Credit Opinion: Bayerische Landesbank
Global Credit Research - 02 Jun 2014
Munich, Germany
Ratings
Category
Outlook
Bank Deposits
Bkd Bank Deposits
Bank Financial Strength
Baseline Credit Assessment
Adjusted Baseline Credit Assessment
Issuer Rating
Senior Unsecured
Senior Subordinate -Dom Curr
Jr Subordinate -Dom Curr
Commercial Paper
Other Short Term -Dom Curr
Moody's Rating
Negative(m)
A3/P-2
Aaa/P-1
D
ba2
baa3
A3
A3
Ba1
Caa1 (hyb)
P-2
(P)P-2
MKB Bank Zrt.
Outlook
Bank Deposits
Bank Financial Strength
Baseline Credit Assessment
Adjusted Baseline Credit Assessment
Negative
Caa2/NP
E
ca
caa2
Contacts
Analyst
Phone
Katharina Barten/Frankfurt am Main 49.69.707.30.700
Michael Rohr/Frankfurt am Main
Carola Schuler/Frankfurt am Main
Torsten-Alexander Thebes/Frankfurt
am Main
Key Indicators
Bayerische Landesbank (Consolidated Financials)[1]
Avg.
[2]12-13 [2]12-12 [2]12-11 [2]12-10 [2]12-09
255,601.0286,823.0309,144.0316,354.0338,818.0 [3]-6.8
Total Assets (EUR million)
352,203.3378,145.0401,313.7424,402.7486,116.0 [3]-7.7
Total Assets (USD million)
14,672.5 14,617.2 14,961.4 15,012.4 15,164.6 [3]-0.8
Tangible Common Equity (EUR million)
20,217.9 19,271.1 19,422.1 20,139.8 21,757.3 [3]-1.8
Tangible Common Equity (USD million)
0.7
0.7
0.7
0.6
0.7
Net Interest Margin (%)
[4]0.7
0.7
0.6
0.9
1.3
0.4
PPI / Average RWA (%)
[5]0.8
0.1
0.7
0.0
0.5
-1.8 [5]-0.1
Net Income / Average RWA (%)
17.4
19.0
19.5
19.5
19.3 [4]18.9
(Market Funds - Liquid Assets) / Total Assets (%)
53.2
52.4
52.9
50.6
42.5 [4]50.3
Core Deposits / Average Gross Loans (%)
15.8
12.9
11.4
11.0
12.5 [5]12.7
Tier 1 Ratio (%)
16,749.4
14.6
12.6
12.1
11.2 [5]3,360.0
Tangible Common Equity / RWA (%)
81.3
77.6
68.7
56.3
84.3 [4]73.6
Cost / Income Ratio (%)
2.7
3.0
3.1
3.5
2.7
Problem Loans / Gross Loans (%)
[4]3.0
21.7
26.9
28.8
33.0
27.5 [4]27.6
Problem Loans / (Equity + Loan Loss Reserves) (%)
Source: Moody's
[1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel II; IFRS [3] Compound Annual
Growth Rate based on IFRS reporting periods [4] IFRS reporting periods have been used for average calculation
[5] Basel II & IFRS reporting periods have been used for average calculation
Opinion
SUMMARY RATING RATIONALE
We assign an A3 long-term rating for senior debt and deposits to Bayerische Landesbank (BayernLB), which
incorporates five notches of rating uplift from the bank's ba2 baseline credit assessment (BCA). The uplift takes
into account that BayernLB would likely benefit from multiple sources of support, in particular, from its majority
owner, the Free State of Bavaria (Aaa, stable), as well as from the cross-sector support arrangements of
Germany's public-sector banks and systemic support. Those levels of support are closely interlinked for publicsector banks, and our unified approach of applying support uplift from multiple sources anticipates concerted
support solutions in case of need.
