DBRS Comments on End of DZ BANK /WGZ BANK Merger Talks, 2008 Coop Banks’ Results – Ratings Unchanged

DBRS has today commented that its ratings for DZ BANK AG Deutsche Zentral-Genossenschaftsbank (DZ BANK) are unchanged, following the end of merger talks between DZ BANK and WGZ BANK AG Westdeutsche Genossenschafts-Zentralbank (WGZ BANK) and the announcement of the local German cooperative banks’ 2008 results.

DBRS rates Senior Unsecured Long-Term Debt of DZ BANK at AA (low), with a Negative trend, while Short-Term Debt is rated at R-1 (middle), with a Stable trend. DZ BANK’s ratings are based on the cohesion, franchise strength and underlying earnings generation ability of the overall German Cooperative Financial Services Network (CFSN or the Sector), of which DZ BANK forms an integral part. CFSN comprises approximately 1,200 local cooperative banks, DZ BANK as the national central institution and specialised service providers, including WGZ BANK. These entities are linked together through CFSN’s Protection Scheme, a support mechanism designed to ensure the viability of each member.

The end of merger talks between DZ BANK and WGZ BANK does not materially affect the financial strength of CFSN overall and, therefore, has no rating implications. In DBRS’s view, the proposed merger would have been marginally positive for CFSN, because it would have allowed for cost synergies and streamlined the Sector’s structure by creating a single central institution serving all local cooperative banks. Nonetheless, the Sector’s risk profile is unaffected, since both DZ BANK and WGZ BANK remain part of CFSN.

The earnings generation ability of CFSN, which is an important rating factor, remains underpinned by the local cooperative banks. The local cooperative banks reported preliminary earnings before risk provisions and taxes of EUR 4.8 billion for 2008 on 25 March 2009. Pre-provision, pre-tax earnings were down 13% from the prior year, holding up reasonably well, although the financial crisis and flat yield curve weighed on income from financial investments and net other income. Net interest income remained stable at EUR 13.2 billion, fees and commissions declined only slightly by 2% year-over-year to EUR 4.1 billion, while administrative expenses were 0.4% lower at EUR 13.0 billion. After-tax earnings of EUR 1.4 billion for 2008 were down 25% from the prior year, primarily due to sharply higher risk provisions on securities holdings of EUR 2.2 billion, reflecting the impact of the financial crisis, in particular write-downs on exposure to Lehman Brothers and Icelandic banks. DBRS views the local cooperative banks’ performance as acceptable, given the challenging environment.

The local cooperative banks’ stable liquidity profile and solid capitalisation also support CFSN’s overall financial profile, which is underpinning the ratings. The local cooperative banks reported a 4.5% increase in customer deposits, ending 2008 at EUR 461 billion. The local cooperative banks’ combined core (tier 1) capital ratio stood at a respectable 10.6% at year-end 2008, up from 9.4% at year-end 2007. The local banks increased their combined core regulatory capital resources by 2.7% to EUR 49.3 billion, largely through earnings retention.

DBRS notes that the positive earnings generated in 2008 by the local cooperative banks are partly offset by DZ BANK’s net loss of EUR 1.0 billion for 2008 and by a reported EUR 195 million net loss at WGZ BANK. As a result, CFSN’s consolidated 2008 net profit is likely to be down substantially from EUR 1.5 billion in 2007. DBRS recognises, however, that the loss at DZ BANK was driven by extraordinary negative effects from the financial crisis of a negative EUR 2.3 billion, including write-downs on bank bonds, government bonds and asset-backed securities (ABS), as well as losses from the failure of Lehman Brothers and Icelandic banks. Excluding these extraordinary effects, DZ BANK generated considerable positive underlying earnings.

DBRS believes that the risk guarantee that CFSN’s Protection Scheme has decided to provide to a portion of DZ BANK’s portfolio of asset-backed securities (ABS), indicates DZ BANK’s continued access to support from within CFSN. In DBRS’s view, the risk guarantee demonstrates CFSN’s cohesion, which is an important rating factor. The risk guarantee covers about EUR 1 billion of DZ BANK’s ABS assets, reducing regulatory capital requirements for the Bank. While DBRS views the risk guarantee as an important signal of support, it is not viewed as substantially altering the risk inherent in DZ BANK’s large overall ABS portfolio of EUR 22.2 billion as of 31 December 2008.

The Negative long-term ratings trend reflects DBRS’s concerns about the impact of the ongoing financial crisis and the deepening recession in Germany on CFSN’s ability to support its member institutions, including DZ BANK. DBRS sees DZ BANK facing significant asset quality challenges at a time when the earnings of the local cooperative banks are reduced by the very challenging environment.

Note:
All figures are in euros unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.