DBRS Comments on DZ BANK’s H1 2009 Results – Senior at AA (low), Trend Negative

DBRS has today commented that the ratings for DZ BANK AG Deutsche Zentral-Genossenschaftsbank (DZ BANK or the Bank), including DZ BANK’s Senior Unsecured Long-Term Debt rating of AA (low), are unaffected by the H1 2009 results of DZ BANK Group (DZ Group or the Group). The long-term ratings trend remains Negative, while the trend on DZ BANK’s R-1 (middle) Short-Term Debt rating remains Stable.

DZ Group, which comprises DZ BANK as the main operating bank and several specialised subsidiaries, generated pre-tax income of EUR 643 million in H1 2009, up 30% from the year-ago period. Results were driven by strong trading gains, which more than offset rising credit provisions and continued write-downs on structured credit. Excluding non-recurring effects, underlying income before provisions and taxes was stable, demonstrating DZ Group’s resilient underlying earnings generation ability under challenging conditions. Adjusted for non-recurring losses of EUR 422 million(mainly write-downs on structured credit) and valuation gains of EUR 365 million, underlying pre-provision income in H1 2009 was EUR 1.073 billion. This was almost unchanged from underlying pre-provision earnings of EUR 1.068 billion in H1 2008, excluding EUR 467 million in negative effects from the financial crisis in the year-ago period.

Net interest income remains the largest income driver for DZ Group, adding a level of stability to the revenue mix. At EUR 1.3 billion in H1 2009, net interest income was down 5% year-over-year, partly driven by reduced spread income from capital markets investments, reflecting the low interest rate environment. DZ Group’s joint lending business with the German cooperative banks recorded higher margins and a rising number of new loans, demonstrating robust momentum in this core business. Further impacting earnings, DZ BANK recorded net trading income of EUR 689 million, rising more than ten-fold as credit spreads narrowed and money market conditions were strong. Although DBRS recognises the Bank’s ability to realise the benefit of the market conditions, DBRS does not view trading gains at this level as sustainable, as they depend on uncertain market trends.

DZ Group’s asset-backed securities (ABS) portfolio, which contains primarily real estate-backed securities and other structured assets, continues to pose a drag on earnings owed to write-downs which caused losses of EUR 313 million in H1 2009. Importantly, the ABS portfolio was reduced by 7% during H1 2009 to EUR 22.6 billion (including undrawn liquidity lines to conduits) as of 30 June 2009 due to repayments. DZ Group benefited from capital relief, as it received a risk guarantee on EUR 1.1 billion of the ABS from the Protection Scheme, the support mechanism of Germany’s Cooperative Financial Services Network (CFSN) to which DZ Group belongs. The guarantee demonstrates the availability of support from CFSN, which is a key factor underpinning the ratings.

Given DZ Group’s solid underlying earnings ability, DBRS views DZ Group as well positioned to cope with further rising credit costs. Loan impairments are expected to remain high, due to the lagging effect from higher corporate insolvencies and unemployment. Risk provisioning in the lending business more than tripled in H1 2009 from the prior-year period to EUR 373 million. DBRS views positively that DZ Group bolstered its reserve buffer in H1 2009, with loan loss reserves growing at a higher rate of 9.1% compared to the 5.3% decrease in total lending volume.

DZ Group made progress in H1 2009 in implementing its capital strengthening plan. The risk guarantee from the Protection Scheme and the issuance of EUR 500 million in tier 1 hybrids helped raise the core capital (tier 1) ratio to 8.6% as of 30 June 2009 from 7.4% at year-end 2008, which is viewed as sufficient. The successful closure of both transactions demonstrates DZ Group’s access to support from CFSN. In addition DZ Group plans to raise up to EUR 400 million of share capital in H2 2009 from its owners, the local cooperative banks.

In addition to DZ Group’s sound franchise and solid earnings generation ability, the ratings reflect the strong cohesion of Germany’s cooperative banking sector, which comprises DZ Group as its main central institution, almost 1,200 local cooperative banks and other related entities. The Negative long-term ratings trend reflects DBRS’s concern about the risk inherent in DZ Group’s sizeable structured credit portfolio. Accelerating write-downs from this portfolio could undermine DZ Group’s earnings and capital at a time when prolonged economic weakness may limit CFSN’s ability to support DZ Group.

Note:
All figures are in Euros unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition; Analytical Background and Methodology for European Co-Operative Banks 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.