OREANDA-NEWS. Fitch Ratings has affirmed German saving banking group Sparkassen-Finanzgruppe's (Sparkassen) Long-term Issuer Default Ratings (IDR) at 'A+' with a Stable Outlook and Viability Ratings (VR) at 'a+'. The Support Rating (SR) has been affirmed at '5' and the Support Rating Floor (SRF) at 'No Floor'. A full list of rating actions is at the end of this rating action commentary.

At the same time, Fitch has affirmed the 'A+' Long-term IDRs of 354 savings banks with a Stable Outlook. A full list of these banks is available at www.fitchratings.com or via the link above.

Fitch rates 354 Sparkassen members (of a total of 409 as of 5 January 2016) on the basis of a group rating based on mutual support. A group of 50 savings banks in Hessen and Thuringia are rated separately as part of S-Finanzgruppe Hessen-Thueringen (A+/Stable/F1+) on the basis of mutual support within that group in addition to support within SFG.

Sparkassen, an unconsolidated grouping of retail-oriented savings banks, are an integral part of Germany's public financial services sector, the Sparkassen-Finanzgruppe (SFG), and Germany's financial sector as a whole. At end-2014, Sparkassen had domestic lending and customer deposit market shares of 28% and 31%, respectively.

The affirmation of Sparkassen's IDRs and VR reflects their stable and consistent business performance supported by Germany's healthy economic environment. The Stable Outlook primarily reflects Fitch's view that growth forecasts for Germany suggest a stable operating performance.

KEY RATING DRIVERS
IDRs and VR
Sparkassen's IDRs are based on SFG's VR. The group's management and strategy has a high influence on the VR. We consider that Sparkassen is among the least cohesive groups where Fitch assigns group ratings. The decentralised structure of the Sparkassen continues to constrain our assessment of the group's management and governance as the group does not prepare formally audited consolidated financial statements, and information available on asset quality and exposure to other members of the SFG, including the Landesbanken, is less detailed than at most other domestic and foreign banking groups. However, we believe that various initiatives launched by Deutscher Sparkassen- and Giroverband (DSGV), the group's central body, to implement group-wide standards for regulatory reporting under the leadership of a central advisory council, should improve efficiency and strengthen the group's cohesiveness over time.

Sparkassen's VR is underpinned by the group's leading domestic retail franchise, granular and relatively low-risk credit exposure, solid and resilient deposit funding profile and stable profitability. These key positive rating drivers are reflected in the group's financial metrics, which are stronger than many of its domestic and foreign peers.

Sparkassen's risk appetite in general is moderate, reflecting their consistent long-term oriented growth strategies, deep expertise of the local economies and their customers and strong granularity in their loan exposures. However, strengthening in loan demand, particularly for housing mortgages, which became more visible in 1H15 suggests a moderate willingness to add to risks. We also see challenges for the group to manage interest rate risk in the banking book due to structural unhedged maturity transformation, which is increasing as sight deposits are growing.

Fitch considers the group's asset quality as strong. We believe that the robust macroeconomic performance in 2014/15, including Germany's low unemployment rate of around 6%, a declining trend in corporate and small businesses insolvencies and improving SME and corporate balance sheets, positively affected the group's asset quality. We estimate that Sparkassen's non-performing loan ratio on average is well below their long-term level. Non-performing loans declined in 2014, but we believe that they have reached their cyclical low and expect a moderate increase in 2015 and 2016.

Sparkassen's performance has benefited loan growth and low loan impairment charges, and net interest income remained stable in 2014. Capitalisation has benefited from profit retention, and the group's CET1 capital ratio of 14.38% at end-2014 compared well with peers, considering conservative risk weightings. However, we expect earnings to come under pressure as a result of persistently low interest rates, which worsen pressure on net interest income and financial efficiency. The group's operating expenses are likely to increase further and in our view, remain inflexible, despite the first signs of a stronger consolidation within the Sparkassen sector. We consider planned branch closures and streamlining of back office functions and IT applications less of an immediate cure to cost inefficiencies but rather a long-term process.
Sparkassen are deposit funded and have structural excess liquidity. We believe the group's sound funding and liquidity profile is a key rating strength. Where Basel III liquidity ratios could pose a challenge for a small minority of savings banks, this is mitigated by the availability of collective intragroup solutions.

The VR also factors in contingent risks from Sparkassen exposure (both participations and funding) to Landesbanken. Despite the fact that the Landesbanken sector recovered in 2015 as a whole, we believe the northern Landesbanken remain vulnerable to a deterioration of their large shipping exposures and a weak euro as reflected by the VR downgrades of NORD/LB and Bremer LB in May 2015. HSH Nordbank AG is subject to either privatisation or wind-down some time in 2018 following requirements of the European Commission's state-aid decision in October 2015.

SUPPORT RATING AND SUPPORT RATING FLOOR
SFG's SR and SRF reflect Fitch's view that legislative, regulatory and policy initiatives have substantially reduced the likelihood of sovereign support for banks in the European Union. The BRRD-Umsetzungsgesetz which requires 'bail in' of creditors in banks under resolution before an insolvent bank can be recapitalised with state funds came into force on 1 January 2015 and the Single Resolution Mechanism (SRM) providing resolution tools and mechanisms started on 1 January 2016. As a result, Fitch believes that extraordinary external support from the sovereign in the event that SFG becomes non-viable- while possible- can no longer be relied upon.

RATING SENSITIVITIES
IDRs and VR:
The group's IDRs and VR are primarily sensitive to a change in Fitch's assessment of the group's cohesiveness. Despite improvements that should strengthen the group's cohesiveness and effectiveness, we do not believe that this development in itself is yet sufficiently strong to result in an upgrade of the VR in the short term. However, further measures to strengthen the consolidated risk monitoring or provide consolidated financial accounts could result in upward pressure on the VR in the medium term.

If the group manages to remain resilient to the effects of low interest rates on its earnings, which is a key driver for its capitalisation, the VR could come under upward pressure. However, we believe that this will be a challenge, and we expect earnings to come under pressure.

A severe and prolonged domestic recession combined with a continuation of low interest rates or even further declines is a key risk to Sparkassen's VR that could lead to a downgrade if it results in a sharp drop in earnings in combination with deteriorating asset quality and rising loan impairment charges. The VR could also come under pressure in the unlikely event of sharply rising interest rates due to the interest rate risk exposure in the banking book.

The group's VR remains sensitive to changes in their contingent liabilities, which include contingent liabilities to the Landesbanken sector. We do not expect any immediate impact over the short term as we believe Landesbanken will be profitable in 2015. However, the cyclicality of their business models or changes in their asset quality makes them vulnerable to an economic downturn.

SUPPORT RATING AND SUPPORT RATING FLOOR:
An upgrade of SFG's SR and an upward revision of its SRF would be contingent on a positive change in our view on Germany's propensity to support its systemically important banks. While not impossible, this is highly unlikely.

The rating actions are as follows:

Sparkassen-Finanzgruppe (Sparkassen)
Long-term IDR: affirmed at 'A+'; Outlook Stable
Short-term IDR: affirmed at 'F1+'
VR: affirmed at 'a+'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'

354 savings banks: IDRs affirmed at 'A+' and 'F1+'; Outlook Stable

The group ratings apply to 354 savings banks out of a total of 409 banks at 8 January 2016.