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      Scope assigns L-Bank a credit rating of AAA with a Stable Outlook

      An explicit government guarantee scheme for L-Bank’s obligations, high strategic importance, a strong liquidity and funding profile, and high asset quality support the rating; limited loan portfolio diversification and modest profitability are challenges.

      The latest information on the rating, including rating reports and related methodologies, are available on this LINK.

      Scope Ratings GmbH has today assigned Landeskreditbank Baden-Württemberg – Förderbank - (L-Bank) a long-term issuer rating of AAA in both local and foreign currency. The agency also assigns a short-term issuer rating of S-1+ in both local and foreign currency. L-Bank’s senior unsecured debt in both local and foreign currency was also rated AAA. All Outlooks are Stable.

      Rating drivers

      Scope’s assignment of the AAA rating on L-Bank reflects: i) the explicit, direct, unconditional, irrevocable and statutory guarantee of the federal state of Baden-Württemberg (AAA/Stable) for L-Bank’s obligations; ii) the mature and supportive legal framework with additional liability support mechanisms provided by the federal state; iii) its high strategic importance as a key government-related entity (GRE) implementing economic policy for the federal state; iv) its strong liquidity and funding profile with excellent capital market access; and v) its strong capital position and high asset quality. L-Bank’s modest, but stable profitability alongside a limited loan portfolio diversification, both foreseen by L-Bank’s public policy mandate, are challenges. The Stable Outlook reflects Scope’s assessment that the risks L-Bank faces are manageable and remain balanced.

      L-Bank’s AAA rating reflects the extensive guarantee framework for its liabilities provided by the federal state of Baden-Württemberg (AAA/Stable), which is the key factor for equalising L-Bank’s ratings with the ratings of the federal state. The explicit, direct, unconditional, irrevocable and statutory guarantee has been laid down in public law since 1998. In addition, L-Bank benefits from further liability support mechanisms provided by the federal state of Baden-Württemberg. These include a maintenance obligation (‘Anstaltslast’) that secures the financial basis of L-Bank and a guarantee obligation (‘Gewährträgerhaftung’) that obliges the federal state to step in if creditor claims cannot be satisfied out of L-Bank's assets. The three-fold guarantee mechanism complies with EU law on state aid, resulting in a high likelihood that government support would be provided by the federal state of Baden-Württemberg to L-Bank if needed.

      The rating is further underpinned by L-Bank’s high strategic importance to the federal state of Baden-Württemberg. As the federal state’s development agency, L-Bank plays a key role in meeting key economic and political objectives on a regional level, in areas such as: i) economic development via the provision of loans, subsidies or other financial assistance, especially to small and medium-sized enterprises (SMEs); ii) housing developments; and iii) financing infrastructure projects. Potential risks to L-Bank’s strong position as the federal state’s sole development bank and its provision of competition-neutral business activities, which are underpinned by a mature and supportive legal framework, are deemed remote.

      L-Bank benefits from a favourable liquidity and funding profile, with an excellent track record of capital markets access. L-Bank has a long-term debt issuance programme including an authorised size of EUR 30bn (of which EUR 14.6bn was utilised at year-end 2018) as well as a commercial paper programme with a funding limit of EUR 15bn (utilisation at year-end 2018: EUR 10.2bn), which is used for short-term refinancing. The explicit liability support by the federal state for obligations in respect of money borrowed, bonds issued, and derivative transactions entered into by L-Bank, eligibility for the European Central Bank’s monetary policy operations, including its quantitative easing programme, and zero risk-weighting has enabled L-Bank to access capital markets on favourable terms. L-Bank’s excellent market access was again observed in July 2019 when it issued a USD 2bn five-year bond with a 2% coupon. Scope therefore expects L-Bank to continue to tap capital markets at very attractive rates.

      Additionally, L-Bank’s capital position is also strong and improving, reflected by a steady rise of its capital ratios in recent years as its board has consistently opted to allocate net profits to retained earnings. As of year-end 2018, L-Bank reported a total capital ratio of 20.6%, composed almost entirely of Common Equity Tier 1 capital (18.6% of risk-weighted assets), below the average for national peers of 27.3%. L-Bank adopts a prudent approach to the management of its regulatory capital, having increased the internally-required minimum total capital ratio by 0.5pps and applying a bank-specific countercyclical buffer of 1% since 2017, the latter of which is above current regulatory requirements.

      Finally, L-Bank’s loan portfolio stands out with its high quality with very low non-performing exposures, reflecting its prudent lending approach focused on low-risk borrowers with strong credit fundamentals and strong due-diligence approach. Its share of problem loans relative to gross customer loans has been steadily decreasing from a peak of 2% in 2015 and reached 0.22% in 2018, the second lowest among national peers whose average problem loans stood at 2% of customer loans in 2018. Only 1.1% of the loan portfolio had a non-investment grade rating at the end of 2018.

      Despite these credit strengths, the AAA rating is challenged by L-Bank’s limited loan portfolio diversification and modest though stable profitability, which are both due to L-Bank’s public policy mandate.

