Morningstar DBRS Confirms Issuer Ratings on DZ BANK Group at AA (low) and R-1 (middle), Stable Trends

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Long-Term and Short-Term Issuer Ratings on DZ BANK AG Deutsche Zentral-Genossenschaftsbank (DZ BANK Group or the Group) at AA (low) and R-1 (middle), respectively. The trends on all credit ratings are Stable. DZ BANK Group benefits from its membership of the Genossenschaftliche Finanzgruppe Volksbanken und Raiffeisenbanken (Cooperative Financial Network; CFN), and as a result the AA (low) Long-Term Issuer Rating incorporates one notch of uplift from the A (high) Intrinsic Assessment (IA). The support assessment for the DZ BANK Group is SA1, reflecting the expectation of support in case of need from within the CFN. A full list of rating actions is included at the end of this press release.

The Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (BVR) organises the CFN's interests and oversees the BVR protection scheme with BVR Institutssicherung GmbH (BVR ISG). As of YE2023, 695 institutions are part of protection schemes, which are financed without government support. They reduce the default risk for individual members by making financial resources available to each institution within the Group. The scheme's strength and structure are key elements in Morningstar DBRS' one-notch uplift of the Group's Long-Term Issuer Rating from its IA.

KEY CREDIT RATING CONSIDERATIONS

DZ BANK Group's A (high) IA takes into account its diversified franchise in Germany, focusing on its role as a central clearing bank and a specialty financial service provider to German cooperative banks. The IA also reflects the Group's sound risk profile; diversified funding profile (which includes access to the CFN's liquidity), and healthy capital cushions. Morningstar DBRS also takes into account DZ BANK Group's adequate but somewhat volatile earnings. While revenues are generally diversified, the Group's insurance and asset management businesses are exposed to capital market volatility. In 2023, the Group recovered from the impact of weak capital markets in the previous year, from a steep increase in net interest income (NII) because of the interest rate environment and more than doubling previous year's net income from the insurance business thanks to a favourable situation in the capital markets.

During H1 2024, the Group's core earnings continued to grow but were offset by weaker income from its insurance business and a steep increase in loan loss provisions because of weaker macroeconomic conditions in Germany. This deterioration was also reflected in the increase of the Group's nonperforming loan (NPL) stock of roughly 5.3% in H1 2024, stemming from its commercial real estate (CRE), corporate, and consumer finance lending businesses. Given the size of the CRE portfolio, which accounts for one-fourth of the total customer loan book, and the cyclicality of the CRE sector, Morningstar DBRS is carefully monitoring developments.

CREDIT RATING DRIVERS

An upgrade DZ BANK Group's Issuer Ratings would require further improvement in the CFN's overall credit profile. The IA would be upgraded if DZ BANK Group's bottom-line profitability undergoes sustained improvement, along with reduced earnings volatility while maintaining solid risk and capital metrics.

Morningstar DBRS could downgrade DZ BANK Group's Issuer Ratings in the case of a substantial deterioration in the overall credit profile of the CFN. A downgrade of the IA could result from a material deterioration in DZ BANK Group's risk profile or a sustained decline in profitability.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Strong
DZ BANK Group serves as the central institution for the CFN in Germany and as a commercial bank. With a total asset size of EUR 664 billion at the end of June 2024, it is Germany's second-largest banking group by total assets, offering a large product range including corporate finance, asset management, insurance, commercial and residential real estate finance, and consumer finance, and therefore acts as the specialty finance provider for the extensive network of cooperative banks. The Group's access to the CFN's customers and distribution channels significantly enhances its franchise strength, as it can leverage its extensive reach and cross-selling capacity.

Earnings Combined Building Block (BB) Assessment: Good/Moderate
Morningstar DBRS views DZ BANK Group's earnings power as diversified, albeit modest compared with international peers. While geographically concentrated in Germany, the Group's revenue mix is highly diversified by business, reflecting its franchise breadth. Despite this, it did not benefit as much as its peers from the favourable interest rate environment.

