OREANDA-NEWS. May 13, 2016. Fitch Ratings has upgraded Bayerische Landesbank's (BayernLB) Viability Rating (VR) to 'bbb' from 'bb+' and affirmed the Long-Term Issuer Default Rating (IDR) at 'A-' with a Stable Outlook. The Short-Term IDR has been affirmed at 'F1' and the Support Rating at '1'. BayernLB's IDRs and Support Rating are driven by institutional support from the bank's owners.

The upgrade of the VR primarily reflects the removal of legacy risks as a result of the resolution of BayernLB's claims against HETA Asset Resolution AG (HETA), in turn positively impacting the bank's asset quality and capitalisation. A stable earnings base over the last 12 months has also improved the bank's business profile.

A full list of rating actions is available at the end of this rating action commentary.

KEY RATING DRIVERS
IDRS, SR AND SENIOR DEBT
BayernLB's IDRs, SR and senior debt rating reflect Fitch's view of a very strong likelihood of combined support from the bank's owners, the state of Bavaria, the regional savings banks, and ultimately Sparkassen-Finanzgruppe (Sparkassen) (SFG, A+/Stable). Support assumptions are underpinned by provisions contained in the statutes of SFG and the Landesbanken institutional protection fund.

Fitch's institutional support considerations are based on the view that the owners consider their investment in BayernLB long-term and strategic. The owners' strong support propensity is underpinned by the focus of BayernLB on its statutory roles, which include supporting the regional economy, acting as the central bank for regional savings banks and as Bavaria's house bank.

In Fitch's view support would need to be forthcoming from SFG as well as the federal state owner to avoid triggering state aid considerations and resolution under the German Sanierungs und Abwicklungsgesetz (SAG), if BayernLB fails. Our assessment of the creditworthiness of Bavaria is underpinned by the stability of Germany's solidarity and financial equalisation system, which links Bavaria's creditworthiness to that of Germany (AAA/Stable). The support ability of SFG, as expressed by its 'A+' IDR, while very strong, is weaker than that of Bavaria. Fitch uses the lower of the parents' ratings, the Long-Term IDR of SFG, as anchor and starting point for determining BayernLB' support-driven ratings.

We notch down BayernLB's Long-Term IDR twice from SFG's 'A+'. The notching reflects BayernLB's role for its owners, which we consider strategic, but not key and integral, as well as uncertainties over potential legal and regulatory barriers related to state aid considerations and provisions of German resolution legislation.

The Stable Outlook reflects stable support assumptions and the Stable Outlook on SFG's Long-Term IDR.

The ratings of senior unsecured obligations are in line with BayernLB's IDRs. BayernLB's 'F1' Short-Term IDR is at the higher of the two Short-Term IDRs that map to an 'A-' Long-Term IDR on Fitch's rating scale. This reflects BayernLB's strong links to the affiliated savings banks, which have ample liquidity and funding resources.

VR
The upgrade of BayernLB's VR is primarily driven by Fitch's expectation that the resolution of further legacy issues, primarily the resolution of claims against HETA, will give management additional flexibility to conclude its restructuring and should result in a better balanced business profile of BayernLB with a clear focus on its client-driven core business areas. At the same time, the bank is now in a good position to repay outstanding state aid to Bavaria.

In July 2015, Bavaria and the Republic of Austria reached an agreement that resulted in a compensation payment of EUR1.23bn to Bavaria to resolve claims related to HETA. This has enabled BayernLB to balance this amount against its outstanding obligation to repay EUR2.3bn of capital received from Bavaria before the 2019 deadline ending EU state aid proceedings, yielding a final balance of EUR1bn.

Asset quality in BayernLB's corporate portfolio is robust with low NPLs, and has continued to improve. The quality in the bank's non-core unit remains significantly weaker and affected the overall NPL ratio of 4.5% of gross loans at end-2015. BayernLB - in common with its peers - also has sector and single borrower concentration risks in its loan book.

BayernLB's financial performance improved with a reported pre-tax profit of EUR640m in 2015 (EUR91m at end-1Q16). We expect adequate and consistent performance in 2016, supporting the bank's moderate profitability despite our expectation of a modest rise in loan impairment charges from their cyclically low levels in 2015.

