession, ensuring that the legal framework for Pfandbriefstelle, including the guarantee structure, continues to be available for the new entity. Originally established in 1939 as a public-law entity, the group's purpose is to support the funding activities of the LandesHypothekenbanken through the issuance of mortgage-/public sector-secured bonds. The Landes-Hypothekenbanken were also allowed to issue covered bonds on their own behalf. Furthermore, Pfandbriefbank is authorised to issue unsecured bonds, but its predecessor company Pfandbriefstelle stopped doing so in 2007. In the context of Pfandbriefbank's grandfathered debt obligations incurred before April 2007, their member banks (with the exception of Salzburger Landes-Hypothekenbank AG, Salzburger Hypo, unrated) benefit from a deficiency guarantee from their then-majority owners, the federal states. In 2003, the statutory support scheme for some Austrian public-sector banks was abolished following a respective decision by the European Commission. To facilitate the adaptation of funding strategies for the affected banks, a phase-out schedule for the state guarantees was agreed with the European Commission, whereby the grandfathering applies for securities as follows: 1) Until their respective maturity if issued before 1 April 2003 2) Until 30 September 2017 if issued between April 2003 and before 1 April 2007 3) All liabilities incurred after 1 April 2007 are not guaranteed, regardless of their maturity. Pfandbriefbank's securities are "grandfathered" by the following members banks: Hypo-Bank Burgenland AG, Eisenstadt (unrated) Austrian Anadi Bank AG (formerly Hypo Alpe-Adria-Bank AG), Klagenfurt (unrated) Heta Asset Resolution AG (formerly Hypo Alpe-Adria-Bank International AG), Klagenfurt, (Ca review for upgrade)2. HYPO NOE Landesbank AG, St. Pölten (unrated) HYPO NOE Gruppe Bank AG, St. Pölten (unrated) Oberoesterreichische Landesbank AG, Linz (unrated) Salzburger Landes-Hypothekenbank AG, Salzburg (unrated) Landes-Hypothekenbank Steiermark AG, Graz (unrated) Hypo Tirol Bank AG, Innsbruck (Ba1 review for upgrade/ba1 review for upgrade; ba3)3) Vorarlberger Landes- und Hypothekenbank AG, Bregenz (Baa1 stable/baa1 stable;baa3)4 Because the guarantee was no longer available after 2007, Pfandbriefbank has stopped issuing new debt and is practically in winddown. Its total assets decreased to 3.4 billion as of year-end 2015 (year-end 2014: 5.6 billion as of year-end 2014; year-end 2013: 6.2 billion). In line with the downsizing of overall issued debt volumes, we note the diminishing importance of Pfandbriefbank for the funding strategy of its member banks. Given the above-mentioned halt in new issuance, Pfandbriefbank's future perspective is unclear. Planned changes in the legal framework will enable Pfandbriefbank to provide funding for Austria's Landes-Hypothekenbanken in the future. However, while these 4
changes could result in a repositioning of Pfandbriefbank, we do not think that any change in strategy would be swift, because of the prolonged time of non-issuance activity that has passed since changes to the legal framework for deficiency guarantees. HONOURING OF THE GUARANTEE OBLIGATIONS FOR PFANDBRIEFBANK HAS LIMITED IMPACT ON THE FEDERAL STATES' RISKBEARING CAPACITY With total assets of 3.4 billion as of December 2015, the risks related to guarantees for Pfandbriefbank appear to be manageable for the Austrian federal states, which form part of the guarantee framework. The federal states' total budget size was 33 billion in 2014 for Pfandbriefbank related Austrian states. We currently rate those from Aa1 negative (Lower Austria) to B3 negative (Carinthia). Ratings Exhibit 1 Category PFANDBRIEFBANK (OESTERREICH) AG Outlook Bkd Senior Unsecured Moody's Rating Stable Ba1 Source: Moody's Investors Service 5
Endnotes 1 The rating shown is Heta's Carinthian state guaranteed senior unsecured debt 2 The rating shown in Heta's Carinthian state guaranteed senior unsecured debt 3 The ratings shown are Hypo Tirol's deposit rating and outlook, its senior unsecured debt rating and outlook, and its baseline credit assessment 4 The ratings shown are Vorarlberger Landes- und Hypothekenbank's deposit rating and outlook, its senior unsecured debt rating and outlook, and its baseline credit assessment 6
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