The Group reported net income of EUR 1.25 billion in H1 2024, down 10.8% year over year (YOY), driven by a steep increase in loan loss provisions and lower net insurance income despite strong core revenues and contained operating costs. During the period, core revenues increased, supported by both NII, which was up 27% YOY on the back of greater business activity, and net fees and commissions, mainly driven by Union Investment, which benefitted from the favourable conditions in the equity markets. In addition, the Group kept expenses under control in H1 2024, down 1.9% YOY, because of the absence of the bank levy in H1 2024 despite inflationary pressures and higher staff costs. Despite this, the Group's cost-to-income ratio as calculated by Morningstar DBRS increased to 53.9% in H1 2024 from 52.4% in H1 2023, although it was better than the past five-year average of 59.8%, which underlines the Group's increasing operating efficiency.

Risk Combined Building Block (BB) Assessment: Strong/Good
The Group's main risk is credit risk, primarily tied to its commercial loan portfolio. The risk largely aligns with the risk appetite of the Group's cooperative owners. The Group's NPL ratio, as calculated by Morningstar DBRS and excluding loans to financial institutions, was 1.9% at the end of June 2024, up from 1.6% at the end of June 2023 and mainly driven by CRE exposures, which account for 23% of total customer loans. The Group's NPL stock increased to EUR 4.0 billion at the end of H1 2024 from EUR 3.8 billion at YE2023, mainly driven by a EUR 94 million NPL influx at DZ HYP AG (DZ HYP), the Group's CRE subsidiary, followed by increases of EUR 43 million and EUR 28 million at the commercial bank and TeamBank AG, respectively. DZ HYP booked loan loss provisions of EUR 41.3 million in H1 2024, almost twice as much as in H1 2023 when it booked EUR 21.9 million, which reflects the challenging environment in the CRE markets. Rising interest rates and the weakening prospects of the German economy have led to lower CRE valuations.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good
In Morningstar DBRS' opinion, DZ BANK Group enjoys robust liquidity levels and a diverse funding profile that reflects its asset mix and role as the central bank of the German cooperative banks. This includes corporate and retail deposits, deposits from affiliated cooperative and other banks, and wholesale funding like Pfandbriefe. The Group's customer net loan-to-deposit ratio stood at 129% at the end of H1 2024; however, this is mitigated by the stable access to liquidity from the CFN. The liquidity surplus of the local cooperative banks is a major contributor to meeting DZ BANK Group's short-term funding needs. The liquidity coverage ratio remained strong at 143% as of the end of H1 2024.

Capitalisation Combined Building Block (BB) Assessment: Good
DZ BANK Group's capital levels are strong with significant cushions above minimum requirements. Limited access to capital markets somewhat mitigates solid capital generation. The Group's fully loaded Basel III CET1 ratio at the end of H1 2024 increased to 15.7% from 15.5% at YE2023, although this increase could be partially offset by an increase in risk-weighted assets (RWAs). The increase in CET1 capital was driven by an interim profit of EUR 655 million and an adjustment to retained earnings, increasing them by EUR 332 million because of the dividend forecast of EUR 760 million for 2023. On the other hand, RWAs increased during H1 2024 by 2.8% to EUR 156 billion because of higher measurement resulting from the equity method, the long-term equity investment in R+V, and the first-time implementation of the standardised approach for the ratings systems for investment funds and guaranteed lending businesses. The CET1 capital ratio at the end of June 2024 comfortably exceeds the minimum capital requirements of 10.01% for 2024, which increased from the 2023 requirement of 9.90% because of an increase in the Pillar 2 requirement for NPL exposures from the beginning of 2024. DZ BANK Group's fully loaded leverage ratio increased to 6.2% at the end of H1 2024, stable YOY and since the implementation of IFRS 17 at R+V. The Bank's MREL ratio as of 30 June 2024 was 41.1%, which is well above regulatory requirements.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/442304

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 Risk 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 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 these credit ratings include Morningstar, Inc. and company documents. Other sources include DZ BANK and CFN 2023 Annual Reports, DZ BANK H1 2024 Interim Report, DZ BANK H1 2024 Presentation, DZ BANK 2023 Facts and Figures, Cooperative Banks 2023 Annual Report, Cooperative Banks Press Releases, and Press Conference Presentations 2019-23. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings 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: NO
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/442301

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, European Financial Institution Ratings
Rating Committee Chair: William Schwartz, Senior Vice President, Global Fundamental Ratings, Credit Practices
Initial Rating Date: 22 May 2007
Last Rating Date: 2 November 2023

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