Fitch Affirms German Cooperative Banks and DZ BANK at 'AA-'; Outlook Stable

In addition, Fitch has affirmed the Long-term IDRs of 1,033 members of GFG's mutual support scheme at 'AA-' with a Stable Outlook. A full updated list of rated GFG members is available at www.fitchratings.com or via the link above.

KEY RATING DRIVERS
IDRS, VR AND SENIOR DEBT
GFG's solid capitalisation has a high influence on its VR and IDRs. The ratings also reflect GFG's strong domestic franchise, particularly in retail banking, good funding, sound asset quality and stable earnings, but also relatively high exposure to structural interest rate risk. They also factor in the group's increasing cohesivness, which is demonstrated among other things by the planned merger of DZ BANK with Westdeutsche Genossenschafts-Zentralbank AG (WGZ BANK).

While GFG continues to maintain a decentralised structure, increasing regulatory demands regarding more robust and more frequent group-wide reporting means that GFG is further strengthening its capacity to react swiftly to external shocks, which should result in improved governance of the group in Fitch's view.

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 is increasingly aligned with GFG's, which is also shown by the announced merger of these institutions, which should be completed by August 2016.

GFG's profitability has remained resilient despite low interest rates putting pressure on margins. We expect net interest income (NII) to suffer in the medium term if interest rates remain low, but in our opinion GFG's profitability is sufficiently strong, flexible and diversified to absorb a significant reduction in NII without jeopardising the group's overall financial flexibility.

GFG's sound earnings and strong capitalisation provide a solid buffer to protect against the impact of a possible sudden rise in interest rates, which is a very unlikely sceanrio in our view.

GFG's VR and IDRs reflect the group's high cohesiveness, which is supported by its tested mutual support mechanism and a recognised deposit protection scheme. In 2015, GFG set up a new deposit protection scheme to fulfil statutory requirements in addition to its already existing mutual support fund, which is now an additional, less regulated, voluntary scheme to protect members' viability. Both entities are managed by the National Association of German Cooperative Banks (BVR), which is also responsible for risk monitoring.

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.

The IDRs of DZ BANK and of its subsidiaries Deutsche Genossenschafts-Hypothekenbank AG (DG HYP), and DVB BANK SE (DVB) 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 DG HYP), ship finance (at DVB) or leasing (VR Leasing) remains material, its overall risk profile benefits from significant diversification including its large and fairly low-risk building society (Bausparkasse Schwaebisch Hall AG (BSH)), insurance businesses (R+V, Insurer Financial Strength rating of 'AA-') and sizeable and performing asset management subsidiary (Union Investment).

SUPPORT RATING AND SUPPORT RATING FLOOR
GFG'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 GFG becomes non-viable - while possible - can no longer be relied upon.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and hybrid capital instruments issued by DZ BANK and DG HYP are rated one notch below 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.

DZ BANK and DG HYP's lower Tier 2 subordinated debt instruments are notched once below GFG's VR to reflect higher loss severity.

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). Hybrid instruments issued by DZ Bank Capital Funding Trust I are rated four notches below GFG's VR, two notches each for loss severity and for incremental non-performance risk as in our view this instrument's distribution trigger is less likely to be activated than in other rated hybrids.

RATING SENSITIVITIES
IDRS, VRs and SENIOR DEBT
The bank's IDRs and VR are primarily sensitive to a change in Fitch's assessment of the group's cohesiveness. However, the group's VR of 'aa-' is already the highest among peers, limiting further potential for an uplift.

In Fitch's view, downside pressure, while currently also limited, could arise from a severe domestic recession resulting in sharply higher corporate default rates or sudden, material increase in interest rates, especially short-term 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 worsen moderately in 2016 due to pressure on NII, in our view GFG's financial flexibility and internal capital generation will remain sufficiently strong for its rating. Moderately weaker profitability on its own would therefore not lead us to downgrade GFG's VR and IDRs. In addition, should a fall in profitability be more pronounced than we currently expect, GFG would have considerable scope to improve its cost efficiency, which suffers from its decentralised structure.

As group ratings, DZ BANK's, DG HYP's and DVB's IDR sensitivities are identical to GFG's.

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

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of subordinated debt and other hybrid securities is notched from GFG's VR and are therefore primarily sensitive to a change in GFG's VR.

The rating actions are as follows:

GFG
Long-Term IDR: affirmed at 'AA-', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Viability Rating: affirmed at 'aa-'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'NF'

1,033 members of GFG's mutual support scheme
Long-Term IDR: affirmed at 'AA-', Stable Outlook
Short-Term IDR: affirmed at 'F1+'

DZ BANK
Long-Term IDR: affirmed at 'AA-', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Debt issuance programme: Long-term rating affirmed at 'AA-', Short-term rating affirmed at 'F1+'
Senior unsecured notes: Long-term rating affirmed at 'AA-', Short-term rating affirmed at 'F1+'
Market linked securities: affirmed at 'AA-emr'
Subordinated LT2 notes: affirmed at 'A+'

DZ BANK's hybrid capital instruments (preferred stocks):
EUR300m DZ Bank Capital Funding Trust I (DE0009078337): affirmed at 'BBB+'
EUR500m DZ Bank Capital Funding Trust II (DE000A0DCXA0): affirmed at 'BBB'
EUR350m DZ Bank Capital Funding Trust III (DE000A0DZTE1): affirmed at 'BBB'
EUR4.3m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series I (DE000A0GN869): affirmed at 'BBB'
EUR45m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series VI (DE000A0GLDZ3): affirmed at 'BBB'
EUR84m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series VII (DE000A0GMRS6): affirmed at 'BBB'
EUR87m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series VIII (DE000A0GWWW7): affirmed at 'BBB'
EUR40m DZ Bank Perpetual Funding Issuer (Jersey) Limited Series IX (DE000A0NTTT1): affirmed at 'BBB'

DG HYP
Long-Term IDR: affirmed at 'AA-', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Debt issuance programme: Long-term rating affirmed at 'AA-', Short-term rating affirmed at 'F1+'
Senior unsecured notes: affirmed at 'AA-'
Subordinated LT2 notes: affirmed at 'A+'

DVB BANK
Long-Term IDR: affirmed at 'AA-', Stable Outlook
Short-Term IDR: affirmed at 'F1+'
Debt issuance programme: Long-term rating affirmed at 'AA-', Short-term rating affirmed at 'F1+'
Senior unsecured notes: affirmed at 'AA-'
Subordinated LT2 notes: affirmed at 'A+'