DBRS Correction: DBRS Confirms Deutsche Pfandbriefbank AG - Senior at A (low), Trend Negative

DBRS has issued a correction to the Deutsche Pfandbriefbank AG press release it issued on March 14, 2013. The corrected version, below, appropriately reflects the assignation of a Negative trend on the long-term obligations in the ratings table at the end of the press release:

DBRS Ratings Limited (DBRS) has today confirmed the ratings for Deutsche Pfandbriefbank AG (pbb or the Bank), including the Senior Unsecured Long-Term Debt & Deposit rating of A (low) and the Short-Term Debt and Deposit rating of R-1 (low). The trend on the Long Term Rating has been changed to Negative from Stable. Concurrent with the above, DBRS has assigned an intrinsic assessment of BBB to pbb, which represents the core operating entity of Hypo Real Estate Group. Meanwhile, DBRS is withdrawing its ratings on Hypo Real Estate Holding AG (HRE), DEPFA Bank plc (DEPFA) and Hypo Public Finance Bank, reflecting the non-core nature of these entities.

The ratings confirmation for pbb and the assignment of the intrinsic assessment reflect the continued progressthe Bank has made with its nearly completed restructuring. This progress is primarily illustrated by pbb’s significantly reduced risk profile, improved regulatory capital position, and sustained profitability following the transfer of troubled assets to the FMS-Wertmanagement (FMS-WM) in 2010. Further, the ratings confirmation reflects pbb’s core franchise, which has largely remained intact throughout the restructuring. However, DBRS notes that pbb’s business model remains challenged by increased competition in its home market of Germany, the on-going low interest rate environment, and the risks linked to the final separation of pbb from DEPFA and FMS-WM. Importantly, the Long Term rating incorporates DBRS’s expectation of timely systematic support for pbb should it be needed in the future, which is indicated by an SA2 support assessment and reflects the government ownership of pbb and ppb’s important role in the German Pfandbrief market. The negative trend reflects the challenging environment and the uncertainty linked to pbb’s future privatization, as the extent of support could decrease depending upon the new ownership structure.

At present, the German government maintains full ownership of pbb through the German Financial Markets Stabilisation Fund (SoFFin). However, per the European Commission’s (E.C.) directive upon its approval of state aid, pbb must be re-privatized by year-end 2015. Consequently, DBRS views the positive track-record of the past two years as supporting the longer term independent strategy and privatization prospects for the Bank. Still, a critical success factor is delivering consistent results, maintaining asset quality and sustaining the Bank’s regained market confidence over the longer term.

Indicative of the Bank’s improving position, it has been profitable for ten consecutive quarters and generated pre-tax profits of EUR 188 million for 2011 and EUR 124 million for 2012. While the results continue to benefit from one-time items, DBRS sees the results as clear evidence of a sustainable turnaround in business at pbb. pbb demonstrated the power of the underlying franchise by originating nearly EUR 17.7 billion of new business since year-end 2010. Notably, the Bank is achieving higher lending margins on new business, which helps to partially offset the effects of a declining nominal asset base. However, DBRS cautions that maintaining its positive performance is at least in part linked to future cost savings, as well as the final separation of FMS-WM from pbb’s operations. pbb’s contractual obligation to provide funding and infrastructure services to FMS-WM expires in September 2013. In parallel, HRE is required to privatise DEPFA by year-end 2014 by the E.C.

Having successfully executed the transfer of certain assets and all SoFFin guaranteed bonds to FMS-WM in 2010, pbb has maintained a reduced risk profile characterised by strict credit discipline and a more manageable level of problem loans. Illustrating the extent of the reduction in the risk profile, exposure at default (EaD) at the end of 2012 was EUR 75 billion compared to EUR 132 billion at 3Q10. This reflects the transfer and the further run down of the Public Budget Finance business. With an EaD of EUR 39 billion, the Public Sector Financing (PSF) segment includes the public budget financing book, which is in wind-down per E.C. requirements, as well as the expanding public investment financing book. The smaller Real Estate Financing (REF) book had EaD of EUR 24 billion at year-end 2012 and represents the Bank’s primary growth focus going forward.

DBRS recognises that pbb’s business model is likely to generate some geographic concentrations in Western European markets, as well as within specific real estate segments including residential and office space. Likewise, some of this exposure can be in more challenged sectors or local markets. Indeed, the E.C. requirements limiting pbb’s geographic and sector activity may reinforce possible concentrations. Nonetheless, there are signs that pbb is maintaining strict credit discipline in pursuing new business across its portfolios and the overall risk profile has generally improved. Specifically, the Bank has adjusted its exposure to geographic markets and segments to reflect both asset quality and pricing. The overwhelming bulk of its portfolio is rated investment grade. Furthermore, the weighted average LTV for new commitments has improved to 56% in 2012 from over 64% two years ago. Having tightened credit standards since the asset transfer, pbb’s total problem loans have remained largely stable at and were EUR 1.1 billion at year-end 2012.

The Bank’s funding and liquidity profile is largely aligned with its business model. The balance sheet is predominantly wholesale funded via secured mortgage pfandbriefe, but with unsecured issues also accounting for a significant component. DBRS notes that pbb issued EUR 6.5 billion of long-term funding in 2012 (65% through pfandbriefe; 35% unsecured) and as of March 2013 has fully repaid LTRO borrowings from the ECB. Nonetheless, DBRS points out that the Bank remains dependent upon senior unsecured financing in addition to its core pfandbriefe activity. This dependence can also prove a weakness during times of market stress. Helping to mitigate this, the Bank’s short term liquidity position remains solid and well managed in DBRS’s view, with pbb’s liquidity ratio remaining well above twice the German Liquidity Ordnance minimum level for most of 2012.

Having shed almost EUR 30 billion in risk-weighted assets since 3Q10, pbb’s regulatory capital ratios are solid. The Bank reported a Tier 1 Capital ratio of 18.1% and a Core Tier 1 Capital ratio of 15.8% at end 2012, but before the application of 2012 earnings. As such, even following the repayment of outstanding silent participations and hybrid capital, pbb’s regulatory capital ratios should remain healthy. On an absolute basis, however, pbb’s capital position is considerably weaker with a Tangible Common Equity ratio of 2.0% at 1H12, as calculated by DBRS. Moreover, DBRS notes that pbb’s total GIIPS exposures represent 367% of the core capital base with total problem loans covering 46% of the core capital base at year end 2012.

DBRS’s SA-2 support assessment considers DBRS’s expectation that pbb will receive additional support if needed. This expectation is not necessarily limited to the current ownership, but is also underpinned by pbb’s strong position within the German Pfandbrief market, which continues to play an important role in the German financial system. This, combined with its current government ownership, is fundamental to the two notch uplift reflected in the senior debt and deposit rating of A (low). However, DBRS highlights that depending upon the method and conditions of its privatization, the level of uplift for pbb could decrease. This is reflected in the negative outlook for the Long Term A (low) rating.

Notes:
All figures are in EUR unless noted otherwise.

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, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments and Rating Bank and Subordinated Debt & Hybrid Capital Instruments with Contingent Risks. These can be found at http://www.dbrs.com/about/methodologies

[Amended July 7, 2014 to reflect actual methodologies used.]

The sources of information used for this rating include the issuer and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer. This rating was assigned without participation by the issuer or any related third party.

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

Lead Analyst: Peter Burbank
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 19 July 2006
Most Recent Rating Update: 8 June 2011

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