DBRS Morningstar Confirms DZ BANK Group at AA (low) / R-1 (middle), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long- and Short-Term Issuer Ratings of DZ BANK AG Deutsche Zentral-Genossenschaftsbank (DZ BANK Group or the Group) at AA (low) / R-1 (middle). The trend on all ratings is stable. The DZ BANK Group benefits from the membership of the Genossenschaftliche Finanzgruppe Volksbanken und Raiffeisenbanken (Cooperative Financial Network or 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.

KEY RATING CONSIDERATIONS

DZ BANK Group’s A (high) IA reflects the Group’s solid profitability underpinned by diversified revenue streams and sound risk profile. It also reflects the Group’s diversified liquidity and funding profile as well as sound levels of capital retention. The IA is underpinned by the Group’s role as a central clearing bank and service provider to the local cooperative banks in Germany. The IA also takes into consideration the competitive German banking market and low interest rate environment which limits earnings upside, as well as some earnings sensitivity to capital market volatility.

More recently, earnings at DZ BANK Group and the CFN have been challenged due to the COVID-19 pandemic. DZ BANK Group’s profits declined in H1 2020 due to negative valuation effects related to capital market volatility and increased loan loss provisions, while net interest income and fees still showed positive momentum. Going forward, DBRS Morningstar expects pressure on profits from factors such as low rates, potentially lower loan demand, and elevated provisioning needs. Capital market movements could also continue to have a negative effect on earnings. However, DBRS Morningstar expects that DZ BANK Group’s and the CFN’s earnings capacity is strong enough to absorb these challenges.

RATING DRIVERS

Given the current COVID-19 pandemic, a rating upgrade is unlikely. However, any improvement in the overall credit profile of the CFN could lead to an upgrade of DZ BANK Group’s Issuer ratings. A strengthening of DZ BANK Group’s bottom line profitability along with reduced earnings volatility could lead to positive pressure on the IA.

Any deterioration in the overall credit profile of the CFN could lead to a downgrade of DZ BANK Group’s Issuer ratings. Negative pressure on the IA could result from a material increase in DZ BANK Group’s risk profile or significant earnings volatility.

RATING RATIONALE

Through a number of intra-network mergers, DZ BANK Group has become Germany’s second largest banking group by total assets. The Group’s significant size, with the potential to deploy scale economies across its business, provides a significant cost advantage in the medium term and the opportunity to reap scale efficiencies, especially given the rising costs from regulation and IT infrastructure. While DZ BANK Group benefits from a diversified earnings stream, more recently, the results have been affected by the low interest rate environment and capital market volatility. Given the ongoing impact from the COVID-19 pandemic we expect DZ BANK Group’s revenues and earnings to be negatively affected. However, given the focus of the Group’s lending is in Germany, which has been less affected by the pandemic than some other European countries to date, as well as the improvement in the Group’s risk profile in recent years, DZ BANK Group and the broader cooperative network should be well positioned to absorb the current challenges.

Despite strong core revenue trends in H1 2020 with net interest income (NII) up 13% year-on year (YoY) to EUR 1.5 billion and fee income up 9.8% YoY to EUR 1.1 billion, Group income before provisions and taxes (IBPT) was EUR 1.1 billion in H1 2020, down quite significantly from EUR 1.6 billion a year earlier mainly due to weaker performance in the insurance segment, which is exposed to equity market performance. Profit before tax (PBT) was EUR 0.6 billion versus EUR 1.5 billion a year earlier, as the provision for loan loss allowance increased from EUR 105 million to EUR 522 million. DBRS Morningstar expects earnings pressure to continue given the low rate environment and possibly lower loan demand, while loan losses should remain elevated. However, we expect earnings generation to remain strong enough to absorb credit costs.
DBRS Morningstar views the overall risk profile of the Group as sound and is of the opinion that the risk profile has improved since the last financial crisis, positioning the Group to better withstand the challenges resulting from COVID-19. Nonetheless, DZ BANK Group’s exposure to corporate customers and its capital markets-related activities add incremental risk to the Group’s overall risk profile. The reported non-performing loan (NPL) ratio for the entire Group edged up slightly to 1.2% at end-H1 2020 from 1.1% at end-2019. In Germany the government, the consumer and the corporate sector have all entered the crisis in relatively strong financial health, which we view as supportive of banks’ credit performance and various support measures are expected to soften the economic impact. However, we expect the deterioration of loan portfolios to become more visible in the future. With the length of economic disruptions still uncertain, there is risk to the downside. In particular, we are monitoring the Group’s fairly large commercial real estate exposure through DZ HYP as well as the remaining EUR 6.1 billion loan exposure to shipping and offshore finance.

DBRS Morningstar views DZ BANK Group’s liquidity as strong. The Group’s loan to deposit ratio (LTD) stood at a relatively high 139% at end-H1 2020, however, the Group also benefits from ample deposits placed by the cooperative banking network and has access to diversified non-deposit funding, including covered bonds. The Group reported a liquidity coverage ratio (LCR) of 140% against a regulatory minimum of 100% and an internal minimum target of 110%.

DZ BANK Group’s fully loaded Basel III Common Equity Tier 1 (CET1) ratio at end-H1 2020 was 14.0% down slightly from the 14.4% year-end 2019, as risk weighted assets (RWAs) increased. The ratio comfortably exceeded the minimum capital requirements of 9.76% for 2020 (not including the temporary easing). The H1 2020 total capital ratio of 17.3% was down from 17.9% at year-end 2019, but also compared well against SREP minimum requirement of 13.26% for 2020 (also not including regulatory easing). DZ BANK Group’s fully loaded leverage ratio declined from 4.9% at year-end to 4.6% at end-2020 H1 2020, well above the 3.5% internal target.

The BVR (Bundesverband der Deutschen Volksbanken und Raiffeisenbanken) organises the interests of the CFN and is in charge of the BVR Institutional Protection Scheme and Deposit Protection Scheme (BVR Institutssicherung GmbH (BVR-ISG). Currently, 836 institutions are part of these protection schemes which are financed without government support. They reduce the default risk for each individual member by making financial resources available to each institution within the Group. The strength and structure of the Scheme are a key element in the one-notch uplift of the Group’s Issuer Rating from the IA.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
The Grid Summary Grades for DZ BANK AG Deutsche Zentral-Genossenschaftsbank’s IA are as follows: Franchise Strength – Strong; Earnings – Strong/Good; Risk Profile – Strong/Good; Funding & Liquidity – Strong; Capitalisation – Strong.

Notes:
All figures are in Euros unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (8 June 2020) https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include DZ BANK and CFN 2019 Annual Reports, DZ BANK H1 2020 Interim Report, DZ BANK H1 2020 Presentation, DZ BANK 2019 Facts and Figures, Cooperative Banks 2019 Annual Report, Cooperative Banks Press Releases and Press Conference Presentations 2016-2019 and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was 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

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

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS Morningstar's outlooks and ratings are under regular surveillance

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/369815

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Sonja Förster - Vice President - Global Financial Institutions Group
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of European FIG - Global FIG
Initial Rating Date: May 22, 2007
Last Rating Date: January 16, 2020

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