Scope affirms L-Bank's credit rating at AAA with Stable Outlook
Scope Ratings GmbH (Scope) 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
The AAA rating of L-Bank is equalised with the AAA/Stable rating of the German Federal State of Baden-Württemberg (Baden-Württemberg), given the state’s explicit, unconditional, unlimited, statutory, direct, and irrevocable guarantee for L-Bank’s existing and future obligations with respect to money borrowed, bonds issued and derivative transactions entered into by the bank.
This is further underpinned by i) a mature and very supportive legal set-up, which makes changes to L-Bank’s business model or guarantee structure unlikely; ii) the bank’s high strategic importance to the Federal State as a key government-related entity implementing economic and social policies with a countercyclical role, supported by the stability of its resources; iii) high capitalisation and asset quality, and iv) a strong liquidity and funding profile with strong capital market access.
Challenges are L-Bank’s modest but stable profitability and undiversified earnings, both foreseen by the bank’s public policy mandate.
The Stable Outlook reflects Scope’s assessment that the risks L-Bank faces are balanced.
The ratings/Outlooks could be downgraded if: i) the Federal State of Baden-Württemberg’s ratings/Outlooks were downgraded; and/or ii) changes occurred to L-Bank’s legal framework or guarantee structure, notably weakening government support.
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.
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 93bn, L-Bank plays an essential role in meeting key economic and political objectives on a regional level. L-Bank’s strategic relevance and ability to adapt to new challenges has been highlighted in the recent crises since 2020. Between 2020 and June 2022, the bank paid out Covid-19 emergency funds from the central and state government to businesses in Baden-Württemberg amounting to over EUR 10bn. Since the energy and cost-of-living shock in early 2022, the bank set up special programmes to support municipalities and businesses, and to further support investments in renewable energy production to increase energy resilience, for example via the “Living with a Future – Photovoltaics” or “Energy Finance” loan programmes and the ‘sustainability bonus’, i.e. interest-rate deductions to businesses with CO2 reporting and/or emissions reduction plans.
Scope sees moderate potential effects on L-Bank’s development banking stemming from the German Federal Constitutional Court’s decision on the second supplementary budget act 2021, via the ruling’s impact on KfW (AAA/Stable) and therefore programmes L-Bank funds via access to KfW facilities.
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. Across these pillars, L-Bank is placing an increasing focus on fostering the green and digital transition of the regional economy and society, in line with the federal state’s agenda. Potential risks to L-Bank’s 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 around 1% of the bank’s exposures had a non-investment grade internal rating at the end of 2022. L-Bank’s share of non-performing exposures over total exposures was 0.1% in 2022, in line with its five-year average.
L-Bank’s Common Equity Tier 1 ratio of 20.6% 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 rules.
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.
L-Bank’s loan portfolio is characterised by regional and sectoral concentration. More than half of its primarily domestic exposures are in the Federal State of Baden-Württemberg. 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. So far during the energy shock triggered by Russia’s war in Ukraine, the region has performed in line with the German economy, with a decline in real economic activity of 0.2% in the first half of 2023. Scope expects the German economy to contract by 0.3% in 2023 and only rebound modestly by 0.4% in 2024. The bank prudently manages concentration risks, for example via single obligor limits.
L-Bank’s profitability is modest but stable, reflecting its non-profit maximising character and public policy mandate according to the L-Bank Act. Operating performance is largely dependent on net interest income, which continues to benefit from high interest rates prevailing in the euro area. In general, L-Bank’s moderate profitability offers only limited buffers in case asset quality were to deteriorate significantly, which Scope deems unlikely.
L-Bank’s cost-to-income ratio stood at 59.5% in 2022, around 5pps above its long-term average, which is relatively high compared to its regional development bank peers. Scope expects cost pressures to persist amid the inflationary environment, such as on staff and other expenses, and ongoing investments in IT infrastructure and digitalisation to modernise the bank’s services. To reduce its cost base, the bank’s management has committed to an efficiency programme that aims to cut around EUR 21m in annual expenditure, or around 10% of its average annual administrative expenditure.
Qualitative Scorecard QS1 and rating equalisation factor
Scope applies a top-down approach (QS1) in assessing the creditworthiness of L-Bank, which takes the public sponsor’s rating (Federal State of Baden-Württemberg: AAA/Stable) as the starting point. Scope sees ‘strong’ integration between L-Bank and the Federal State of Baden-Württemberg, 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); iii) fulfilment of operating activities exclusively on behalf of the government, with the purpose of implementing economic and social policies; and iv) its high financial interdependence with the Federal State due to significant direct funding provided by L-Bank to municipalities.
For further details, please see Appendix I of the associated rating report.
Scope then applies a rating equalisation factor given the explicit, unconditional, unlimited, statutory, direct and irrevocable guarantee of the Federal State of Baden-Württemberg for L-Bank’s obligations with respect to money borrowed, bonds issued and derivative transactions entered into by the bank.
The approach also includes a supplementary analysis of the entity’s business and financial risk profiles, which has no bearing on the final credit ratings.
The assessments under QS1 and the rating equalisation factor result in an indicative rating of AAA.
The results were discussed and confirmed by a rating committee.
Factoring of Environment, Social and Governance (ESG)
ESG factors material to L-Bank’s credit quality are captured by Scope’s rating approach through several analytical areas.
Governance and social considerations are material to L-Bank’s credit rating and were included in Scope’s assessment of: i) L-Bank’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 and social objectives, including the financing of social housing; and ii) L-Bank’s standalone fundamentals, highlighting its conservative risk profile and management.
Environmental considerations include the bank’s role in fostering and enabling the public sponsor’s climate protection agenda. The Federal State of Baden-Württemberg’s Climate Protection and Climate Change Adaptation Act (Climate Act) envisages a reduction in greenhouse gas emissions of 65% versus 1990 levels, and net neutrality by 2040, five years earlier than the German central government. To this end, the bank introduced several initiatives and set up a dedicated team to streamline and operationalise its sustainability strategy. This includes: i) updating its sustainability strategy; ii) introducing L-ESG, the bank’s holistic approach to managing all relevant sustainability-related topics; iii) establishing a sustainable finance team, which reports directly to the executive board; and iv) establishing a bank-wide ESG-database project.
As regards its development activity, L-Bank reports on their impact in relation to the UN’s Sustainable Development Goals. The bank’s activities positively impact 13 out of the 17 goals, with a particular focus on “decent work and economic growth”, “industry, innovation and infrastructure” and “sustainable cities and communities”. Further, as part of the federal state’s Climate Act, any new, renewed or altered development programme has to undergo a compatibility check with the Climate Act.
The bank is expanding its development loan products to support its public sponsor’s sustainability agenda, for example via adding an ‘Energiefinanzierung’ loan product targeted at funding sustainable investments. Further, the bank introduced a ‘sustainability bonus’, i.e. interest-rate deductions to businesses with CO2 reporting and/or emissions reduction plans.
Finally, the bank produces non-financial reports, including on its efforts to be climate-neutral by 2030 for its own operations, and by 2040 for its overall banking activities, taking into account the impact of its lending, investing and refinancing operations.
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 L-Bank’s fundamentals.
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 and/or Outlooks were not amended before being issued.
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: Julian Zimmermann, Associate Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 22 January 2020. The Credit Ratings/Outlooks were last updated on 2 December 2022.
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.
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