We assign a standalone bank financial strength rating (BFSR) of D to BayernLB, equivalent to a ba2 BCA. The
rating reflects combination of (1) sound capital metrics, which are strong compared with those of similarly rated
banks; (2) the requirement to repay EUR4 billion of capital to the Free State of Bavaria by 2019; and (3) tail risks
relating to potential legal obligations towards its former subsidiary Hypo Alpe-Adria-Bank International AG (HAA,
unrated) as well as the disproportionately large costs of stabilising its Hungarian subsidiary MKB Bank Zrt. (MKB,
deposits Caa2 negative, BFSR E/BCA ca) which operates under substantial market stress. The limited visibility of
the bank's future risk-adjusted profitability and capital generation arising from the ongoing overhaul of the business
model will likely remain a rating constraint for some time. BayernLB will require several more years to downsize,
refocus and restructure its franchise, fully stabilise its financial profile and achieve independence from external
support.
We maintain a Aaa rating for those obligations of BayernLB that qualify for `grandfathering' of the public law
guarantee (Gewaehrtraegerhaftung) of the Free State of Bavaria.
Rating Drivers
- The franchise remains under pressure from legacy investments and the implications of state aid
- Improved capitalisation represents a satisfactory mitigant to legal and commercial risks
- Austrian HAA's claim concerning a supposedly equity-substituting loan implies major legal risk
- Profitability is weak and highly volatile
- Liquidity and asset quality is satisfactory
- BayernLB benefits from implicit support from the financially robust State of Bavaria
Rating Outlook
The outlook on the A3 long-term debt and deposit ratings is negative. The negative outlook takes into account the
recent adoption of the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism
(SRM) regulation in the EU. In particular, this reflects that, with the legislation underlying the new resolution
framework now in place and the explicit inclusion of burden-sharing with unsecured creditors as a means of
reducing the public cost of bank resolutions, the balance of risk for banks' senior unsecured creditors has shifted
to the downside. Although our support assumptions are unchanged for now, the probability has risen that they will
be revised downwards to reflect the new framework. For further details, please refer to our Special Comment
entitled "Reassessing Systemic Support for EU Banks," published on 29 May 2014.
The outlook on the standalone D BFSR, the Ba1 ratings for subordinated instruments and the Aaa rating of
`grandfathered' long-term senior and subordinated debt and deposit ratings is stable.
The outlook on the Caa1 (hyb) rating of profit participation certificates is positive and the outlook on the Ca (hyb)
rating of BayernLB Capital Trust I securities is stable (also see details toward the end of this report).
What Could Change the Rating - Up
Positive rating pressure on the standalone D BFSR would be subject to (1) clarity on the legal obligations of
BayernLB towards its former subsidiary HAA in the context of the pending lawsuit (as discussed in the "Detailed
Rating Considerations" section); and (2) clarity on the final costs of stabilising MKB and/or its successful sale. A
strengthening of the bank's recurring earnings power from core businesses would also be vital.
Higher debt and deposit ratings would be subject to a multiple-notch raising of the ba2 BCA, coupled with
unchanged support assumptions
What Could Change the Rating - Down
The standalone D BFSR could come under pressure from major, in particular unexpected, setbacks in BayernLB's
capital adequacy metrics. In particular, a full loss of the amounts outstanding to HAA or developments in Hungary
that trigger weakening prospects of a stabilisation of MKB and/or yet higher capital requirements could also trigger
a downgrade. Such developments could derail the restructuring process insofar as BayernLB may need to
reschedule the return of the remaining EUR4 billion in capital to the Federal State of Bavaria that it needs to repay
by 2019.
A downgrade of the BFSR would trigger a downgrade of BayernLB's A3 senior debt and deposit ratings. In
addition, a downward revision of our current assumptions of systemic support - which may arise in the context of
the new Bank Recovery and Resolution Directive - could also have adverse implications for the A3 long-term
ratings.
