DBRS Confirms DZ BANK at AA (low)

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 Intrinsic Assessment (IA) of A (high), the support designation of SA-2 and the Short-Term rating of R-1 (mid). The trend for all ratings is Stable.

The ratings reflect DZ BANK’s role as a provider of products and services to Germany’s Cooperative Financial Services Network (CFSN or the Group), including its central role in providing central clearing bank and liquidity services for 82% of the 1,091 local cooperative banks which make up the CFSN Group. DZ BANK itself ranks as Germany’s fourth largest bank and it accounts for roughly 32% of the CFSN’s assets. DBRS has a group rating approach to DZ BANK and CFSN. This reflects the CFSN Group’s cohesion, underpinned by the CFSN Protection “Scheme” (“Scheme”) which ensures the viability of all members. As such, DZ BANK’s rating is driven by our assessment of the CFSN Group overall, which incorporates the strengths of DZ BANK, including its top-tier market positions in areas such as corporate banking, asset management, life insurance and home savings and loans.

The IA of A (high) also reflects the strong and defensible German banking franchise of the CFSN. With approximately 30 million customers, of which 17.3 million are shareholders, CFSN has a 24% 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 approximately 13,200 branches and significant on-line banking distribution channels. As a result of the Group’s importance to the German banking system, DBRS views CFSN as systemically important and has assigned an SA-2 designation to DZ BANK, which leads to a one notch uplift to the intrinsic assessment and supports the AA (low) rating.

Despite the strengths of CFSN overall, the potential for upward pressure for the DZ BANK rating is limited. Indeed, DBRS views defending the cooperative sector’s already strong market share as an ongoing challenge for the Group given banking competition in Germany. The current Stable trend reflects not only the stability to date of CFSN’s overall franchise, but also the expectation that DZ BANK will maintain its focus on supporting business across the cooperative network, as well as cautious management of the riskier and more volatile portions of DZ BANK’s operations, including the asset-backed securities (ABS) and Securities portfolios, commercial real estate and shipping. Together with the need to strengthen capital, these represent DBRS’ main concerns regarding the DZ BANK’s risk profile. Separately, 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.

In DBRS’ view, CFSN’s stable retail-oriented franchise is well-entrenched and supports the Group’s resilient earnings. Core earnings are underpinned by the local cooperative bank network and the strong relationship with the German SME or Mittelstand sector. For 2012 (the most recent data available for the CFSN), the Group reported further strength in SME lending, complemented by improved results on investments and from insurance activity. These contributed to CFSN’s net profit of EUR 6.872 billion for the year. At the DZ BANK Group level, net profits for 1H13 were reported at EUR 917 million. These results reflected the continued growth in the German economy, a relatively stable lending portfolio and net interest margin, as well as a benign level of loan loss provisioning needs. However the main driver of the increase in 1H13 earnings was valuation gains which DBRS does not view as sustainable. Therefore the role of DZ BANK as supplier of products and services to the Group, that generates more stable net interest income and net fee and commission income, is viewed as a key strength for DZ BANK.

DBRS views CFSN’s liquidity profile as strong, supported by the solid deposit base of the local cooperative banks’ extensive branch network. This strength is also reflected at the DZ BANK level through the significant level of local cooperative bank liquidity deposited centrally with the Bank. Overall, DZ BANK’s funding profile is fairly diversified.

Although DZ BANK has increased its capital base markedly in recent years, further increases in capital are planned in the run up to the upcoming European level asset quality review and stress tests. At mid-year 2013, DZ BANK reported a Tier 1 ratio (as per Basel 2.5 and based on German GAAP reporting) of 16.1%, a 250 basis point improvement from 13.6% at year-end 2012. The stronger ratio reflected EUR 1.4 billion in retained earnings, as well as ongoing risk-weighted asset (RWA) management and a EUR 275 million reduction in capital deductions linked to securitisations. DBRS notes that the Bank is in the process of launching a rights issue from its cooperative bank shareholders for 2Q14 which could contribute a further EUR 1.4 billion to the equity base. As of 1H13, the Bank was in full compliance with the European Banking Authority (EBA) capital adequacy requirements, but DZ BANK’s pro forma Basel III core tier 1 ratio of 8.2% is significantly lower than Basel 2.5 ratios highlighting the need for further capital. DBRS notes the CFSN has historically maintained adequate capitalisation. At year-end 2012, CFSN’s consolidated Tier 1 ratio was 10.1%, an improvement from 9.1% at end 2011.

Notes:
All figures are in Euros (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: Support Assessment for Banks and Banking Organisations and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company reports 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 rating. This credit rating was not initiated at the request of the issuer.

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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.

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

Lead Analyst: Peter Burbank
Rating Committee Chair: Roger Lister
Initial Rating Date: May 22, 2007
Most Recent Rating Update: October 4, 2012

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