      First, L-Bank’s loan portfolio is characterised by both regional and sectoral concentration. The financial and public sectors account for 45% and 34% of total risk exposures respectively while 91% of L-Bank’s exposures are in Germany (of which 68.5% in Baden-Württemberg). While not uncharacteristic of a regional development bank, geographical exposure concentration increases the risks of balance sheet deterioration if, for instance, economic conditions in Baden-Württemberg’s export-oriented economy were to worsen significantly. Scope notes positively, however, that L-Bank’s exposure concentration to the financial sector is largely for on-lending purposes with the ultimate risk being assumed by commercial banks (i.e. the ‘house-bank principle’). L-Bank’s double-recourse loan protection, that is, its direct claim against the ultimate borrower as well as the intermediary bank to whom it provided the initial loan, further mitigates its credit risks and allows L-Bank to provide subsidised loans whilst reducing capital requirements.

      Second and finally, L-Bank’s profitability has been modest though stable, reflecting the non-profit character of its business model and its public policy mandate. The low interest rate environment vis-à-vis robust demand for housing loans and infrastructure promotion have put L-Bank’s return on average assets under pressure, averaging around 0.07% over the past five years which is below the average for national peers (0.16%). Furthermore, L-Bank’s business performance is largely dependent on interest income which constitutes its primary source of revenue. The low net interest margin of 0.5% in 2018 could signal a risk to L-Bank’s business performance if its asset quality were to significantly deteriorate. With a slight increase of net interest income despite the low interest rate environment, an increase of commission income and falling administrative expenses, L-Bank’s cost-to-income ratio improved from 52.4% to 44.5% in 2018 which is low compared to its national peers’ average of 72.0%. Still, going forward, Scope expects profitability to remain stable yet subdued, with low interest rates set to continue.

      Qualitative Scorecard (QS1 and QS2)

      Provided that the GRE benefits from an ‘integral/strong’ level of integration with the government, Scope may apply the ‘top-down’ approach which takes the government’s rating as the starting point and then negatively adjusts it by up to three notches (although exceptions can apply). Equalisation of a GRE’s rating with that of its government is possible if an explicit guarantee exists.

      Scope assigns a ‘strong’ level of integration between L-Bank and the federal state of Baden-Württemberg (QS1), reflecting i) single public ownership by the federal state; ii) L-Bank’s public legal status as an ‘Anstalt des öffentlichen Rechts’ (public law institution); and iii) the fulfillment of operating activities exclusively on behalf of the government with the main purpose of providing a key public service in the public interest.

      On this basis, Scope applies the rating equalisation factor due to the explicit, direct, unconditional, irrevocable and statutory government guarantee for L-Bank’s obligations provided by the federal state of Baden-Württemberg (AAA/Stable).

      Scope assigns a ‘medium’ assessment to the ‘control and regular government support’ for L-Bank (QS2) as a result of: i) the ‘high’ ability of the government to control L-Bank given that the scope and content of L-Bank’s business activities are defined and regulated by law; and ii) the ‘limited’ regular financial support for L-Bank, reflecting its positive and stable operating performance as well as its excellent access to capital markets.

      Scope assigns a ‘high’ assessment to the ‘likelihood of exceptional government support’ if L-Bank were to experience difficulties in payment (QS2), reflecting L-Bank’s i) ‘high’ strategic importance to the government, ii) ‘low’ substitution risk; and iii) ‘significant’ potential macroeconomic costs if the provision of L-Bank’s services was interrupted.

      Scope therefore captures the benefit of the guarantee framework, which allows L-Bank to operate without regular financial support from the federal state of Baden-Württemberg (AAA/Stable), in its assessment of the ‘high likelihood of exceptional government support’, recognizing that it is the functioning of the framework that provides continuous regular support to L-Bank if needed, which in turn makes the need for exceptional support highly unlikely.

      For further details, please see Figures 2 and 3 of the rating report.

      Outlook and rating-change drivers

      The assignment of the Stable Outlook reflects Scope’s view that risks to the ratings are manageable and remain broadly balanced. The ratings could be downgraded in the event of: i) a downgrade of the federal state of Baden-Württemberg; and/or ii) changes in the legal framework or guarantee structure, notably weakening government support for L-Bank.

      Rating committee
      The main points discussed during the rating committee were: i) Integration with government; ii) guarantee structure; iii) control and regular government support; iv) likelihood of exceptional support; v) supplementary analysis: L-Bank’s fundamentals.

      Methodology
      The methodology applicable for this rating and/or rating outlook, ‘Rating Methodology: Government Related entities’, published on 12 July 2019, is available on www.scoperatings.com.
      Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerepweb/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

      Solicitation, key sources and quality of information
      The rated entity and/or its agents participated in the rating process.
      The following substantially material sources of information were used to prepare the credit rating: the rated entity, public domain. Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
      Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

      Regulatory disclosures
      This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
      Lead Analyst: Rating prepared by Jakob Suwalski, Associate Director.
      Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director.
      The ratings/outlook was first released by Scope on 22 January 2020.

      Potential conflicts
      Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

      Conditions of use / exclusion of liability
      © 2020 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5 D-10785 Berlin.

      Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.
       

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