DETAILED RATING CONSIDERATIONS
FRANCHISE REMAINS UNDER PRESSURE FROM LEGACY INVESTMENTS AND THE IMPLICATIONS OF
STATE AID
We consider BayernLB to be one of the weaker Landesbanken (regional public-sector banks) in terms of
franchise, considering that (1) failed acquisitions and security investments in the past continue to weigh heavily on
the bank's franchise; (2) BayernLB's 99.9% owned Hungarian subsidiary MKB continues to contribute
disproportionately large losses to group results; (3) the capital consumption of assets earmarked as "non-core" is
high, even though the majority of these assets represents manageable risk; and (4) the process of restructuring
the bank, which BayernLB has to perform in accordance with the European Commission's (EC) ruling, is lengthy
and requires continued attention from senior management.
That said, BayernLB has made good progress towards downsizing its asset base and divesting non-core
subsidiaries and participations. The positive long-term factors of the restructuring are material as BayernLB will
eventually be a smaller, less complex and better-focused group.
IMPROVED CAPITALISATION REPRESENTS A SATISFACTORY MITIGANT TO LEGAL AND COMMERCIAL
RISKS
Thanks to various support measures in the past, BayernLB now reports robust regulatory capital ratios. Supported
by proactive risk-weighted asset (RWA)-management in recent quarters, BayernLB was able to moderate the
impact of the stricter capital definition under CRR/CRD IV. Based on preliminary data as of March 2014, its
Common Equity Tier 1 (CET1) ratio is 13.7%, and the fully-loaded CET1 ratio 9.9% (excluding hybrid capital). A
deduction from CET1 capital to account for the legal risk relating to HAA brings these (pro-forma) ratios down to
13.3% and 8.9%, respectively.
These capital ratios compare favourably with similarly rated peers, and represent a key stabilising factor for the
standalone D BFSR. However, several factors pose risks to BayernLB's capital position which constrain our
assessment of capital. The most prominent factors are (1) the requirement to return the remaining EUR4 billion of
capital to the State of Bavaria by 2019 (or one third of its current CET1 capital, equivalent to 4.2 percentage points
of the CET1 ratio) which affords prudent capital management over the next few years; (2) the pending lawsuit in
the context of HAA's treatment of a multi-billion-euro loan from BayernLB as capital (as outlined below); and (3) the
uncertainty regarding how much additional capital will be absorbed by BayernLB's loss-making operations in
Hungary. Each of these factors in isolation represents a limited risk, and we note that BayernLB could return the
outstanding EUR4 billion upfront and still command a Basel III CET1 ratio under phase-in in excess of 8%;
however, the combination of these risks represents a major drawback.
BayernLB also still relies on substantial "non-capital" support facilities in the form of a portfolio risk-takeover (a
credit default swap (CDS), written by the State of Bavaria) to obtain capital relief.
HAA'S CLAIM CONCERNING A SUPPOSEDLY EQUITY-SUBSTITUTING LOAN IMPLIES MAJOR LEGAL
RISK
HAA's view to treat outstanding debt from BayernLB as an equity-substituting shareholder's loan bears risks to
BayernLB's capital and overall stability (see our Credit Focus report "BayernLB: Multiple challenges will pressure
capital as the bank completes its restructuring", 17 February 2014). BayernLB needs to reserve, through a
deduction from regulatory capital, EUR1 billion to account for this legal risk, thereof up to EUR800 million in 2014,
and the remainder in 2015. Although the outcome of this dispute is uncertain, it constitutes a setback in
BayernLB's effort to distance itself from the financial and reputational damage connected with its acquisition (and
subsequent divestment) of HAA. The loan to HAA has an outstanding amount of EUR2.36 billion, and principal and
interest paid since 2008 brings the total amount disputed by HAA to EUR4.26 billion. While the legal risk relating to
the HAA lawsuit is difficult to quantify, it represents a high-severity risk given the size of HAA's claim relative to
BayernLB's capital.
