Sparkasse KoelnBonn

FINANCIAL INSTITUTIONS
CREDIT OPINION
26 July 2016
Sparkasse KoelnBonn
Update following affirmation of ratings
Update
Summary Rating Rationale
On 18 July, we affirmed Sparkasse KoelnBonn's (SKKB's) Aa3 long-term deposit ratings and
the bank's A2 long-term debt ratings with a stable outlook. We also affirmed the bank's
P-1 short-term deposit ratings, its Baa2 subordinated debt rating and its Aa3(cr)/P-1(cr)
Counterparty Risk (CR) Assessments. At the same time, we upgraded SKKB’s baseline credit
assessment (BCA) to ba1 from ba2, while we afffirmed the bank’s baa1 adjusted BCA.
RATINGS
Sparkasse KoelnBonn
Domicile
Koeln, Germany
Long Term Debt
A2
Type
Senior Unsecured Dom Curr
Outlook
Stable
Long Term Deposit
Aa3
Type
LT Bank Deposits - Fgn
Curr
Outlook
Stable
Please see the ratings section at the end of this report
for more information. The ratings and outlook shown
reflect information as of the publication date.
SKKB's long-term debt and deposit ratings reflect: (1) the bank's upgraded ba1 BCA; (2) its
affirmed baa1 Adjusted BCA, which incorporates unchanged very high affiliate support from
Sparkassen-Finanzgruppe (S-Finanzgruppe; Aa2 stable, a2)1 which results in three (previously
four) notches of affiliate support; (3) the results of our Advanced Loss Given Failure (LGF)
Analysis, which provides three notches of rating uplift for deposits and one notch for senior
debt from the baa1 Adjusted BCA; and (4) our assumption of “moderate” government
support, resulting in one notch of rating uplift for SKKB's debt and deposits.
The upgrade of SKKB's standalone BCA by one notch to ba1 reflects the bank's improved
capital, also considering increasing high-quality additional capital reserves allowed by
German GAAP (§340f reserves) and a binding agreement reached earlier in 2016 that
provides SKKB's management full discretion to convert silent participation instruments into
new common equity.
Analyst Contacts
Bernhard Held, CFA
49-69-70730-973
VP – Senior Analyst
[email protected]
Exhibit 1
Rating Scorecard - Key Financial Ratios
Carola Schuler
49-69-70730-766
Managing Director Banking
[email protected]
Alexander Hendricks,
49-69-70730-779
CFA
Associate Managing
Director - Banking
[email protected]
Source: Moody's Financial Metrics
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
Credit Strengths
»
Solid, deposit-based funding profile and sound liquidity
»
Improving asset quality supported by the bank's stable Macro Profile of Very Strong-
»
SKKB benefits from strong cross-sector support
Credit Challenges
»
Planned hybrid capital conversion will improve SKKB's still weak capital structure
»
Operating profitability is subject to continued pressure in the low interest rate environment
»
Declining trend in senior and subordinated debt loss-absorption capacity
Rating Outlook
»
The outlook on the bank's long-term debt and deposit ratings is stable, reflecting our expectation that the future strengthening
of the bank's BCA, following a conversion of €500 million of silent participations into common equity, will be offset by a less
favourable loss-given-failure for senior debt and deposits.
Factors that Could Lead to an Upgrade
»
An upgrade of SKKB’s BCA would be subject to a conversion of the bank’s €500 million of silent participations into common
equity. The BCA could further benefit from a recovery of the bank’s profitability beyond our current expectations after the
conversion of these silent participations.
»
An upgrade of the BCA may not directly translate into an upgrade of SKKB’s long-term debt and deposit ratings, as indicated by
the stable rating outlook, because we expect upward pressure on the BCA to be offset by an increase in the loss severity for these
instruments under our Advanced LGF analysis.
Factors that Could Lead to a Downgrade
»
A downgrade of SKKB’s BCA is currently unlikely, unless the bank experiences asset quality and/or profitability deterioration beyond
our current expectations.
