Morningstar DBRS Confirms Kommunalkredit Austria AG's BBB Long-Term Issuer Rating, Changes Trend to Stable from Positive

DBRS Ratings GmbH (Morningstar DBRS) confirmed the ratings of Kommunalkredit Austria AG (KA or the Bank), including the Long-Term Issuer Rating at BBB and the Short-Term Issuer Rating at R-2 (high). Morningstar DBRS also changed the trends on all ratings to Stable from Positive. The Intrinsic Assessment (IA) for the Bank remains BBB, while the Support Assessment is confirmed at SA3.

KEY CREDIT RATING CONSIDERATIONS

The confirmation of the credit ratings reflects KA's good profitability and sound asset quality profile as well as the capital support received following the recent change in the ownership structure. The Bank has consistently outperformed its financial targets, and Morningstar DBRS is of the opinion that KA's performance continues to benefit from further balance-sheet growth. The credit ratings also reflect KA's small size, limited revenue diversification and some concentration risks. Asset quality remains solid; however, minor deterioration was reported in 2023. KA's funding sources are balanced between the growing deposit base and covered bonds, and the Bank has consistently maintained high liquidity buffers. The credit ratings take also into consideration KA's growing franchise in Infrastructure and Energy (I&E) finance and solid public finance business. Morningstar DBRS expects the capital injection from the new majority shareholder to support potential further expansions in the Bank's franchise.

The trend change to Stable from Positive largely reflects the increased uncertainty over the Bank's organizational structure and long-term performance following the unexpected departure of the CEO as a result of a vote of no-confidence from the Supervisory Board. In Morningstar DBRS' view, KA's former CEO played a pivotal role in all aspects of the organisation and business expansion of KA in recent years. Despite the growing size of the business and improving profitability, Morningstar DBRS considered the key man risk as a vulnerability and challenge for KA.

KA's Chief Risk Officer was appointed as an interim CEO. He will navigate KA until a new member of the management board has been appointed. While further organizational changes and transition risks could be expected in the short to medium term, Morningstar DBRS expects that the Bank's strategy will remain unchanged and aligned with the new majority shareholder. Alongside the capital increase, Altor Equity Partners brings extensive experience and track record in infrastructure projects in Europe.

CREDIT RATING DRIVERS

Given the unexpected departure of the CEO, a positive credit rating action is contingent on the appointment of a new management board that eliminates uncertainty over the Bank's organizational structure and future direction. A longer track record of strong earnings, while maintaining solid asset quality, and sound liquidity and capital management is required for a credit ratings upgrade.

Potential weakening in the Bank's organizational structure and performance stemming from this transition period could lead to a negative credit rating action. A significant deterioration in asset quality, which would lead to material weakening of profitability and capitalization, could also result in a negative credit rating action.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Weak

Kommunalkredit is a small bank with total assets of EUR 6.0 billion as of H1 2024. The Bank is mainly specialised in public, and infrastructure and energy (I&E) finance, especially in the energy & environment, social infrastructure, transport, natural resources, and digitalisation sectors. The Bank is well established, ranking among the top 20 originators in the European I&E finance market. Its relatively small size makes the Bank less dependent on movements in the overall market and leaves ample room for growth. KA also has a solid presence in public finance serving mainly Austrian and EU based municipalities. In addition to net interest income from assets held on balance sheet, the Bank derives fee income from its subsidiary, Kommunalkredit Public Consulting (KPC), and from loan syndication, gradually supplemented by ancillary business such as a growing asset management platform, advisory, development equity, and other.

In July 2024, Altor Equity Partners, a private equity firm based in Sweden, successfully concluded the acquisition of 80% of KA's shares. The former majority owners, Interrita One Sàrl and Trinity Investments, remain as minority shareholders (each indirectly holding 9.9%), and the Austrian Association of Municipalities holds the remaining 0.2% share. After completing the sale process, the new majority shareholder injected an additional EUR 100 million capital, which is likely to enable the Bank to expand its business and participate in larger deals in I&E finance.

In August 2024, Mr. Bernd Fislage, who has played a pivotal role in all aspects of the organisation and business expansion as CEO of KA since 2017, unexpectedly left the Bank due to a vote of no confidence from the Supervisory Board, and the Chief Risk Officer was appointed as an interim CEO. Morningstar DBRS understands that this move resulted from divergent views between the former CEO and the new owner over KA's organizational structure and culture. As a result of this, further organizational changes and transition risks could be expected in the short to medium term.

