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Rating action

Scope Ratings GmbH has today affirmed the AAA long-term issuer and senior unsecured ratings of Landeskreditbank Baden-Württemberg - Förderbank - (L-Bank) in both local and foreign currency. The agency has also affirmed the S-1+ short-term issuer rating in both local and foreign currency. All Outlooks are Stable.

Summary and Outlook

Scope’s affirmation of L-Bank’s AAA rating reflects: i) the explicit, unconditional, unlimited, direct and irrevocable guarantee of the German Federal State of Baden-Württemberg (AAA/Stable) for L-Bank’s obligations; ii) the mature and very supportive legal set-up, making changes in L-Bank’s business model or guarantee structure unlikely; iii) the bank’s high strategic importance as a key government-related entity (GRE) implementing economic and social policies for the federal state; iv) sound asset quality and high capitalisation; and v) the strong liquidity and funding profile with excellent capital market access. L-Bank’s modest but stable profitability alongside limited loan portfolio diversification reflect the development bank’s public policy mandate. The Stable Outlook reflects Scope’s assessment that the risks L-Bank faces are 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 rationale

L-Bank’s AAA rating reflects the extensive guarantee framework for its liabilities provided by the German Federal State of Baden-Württemberg, which is the key factor for equalising L-Bank’s ratings with the ratings of the federal state. The explicit, unconditional, unlimited, direct and irrevocable guarantee can only be amended, revoked or restricted through a parliamentary act of Baden-Württemberg. Scope deems any such development unlikely.

Baden-Württemberg assumes the bank’s institutional liability (Anstaltslast) and guarantee obligation (Gewährträgerhaftung). The three-fold guarantee mechanism provides a very high likelihood that government support would be provided by Baden-Württemberg to L-Bank if needed. In line with other German state development banks, the bank is exempt from insolvency procedures as it is chartered under public law. As such L-Bank has become exempt from the ECB supervision as a CRR credit institution in 2019 and does not need to establish a bail-in able liability structure.

The rating is underpinned by L-Bank’s high strategic importance to the Federal State of Baden-Württemberg. As the federal state’s development agency, with total assets of EUR 78bn, L-Bank plays a key role in meeting key economic and political objectives on a regional level. L-Bank’s key strategic position was recently highlighted as it was the sole distributor of emergency grants to businesses in Baden-Württemberg affected by the Covid-19 crisis (Soforthilfe Corona). L-Bank’s activities are split into four promotional pillars: i) development loans to support the regional economy and promote affordable housing, home-ownership, and municipal infrastructure; ii) equity participations; iii) the development of Baden-Württemberg as an investment location through the bank’s technology parks; and iv) the provision of financial assistance on behalf of Baden-Württemberg. 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’s asset quality is high, underpinned by the bank’s double-recourse loan protection for its policy mandated lending business. Typically, L-Bank has a direct claim against the intermediary bank to whom it provided the initial loan (‘house-bank principle’) as well as the ultimate borrower. Only 1% of the loan portfolio had a non-investment grade internal rating at the end of 2019. L-Bank’s share of problem loans relative to gross customer loans has been steadily decreasing to 0.6% in 2019 from a peak of 2% in 2015. It is the second lowest among national peers, which averaged 1.5% in 2019.

L-Bank’s Tier 1 capital ratio of 20.1% is sound. Scope expects the Federal State of Baden-Württemberg to continue allowing the bank to retain earnings to support further growth and to provide sufficient buffer for regulatory changes. At least half of annual profits must be retained according to the L-Bank Act. L-Bank’s regulatory capital management is viewed as prudent and the bank consistently reported significant buffers for all risk types.

The guarantee structure allows the bank to tap capital markets at favourable rates and provides resilient access to capital markets when needed. The bank demonstrates a favourable liquidity and funding profile, with an excellent track record of capital markets access. This is further supported by preferential treatment of the bank’s bonds under Solvency II, along with their recognition as Level 1 high-quality liquid assets for liquidity coverage ratio requirements and zero risk-weighting under Basel.

Despite these credit strengths, challenges to the AAA rating include limited loan portfolio diversification and modest though stable profitability, both reflections of L-Bank’s public policy mandate.

First, L-Bank’s loan portfolio is characterised by regional and sectoral concentration. About two thirds of its primarily domestic exposures are located in the Federal State of Baden-Württemberg. More than half of its exposures are towards other financial institutions as well as about 30% towards local public sector entities. The regional concentration makes the bank’s asset quality somewhat susceptible to developments in the federal state. Should economic conditions in Baden-Württemberg’s export-oriented economy worsen significantly during a protracted period, this could ultimately also impact the bank’s asset quality and profitability. Unfavourable demographic trends and the environmental transition pose longer-term challenges to the outlook for Baden-Württemberg’s export-oriented engineering and car manufacturing industry. However, in the context of the Covid-19 crisis, Baden-Württemberg’s competitive manufacturing and housing sectors have remained resilient and single name concentration risks are managed prudently by the bank via single obligor, country and concentration limits.

Second and finally, L-Bank’s profitability is modest though stable, reflecting its non-profit character and public policy mandate according to the L-Bank Act. L-Bank’s performance is largely dependent on its primary source of revenue, interest income. The bank could not decouple from the challenges of the low interest rate environment, but most of its lending exhibit low but stable margins in its mandate driven businesses. A net interest margin of only 0.34% in 2019 leaves limited room if asset quality were to significantly deteriorate. Even though its cost to income ratio has increased to 53.5% in 2019 from 44.5% in 2018, it still compares favorably to its national peers.

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 the bank’s i) single public ownership by the federal state; ii) public legal status as an ‘Anstalt des öffentlichen Rechts’ (public law institution); and iii) fulfillment of operating activities exclusively on behalf of the government, with the main purpose of providing a key public service in the public interest. Scope applies the rating equalisation factor due to the explicit, unconditional, unlimited, direct and irrevocable 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 and excellent access to capital markets, which enable L-Bank to fulfill its promotional duties without recourse to federal state contributions.

Scope assigns a ‘high’ assessment to the ‘likelihood of exceptional government support’ if L-Bank were to experience difficulties in making payments (QS2), reflecting L-Bank’s ‘high’ strategic importance to the government.

For further details, please see Appendix I of the rating report.

Factoring of Environment, Social and Governance (ESG)

Governance and social considerations are material to L-Bank's rating and included in Scope’s assessment of i) L-Bank’s level of integration with the sponsoring government, highlighting the supportive legal framework requiring L-Bank to comply with its statutes and fulfil its role as a competition-neutral public-law institution, including the general provision of key services in the public interest to support regional economic and social objectives, and, specifically, deal with the implications of the coronavirus outbreak; and ii) L-Bank’s standalone fundamentals, highlighting the high quality of its governance alongside conservative financial and risk management. Long-term environmental developments were also considered alongside the assessment of rating-relevant credit risks but did not play a direct role in this rating action.

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

Methodology
The methodology used for this ratings and/or rating outlooks (Rating Methodology: Government Related Entities, 6 July 2020) are available on https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
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 ratings process.
The following substantially material sources of information were used to prepare the credit rating: issuer and 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 the issuance of the rating, 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, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Jakob Suwalski, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlooks were 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
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