DBRS Confirms A (high) Floor Ratings on Sparkassen-Finanzgruppe with Stable Trend

On 27 March 2013, DBRS Ratings Limited (DBRS) confirmed its floor ratings for all members of the Joint Liability Scheme (Haftungsverbund or the Scheme) Sparkassen-Finanzgruppe (Sparkassen-Finanzgruppe or the Group). The Trend on all ratings is Stable. The floor ratings are based on the depth and resources of the Joint Liability Scheme, the additional support for the Group’s members from their public owners (Träger), as well as broader systemic support. The ratings also consider the underlying earnings potential and the solid franchise of the savings banks and the overall importance of the Group to the German banking sector. Offsetting these rating strengths are the elevated risk profile and weak overall earnings of several Landesbanks that are a significant part of the Group, and the level of competition in the savings banks’ core business of German retail banking.

The floor ratings of A (high) for Issuer & Senior Long-Term Debt and R-1 (middle) for Short-Term Instruments apply to each member of Sparkassen-Finanzgruppe’s joint liability Scheme. The Joint Liability Scheme includes 423 German savings banks, the seven Landesbank groups, ten public-sector building societies (LBS), the Group’s central asset manager DekaBank and other specialised service providers. The floor ratings indicate that each member of the Joint Liability Scheme is rated at least at A (high)/R-1 (middle); However, this does not prevent members from potentially achieving higher individual ratings based on their individual credit assessment.

In DBRS’s view, the Joint Liability Scheme of Sparkassen-Finanzgruppe reduces the default risk for each individual member, because the Scheme makes financial resources available to each institution within the Group. As such, the strength and structure of the Scheme is a key factor considered in the floor ratings. The Joint Liability Scheme is designed to ensure the solvency and viability of each member, thereby protecting creditors and counterparties. Since the Scheme’s inception in 1973, no member has defaulted, an indication which DBRS views as the Scheme fulfilling its function. However, DBRS recognises that the Joint Liability Scheme has limitations, as it does not amount to a legal cross-guarantee. Moreover, while the combined resources of the Scheme have enabled it to cope with most stress scenarios, resources may be insufficient in a wider systemic crisis. These limitations are factored into the floor ratings.

As mentioned above, the internal support mechanism of Sparkassen-Finanzgruppe is complemented by external support for the Group’s Landesbank members, thereby adding a level of stability to the floor ratings. During the recent financial crisis, several Landesbanks received support from their public owners in the form of capital injections or other forms of support, such as from the Sparkassen or via risk shielding from the German government. In DBRS’s view, these external measures reduce the need for additional support from within the Group; however, they do not fully eliminate it. Nonetheless, DBRS sees the availability of this external support as benefitting the Group, as it lessens the potential burden of the Landesbanks on the wider membership. However, any indication of reduced access to systemic support for the Landesbanks would likely lead to downward pressure on the floor ratings, as it could reduce the total financial resources available to the members of Sparkassen-Finanzgruppe.

The floor ratings also consider the overall strong market positions and the solid franchises of the institutions comprising the Sparkassen-Finanzgruppe. Despite some marginal share decrease in recent years, together, the Group’s members maintain leading positions across many areas of German banking as demonstrated by the strong combined market shares of roughly 42% nationally in both retail customer deposits and business lending at year-end 2011. The Group continues to see solid lending and deposit activity, especially at the savings bank level. The sizeable combined market shares demonstrate the Group’s importance to the German banking sector. Likewise, the close relationship of its members is illustrated by the increasing levels of cohesion that exists among the savings banks, which helps to promote cross selling. DBRS sees the Group’s overall franchise strength as benefitting from the solid positioning of the savings banks, whereas the negative impact from weaker Landesbanks has diminished somewhat following meaningful de-risking and restructuring.