PROFITABILITY IS WEAK AND HIGHLY VOLATILE
BayernLB's core profitability is a major constraining factor for the BFSR. Large one-off charges, risk provisions
and impairments on investments and the losses incurred by its Hungarian subsidiary MKB have repeatedly
impacted its profitability. We maintain a modest outlook on profitability considering (1) persistent pressure on core
revenues; (2) the material fees paid for the risk shield; and (3) significant charges for bank levies in Germany and
Hungary.
BayernLB's 2013 pre-tax results, adjusted for valuation charges caused by movements of own credit spreads
(OCS), was EUR306 million and included several positive and negative one-off effects. In particular, these
included a EUR351 million gain on the sale of a German subsidiary and a EUR279 million valuation charge on the
CDS from the Free State of Bavaria. This result remained considerably below that of 2012 (adjusted for OCS:
EUR754 million), because the group had to absorb a disproportionately large EUR401 million loss contributed by
MKB (2012: loss of EUR308 million).
LIQUIDITY IS SATISFACTORY
BayernLB's liquidity and funding profile is satisfactory as short-term liquidity gaps from funding mismatches are
comfortably covered by the bank's sizeable liquidity buffer. Reported excess liquidity across term buckets as of
December 2013 reflect that the liquidity situation has improved further from the comfortable levels in 2012. In the
absence of major structural mismatches, the group relies on access to debt capital markets mainly for its new
underwritings, but not for the rollover of existing assets (assuming stable deposits).
Owing to modest new underwriting, the group has very limited funding needs. Debt capital market funding
requirements in 2014 are modestly higher at EUR7.6 billion (2013: EUR6.6 billion). The group plans to raise more
than half of this amount with covered bonds. A major portion is regularly covered (without tapping the market) by
placing notes with the regional savings banks. The gradual maturing of the group's EUR33 billion remaining
`grandfathered' debt (as of year-end 2013) in the years 2014-15 does not pose a risk as it is broadly matched by
maturing assets.
ASSET QUALITY IS SATISFACTORY AND IN LINE WITH PEERS
We consider the group's current asset quality to be broadly in line with peers, particularly after the sale and
deconsolidation of several higher-risk subsidiaries, and because a large portion of the most toxic assets benefits
from a second-loss risk shield of the Free State of Bavaria. However, BayernLB's 2.7% problem loan ratio (as of
December 2013) partly reflects the currently benign credit environment in Germany. The ratio excludes
BayernLB's impaired exposures relating to financial and other assets, but includes performing exposures which
are more than 90 days past due. Whilst the trend in 2013 was positive (total impaired loans were lower by 18% ),
asset quality metrics may weaken as the bank changes its lending focus from large multinational corporates
towards SME clients. We also note that a late entry into the SME lending market may require compromising on
risk-return or on credit quality, with a negative impact on asset quality for the group.
The quality of the EUR49 billion commercial real estate (CRE) portfolio is broadly in line with the market. Most of it
is concentrated in Germany for which we maintain a stable outlook, but we see continuing pressure on asset
quality for the EUR2.1 billion (2012: EUR2.4 billion) CRE exposure in Hungary.
We regard the bank's EUR7.0 billion exposure to the European periphery countries (as of December 2013) as
manageable given that (1) the exposure is diversified across sectors, with modest holdings of (sub-) sovereign
bonds (EUR750 million); and (2) the total exposure to the more pressured countries - i.e., Greece, Ireland and
Portugal (EUR908 million ) - is comparatively modest.
BayernLB's diminishing exposure to structured credit products (EUR7.0 billion as of December 2013 , down from
EUR9.5 billion at year-end 2012) poses low risk, as it is largely limited to its (fully provisioned) EUR1.2 billion firstloss piece.
Global Local Currency Deposit Rating (Joint Default Analysis)
Given its status as a public-sector bank, BayernLB's A3 long-term issuer, debt and deposit ratings are supported
by a very high probability of external support from multiple sources, in particular from its two stakeholders, the
Free State of Bavaria (holding 75%) and the Association of the Bavarian Savings Banks (25%).
