Scope Ratings GmbH (Scope) has today affirmed LfA Förderbank Bayern’s long-term issuer and senior unsecured debt ratings at AAA in both local and foreign currency with Stable Outlooks. Scope has also affirmed its short-term issuer rating of S-1+ in both local and foreign currency with a Stable Outlook.

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

Summary and Outlook

The AAA rating of LfA Förderbank Bayern (LfA) is equalised with the AAA/Stable rating of the German federal state of the Free State of Bavaria, given the federal state’s explicit, unconditional, unlimited, statutory, direct and irrevocable guarantee for LfA’s obligations.

This is further 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) with a counter-cyclical role; iii) high capitalisation and asset quality; and iv) a strong liquidity and funding profile with strong capital market access. Challenges are LfA’s modest but stable profitability and limited loan portfolio diversification, though both are foreseen by the bank’s public mandate.

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 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 Bavaria (AAA/Stable), 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, which Scope deems an unlikely scenario.

Bavaria also assumes the bank’s institutional liability (Anstaltslast) and guarantee obligation (Gewährträgerhaftung). The three-fold guarantee mechanism makes it almost certain 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-up companies in Bavaria, with total assets of EUR 23.6bn at YE 2021, LfA plays an essential role in meeting key economic and political objectives to promote Bavaria as a business location.

LfA’s crucial strategic position and countercyclical action was highlighted during the Covid-19 crisis, supported by the stability of the bank’s resources. In 2020, Bavaria provided a sizeable guarantee of EUR 12bn that allowed LfA to increase loans, guarantees and risk mitigation products for its commercial bank partners. This allowed SMEs and start-ups to retain their access to bank funding. In turn, LfA’s total activities reached a record high in 2020 of EUR 4.3bn compared with EUR 2.6bn in 2019. In 2021, business volumes declined to EUR 3.2bn with the lower demand for Covid-19 programmes (EUR 1.5bn in 2020 against EUR 488m in 2021). In mid-2022, the bank discontinued its pandemic-related products. The bank continues to display an ability to adapt products to current needs, by expanding its guarantee products to businesses affected by the Ukraine conflict and energy shock, and setting up a dedicated loan programme to help bridge liquidity needs of affected businesses.

LfA’s asset quality remains high, underpinned by the bank’s double-recourse loan protection for its policy-mandated lending. LfA’s share of non-performing exposures over interbank assets and customer loans increased in 2021 to 1%, up from 0.6% in 2020 and 0.4% in 2019. 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 86% of LfA’s exposures (comprising interbank assets and net customer loans) are to financial institutions. For the bank’s activities at own risk, namely direct lending to municipalities of around EUR 1.2bn and guarantees and other risk mitigation products for its intermediary bank partners of around EUR 2bn, 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 and energy crises.

Further, LfA’s capitalisation is sound, supported by earnings retention, with a Common Equity Tier 1 capital ratio of 20% at the end of 2021, down from 22.3% in 2020 due to an increase in risk-weighted assets. Under LfA law, at least 25% of annual profits must be transferred to reserves. 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 liquidity and funding profile is strong with an excellent 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 mandate.

LfA’s loan portfolio exhibits regional and sectoral concentration. A significant worsening in the conditions of Bavaria’s export-oriented economy over a protracted period could ultimately impact the bank’s asset quality and profitability given its countercyclical role. This risk is highlighted by the difficulties currently faced by certain industries, including automotive, due to the high gas and electricity prices and the lingering, although improving, global supply chain disruptions and key production input shortages. However, Bavaria’s competitive economic base remained resilient in 2020-21, supported by significant fiscal aid.

Finally, the bank’s profitability is modest, reflecting its non-profit character and public mandate under the LfA law. LfA’s performance relies on its primary source of revenue, interest income. A net interest margin of around 0.5% over 2018-21 provides a low buffer if asset quality were to deteriorate significantly, which Scope deems unlikely. The bank’s cost-to-income ratio declined to 47.9% in 2021, below the bank’s 55% target, which compares favourably with national peers. Scope expects some cost pressures amid the inflationary environment, such as on staff and administrative expenses, while the continued digitising of processes, including automatic approvals within certain programmes, should lead to moderate longer-term cost savings.

Qualitative Scorecard QS1

Scope applies a top-down approach (QS1) in assessing the creditworthiness of LfA, which takes the public sponsor’s rating (Free State of Bavaria: AAA/Stable) as the starting point. Scope sees ‘strong’ integration between LfA and the Free State of Bavaria, reflecting the bank’s: i) sole public ownership by the federal state; ii) public legal status as an ‘Anstalt des öffentlichen Rechts’ (public law institution); and iii) fulfilment of operating activities exclusively on behalf of the government, with the main purpose of implementing economic and social policies.

Scope then applies a rating equalisation factor given the explicit, unconditional, unlimited, statutory, direct and irrevocable guarantee of Bavaria for LfA’s obligations. The approach also includes a supplementary analysis of the entity’s business and financial risk profiles, which has no bearing on its ratings.
The assessments under QS1 and the rating equalisation factor result in an indicative rating of AAA.

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

The results were discussed and confirmed by a rating committee.

Factoring of Environment, Social and Governance (ESG)

ESG factors material to LfA’s credit quality are captured by Scope’s rating approach through several analytical areas.

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 public sponsor, highlighting the supportive legal framework that requires the bank to comply with its statutes and fulfil its role as a competition-neutral public-law institution, including the provision of key services to support regional economic objectives; and ii) LfA’s standalone fundamentals, highlighting its high-quality governance and conservative risk management.

Scope also considered long-term environmental developments alongside its assessment of rating-relevant credit risks, but these did not play a direct role in this rating action. Considerations include the bank’s detailed reporting on its sustainability agenda via sustainability reports and its efforts to be climate-neutral by 2028. The bank also recently introduced its ‘Energiekredit Regenerativ’ loan product targeted at funding sustainable investments.

Rating committee
The main points discussed during the rating committee were: i) the level of integration with the government; ii) the liability support mechanism; and iii) a supplementary analysis of LfA’s fundamentals.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Government Related Entities, 6 May 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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.
With Rated Entity or Related Third Party Participation   YES
With Access to Internal Documents                                YES
With Access to Management                                          YES
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: 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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