DBRS confirms Rabobank at AAA; Trend changed to Negative

DBRS Ratings Limited (DBRS) has today confirmed the ratings of Rabobank Nederland (Rabobank or the Group), including its AAA rating for Long-Term Deposits & Senior Debt and the R-1 (high) Short-Term Debt rating. The Trend on the long-term ratings has been revised to Negative from Stable while the trend on the short-term rating remains Stable. Rabobank’s ratings reflect an intrinsic assessment (IA) of AA (high) combined with a support assessment of SA-2, which results in a one notch uplift to the final rating from the IA. The SA-2 considers the importance of Rabobank to the financial system in the Netherlands and DBRS’s expectation of government support should it prove necessary.

The revision of the trend to Negative reflects several factors including the notably lower profit and efficiency metrics compared to other similarly rated banks, the relatively large structural wholesale funding reliance, and the still evolving investigations by various regulatory agencies and authorities into potential LIBOR and EURIBOR manipulation by the Group. Further, the trend change reflects the challenging economic environment in the Netherlands, which DBRS expects to lead to continued elevated provisioning charges, potentially in excess of more normal cyclical levels.

The ratings continue to reflect the Group’s extremely strong franchise including market-leading positions in retail savings, residential mortgages, small to mid-sized enterprises and food and agricultural lending in the Netherlands, as well as its international food and agribusiness franchise where Rabobank is acknowledged as a global leader. A key factor underpinning the intrinsic rating is the conservative business culture rooted in the Group’s cooperative organisation that continues to demonstrate strong cohesion and member participation. The rating also reflects the credit strength of the overall Group, as the Group’s members, the local Rabobanks, as well as Rabobank Nederland and other subsidiaries, are linked together by a cross-guarantee system where members are joint and severally liable for each other’s commitments.

Although the Group has performed well throughout the financial crisis, earnings have weakened, as the economic environment in the Netherlands remains challenging. Given the Group’s lower risk profile DBRS would not expect profitability ratios at the top-end of the peer group, but the ongoing relative weakness in profitability is a factor in the Negative Trend. For 1H13, Rabobank reported a net profit of EUR 1.1 billion, 14% lower than the same period of 2012. However, adjusting these results to include the payments on the Group’s capital securities and trust preferred securities and minority interests would result in a DBRS calculated net profit of EUR 711 million. DBRS notes that the 1H13 results include a one-time provision for the LIBOR issue, but the magnitude of the provision has yet to be made public. The results for the full-year will benefit from a gain on the sale of Robeco, and in addition, the 2014 results will be impacted by the one-off resolution levy introduced by the Dutch State as a result of the nationalisation of SNS Reaal Group.

Although in 2012 and 1H13 income before provisions and taxes (IBPT) has been at similar levels to the past, reaching EUR 1.8 billion in 1H13 and EUR 3.6 billion in 2012 (all on a DBRS adjusted basis which includes the payments on capital securities) the substantially increased impairment charges have led to weakening net profitability. In 1H13 the cost of risk totalled EUR 1.1 billion, at similar levels to the EUR 2.4 billion in 2012, but substantially higher than the EUR 1.2 billion charge in 2010, and the EUR 1.6 billion charge in 2011. As a result of the lower profitability, the Group is aiming to improve its efficiency through a reduction of 8,000 jobs at the local Rabobanks, out of a current total of 28,000. Improving efficiency is important given that on an adjusted basis the cost income ratio was almost 70% in 1H13, a challenge for the Group.

Overall DBRS views the risk profile of Rabobank as low and this is reflected in the current ratings. However in recent periods the cost of risk has increased as a result of the difficult operating environment, especially in the Netherlands. This is especially important for Rabobank as 76% of the private sector loan portfolio is in the Netherlands. Over the total private sector loan portfolio, at end-June 2013, impaired loans accounted for 2.8%, up from 2.4% at end-2012, reflecting the environment. Although impaired loans in the Dutch mortgage portfolio have increased in recent periods they still remain at very low levels as evidenced by the impaired loan ratio of 0.43% at end-June 2013. DBRS would however expect this ratio to continue to rise as a result of the difficult environment and the substantial fall in house prices.

DBRS views the exposure to commercial real estate (CRE) as a further challenge for the Group. As of end-June 2013 the total exposure to commercial real estate was approximately EUR 32 billion. At end-June 2013 the impaired loan ratio for the total loan portfolio to lessors of real estate, including the Group’s Irish portfolio, was 17%. The impaired loan ratio for the total domestic portfolio, including the property development exposure was 12.5% at end-June 2013, up from 10.3% at end-2012. As a result, impairment charges remain elevated with the provision for the total loan portfolio to lessors of real estate at EUR 273 million in 1H13. DBRS would expect this to continue for some time given the weak outlook for commercial real estate in the Netherlands. Coverage of the impaired total loan portfolio to lessors of real estate was 40% at end-June 2013. Although the vast majority of the Group’s exposure to real estate is investment related, Rabobank announced in May that the activities in the field of commercial real estate development will be phased out. DBRS views this positively.

Rabobank’s sound funding and liquidity profile and its conservative liquidity management are key factors underpinning the high ratings. However, the reliance on wholesale funding remains significant, as indicated by the reported 135% loan to deposit ratio at end-June 2013. DBRS continues to see this level as elevated, especially when compared to similarly rated peers. DBRS expects the focus on raising customer deposits to continue. Although the Group has a diversified mix of funding sources, the large wholesale funding reliance (the Group had EUR 197.9 billion of debt securities issued at end-June 2013) does expose Rabobank to the more volatile wholesale markets. The Group’s liquidity remains strong with the EUR 47.8 billion of short-term debt covered 2.7 times by the liquidity portfolio, which totalled EUR 131 billion.

DBRS views Rabobank as solidly capitalised, given its low risk profile, conservative business model and overall operating philosophy and this is a further key factor in the high ratings. DBRS considers the conservative approach to capital management as prudent given the Group’s mutual status, which limits its ability to raise external capital should it be necessary. However, the ability to raise equity capital through “Member Certificates” has enhanced its financial flexibility. At end-June 2013, the Core Tier 1 capital ratio, which includes the Member Certificates, stood at 12.9%, while its Tier 1 ratio was 16.9%. The Group aims to increase its capital ratios with a target of at least 14% for the Core Tier 1 ratio and at least 20% for the total capital ratio by end-2016. Additionally, the Group endeavours to improve the quality of the capital base by increasing the proportion of retained earnings and reducing the importance of the member certificates, which at end-June 2013 accounted for 19% of the core Tier 1 capital.

For the trend to be restored to Stable at the AAA rating level, DBRS would expect improvement in both profitability and efficiency, further progress in reducing the reliance on wholesale funding, and to see evidence that the LIBOR issue does not have any strategic or franchise implications for the Group. The Group’s ratings are at the very top end of DBRS’s global ratings universe and at this rating level the reliance on wholesale funding and the lower profit and efficiency metrics are pressuring the ratings. This pressure would increase should there be further deterioration in the credit quality of the residential mortgage, domestic business or real estate lending leading to higher impairment charges, or should the outcome of the LIBOR issue damage the franchise.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal methodology applicable is: the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. The rating methodologies and criteria used in the analysis of this transaction can be found at: http://www.dbrs.com/about/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.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
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Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Ross Abercromby
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 19 January 2012

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