Notching Considerations
SUBORDINATED DEBT
The Ba1 ratings for subordinated instruments, which carry a stable outlook, are based on BayernLB's baa3
adjusted BCA ("anchor rating level") which incorporates two notches of support to its standalone rating.
HYBRID INSTRUMENTS
The profit participation certificates (Genussscheine) Series 12 due at the end of 2019 are rated Caa1 (hyb) with a
positive outlook, based on the expected loss approach. Following several years of underperformance, the 2012
local GAAP result allowed a full write-back of principal and deferred and current coupon payments. As a result of
the loss under local GAAP, the coupons for the year 2013 are deferred. In our view, these are quite likely to be
paid before the instrument falls due.
BayernLB's perpetual non-cumulative preferred securities (Tier 1 instruments) issued by BayernLB Capital Trust I
are rated Ca (hyb), with a stable outlook. The rating takes into account (1) the October 2012 tender offer for these
instruments that implied a principal loss of 53% on the securities; and (2) the risk of future coupon losses after a
coupon was paid for 2013, despite a loss posted under local GAAP, due to a dividend pusher.
Should a sustained, stronger performance (under local GAAP) warrant an improving outlook for these instruments,
we may change our ratings approach towards the standard notching from the adjusted BCA, rather than an
approach based on an expected loss analysis. However, because of further one-off charges that we expect to
burden the local GAAP accounts in 2014-15, the near-term risk of renewed coupon losses or deferrals is relatively
high.
Foreign Currency Deposit Rating
BayernLB's foreign-currency deposit rating is A3 with a negative outlook.
Foreign Currency Debt Rating
BayernLB's senior unsecured foreign-currency debt rating is A3 with a negative outlook.
ABOUT MOODY'S BANK RATINGS
Bank Financial Strength Ratings
Moody's Bank Financial Strength Ratings (BFSRs) represent Moody's opinion of a bank's intrinsic safety and
soundness and, as such, exclude certain external credit risks and credit support elements that are addressed by
Moody's Bank Deposit Ratings. BFSRs do not take into account the probability that the bank will receive such
external support, nor do they address risks arising from sovereign actions that may interfere with a bank's ability
to honour its domestic or foreign currency obligations. Factors considered in the assignment of BFSRs include
bank-specific elements such as financial fundamentals, franchise value, and business and asset diversification.
Although BFSRs exclude the external factors specified above, they do take into account other risk factors in the
bank's operating environment, including the strength and prospective performance of the economy, as well as the
structure and relative fragility of the financial system, and the quality of banking regulation and supervision.
Global Local Currency Deposit Rating
A deposit rating, as an opinion of relative credit risk, incorporates the BFSR as well as Moody's opinion of any
external support. Specifically, Moody's Bank Deposit Ratings are opinions of a bank's ability to repay punctually
its deposit obligations. As such, they are intended to incorporate those aspects of credit risk relevant to the
prospective payment performance of rated banks with respect to deposit obligations, which includes: intrinsic
financial strength, sovereign transfer risk (in the case of foreign currency deposit ratings), and both implicit and
explicit external support elements. Moody's Bank Deposit Ratings do not take into account the benefit of deposit
insurance schemes which make payments to depositors, but they do recognise the potential support from
schemes that may provide assistance to banks directly.
According to Moody's joint default analysis (JDA) methodology, the global local currency deposit rating of a bank
is determined by the incorporation of external elements of support into the bank's Baseline Credit Assessment. In
calculating the Global Local Currency Deposit rating for a bank, the JDA methodology also factors in the rating of
the support provider, in the form of the local currency deposit ceiling for a country, Moody's assessment of the
probability of systemic support for the bank in the event of a stress situation and the degree of dependence
between the issuer rating and the Local Currency Deposit Ceiling.