»
A future downgrade of SKKB’s BCA may not directly translate into a downgrade of SKKB’s long-term ratings, if our assumption of a
very high support probability by S-Finanzgruppe’s IPS remains unchanged.
»
However, SKKB’s long-term ratings may be downgraded based on a stronger increase in loss-given-failure for SKKB’s individual
debt classes than we currently anticipate. Such higher loss severities could result from a continued reduction in senior and
subordinated debt volumes outstanding.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
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Sparkasse KoelnBonn: Update following affirmation of ratings
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
Key Indicators
Exhibit 2
Sparkasse KoelnBonn (Unconsolidated Financials) [1]
Total Assets (EUR billion)
Total Assets (USD billion)
Tangible Common Equity (EUR billion)
Tangible Common Equity (USD billion)
Problem Loans / Gross Loans (%)
Tangible Common Equity / Risk Weighted Assets (%)
Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%)
Net Interest Margin (%)
PPI / Average RWA (%)
Net Income / Tangible Assets (%)
Cost / Income Ratio (%)
Market Funds / Tangible Banking Assets (%)
Liquid Banking Assets / Tangible Banking Assets (%)
Gross loans / Due to customers (%)
12-152
12-142
12-133
12-123
12-113
Avg.
26.5
28.8
1.2
1.3
3.4
7.8
47.1
1.5
0.8
0.1
82.7
13.1
20.5
102.3
27.4
33.1
1.1
1.3
4.0
7.4
57.8
1.5
0.8
0.3
82.6
17.1
22.1
106.6
28.7
39.6
1.0
1.4
4.8
6.5
71.4
1.5
0.6
0.2
84.5
21.0
23.4
109.9
28.9
38.1
0.9
1.2
5.0
5.4
78.1
1.5
0.7
0.1
79.7
28.5
19.8
117.6
29.3
38.1
0.9
1.2
4.7
5.6
74.9
1.4
0.5
0.0
85.9
32.7
19.6
125.2
-2.54
-6.74
5.84
1.24
4.35
7.66
65.95
1.55
0.86
0.15
83.15
22.55
21.15
112.35
[1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; LOCAL GAAP [3] Basel II; LOCAL GAAP [4] Compound Annual
Growth Rate based on LOCAL GAAP reporting periods [5] LOCAL GAAP reporting periods have been used for average calculation [6] Basel III - fully-loaded or transitional phase-in &
LOCAL GAAP reporting periods have been used for average calculation
Source: Moody's Financial Metrics
Detailed Rating Considerations
SKKB is one of the largest German savings banks, with total assets of €26.5 billion as of December 2015. It is active in corporate and
retail banking and is wholly owned by the Cities of Cologne (70%, unrated) and Bonn (30%, unrated). SKKB reports under local GAAP.
Planned hybrid capital conversion will improve SKKB's Weak capital structure
SKKB's modest capitalisation and weak capital structure remain a constraint for the BCA, despite our recent upgrade of the assigned
Capital score to ba3 from b2. SKKB has entered into an agreement with its owners that allows the bank to convert €500 million of
silent participations held by the owners into common equity. Until year-end 2017, these instruments are currently treated as Additional
Tier 1 (AT1) for regulatory capital purposes. We expect that these will be converted by the bank into instruments eligible as regulatory
Common Equity Tier 1 (CET1) in 2017. The conversion right gives the bank access to additional committed equity sources, which leads
us to assign a capital score of ba3, one notch above the b1 macro-adjusted capital score.
Prior to this expected conversion, SKKB reported a weak regulatory CET1 ratio of 7.0% as of year-end 2015 (2014: 6.7%); the Tier 1
ratio that includes AT1 capital was 10.3%. While we expect that the structural weakness will be addressed, we expect only modest
internal capital generation during 2016-19. We also note that SKKB's ability to maintain a sound total capital structure and ratios will
require replacement of maturing subordinated instruments.
