Rating action

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.

Scope further acknowledges 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, where it serves as a crucial government-related entity (GRE) with a counter-cyclical function, reinforced by the bank’s resource stability; iii) high levels of capitalisation and asset quality; and iv) a robust liquidity and funding profile that ensures strong access to capital markets. Challenges relate to LfA’s modest but stable profitability and limited loan portfolio diversification, though both influenced 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 robust guarantee framework provided by Bavaria (AAA/Stable), which serves as the primary factor equalising LfA's ratings with the ratings of the federal state. This guarantee is explicit, unconditional, unlimited, statutory, direct, and irrevocable, with alterations, revocation, or restrictions requiring a parliamentary act of Bavaria, an event considered highly unlikely by Scope.

Bavaria also undertakes LfA's institutional liability (Anstaltslast) and guarantee obligation (Gewährträgerhaftung). This three-fold guarantee mechanism significantly enhances the likelihood of government support for LfA if ever needed. In line with other German state development banks, LfA is exempt from insolvency procedures due to its public law charter.

The bank's activities carry a high level of strategic importance for its public sponsor. LfA plays a pivotal role in advancing critical regional economic objectives, primarily by providing financing to medium-sized corporations, freelancers, start-up enterprises, and municipalities in Bavaria, further enhancing Bavaria's appeal as a business location. LfA's strategic significance and its capacity to adapt to crises were demonstrated during the Covid-19 pandemic, as it swiftly adjusted existing products and introduced new ones to provide vital support, underpinned by a dedicated guarantee from the federal state.

LfA's activities mainly focus on the financial sector, accounting for 84% of its total exposure. The bank also engages in self-supported activities, including direct lending to Bavarian municipalities totalling around EUR 1.6bn at YE 2022. Additionally, LfA offers guarantee and risk mitigation products for businesses, especially startups without sufficient collateral. As of YE 2022, the volume of guarantee and risk participation products reached approximately EUR 1.9bn, nearly doubling its 2019 level, primarily due to the Covid-19 response mandated by Bavaria. Counter-guarantees provided by Bavaria mitigate risk exposure, enhancing overall risk management.

In 2022, the bank's total activities amounted to EUR 2.95bn (EUR 2.61bn in loans and EUR 336m in risk-participation products). This marked a decrease from 2021 and 2020 levels of EUR 3.2bn and EUR 4.3bn, respectively. The higher volumes in 2020-21 were due to the Covid-19 pandemic, with the bank disbursing EUR 2bn in loans and providing guarantees, which were counter-guaranteed by the Bavarian state. Traditional product volumes have remained stable, averaging around EUR 2.7bn over the past three years.

In 2023, Scope expects a reduction in LfA's business volume compared to 2022. This decrease is due to the conclusion of pandemic-related initiatives in June 2022 and reduced demand for LfA's financial products, influenced by the prevailing macroeconomic conditions characterised by an economic slowdown and high interest rates. While overall loan volumes in 2023 align with the bank's strategic projections, certain products like Investivkredit and Innovationskredit 4.0 have seen increased demand.

The bank consistently adjusts its product offerings to meet current needs, such as expanding its guarantee products to assist businesses affected by the inflationary shock and the Ukraine conflict in July 2022. It also introduced an energy liquidity loan programme to help businesses facing rising energy costs. Furthermore, LfA continues to promote renewable energy adoption and energy efficiency through programmes like Energiekredit Regenerativ and Energiekredit.

Throughout the period 2020-22, the bank's asset quality demonstrated resilience in the face of various crises. This resilience is attributed to the protective cushion provided by double-recourse loan protection within its on-lending portfolio. 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.

LfA's loan portfolio demonstrates robust asset quality, with non-performing exposures totalling EUR 182.8m at YE 2022, equivalent to 0.93% of interbank assets and customer loans. The bank's non-performing loans ratio, based on BaFin's definition, stood at 0.85% by YE 2022, confirming effective management of non-performing assets and strong credit quality.