National Scale Rating
National scale ratings are intended primarily for use by domestic investors and are not comparable to Moody's
globally applicable ratings; rather they address relative credit risk within a given country. A Aaa rating on Moody's
National Scale indicates an issuer or issue with the strongest creditworthiness and the lowest likelihood of credit
loss relative to other domestic issuers. National Scale Ratings, therefore, rank domestic issuers relative to each
other and not relative to absolute default risks. National ratings isolate systemic risks; they do not address loss
expectation associated with systemic events that could affect all issuers, even those that receive the highest
ratings on the National Scale.
Foreign Currency Deposit Rating
Moody's ratings on foreign currency bank obligations derive from the bank's local currency rating for the same
class of obligation. The implementation of JDA for banks can lead to high local currency ratings for certain banks,
which could also produce high foreign currency ratings. Nevertheless, it should be noted that foreign currency
deposit ratings are in all cases constrained by the country ceiling for foreign currency bank deposits. This may
result in the assignment of a different, and typically lower, rating for the foreign currency deposits relative to the
bank's rating for local currency obligations.
Foreign Currency Debt Rating
Foreign currency debt ratings are derived from the bank's local currency debt rating. In a similar way to foreign
currency deposit ratings, foreign currency debt ratings may also be constrained by the country ceiling for foreign
currency bonds and notes; however, in some cases the ratings on foreign currency debt obligations may be
allowed to pierce the foreign currency ceiling. A particular mix of rating factors are taken into consideration in order
to assess whether a foreign currency bond rating pierces the country ceiling. They include the issuer's global local
currency rating, the foreign currency government bond rating, the country ceiling for bonds and the debt's eligibility
to pierce that ceiling.
About Moody's Bank Financial Strength Scorecard
Moody's bank financial strength model (see scorecard below) is a strategic input in the assessment of the financial
strength of a bank, used as a key tool by Moody's analysts to ensure consistency of approach across banks and
regions. The model output and the individual scores are discussed in rating committees and may be adjusted up or
down to reflect conditions specific to each rated entity.
Rating Factors
Bayerische Landesbank
Rating Factors [1]
Qualitative Factors (50%)
A
B
C
D
E
Total Score
D+
Trend
Factor: Franchise Value
Market share and sustainability
Geographical diversification
Earnings stability
Earnings Diversification [2]
Factor: Risk Positioning
Corporate Governance [2]
Neutral
B
Neutral
CE+
Neutral
C-
Neutral
A
Neutral
D
Improving
C
Neutral
x
x
x
x
- Risk Management
- Controls
x
x
Financial Reporting Transparency
x
x
x
x
Credit Risk Concentration
x
- Borrower Concentration
- Industry Concentration
x
x
Liquidity Management
Market Risk Appetite
Factor: Operating Environment
Economic Stability
Integrity and Corruption
Legal System
x
Financial Factors (50%)
Factor: Profitability
PPI % Average RWA (Basel II)
Net Income % Average RWA (Basel II)
Factor: Liquidity
(Market Funds - Liquid Assets) % Total Assets
Liquidity Management
Factor: Capital Adequacy
Tier 1 Ratio (%) (Basel II)
13.37%
Tangible Common Equity % RWA (Basel II)
14.58%
Factor: Efficiency
Cost / Income Ratio
Factor: Asset Quality
Problem Loans % Gross Loans
Problem Loans % (Equity + LLR)
Lowest Combined Financial Factor Score (15%)
Aggregate BFSR Score
Aggregate BCA Score
Assigned BFSR
Assigned BCA
D-
x
Controls and Risk Management
Economic Insolvency Override
Neutral
x
- Ownership and Organizational Complexity
- Key Man Risk
- Insider and Related-Party Risks
- Global Comparability
- Frequency and Timeliness
- Quality of Financial Information
D+
x
x
x
x
x
0.69%
0.27%
18.59%
x
76.14%
2.92%
25.90%
DNeutral
D+
baa3/ba1
D
ba2
[1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information.
[2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral.
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MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually
at www.moodys.com under the heading "Shareholder Relations — Corporate Governance — Director and
Shareholder Affiliation Policy."
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