DBRS Confirms DZ BANK AG’s Ratings, Senior at AA (low), Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of DZ BANK Deutsche Zentral-Genossenschaftsbank AG (DZ BANK or the Bank), including the Bank’s Senior Unsecured Long-Term Debt rating of AA (low). The trend for all ratings is Stable. The ratings action follows a detailed review of DZ BANK’s operating results, financial fundamentals and future prospects.

The ratings primarily reflect DZ BANK’s critical role as a central clearing bank and liquidity provider for 80% of the 1,115 local cooperative banks which make up Germany’s Cooperative Financial Services Network (CFSN, or the Group). Moreover, DZ BANK (Germany’s fourth largest bank) represents approximately 32% of the Group’s assets, and provides local products and services for the cooperative banks. In DBRS’s view, the Group’s interconnectedness, underpinned by the Group Protection “Scheme” which ensures the viability of all members, warrants a group rating approach. As such, DZ BANK’s rating is driven by our assessment of the Group overall.

The ratings reflect the strong and defensible German banking franchise of the CSFN. With approximately 30 million customers, of which 17 million are shareholders, CSFN has a 25% market share in Germany with a primary focus on retail customers and small and medium-sized enterprises (SMEs) or Mittelstand. Overall, CFSN is the second largest provider of financial services in Germany with 13,350 branches and significant on-line banking distribution channels. As a result of the Group’s importance to the banking system and economic vitality of Germany, DBRS views CFSN as systemically important. Consequently, DBRS has assigned a SA2 designation to DZ BANK, which leads to a one notch uplift to the intrinsic rating of A (high).

DBRS also considers the intrinsic strength of DZ BANK that includes top-tier market positions in areas such as corporate banking, asset management, life insurance and home savings and loans. Although DZ BANK reported a net loss in 2008 stemming from the global financial crisis, the Bank has returned to profitability despite the on-going challenges of higher provisioning needs, losses from its OVAG investment in Austria, as well as fair value and price volatility in the ABS and GIIPs portfolios. Specifically, DZ BANK reported a net profit of EUR 404 million in 1H12 compared to a net profit of EUR 449 million in 1H11. Given volatile markets and a slowing German economy, DBRS expects profitability to be pressured over the intermediate term.

DBRS views DZ BANK’s capital as improving appropriately and in line with the rising capital norms across the banking industry. At mid-year 2012, DZ BANK reported a Tier 1 ratio of 12.17%, a 280 basis point improvement from 10.09% at year-end 2011 and greatly improved from a level below 8% in 2008. DBRS notes the latest improvement in the Bank’s capital position was achieved via the 2012 regulatory recognition of contingency and general bank reserves as part of core capital in the amount of EUR 1.327 billion. This brought total core capital to EUR 11.383 billion at 1H12. Earlier increases in both 2011 and 2010 had largely been based on improved internal earnings generation. As of 1H12, the Bank was in full compliance with the EBA capital adequacy requirements, including the required EUR 350 million capital buffer identified in the EBA’s most recent “flash stress test”. Yet on-going profitability and retained earnings may be needed to counterbalance remaining risks to capital.

DBRS recognises the progress DZ BANK has achieved in reducing its exposure to structured credit products and asset-backed securities, as well as reducing overall GIIPS exposure. Nonetheless, the fair market value of each book at 1H12 exceeded DZ BANK’s core capital. At end June 2012, DZ BANK’s securitisation portfolio had been reduced to a fair value of EUR 12.0 billion, only marginally lower than at year end 2011, but down markedly from EUR 16.4 billion at year-end 2010. Likewise, total exposure to GIIPs countries remains high at EUR 12.9 billion, despite sharp reductions from elevated exposures above EUR 33.3 billion at year end 2009. Within the current exposure at June 2012, sovereigns account for less than half at EUR 5.2 billion and balances are principally Spanish (EUR 2.6 billion) and Italian (EUR 1.9 billion) securities.

Although the trend is Stable, DBRS continues to view several challenges for DZ BANK and the CFSN Group. These include managing the impact of the still uncertain environment, ensuring the on-going cohesion of the Group, defending its leading market positions and further reducing the risks inherent in its still sizeable ABS, structured investment and GIIPs portfolios. Moreover, given the uncertainty in the regulatory environment, managing the risk associated with pending changes as to capitalisation, liquidity and government support remains a challenge for DZ BANK, like most financial institutions across the globe, Lastly, given that CFSN’s internal support mechanism is a key rating factor, any regulatory or other changes that would reduce the availability of support to the Group’s members from the “Scheme” and from external systemic support could negatively affect the support assessment.

Notes:
All figures are in Euros 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 company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Peter Burbank
Rating Committee Chair: Roger Lister
Initial Rating Date: 22 May 2007
Most Recent Rating Update: 22 July 2011

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