The Sparkassen-Finanzgruppe’s underlying earnings generation ability reflects both the stability of the savings banks’ performance, as well as the improving risk profile of most of the Landesbanks, which DBRS expects may contribute to lower earnings volatility in the future. In 2011, the most recent year for which aggregate data is available, Sparkassen-Finanzgruppe recorded EUR 16.4 billion of operating earnings before other and non-operating income/expenses and before valuation results (which under German GAAP include losses on loans, securities). This was a decline compared to EUR 17.1 billion in 2010 and was impacted by lower aggregated results at the Landesbanks. Earnings figures for 2011 were also impacted by positive valuation results (EUR 6.2 billion), and offset by the re-classification of some German reserve contributions from post-profit allocations to the extraordinary expense level (or from 340h hidden reserves to 340g general banking reserves as defined under the German Commercial Code, or Handelsgesetzbuch (HGB)). In 2011 the group recorded EUR 17.5 billion in extraordinary expenses, and restated extraordinary expenses for 2010 figures at EUR 5 billion instead of EUR 2 billion. This strongly impacted bottom line earnings reported as net income of EUR 1.6 billion for 2011 and a restated net income of EUR 3.1 billion for 2010 (vs. the EUR 6 billion originally reported).

In DBRS’ view the overall risk profile of Sparkassen-Finanzgruppe remains negatively impacted by the higher earnings volatility potential from the Landesbank sector, as well as the more wholesale orientation of the state level banks. Nonetheless, DBRS acknowledges that significant de-risking and restructuring has reduced the level of future volatility. Likewise, credit quality of the savings banks has generally benefited from the stronger domestic economy, as well as improved credit standards and processes. Nonetheless, at the savings bank level, the allowance for loan losses increased to EUR 900 million in 2012 compared to EUR 600 million in 2011 indicating on-going attention and concerns for asset quality even within the generally lower risk German market.

The Sparkassen-Finanzgruppe’s overall liquidity and capitalisation are also considered in the ratings. Importantly, DBRS recognises that the strong deposit base and sound liquidity of the savings banks which in part is offset by the more wholesale-oriented funding profile of the Landesbanks. Nonetheless, the Landesbanks benefit from sizeable deposits from savings banks, as well as the strong track-record of governmental liquidity support offered during the recent crisis. In DBRS’s view, this reduces potential demands on the joint liability Scheme and adds to the satisfactory evaluation for liquidity across the Group. Likewise, capitalisation remains appropriate in DBRS’ view. The savings banks reported a Tier 1 capital ratio 12.5% and a total capital ratio of 15.9% at year-end 2012. On a combined basis for both the savings banks and Landesbanks, the Tier 1 ratio was 11.5% at end 2011, up from 10.9% at year-end 2010.

For DBRS, the Sparkassen-Finanzgruppe continues to face several challenges. These include defending the still dominant position of savings banks in German retail while also maintaining margins and solid profitability. Both are challenged by strong competition and are under increased pressure due to the low interest rate environment. Maintaining the dominant position is particularly important, as the savings banks’ solid retail franchise underpins the overall Group’s franchise strength. Lastly, as with most financial institutions operating across the globe, the Group needs to manage business strategies to adapt to the ever-changing regulatory environment. While DBRS sees the Group as a whole as generally well-positioned to adapt to challenges, increasing competition and regulatory requirements could present problems at the level of individual institutions.

The trend on the floor ratings is Stable. This reflects DBRS’s expectation that the support mechanisms will remain intact, underscored by the stable performance of the savings banks and the general reduction in risk and volatility at the Landesbanks. Given that the structure and strength of the Joint Liability Scheme is a key rating factor, regulatory or other changes that would reduce the availability of support to the Group’s members from the Scheme or from external support could negatively affect the Stable trend.

Notes:
All figures are in Euros (EUR) unless otherwise noted.
The principal applicable methodologies are Global Methodology for Rating Banks and Banking Organisations and DBRS Criteria – Intrinsic and Support Assessments. These can be found at: http://www.dbrs.com/about/methodologies

[Amended July 7, 2014 to reflect correct link to the methodologies.]

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

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: 8 Jan 2007
Most Recent Rating Update: 25 April 2012
For additional information on this rating, please refer to the linking document under Related Research.
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