Fitch Upgrades German Cooperative Banks and DZ BANK to 'AA-'/Outlook Stable
In addition, Fitch has upgraded the Long-term IDRs of 1,062 members of GFG's mutual support scheme to 'AA-' from 'A+' with a Stable Outlook. The agency has also affirmed and withdrawn the IDRs of 31 local cooperative banks, members of the scheme, as a result of their mergers into other rated members. A full updated list of GFG's 1,062 rated members following these rating actions is available at www.fitchratings.com or via the link above.
GFG is Germany's cooperative financial services network and the country's second-largest domestic retail banking group.
KEY RATING DRIVERS- VR AND IDRs
Following the EUR1.5bn capital injection in DZ BANK in mid-2014, capital allocation within the group has improved. This mitigates our view of more limited fungibility of capital compared with, for instance, capital fungibility within a listed banking group.
While GFG continues to maintain a decentralised structure, increasing regulatory demands for more robust and more frequent group-wide reporting means that GFG is, in our view, now better positioned to react swiftly to external shocks and that GFG's financial data is becoming more comparable with that of peers.
After several years of disposing of non-core activities, DZ BANK and WGZ BANK are now less exposed to more volatile asset classes, which should reduce the group's overall earnings volatility and the need for additional capital injections in GFG's central institutions. We consider that the central institutions' strategy to be increasingly aligned with GFG's, which underpins our view that the central institutions are closely integrated into the group and therefore are assigned a group rating.
GFG's profitability has proven to be resilient in the continued low-interest rate environment. While we expect net interest income (NII) to suffer in the medium-term, assuming interest rates remain low, GFG's profitability is in our opinion sufficiently strong, flexible and diversified to absorb a significant reduction in NII without jeopardising the group's overall financial flexibility.
GFG's VR and IDRs continue to be underpinned by its strong and diversified nationwide banking franchise, which results in considerable pricing power, low-risk and granular credit exposure and strong asset quality and profitability indicators which are in line or better than those of international peers rated in the low 'AA' rating range. GFG's VR and IDRs also reflect the group's strong funding profile, capitalisation and leverage.
GFG's VR and IDRs also factor in a still sizeable but manageable exposure to higher risk and more volatile asset classes at GFG's two central institutions as well as pressure on operating costs from increasing regulatory requirements.
The IDRs (group ratings) apply collectively to GFG as a group and individually to the scheme's 1,062 members. The IDRs are based on the approach described in Fitch's "Global Bank Rating Criteria". In line with these criteria, no VR is assigned to the individual members (including DZ BANK).
GFG's VR and IDRs reflect the group's high cohesiveness, which is supported by its tested mutual support mechanism. The protection scheme providing GFG's members with mutual support is managed by Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (BVR).
Fitch considers the likelihood of mutual support, if needed, as extremely high given GFG's extensive track record, and its members' deep institutional integration. To date, the support mechanism has always been sufficient to support even GFG's largest members.
GFG's primary banks reported their 2014 result today. Pre-tax profit for 2014 of EUR7.3bn was broadly unchanged from 2013. Solid loan growth and negligible loan impairment charges compensated for continued pressure on the banks' net interest margin resulting from lower NII arising from structural interest rate positions. GFG's 2014 consolidated results, including DZ Bank, will in our view likely exceed 2013's, largely due to significant non-recurring gains at DZ BANK.
The IDRs of DZ BANK are group ratings and as such, the key rating drivers are identical to GFG's.
While DZ BANK's exposure to higher-risk business lines including commercial real estate (largely at Deutsche Genossenschafts-Hypothekenbank AG (DG HYP)), ship finance (at DVB BANK SE (DVB)) or leasing (VR Leasing) remains significant, its overall risk profile benefits from significant diversification including its large and fairly low-risk building sociecty (Bausparkasse Schwaebisch Hall AG (BSH)), insurance businesses (R+V, Insurer Financial Strength rating of 'AA-') and sizeable and performing asset management subsidiary (Union Investment).
In 2014, DZ BANK performed strongly with pre-tax income adjusted for non-recurring items significantly above its EUR1.5bn annual pre-tax target. Reported pre-tax income was EUR2.9bn but included significant one-off effects related to fair-value gains on bonds (EUR327m, largely at DG HYP), accounting changes regarding net fee income at BSH, gains on own credit spreads and the sale of equity participations. We believe that DZ BANK's EUR1.5bn pre-tax target is achievable in 2015 despite continued pressure on NII (down 2.2% y-o-y in 2014) and steadily increasing operating expenses (up 5.1% y-o-y).