Earnings Combined Building Block (BB) Assessment: Good

In Morningstar DBRS' view, KA's earnings capacity is strong and continuously improving as the Bank has benefitted from strong balance sheet growth and the high interest rate environment. Morningstar DBRS expects KA's positive revenue momentum to continue to benefit from factors such as balance sheet growth, strong new business margins, and, to a lesser extent, increasing underwriting volumes. At the same time, management will continue to keep its focus on costs in order to achieve its medium-term, double-digit return on equity (ROE) target.

The Bank reported a net profit of EUR 100.5 million in 2023, up 28% year over year (YOY), mainly driven by higher interest income, translating into an ROE of 19.2% as calculated by Morningstar DBRS, up from 17.5% in 2022. Net interest income rose significantly, up 53% YOY to EUR 192.4 million at year-end (YE) 2023, reflecting strong asset growth of 27% and the high interest rate environment. Profitability continued to improve in H1 2024. The Bank reported a net profit of EUR 47.1 million in H1 2024, up from EUR 41.7 million in H1 2023, reflecting higher interest and fee income, which more than offset an increase in administrative expenses. This translated into a high ROE of 15.8% (Morningstar DBRS calculation). H1 2024 net interest income increased to EUR 89.5 million from EUR 81.8 million a year earlier as the loan portfolio expanded by 18% YOY to EUR 5.3 billion at the end of H1 2024.

Risk Combined Building Block (BB) Assessment: Good / Moderate

Morningstar DBRS considers KA's asset quality as good, reflecting low risk public financing, conservative underwriting standards and general resilience of I&E lending. However, asset quality pressures are slightly rising, as the gross nonperforming loans (NPLs) have increased, albeit from a very low base, mainly due to defaults in the I&E sector. In addition, sector concentration risk has been increasing with the strong growth of the I&E portfolio and a significant proportion of the I&E assets are sub-investment grade. Single name concentration in the private sector lending portfolio is on the high side as well.

The gross NPL ratio has increased to 1.4% at YE 2023, due to four exposures in I&E finance. Two exposures are largely guaranteed by an export agency, and excluding these exposures the NPL ratio would decline to around 1.0%. In Morningstar DBRS' view, the Bank's asset quality is still good, but relatively high borrower and sector concentration continues to pose some tail risk. The sub-investment grade exposure is also substantial, standing at 40% of the total portfolio and 69% of the I&E portfolio as of H1 2024. Morningstar DBRS notes that the proportion of the I&E portfolio (including corporates) accounted for 55% of the total EUR 6.1 billion loan portfolio (including undrawn lines) at the end of H1 2024.

Funding and Liquidity Combined Building Block (BB) Assessment: Good / Moderate

KA's funding profile is sound, and increasingly reliant on deposits. KA has demonstrated access to unsecured wholesale markets, however, given its small size and infrequent issuance needs, wholesale funding conditions may not always be favorable. As at the end of June 2024, the Bank had EUR 1,049 million of covered bond outstanding and a cover pool with a value of EUR 1.2 billion. Customer deposits have become the Bank's most important source of funding, representing 61% of the Bank's total funding at end-June 2024. However, Morningstar DBRS notes that retail deposits are mostly collected online.

KA has a robust liquidity profile with a liquidity position of EUR 1.5 billion at end-H1 2024 (around 25% of total assets), including EUR 534 million of high-quality liquid assets (HQLA), and EUR 992 million of cash, cash equivalents, and balances with central banks, well in excess of total debt maturities until YE2026. At the end of H1 2024, the Bank's Liquidity Coverage Ratio (LCR) was high, at 476%, and the Net Stable Funding Ratio (NSFR) was at 132%, which are well above the minimum requirements.

Capitalisation Combined Building Block (BB) Assessment: Good

At the Bank level, KA reported a CET1 ratio of 15.5% at the end of H1 2024, down from 17.9% at year-end due to a combination of higher risk weighted assets reflecting strong lending growth, and H1 2024 retained earnings not yet being reflected in capital. The regulatory minimum requirement for the Bank's CET1 ratio is 9.5% and the Bank aims to maintain a ratio of 15%. Morningstar DBRS notes that KA's capital ratios can fluctuate due to its origination and syndication activities. In Morningstar DBRS' view, it is essential for the Bank to maintain high cushions over minimum capital requirements, as a safeguard against the credit risk concentration and syndication risk as well as the relative illiquidity of the financed assets. The EUR 100 million capital injection from the new owner will likely be consumed for further portfolio growth.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/440039.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

Notes:
All figures are in Euros unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (4 June 2024) https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for this credit rating include Morningstar Inc. and company documents, KA's Annual Reports 2019-2023, KA's Interim Report H1 2024, and KA's Extended Company Presentation. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/440038.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nicola De Caro, Senior Vice President, Sector Lead
Rating Committee Chair: Elisabeth Rudman, Managing Director
Initial Rating Date: September 30, 2015
Last Rating Date: September 27, 2023

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