SKKB's modest bottom-line profitability implies that economic setbacks and/or a further tightening of regulatory capital requirements
cannot be swiftly addressed through earnings retention; we have assigned a b2 Profitability score. In addition, further capital measures
to bolster Additional Tier 1 or Tier 2 capital will require prudent management of the bank's limited resources given the additional costs
involved. That said, we expect that Tier 2 capital will be available at attractive rates. SKKB plans to issue subordinated capital in order
to more comfortably meet the 10.5% minimum total capital ratio applicable from 2019, by which date some outstanding subordinated
instruments will mature.
Solid, increasingly deposit-based funding profile and sound liquidity
SKKB's liquidity and funding profile benefits from a substantial amount of liquid assets, high and granular deposit levels, and diversified
alternative funding sources, which together imply low funding risks. We expect that this profile will remain unchanged, underpinned by
SKKB's retail-focused business model and high (and rising) levels of household savings. At the same time, the recent reduction of senior
unsecured and subordinated funding may prospectively translate into higher loss-given-failure for institutional depositors and senior
unsecured investors.
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26 July 2016
Sparkasse KoelnBonn: Update following affirmation of ratings
MOODY'S INVESTORS SERVICE
FINANCIAL INSTITUTIONS
SKKB's refinancing needs are modest, given stable customer deposits of €16.3 billion (2014: €15.6 billion) against a loan book of
€19.5 billion at year-end 2015 (2014: €19.8 billion). In addition, SKKB places parts of its securitised liabilities with its clients, including
subordinated debt. The bank's funding strategy includes long-term funds from the issuance of mortgage and public-sector Pfandbriefe
(covered bonds), which provide for diversification and easier market access.
SKKB had adequate liquidity reserves as of year-end 2015 and reports that it is already in compliance with the new regulatory liquidity
ratios under CRR/CRD IV, with a 199% Liquidity Coverage Ratio.
Profitability benefits from improving asset quality, but is subject to pressure in the low rates environment
We expect that SKKB's net income will remain at low levels in 2016-17, commensurate with our assigned profitability score of b2.
Thereafter, the bank will benefit from the expiry of several expenses, including (1) an approximate €15 million annual provision (expiry
expected in 2016) for potential losses of Erste Abwicklungsanstalt (EAA; Aa1 stable)2, the unwinding vehicle of the former WestLB (now
Portigon, unrated), wholly owned by the Land of Nordrhein-Westfalen (Aa1 stable)3; and (2) close to €40 million in interest payments
on its silent participations. We expect that the bank will only achieve significant additional improvements in results if interest rates pick
up from their currently extended low levels.
For 2015, SKKB reported a net profit of €25.8 million, down from a Moody's-adjusted net income of €75.4 million in 2014. The bank's
2015 results benefitted from the continued moderate level of specific loan loss provisioning of €21 million or 18% of pre-provision
income. This reflects the continued improvement in asset quality, as expressed by a 3.4% problem loan ratio as of year-end 2015,
down from 4.0% in December 2014. At the same time, the bank's net interest income declined to €382 million by €14 million, whereas
the bank's cost-income ratio remained broadly unchanged at a high 82.7%. In addition, the bank's 2014 results had been supported by
the sale of a 50% stake in real estate asset manager Corpus Sireo Holding (unrated).
The bank's asset quality remains on an improving trend, driven by the favourable operating environment of Germany, as well as the
bank's good progress in working out higher-risk legacy assets. At the same time, single-name concentrations in SKKB's corporate loan
book and securities portfolio, whilst on a reducing trend, remain large in the context of the bank's capital. SKKB also continues to
provide funding to commercial real-estate funds, some of which have been underperforming, which has triggered legal disputes with
the funds' capital sponsors. We adjust the bank's score for Asset Risk down to ba1 from the ratio-implied baa1 score in order to duly
reflect these risk concentrations, as well as the market risk (that is, the residual interest rate risk after hedges), which relates to the
natural mismatch of the bank's short-term funding profile.