DZ BANK's capitalisation improved significantly during 2014, largely as a result of a EUR1.5bn capital increase subscribed for by GFG members in 3Q14 and adequate internal capital generation. As a result, its fully-loaded common equity Tier 1 ratio of 11.4% at end-2014 compares adequately with peers. Leverage is weaker than that of many peers (end-2014 fully-applied Basel III leverage ratio of 3.2%) but on an improving trend.
DZ BANK's funding and liquidity are strong, benefitting from local banks' placing excess liquidity with the bank. Reliance on wholesale funding markets is moderate and largely met by covered bond issuance.
RATING SENSITIVITIES - VR AND IDRs
Following the upgrade, upside potential for GFG's VR and Long-term IDR is limited. This is reflected in the Stable Outlook on GFG's Long-term IDR.
Downside pressure, while currently also limited, could arise from a severe domestic recession resulting in sharply higher corporate default rates. The group ratings are also sensitive to significant regulatory changes or changes in the group's strategy affecting its cohesiveness, neither of which we expect.
While we expect GFG's profitability to moderately worsen in 2015 and 2016 due to pressure on NII, GFG's financial flexibility and internal capital generation will in our view remain sufficiently strong for its rating level and moderately weaker profitability on its own would therefore not lead us to downagrade GFG's VR and IDRs. In addition, should a fall in profitability be more pronounced than we currently expect, then GFG would have considerable scope to improve its cost efficiency, which suffers from its decentralised structure.
As group ratings, DZ BANK's IDRs' rating sensitivities are identical to GFG's.
KEY RATING DRIVERS - SUPPORT RATING AND SRF
GFG's SRF is based on our view that there is an extremely high probability that the German state (AAA/Stable) would support GFG or individual members if needed, given GFG's systemic importance.
DZ BANK's SRF reflects Fitch's view of the likely state support available to the bank if a severe crisis, compounded by DZ BANK's size, proved so substantial that it was beyond GFG's ability to support. Systemic support would, in our view, be motivated by GFG's reliance on DZ BANK to serve the vast majority of the group's 30 million domestic clients. In Fitch's opinion, state support to GFG would likely be channelled through the mutual support scheme or DZ BANK. The latter's SRF is aligned with GFG's. However, we view the risk that GFG or DZ BANK may require state support in the foreseeable future as remote.
RATING SENSITIVITIES - SUPPORT RATING AND SRF
In our view, legislative, regulatory and policy initiatives in Germany and the euro zone are reaching a point where a resolution of a large bank or banking group can be achieved without excessively disrupting financial markets. The EU's Bank Recovery and Resolution Directive (BRRD) has been implemented into German legislation (BRRD-Umsetzungsgesetz) and the Single Resolution Mechanism (SRM) for eurozone banks starts on 1 January 2016. These will dilute the influence Germany has in deciding how German banks are resolved, which in Fitch's view, increases the likelihood of senior debt losses if a bank becomes non-viable.
The SR and SRF are sensitive to progress made in implementing the BRRD and SRM. The BRRD-Umsetzungsgesetz requires 'bail in' of creditors in banks under resolution from 1 January 2015 before an insolvent bank can be recapitalised with state funds. The SRM will be in place in a year's time. This should all mean that GFG members will be 'resolvable' without jeopardising the wider financial system. Once resolution tools and mechanisms have been put in place they will become an overriding factor in our support-driven ratings.
Fitch expects to downgrade GFG's and DZ BANK's Support Ratings to '5' and revise their SRF to 'No Floor' during 1H15. Since GFG's and DZ BANK's IDRs are based on GFG's VR, the revision of the SRF to 'No Floor' would have no effect on the IDRs which would remain unchanged. In the meantime, GFG's SRF remains sensitive to changes in Germany's ability to support as reflected in its sovereign rating (AAA/Stable).
KEY RATING DRIVERS AND SENSITIVITIES - SUBORDINATED AND HYBRID SECURITIES
Subordinated debt and hybrid capital instruments issued by DZ BANK and DG HYP have all been upgraded by one notch, mirroring the one-notch upgrade of GFG's VR. The use of GFG's VR as the anchor rating is based on Fitch's view that GFG will at all times ensure that DZ BANK and DG HYP are able to meet their payments on these instruments. Consequently, these bonds' ratings are primarily sensitive to a change in GFG's VR.