BayernLB's capitalisation and leverage have improved to adequate levels. The bank reported a 11.7% fully-loaded CET-1 ratio and a 3.9% phase-in Basel III leverage ratio at end-1Q16. We expect that further reductions in risk weighted assets (RWAs) in the bank's non-core unit will mitigate upward pressure on RWAs from regulatory changes.

The bank's funding is diversified and includes material wholesale funding but benefits from access to the liquidity pool of savings banks and retail deposit at DKB, its internet bank subsidiary.

STATE-GUARANTEED/GRANDFATHERED SENIOR, SUBORDINATED AND MARKET LINKED SECURITIES
The 'AAA' ratings of BayernLB state-guaranteed/grandfathered senior, subordinated debt and market-linked securities reflect the credit strength of Bavaria as guarantor.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
BayernLB's subordinated debt instruments are notched down once from the VR to reflect loss severity relative to average recoveries.

The upgrade of the securities issued by BayernLB Capital Trust I to 'BB-' is based on Fitch's view that these instruments are now performing. The ratings for these instruments are notched down four times from the bank's VR, two notches for loss severity relative to average recoveries and two notches for incremental non-performance risk.

Restrictions set by the European Commission are still in place. These allow only for contractually obligatory coupon payments on hybrid securities until the bank's state aid has been repaid. The terms of the securities require the bank to make coupon payments if certain other distributions have been made, and coupon on the securities was paid in 2015.

BayernLB used part of its EUR402m 2015 German GAAP unconsolidated profit to replenish other outstanding hybrid instruments, which together with our expectation that the bank's improved profitability makes common dividend payments more likely, improves the prospects for coupon payments on the rated instruments.

RATING SENSITIVITIES
IDRS, SR AND SENIOR DEBT
The IDRs, SRs and senior unsecured debt ratings are sensitive to changes in assumptions around the propensity or ability of BayernLB's owners to provide timely support. This may be indicated by a change to SFG's IDRs. The IDRs are also sensitive to changes to its owners' strategic commitment to BayernLB and importance of BayernLB for its home region or for the savings bank sector.

A change to our assessment of the risks of triggering a resolution process ahead of support for a Landesbank could also affect the SRs, IDRs and senior unsecured debt ratings.

VR
BayernLB's VR is primarily sensitive to a change in Fitch's assumptions regarding the strength of the economic environment in Germany, which is a main driver of BayernLB's business performance. The VR could see upward pressure if BayernLB's capitalisation strengthens and if profitability improves further, which we do not expect in the short-term.

The VR would come under pressure if deterioration in the economy leads to weaker corporate asset quality and significantly higher loan impairment charges that affect the bank's earnings capacity.

STATE-GUARANTEED/GRANDFATHERED SENIOR, SUBORDINATED AND MARKET LINKED SECURITIES
BayernLB's state-guaranteed/grandfathered senior and subordinated debt ratings and market-linked securities are sensitive to changes in Fitch's view of the creditworthiness of Bavaria, which is closely linked to that of the Federal Republic of Germany.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
BayernLB's subordinated debt and other hybrid instruments ratings are primarily sensitive to changes in the bank's VR. The rating of the securities issued by BayernLB Capital Trust I is also sensitive to changes in their notching, which could arise if Fitch concludes that incremental non-performance risk had increased. This could be the result of a substantial weakening of the bank's performance, which could increase the risk of coupon non-payment.

The rating actions are as follows:

Bayerische Landesbank
Long-Term IDR: affirmed at 'A-'; Outlook Stable
Short-Term IDR: affirmed at 'F1'.
Support Rating: affirmed at '1'
Viability Rating: upgraded to 'bbb' from 'bb+'
Long- and Short-term senior debt, including programme ratings: affirmed at 'A-'/'F1'
Commercial paper: affirmed at 'F1'
State-guaranteed/grandfathered senior and subordinated debt: affirmed at 'AAA'
State-guaranteed/grandfathered market-linked securities: affirmed at 'AAAemr'
Senior market-linked securities: affirmed at 'A-emr'
Subordinated debt: upgraded to 'BBB-' from 'BB'

BayernLB Capital Trust I
Hybrid capital instruments: upgraded to 'BB-' from 'CCC'