SKKB's rating is supported by its Macro Profile of Very StrongThe vast majority of SKKB's assets are in Germany, resulting in a `Very Strong-' Macro Profile, in line with Germany's Macro Profile.
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26 July 2016
Sparkasse KoelnBonn: Update following affirmation of ratings
MOODY'S INVESTORS SERVICE
FINANCIAL INSTITUTIONS
Notching Considerations
Affiliate Support
SKKB benefits from an unchanged very high level of cross-sector support from Sparkassen-Finanzgruppe. Cross-sector support
materially reduces the probability of default, as it would be available to stabilise a distressed member bank and not just compensate for
losses in a resolution. Our assumptions result in three notches of rating uplift to SKKB's debt and deposit ratings, down by one notch
compared to the situation before SKKB's BCA upgrade to ba1. As a result of the higher starting point of SKKB’s BCA, the unchanged
support assumption now provides less notching benefit for SKKB’s Adjusted BCA.
Loss Given Failure
In our Advanced LGF analysis, we consider the risks faced by the different debt and deposit classes across the liability structure in a
resolution. We assume residual tangible common equity (TCE) of 3% and losses post-failure of 8% of tangible banking assets, a 25%
run-off in "junior" wholesale deposits and a 5% run-off in preferred deposits. In the case of SKKB our assumption is that only a small
percentage (10%) of the bank's deposit base can actually be considered junior and qualify as bail-in-able under BRRD. These ratios are
in line with our standard assumptions. In line with the new German insolvency legislation that will effectively subordinate senior bonds
and notes to deposits in resolution from January 2017, we base our calculation on the assumption that deposits are preferred to most
senior unsecured debt instruments.
For deposits, our LGF analysis indicates an extremely low loss-given-failure, leading to a three-notch uplift from the bank's baa1
adjusted BCA.
For SKKB's senior unsecured debt our LGF analysis indicates a low loss-given-failure, leading to a one-notch uplift from the bank's baa1
adjusted BCA.
For SKKB's subordinated debt, rated Baa2, our LGF analysis indicates a high loss-given-failure, positioning this rating one notch below
the baa1 adjusted BCA.
Government Support
German banks operate in an environment of materially weakened prospects for financial assistance from the government; we assume
that the restrictions imposed under the EU Bank Recovery and Resolution Directive to support SKKB in the event of its failure apply
equally to the bank's public-sector owners. Nonetheless, we maintain one notch of rating uplift in our senior debt and deposit ratings
for SKKB, reflecting assumptions of a modest support probability. Our government support assumptions reflect the size and high
systemic relevance of S-Finanzgruppe of which SKKB is a member.
About Moody's Bank Scorecard
Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in
conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecard
may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong
divergence). The Scorecard 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.
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26 July 2016
Sparkasse KoelnBonn: Update following affirmation of ratings
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
Rating Methodology and Scorecard Factors
Exhibit 3
Sparkasse KoelnBonn
Macro Factors
Weighted Macro Profile
Very
Strong -
Financial Profile
Factor
Historic Macro
Ratio Adjusted
Score
Credit
Trend
Assigned Score
Key driver #1
Key driver #2
Solvency
Asset Risk
Problem Loans / Gross Loans
4.0%
baa1
←→
ba1
Sector concentration
Interest rate risk
Capital
TCE / RWA
7.8%
b1
↑
ba3
Access to capital
Nominal leverage
Profitability
Net Income / Tangible Assets
0.1%
b2
←→
b2
Expected trend
Earnings quality
Combined Solvency Score
Liquidity
Funding Structure
Market Funds / Tangible Banking Assets
