DBRS Comments on Landesbank Berlin’s 1H 2012 Results–Senior at A (high), Stable

DBRS Ratings Ltd. (DBRS) has today commented that the ratings for Landesbank Berlin AG (LBB AG), including LBB AG’s Issuer & Senior Long-Term Debt rating of A (high), are unchanged following the publication of the 1H 2012 results for LBB AG’s parent, Landesbank Berlin Holding AG (LBB or the Group). The trend on all ratings remains Stable. LBB’s ratings are underpinned by the Group’s intrinsic profile, the ownership of the German savings banks and by DBRS’s floor ratings of A (high) for the members of the joint liability scheme of Sparkassen-Finanzgruppe.

In DBRS’s view, LBB’s 1H12 results confirm the strength of the Group’s customer driven businesses, as well as the on-going challenges to reduce risk and strengthen capital across the Group. For the first half, LBB reported an operating profit of EUR 146 million compared to EUR 112 million for 1H11. The result was helped by the narrowing spread environment, which contributed to a fair market value adjustment for the period of EUR 109 million, some 24% higher than for the same period last year. Despite the improved operating performance, net profit after tax for 1H12 fell slightly year-on-year (YoY) to EUR 76 million and was impacted by EUR 31 million in restructuring charges linked to the closure of LBB’s London and Luxembourg branches, as well as higher tax expenses.

At the Group level, net interest income (NII) for the first half improved by 5% to EUR 457 million and benefited from higher volumes of money market activity and the favourable development in interest rates. In parallel, net allocations to loan loss for the wider Group fell 26% YoY to EUR 17 million, as EUR 90 million in reversals largely offset EUR 107 million in new charges. The overall improvement benefited from the stability of the Berlin Brandenburg economy as well as internal bank processes. DBRS expects that successful strengthening of LBB’s customer driven businesses and strategy will remain key to the Group’s overall success.

On a segment basis, all segments were profitable for 1H12. However, for the second quarter alone, earnings were virtually nil for both the Retail Banking and Capital Markets segments. During the second quarter, Retail operations were impacted by higher credit costs and Capital Markets by less favourable market dynamics. DBRS notes that results for both Retail Banking and Corporate Banking reflect a change in the internal settlement method for these segments and make YoY comparison difficult. For the half-year, Retail Banking reported pre-tax operating earnings of EUR 11 million. Segment results were also impacted by a doubling of net risk provisioning levels to EUR 32 million as well as an adjustment in the value of equity investments. The doubling of provisions was linked to a re-evaluation of provisioning needs following updated collection data on current exposures. Despite the lower YoY results, DBRS views the underlying strength of the customer franchise as healthy as evidenced by retail customer deposits which rose by EUR 196 million YoY and a net increase of 12,000 new current accounts at Berliner Sparkasse. LBB reported continued success in its consumer finance platform for the Savings Banks, S-Kreditpartner GmbH (SKP). More than 90 savings banks are offering the full range of consumer loan products and LBB reported an increasing demand from the savings banks for customised solutions. DBRS views this as strengthening the very important relationship with its Savings Banks partners and also adding to long-term earnings potential from retail.

Pre-tax results at the Regional Corporate Banking level improved in 2Q12 with resulting 1H12 operating earnings of EUR 30 million. DBRS notes that similar to Retail Banking, results were negatively impacted by the change in the Group’s internal settlement method, thereby making YoY comparisons difficult. Nevertheless, in DBRS’s view, the underlying trend was more positive with corporate lending volumes rebounding in 1H12 by 16% YoY to EUR 600 million and the number of customers expanding to more than 69,200. DBRS considers this solid performance in a region with high competition amongst banks for market share as demonstrating the strength of the franchise.

Within the Real Estate Financing segment, pre-tax profit of EUR 135 million for 1H12 was nearly 50% higher than the previous year. Results benefited from a combination of improved NII for real estate lending, net reversals in loan loss allocations, as well as a net contribution from fair market valuation adjustments. Nonetheless, this upside was partly offset by EUR 8 million in expenses for the Real Estate segment linked to restructuring costs. Total contract volumes for 1H12 were lower at EUR 1.9 billion (not including extensions), and were impacted by continued high levels of competition for new business and LBB notes that levels were also impacted by higher internal margin requirements for real estate exposure. Despite the still strong results from the segment, DBRS views LBB’s exposure to the cyclical real estate sector as a potential drag to the more stable retail and corporate segments.

In DBRS’s view, LBB’s Capital Markets activity remains the most volatile portion of the Group’s business and its large relative size continues to by the primary driver of Group results. Pre-tax results for 1H12 were EUR 148 million. This was roughly unchanged from 1Q12, and the lack of profitability in the second quarter was influenced by EUR 23 million in restructuring costs linked to the closure of LBB’s London and Luxembourg branches and a further reduction in risk exposure – all part of efforts to focus on customer driven activity. Nonetheless, for the full half-year, the result was sharply higher than the EUR 37 million reported for 1H11. The improved result reflected better financial market conditions, particularly during the 1Q12. For 1H12, positive fair market valuation adjustments alone contributed EUR 92 million to the segment’s pre-tax results. DBRS views positively the Group’s strategy to refocus the Capital Markets segment towards customer driven business and to focus more on its close partnership with the Savings Banks. Nonetheless most of this strategy is still to be executed. DBRS will continue to monitor the Bank’s results for evidence that the benefits of this shift in strategic focus are being realised.

In terms of liquidity, LBB continues to enjoy significant deposits from its own customers, as well as deposits from its Savings Bank partners. Indeed, the proportion of lending funded by own deposits improved to 85% as of the end of June compared to 79% at end March. Although liquidity remains satisfactory, DBRS continues to view LBB’s capital resources as limited. RVG Group, LBB’s ultimate parent, reported a Tier 1 capital of 13.2% and an overall capital ratio of 14.8% for end June 2012, both just above the respective 12.5% and 14.36% ratios reported at year end 2011. Looking ahead to forthcoming changes to regulatory capital requirements, LBB plans to reduce overall risk weighted assets in non-customer driven activities in order to release up to EUR 750 million in capital resources by 2014. The Group also plans to convert its silent participation into Basel III qualifying equity by the end of the current year. In DBRS’s view, achieving both will be important in maintaining capital levels at LBB and LBB Holding.

Notes:

All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include publicly available company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following the disclosure.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Peter Burbank
Approver: William Schwartz
Initial Rating Date: 22 January 2007
Most Recent Rating Update: 29 June 2012

For additional information on this rating, please refer to the linking document under Related Research.