DZ BANK and DG HYP's lower Tier 2 subordinated debt instruments are notched down once from GFG's VR in line with Fitch criteria. Most hybrid capital instruments (see list below) are notched five times from GFG's VR (twice for loss severity, three times for incremental non-performance risk relative to the VR). DZ Bank Capital Funding Trust I is rated four notches below GFG's VR, including only two notches for incremental non-performance risk as this instrument's distribution trigger is in our view less likely to be activated than in other rated hybrids.
The rating actions are as follows:
GFG
Long-Term IDR: upgraded to 'AA-' from 'A+', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Viability Rating: upgraded to 'aa-' from 'a+'
Support Rating: affirmed at '1'
Support Rating Floor: affirmed at 'A+'
1,062 members of GFG's mutual support scheme
Long-Term IDR: upgraded to 'AA-' from 'A+', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
The IDRs of the following 31 members have been upgraded to 'AA-' from 'A+'. The Short-term IDR has been affirmed at 'F1+'. The Outlook is Stable. All ratings have been withdrawn as a result of the institutions' mergers into other rated members of the group:
Volksbank Seeheim-Jugenheim eG
Raiffeisenbank Kempten eG
Raiffeisenbank Teck eG
Volksbank Freiberg und Umgebung eG
Enztalbank eG
Volksbank Nagoldtal eG
Volksbank Saar-West eG
Raiffeisenbank Friedelsheim-Roedersheim eG
Birsteiner Volksbank eG
Spar- und Darlehnskasse Schloss Holte-Stukenbrock eG
Bielefelder Volksbank eG
Volksbank Grevenbrueck eG
Vereinigte Volksbank eG Telgte
Vereinigte Volksbank eG Wernigerode
Volksbank Kehdingen eG
Vereinigte Volksbank eG
Raiffeisenbank Thuengersheim eG
Raiffeisenbank Neunkirchen am Brand eG
Raiffeisenbank Wildenberg eG
Volksbank Guenzburg eG
Raiffeisenbank Hallbergmoos-Neufahrn eG
Volksbank Tailfingen eG
Raiffeisenbank Donau-Iller eG
Raiffeisenbank Ingoldingen eG
Raiffeisenbank Lutzerather Hoehe eG
VR-Bank Mainz eG
Raiffeisenbank Trendelburg eG
Evangelische Darlehnsgenossenschaft eG
Volksbank Einbeck eG
Volksbank Langen-Gersten eG
Volksbank eG Elmshorn
Volks- und Raiffeisenbank Wismar eG
DZ BANK
Long-Term IDR: upgraded to 'AA-' from 'A+', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Support Rating: affirmed at '1'
Support Rating Floor: affirmed at 'A+'
Debt issuance programme: Long-term rating upgraded to 'AA-' from 'A+', Short-term rating affirmed at 'F1+'
Senior unsecured notes: Long-term rating upgraded to 'AA-' from 'A+', Short-term rating affirmed at 'F1+'
Market linked securities: upgraded to 'AA-emr' from 'A+emr'
Subordinated LT2 notes: upgraded to 'A+' from 'A'
DZ BANK's hybrid capital instruments (preferred stocks):
EUR300m DZ Bank Capital Funding Trust I (DE0009078337): upgraded to 'BBB+' from 'BBB'
EUR500m DZ Bank Capital Funding Trust II (DE000A0DCXA0): upgraded to 'BBB' from 'BBB-'
EUR350m DZ Bank Capital Funding Trust III (DE000A0DZTE1): upgraded to 'BBB' from 'BBB-'
EUR10m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series I (DE000A0GN869): upgraded to 'BBB' from 'BBB-'
EUR50m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series VI (DE000A0GLDZ3): upgraded to 'BBB' from 'BBB-'
EUR100m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series VII (DE000A0GMRS6): upgraded to 'BBB' from 'BBB-'
EUR100m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series VIII (DE000A0GWWW7): upgraded to 'BBB' from 'BBB-'
EUR50m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series IX (DE000A0NTTT1): upgraded to 'BBB' from 'BBB-'
DG HYP
Long-Term IDR: upgraded to 'AA-' from 'A+', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Debt issuance programme: Long-term rating upgraded to 'AA-' from 'A+', Short-term rating affirmed at 'F1+'
Senior unsecured notes: upgraded to 'AA-' from 'A+'
Subordinated LT2 notes: upgraded to 'A+' from 'A'
DVB BANK
Long-Term IDR: upgraded to 'AA-' from 'A+', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Debt issuance programme: Long-term rating upgraded to 'AA-' from 'A+', Short-term rating affirmed at 'F1+'
Senior unsecured notes: upgraded to 'AA-' from 'A+'
Subordinated LT2 notes: upgraded to 'A+' from 'A'
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