OREANDA-NEWS. Fitch Ratings has placed Duesseldorfer Hypothekenbank AG's (DHB) 'BBB-' Long-term Issuer Default Rating (IDR) on Rating Watch Negative (RWN) and downgraded its Viability Rating (VR) to 'c' from 'ccc'. A full list of rating actions is at the end of this rating action commentary.

The downgrade of the VR reflects external events since the affirmation of DHB's ratings on 24 February 2015 (see 'Fitch Affirms 3 German CRE Lenders' at fitchratings.com). In light of DHB's highly concentrated single exposures in its legacy public-sector portfolio, Fitch believes that these events make the bank more vulnerable to adverse credit events than previously expected and could overstretch its tight financial flexibility.

In addition, we have placed DHB's IDRs and other support-driven ratings on RWN to reflect the likelihood of downgrade unless there are clear signs of external support for the bank in the near future, given that the need for such support has, in Fitch's view, become urgent. DHB's IDRs reflect the agency's opinion that support will be available ultimately from the German government, most likely via the voluntary deposit protection fund (DPF) of the country's private sector banks.

KEY RATING DRIVERS AND SENSITIVITIES - IDRs, SUPPORT RATING (SR), SUPPORT RATING FLOOR (SRF) AND DEBT ISSUANCE PROGRAMME
DHB's Long-term IDR is at its SRF, which is at the low end of the investment-grade category and reflects the track record of systemic support available even to small specialised German Pfandbrief issuers. Fitch would expect systemic support to come firstly from the DPF. However, if the DPF's resources prove insufficient, we would expect the German government to channel systemic support via the DPF. This scenario would be comparable with the provision of support to Bankhaus Lehman AG in 2008.

The RWN on the IDRs, SR, SRF and debt issuance programme reflect the uncertain timing of the external support providers' response to the capital need that Fitch believes has become necessary by the recent developments. We would need support to be forthcoming to affirm the ratings. If there is no tangible and credible evidence in the near term that support will be available but the bank is still operating as a going concern, we expect to downgrade the Long-term IDR to 'BB-', and the Short-term IDR to 'B', by end-1H15. This would be based on our view that there would still be a moderate probability of support from DPF once a need for such support is identified by the regulator. We could downgrade the Long-term IDR to as low as 'C' (assuming no default) if no support is forthcoming.

In addition, in Fitch's view, the implementation of the bank resolution framework in Germany will reduce sovereign support for banks, including through the DPF. Germany has implemented the European Bank Recovery and Resolution Directive (BRRD) into national law including early adoption of the bail-in tool. Consequently, we expect to revise DHB's SRF to 'No Floor' by end-1H15.

While systemic support is clearly decreasing, we expect DHB's institutional deposit base to continue to benefit from the DPF's extensive coverage. The DPF effectively guarantees all of DHB's otherwise unsecured funding. This creates a high incentive for DPF to extend institutional support to DHB, which we would likely factor into DHB's IDRs. We are therefore unlikely to downgrade the Long-term IDR to below 'BB-' unless there are signs that DPF support may not be forthcoming. Fitch will shortly publish a special report outlining its approach to factoring in potential support from the DPF for small German banks in the BRRD environment.

DHB's sale to a group of European financial investors was agreed in August 2014 and is still pending regulatory approval. Should this change in ownership go ahead, in our view it is unlikely to address DHB's severe capital and liquidity weaknesses, and Fitch generally considers financial investors' ability and propensity to support banks as unreliable. We believe that the combination of the bank's weaknesses, the nature of the buyer and recent detrimental external events are likely to at best delay the sale.

KEY RATING DRIVERS AND SENSITIVITIES - VR
The recent detrimental external events combined with the high concentration risk inherent to DHB's legacy public-sector assets significantly increase the bank's credit and liquidity risks, which in Fitch's view now exceed the bank's weak risk absorption capacity. Consequently, we believe that DHB now displays an exceptionally high level of fundamental credit risk and failure of the bank is inevitable unless it receives capital support, as indicated by the downgrade of the VR to 'c' from 'ccc'.

An upgrade of DHB's VR would require a large capital injection and a reasonable level of certainty that the liquidity risks arising from recent developments will not materialise.

The rating actions are as follows:
Long-term IDR: 'BBB-', placed on RWN
Short-term IDR: 'F3', placed on RWN
Viability Rating: downgraded to 'c' from 'ccc'
Support Rating: '2', placed on RWN
Support Rating Floor: 'BBB-', placed on RWN
Debt issuance programme: 'BBB-'/'F3', placed on RWN