LfA's capitalisation exceeds regulatory requirements, with a CET1 capital ratio of 19.5% as of YE 2022. Over the past five years (2017-2022), risk-weighted assets increased by approximately 10%, mirroring the growth in CET1 capital achieved through earnings retention. LfA has consistently maintained a relatively high average risk weight, accounting for 37% of total assets in the last three years. Scope expects capital buffers to gradually expand as the bank continues to retain profits.

With explicit liability backing from the Free State of Bavaria, LfA benefits from strong access to financial markets and favourable regulatory treatment of its debt obligations. The bank primarily funds its operations through medium to long-term debt securities with maturities of three to ten years.

LfA's well-established access to capital markets, along with its ability to tap central bank facilities contribute to maintaining ample liquidity. At YE 2022, LfA's liquidity coverage ratio stood at 318%, aligning with levels observed in prior years. This signifies a robust liquidity position, ensuring that the bank is well-prepared to meet its funding requirements and withstand potential liquidity stress scenarios.

While the bank exhibits certain favourable credit characteristics, it also faces challenges stemming from its specific public mandate, such as limitations on loan portfolio diversification and its moderate, if stable, profitability.

LfA's exposure is concentrated in the financial sector, accounting for 84% of its total exposure, or EUR 16.5bn at YE 2022. The underlying loan portfolio, representing the end-customers of funds on-lent to LfA's partner banks, displays diversification both across sectors and geographic regions within Bavaria.

This concentration, whether sectoral or geographical, is influenced by the nature of the bank's mandate. Potential long-term risks include transition risks, particularly in the automotive sector, as Bavaria's economy has a strong tie to the export-oriented industry. Nevertheless, Bavaria's economy demonstrated relative resilience, even when faced with challenges like the surge in energy prices and rising interest rates during the first half of 2022. This resulted in robust growth of 0.5% YoY in real terms, while Germany as a whole contracted by 0.3% during the same period.

Finally, LfA's profitability is modest, a direct result of its public mandate. Over the past five years, the return on equity averaged around 1.6%, closely in line with the national peer average. In prior years, net profits were either retained or allocated to the Free State of Bavaria. The state subsequently reinvested these proceeds back into the bank, thus strengthening the institution's capitalisation.

Scope anticipates some cost pressures, particularly considering the inflationary environment affecting staff and administrative expenses. However, ongoing digitisation efforts, including automatic approvals within specific programmes, are expected to lead to moderate longer-term cost savings.

Qualitative Scorecard QS1 and Equalisation Factor

Scope employs a top-down approach (QS1) to evaluate LfA's creditworthiness, commencing with the public sponsor's rating (Free State of Bavaria: AAA/Stable).

This approach acknowledges a 'strong' level of integration between LfA and the Free State of Bavaria, which is underscored by the following factors: i) LfA's sole public ownership by the state; ii) its public legal status as an 'Anstalt des öffentlichen Rechts' (public law institution); iii) its exclusive mandate to carry out activities on behalf of the government, primarily aimed at implementing economic and social policies; and iv) its high financial interdependence with the state due to LfA's significant direct funding of Bavaria's municipalities.

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 impact on the final credit 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)

Scope incorporates ESG factors into its credit rating methodology when assessing LfA's creditworthiness.

The evaluation considers governance and social aspects, reflecting the extent of LfA's alignment with its public sponsor. This assessment underlines the supportive legal framework mandating compliance with the bank's statutes and its role as a competition-neutral public-law institution, serving regional economic objectives. Moreover, Scope analyses LfA's stand-alone fundamentals, emphasising its robust governance and conservative risk management practices.

While Scope has not directly attributed these factors to the current rating action, Scope has considered the bank's long-term environmental considerations within the context of assessing credit risks. This perspective includes a comprehensive review of the bank's sustainability initiatives, such as its sustainability reports and its ambitious target to achieve climate neutrality by 2028. Additionally, LfA has introduced the 'Energiekredit Regenerativ' loan product aimed at promoting 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 (Government Related Entities Rating Methodology, 13 July 2023), 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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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, Senior Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 10 December 2021. The Credit Ratings/Outlooks were last updated on 11 November 2022.

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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