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.

The latest information on the rating, including rating reports and related methodologies, is available here.

Summary and Outlook

Scope’s affirmation of L-Bank’s AAA rating reflects: i) the explicit, unconditional, unlimited, statutory, 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, which makes changes to 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) a strong liquidity and funding profile with excellent capital market access. L-Bank’s modest but stable profitability alongside limited loan portfolio diversification are in line with 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 L-Bank’s legal framework or guarantee structure, notably weakening government support for the 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, statutory, 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 became exempt from ECB supervision as a CRR credit institution in 2019 and does not need to establish a bail-in able liability structure.

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, with total assets of EUR 87bn, L-Bank plays an essential role in meeting key economic and political objectives on a regional level. L-Bank’s crucial strategic position has been highlighted during the Covid-19 crisis. In 2020 the bank paid out emergency funds from the central and state government to businesses in Baden-Württemberg affected by the pandemic amounting to EUR 2.7bn. 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 (the ‘house-bank principle’) as well as the ultimate borrower. Only 1.2% of the loan portfolio had a non-investment grade internal rating at the end of 2020. L-Bank’s share of non-performing exposures over customer loans has been steadily decreasing to 0.5% in 2020 from 2% in 2016.

L-Bank’s Tier 1 capital ratio of 20.4% 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 a sufficient buffer for regulatory changes. At least half of annual profits must be retained according to the L-Bank Act. Scope views L-Bank’s regulatory capital management as prudent and the bank has 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 market 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 driven by L-Bank’s public policy mandate.

First, L-Bank’s loan portfolio is characterised by regional and sectoral concentration. More than half of its primarily domestic exposures are located in the Federal State of Baden-Württemberg. In addition, more than half of its exposures are towards other financial institutions as well as about 27% towards local public sector entities. The regional concentration makes the bank’s asset quality susceptible to developments in the federal state. Should economic conditions in Baden-Württemberg’s export-oriented economy worsen significantly over 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, also supported by significant fiscal support. In addition, counterparty concentration risks are managed prudently by the bank via single obligor, country and concentration limits.

Finally, L-Bank’s profitability is modest but stable, reflecting its non-profit maximising 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 has not been able to decouple from the challenges of the low interest rate environment, but most of the lending in its mandate-driven businesses has low but stable margins. A net interest margin of only 0.25% in 2020 provides a low buffer in case asset quality were to deteriorate significantly which Scope deems unlikely. Although the bank’s cost-to-income ratio increased to 57.9% in 2020 from 44.5% in 2018, it still compares favourably to that of national peers.

Qualitative Scorecard (QS1 and QS2)

If a GRE benefits from an ‘integral/strong’ level of integration with its government, Scope may apply a ‘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). The equalisation of a GRE’s rating with that of its government is possible if an explicit guarantee exists.

Scope sees 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, statutory, direct and irrevocable guarantee for L-Bank’s obligations provided by the Federal State of Baden-Württemberg (AAA/Stable).

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

Scope assesses ‘control and regular government support’ for L-Bank as ‘medium’ (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.

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 were included in Scope’s assessment of: i) L-Bank’s level of integration with the sponsoring government, highlighting the supportive legal framework which requires 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 as well as its conservative financial and risk management. Long-term environmental developments were also considered alongside an 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) the level of integration with the government; ii) the liability support mechanism; iii) control and regular government support; iv) the likelihood of exceptional support; and v) a supplementary analysis of L-Bank’s fundamentals.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Government Related Entities, 5 May 2021), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Jakob Suwalski, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 22 January 2020. The Credit Ratings/Outlooks were last updated on 27 November 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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