13.1%
a1
←→
a1
Market
funding quality
Liquid Resources
Liquid Banking Assets / Tangible Banking Assets
20.5%
baa1
←→
baa2
Asset encumbrance
Combined Liquidity Score
Financial Profile
Business Diversification
Opacity and Complexity
Corporate Behavior
Total Qualitative Adjustments
Sovereign or Affiliate constraint:
Scorecard Calculated BCA range
Assigned BCA
Affiliate Support notching
Adjusted BCA
Balance Sheet
Other liabilities
Deposits
Preferred deposits
Junior Deposits
Senior unsecured bank debt
Dated subordinated bank debt
Junior subordinated bank debt
Preference shares (bank)
Senior unsecured holding company debt
Dated subordinated holding company debt
Junior subordinated holding company debt
Preference shares (holding company)
Equity
Total Tangible Banking Assets
6
100%
26 July 2016
ba2
ba3
a2
a3
ba1
0
0
0
0
Aaa
baa3-ba2
ba1
3
baa1
in-scope (EUR)
6,867
16,245
14,621
1,625
1,570
318
224
500
% in-scope
25.9%
61.3%
55.1%
6.1%
5.9%
1.2%
0.8%
1.9%
at-failure (EUR)
8,005
15,108
13,890
1,218
1,570
318
224
500
% at-failure
30.2%
57.0%
52.4%
4.6%
5.9%
1.2%
0.8%
1.9%
796
26,520
3.0%
100%
796
26,520
3.0%
100%
Sparkasse KoelnBonn: Update following affirmation of ratings
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
Debt class
Counterparty Risk Assessment
Deposits
Senior unsecured bank debt
Dated subordinated bank debt
Instrument Class
Counterparty Risk Assessment
Deposits
Senior unsecured bank debt
Dated subordinated bank debt
De jure waterfall De facto waterfall
Notching
LGF
Assigned Additional Preliminary
LGF
notching
Rating
Instrument Sub- Instrument SubDe jure De facto notching
guidance notching
Assessment
volume + ordination volume + ordination
versus
subordination
subordination
BCA
17.4%
17.4%
17.4%
17.4%
3
3
3
3
0
a1 (cr)
17.4%
6.9%
17.4%
12.8%
2
3
3
3
0
a1
17.4%
6.9%
12.8%
6.9%
2
1
1
1
0
a3
6.9%
5.7%
6.9%
5.7%
-1
-1
-1
-1
0
baa2
Loss Given
Failure notching
3
3
1
-1
Additional Preliminary Rating
notching
Assessment
0
0
0
0
a1 (cr)
a1
a3
baa2
Government
Local Currency rating Foreign
Support notching
Currency
rating
1
Aa3 (cr)
-1
Aa3
Aa3
1
A2
-0
Baa2
--
Source: Moody's Financial Metrics
Ratings
Exhibit 4
Category
SPARKASSE KOELNBONN
Outlook
Bank Deposits
Baseline Credit Assessment
Adjusted Baseline Credit Assessment
Counterparty Risk Assessment
Senior Unsecured -Dom Curr
Subordinate -Dom Curr
Moody's Rating
Stable
Aa3/P-1
ba1
baa1
Aa3(cr)/P-1(cr)
A2
Baa2
Source: Moody's Investors Service
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26 July 2016
Sparkasse KoelnBonn: Update following affirmation of ratings
MOODY'S INVESTORS SERVICE
FINANCIAL INSTITUTIONS
Endnotes
1 The ratings shown are S-Finanzgruppe's Corporate Family Rating and outlook and its BCA.
2 The rating shown is EAA's senior unsecured rating and outlook
3 The rating shown is Nordrhein-Westfalen's senior unsecured rating and outlook.
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26 July 2016
Sparkasse KoelnBonn: Update following affirmation of ratings
MOODY'S INVESTORS SERVICE
FINANCIAL INSTITUTIONS
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entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered
with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.
MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred
stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees
ranging from JPY200,000 to approximately JPY350,000,000.
MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.
REPORT NUMBER 1031819
9
26 July 2016
Sparkasse KoelnBonn: Update following affirmation of ratings
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
Analyst Contacts
Christina Gerner
Associate Analyst
10
26 July 2016
CLIENT SERVICES
Camilla P Tenn
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Americas
1-212-553-1653
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852-3551-3077
Japan
81-3-5408-4100
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Sparkasse KoelnBonn: Update following affirmation of ratings