DBRS Confirms DZ BANK at AA (low), Changes Trend to Negative

DBRS has today confirmed the ratings of DZ BANK AG Deutsche Zentral-Genossenschaftsbank (DZ BANK or the Bank) and changed the trend on its long-term ratings to Negative from Stable, including the trend on DZ BANK’s Senior Unsecured Long-Term Debt rating of AA (low). The Bank’s Short-Term Debt rating of R-1 (middle) was confirmed with a Stable trend.

The rating actions reflect the sound underlying franchise of the German Cooperative Financial Services Network (CFSN, FinanzVerbund), of which DZ BANK forms a key component. DBRS’s ratings for DZ BANK are based on the financial profile of the overall cooperative banking sector, given the strong cohesion and the robust support mechanism among CFSN’s member institutions. The cooperative banking sector comprises DZ BANK Group, about 1,200 local cooperative banks and other entities, which together form the second largest financial services provider in Germany. CFSN has a history of generating stable income from its resilient retail and business banking franchises. The sector’s sound capitalisation, solid liquidity, decentralised model and robust support mechanism should enable CFSN to cope with the significant challenges posed by the financial crisis and the deteriorating economy, which affect the financial industry overall.

The Negative trend change for DZ BANK’s long-term ratings reflects DBRS’s concern that the Bank faces significant asset quality challenges at a time when the worsening economic environment is also placing pressure on its underlying income and on CFSN overall. DBRS expects negative valuation effects related to the ongoing financial markets crisis and the deteriorating economy to weigh on the overall sector’s earnings in the near term.

DZ BANK, like other financial institutions, has sustained writedowns and negative valuation effects from exposures to Lehman Brothers, the Icelandic banks and other financial institutions. In addition, DZ BANK holds a portfolio of asset-backed securities (ABS) amounting to EUR 26.4 billion as of June 2008, which has sustained negative valuation effects and impairments in recent periods. Moreover, DZ BANK has sizeable holdings of public-sector bonds and other assets that have also sustained negative valuation effects. As a result, earnings for the first ten months of 2008 have been negative for DZ BANK Group; however, DZ BANK Group has stated that it expects positive earnings for the full-year 2008.

DBRS expects earnings of CFSN overall to remain under pressure in the near term, due to DZ BANK’s challenges and also to lower earnings at the 1,200 local cooperative banks that are part of CFSN. The local cooperative banks have been negatively affected by the financial crisis and they, like other financial institutions, are exposed to the deteriorating economic environment. DBRS expects CFSN overall to remain profitable in 2008; however, the current challenges limit CFSN’s ability to absorb potential further negative effects from the financial crisis out of current earnings.

DBRS recognises that the financial crisis has also reduced competition among banks, increased margins and led to a renewed focus on traditional lending and deposit-taking business models. This benefits the cooperative banks, which have experienced deposit inflows in recent months. However, in DBRS’s view, these benefits are likely to be outweighed by the negative effects from the crisis over the short term.

The capitalisation of both DZ BANK and CFSN remains sufficient, with a 8.8% core capital ratio as of June 2008 for DZ BANK and a total capital ratio (under Basel I) of 12.3% for CFSN as of year-end 2007. DBRS notes positively that DZ BANK is focused on further enhancing its capital position. The strong retail deposit franchise of the 1,200 local cooperative banks within CFSN supports the sector’s solid liquidity profile.

DBRS will monitor how DZ BANK addresses the significant challenges it faces and how these challenges affect the overall CFSN, of which DZ BANK forms a major component. If DZ BANK manages to reduce its market crisis-related losses, while maintaining sound underlying performance and reducing its risk exposure, the long-term ratings trend could revert back to Stable. If, however, the Bank continues to sustain further losses and the overall sector’s earnings power is further diminished, this could have negative rating implications.

Notes:
The applicable methodology is Analytical Background and Methodology for European Bank Ratings, Second Edition, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.