Scope Ratings GmbH (Scope) has today assigned LfA Förderbank Bayern (LfA) a long-term issuer rating of AAA in both local and foreign currency. Scope has assigned a short-term issuer rating of S-1+ in both local and foreign currency. LfA’s senior unsecured debt in both local and foreign currency has also been rated AAA. All Outlooks are Stable.

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

Summary and Outlook

Scope’s assignment of LfA’s AAA rating reflects the explicit, unconditional, unlimited, statutory, direct and irrevocable guarantee of the Free State of Bavaria (AAA/Stable) for LfA’s obligations in respect of money borrowed, bonds issued and derivative transactions entered into by the bank. The rating is underpinned by: i) a mature and very supportive legal set-up, which makes changes to LfA’s business model or guarantee structure unlikely; ii) the bank’s high strategic importance to the federal state as a key government-related entity (GRE) implementing economic policies; iii) high capitalisation and asset quality; and iv) a resilient funding profile and ample liquidity with strong capital market access. LfA’s modest but stable profitability and limited loan portfolio diversification, both foreseen by the bank’s public policy mandate, are challenges. The Stable Outlook reflects Scope’s assessment that the risks LfA faces are balanced.

The ratings could be downgraded in the event of: i) a downgrade of the Free State of Bavaria; and/or ii) changes in LfA’s legal framework or guarantee structure, notably weakening government support for the bank.

Rating rationale

LfA’s AAA rating reflects the extensive guarantee framework for its liabilities provided by the Free State of Bavaria, which is the key factor for equalising LfA’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 Bavaria. Scope deems any such development unlikely.

Bavaria also assumes the bank’s institutional liability (Anstaltslast) and guarantee obligation (Gewährträgerhaftung). The three-fold guarantee mechanism provides an almost certain likelihood that government support would be provided to LfA if ever needed. In line with other German state development banks, the bank is exempt from insolvency procedures as it is chartered under public law.

The rating is further underpinned by LfA’s high strategic importance to the Free State of Bavaria. As a key development agency for the promotion of SMEs and start-ups in Bavaria, with total assets of EUR 23.1bn, LfA plays an essential role in meeting key economic and political objectives to promote the business location on a regional level. LfA’s crucial strategic position has been highlighted during the Covid-19 crisis. In 2020 the bank was equipped with a sizeable guarantee by the Free State of Bavaria of EUR 12bn, to allow it to increase the disbursement of loans with a high degree of guarantees and other risk mitigation products provided by LfA for its commercial bank partners. This has allowed SMEs and start-ups at risk due to the pandemic to continue to access bank funding. In turn, LfA’s total activities in 2020 reached a record high of EUR 4.3bn, up from EUR 2.6bn in 2019.

LfA’s activities are split into six promotional pillars: i) financing for start-ups; ii) financing growth-enhancing business investments; iii) technology; iv) energy and environmental impact; v) liquidity support; and vi) municipal infrastructure. Potential risks to LfA’s key position as one of two federal state development banks (with a clear distinction between the mandates of the two) and its provision of competition-neutral business activities, which are underpinned by a mature and supportive legal framework, are deemed remote.

LfA’s asset quality is high, underpinned by the bank’s double-recourse loan protection for its policy mandated lending business. Typically, LfA 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. Around 85% of total loans are to financial institutions. For the bank’s activities at own risk, namely direct lending to municipalities of around EUR 1.18bn and guarantee and other risk mitigation products for its intermediary bank partners of around EUR 1.7bn, LfA benefits from the strong credit risk profiles of the Bavarian public sector on top of EUR 12bn in counter-guarantees provided by the Free State of Bavaria for the bank’s own-risk activities in relation to the Covid-19 crisis. LfA’s share of non-performing exposures over customer loans has been broadly stable over the past years at 0.6% in 2020 and 0.4% in 2019.

Further, LfA’s capitalisation is sound, supported by earnings retention, with a Common Equity Tier 1 capital ratio of 22.3% at the end of 2020. Scope expects the Free State of Bavaria to continue allowing the bank to retain its net profit to support further growth. This provides a sufficient buffer for regulatory changes and partially mitigate pressure on revenues from the low-yield environment. At least 25% of annual profits must be transferred to reserves according to the LfA law. Scope views LfA’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 LfA’s public policy mandate.

LfA’s loan portfolio is characterised by regional and sectoral concentration. More than 80% of its exposures are towards other financial institutions, representing the bank’s on-lending activities. However, the underlying loan portfolio of end-customers is diversified across sectors and within Bavaria. Should economic conditions in Bavaria’s export-oriented economy worsen significantly over a protracted period, this could ultimately also impact the bank’s asset quality and profitability given its countercyclical role. This risk is currently highlighted by the difficulties in certain industries, including the automotive industry, with global supply chain disruptions and key production input shortages. Population ageing and the environmental transition pose longer-term challenges to the outlook for the state’s export-oriented engineering and car manufacturing industry. However, in the context of the Covid-19 crisis, Bavaria’s competitive economic base has remained resilient, also supported by significant fiscal aid.

Finally, the bank’s profitability is modest, reflecting its non-profit maximising character and public policy mandate according to the LfA law. LfA’s performance relies on its primary source of revenue, interest income, which is challenged by the low interest rate environment. A net interest margin of around 0.5% over 2018-20 would provide a low buffer if asset quality were to deteriorate significantly, which Scope deems unlikely. The bank’s cost-to-income ratio, a key metric for management, has been stable in the last three years at around 55%-57% and 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 may 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 LfA and the Free State of Bavaria (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 LfA’s obligations provided by the Free State of Bavaria (AAA/Stable).

Scope views the ‘likelihood of exceptional government support’ as ‘high’ if LfA 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 LfA as ‘medium’ (QS2) as a result of: i) the ‘high’ ability of the government to control LfA, given that the scope and content of LfA’s business activities are defined and regulated by law; and ii) the ‘limited’ regular financial support for LfA, reflecting its positive and stable operating performance and strong access to capital markets, which enable the 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 LfA's rating and were included in Scope’s assessment of: i) LfA’s level of integration with the sponsoring government, highlighting the supportive legal framework, which requires the 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 objectives, e.g. its role in the Covid-19 crisis; and ii) LfA’s standalone fundamentals, highlighting the high quality of its governance and conservative 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 LfA’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.
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 rating 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: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 10 December 2021.

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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