March 24, 2017 / 2:46 PM / 4 months ago

Fitch Affirms Aareal Bank at 'BBB+'; Outlook Stable

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(The following statement was released by the rating agency) FRANKFURT/LONDON, March 24 (Fitch) Fitch Ratings has affirmed Aareal Bank AG's Long-Term Issuer Default Rating (IDR) and senior debt ratings at 'BBB+'. The Viability Rating (VR) has been affirmed at 'bbb+. The Outlook on the Long-Term IDR is Stable. A full list of rating actions is at the end of this commentary. KEY RATING DRIVERS - IDRs, VR, AND SENIOR DEBT RATINGS Aareal's IDRs and senior debt ratings are driven by the bank's standalone strength, as expressed in its VR. The VR primarily reflects the bank's company profile as a commercial real estate (CRE) lender, which exposes its operations to the inherently cyclical CRE sector. This concentration is mitigated by the bank's resilient performance and strengthened capitalisation. We view management's public commitment to maintaining comfortable capital buffers as realistic in light of Aareal's established record of robust internal capital generation. The bank's fully-loaded CET1 ratio increased to a solid 15.7% at end-2016 from 13.1% at end-2015. This was mainly driven by a reduction in risk-weighted assets resulting from the wind-down of non-core assets and the steering of the core loan portfolio towards the lower end of the targeted range of EUR25bn-EUR27bn. Concurrently, the fully-loaded total capital ratio increased to 24.3% and thus comfortably exceeded Aareal's individual 2017 transitional SREP (Supervisory Review and Evaluation Process) requirement of 11% including buffers. Continuing reduction of non-core assets and more active use of loan syndication should allow the bank to maintain its solid capitalisation in the medium term, despite its shift to a more shareholder-friendly dividend policy. A material deterioration of the overall benign international CRE markets seems unlikely in the short term. Aareal is only moderately exposed to pockets of risks that are gradually building up in the German CRE market as a result of the low interest rates and intense competition. Non-performing loans (NPLs) peaked in the bank's weak Italian CRE loan book in 4Q15 and remained fairly stable in 2016. We do not expect any material improvement from ongoing restructuring measures on this portfolio in the short term. Aareal's performance has been relatively stable over the current credit cycle, despite its concentration on the structurally cyclical CRE market, and we expect it to remain sound in 2017. Performance benefits from the bank's diversification by geography and property type, which mitigates the continuous margin erosion in new domestic lending since 2013. However, the pressure on CRE lenders' profitability and capital is likely to increase further in the medium term, reflecting challenges from strong competition, margin pressure and an upward normalisation of loan impairment charges from (except for Italy) currently very low levels. Aareal benefits from a solid funding mix consisting of Pfandbriefe, unsecured private placements including Schuldscheine and a large, growing and resilient institutional housing deposit base. The latter is a key competitive advantage as it results in low reliance on unsecured market funding and should create a substantial funding cost advantage when interest rates normalise. We have not given any uplift to Aareal's Long-Term IDR relative to its VR despite significant layers of subordinated debt. This is because the Long-Term IDR would not achieve a higher level than the current 'BBB+' if Aareal's junior debt buffer was in the form of Fitch Core Capital (FCC) rather than debt. This is primarily driven by our view that the bank's company profile, as a largely wholesale-funded monoline CRE lender, constrains its VR at 'bbb+'. In addition, we believe that Aareal's resolution plan is still evolving, which means that the point at which the bank would be resolved, the likely resolution tool and the expected level of capitalisation after a bail-in are still uncertain. The IDRs of Aareal's fully-owned subsidiary, Westdeutsche ImmobilienBank AG (WI), are equalised with those of Aareal. This reflects our expectation that institutional support from Aareal will remain strong. This is supported by a control and profit-and-loss sharing agreement between the two entities that came into force after WI's acquisition by Aareal in 2Q15, and which obliges Aareal to compensate under certain conditions potential losses arising at WI. We have not assigned a VR to WI because Aareal will continue to wind it down without originating new business and shift assets to WI as the need arises to replenish its subsidiary's cover pools. We expect WI's banking business to be merged into Aareal in the short term. SUPPORT RATING AND SUPPORT RATING FLOOR Aareal's Support Rating (SR) and Support Rating Floor (SRF) reflect our view that, following the implementation of legislation and resolution tools pursuant to the EU's Bank Recovery and Resolution Directive (BRRD) in Germany in early 2015, senior creditors can no longer rely on receiving full extraordinary support from the sovereign, should Aareal become non-viable. WI's SR of '2' reflects our view that the subsidiary benefits from Aareal's strong propensity and adequate ability to support. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Aareal's Tier 2 notes are notched down once from the VR to reflect their higher loss severity relative to senior debt. The legacy, non-Basel III compliant hybrid securities issued by Capital Funding GmbH and Aareal Capital Funding LLC (Delaware) are notched down four times from Aareal's VR (two notches for high loss severity risk and two notches for high non-performance risk relative to that captured in the VR). The bank's large distributable reserves significantly mitigate, in our view, the non-performance risk arising from the instruments' respective distributable profit triggers. Aareal's Basel III-compliant additional Tier 1 (AT1) hybrid securities are rated five notches below the VR, twice for loss severity to reflect their write-down on breach of their 7% trigger, and three times for non-performance risk to reflect the fully discretional coupon payments. DERIVATIVE COUNTERPARTY RATINGS AND DEPOSIT RATINGS Aareal's Derivative Counterparty Rating (DCR) reflects Fitch's view that the bank has sufficient combined buffers of qualifying junior and vanilla senior debt that could be used to recapitalise it, restore its viability and prevent default on other "preferred" senior liabilities upon resolution. The protection afforded to "preferred" senior debt, deposits and derivative counterparties by those buffers means the DCR and Long-Term Deposit Rating are each given a one-notch uplift above the Long-Term IDR to reflect these liabilities' lower vulnerability to default than vanilla senior debt. Aareal's Short-Term Deposit Rating is aligned with the bank's Short-Term IDR, which is the lower of the two options available at a 'A-' level. This is because of high uncertainty regarding the bank's likely balance sheet composition upon default and how a resolution scenario would affect short-term depositors in Germany, given the lack of precedent for favouring short-term creditors. RATING SENSITIVITIES IDRs AND VR Aareal's IDRs and senior debt rating are sensitive to the same drivers as the VR. In the medium term, Aareal's VR will remain primarily vulnerable to asset quality deterioration. An upgrade of Aareal's VR is unlikely as we believe that the bank's monoline CRE lending business model is not commensurate with a rating in the 'a' category despite its solid asset quality. A higher VR would require significant diversification into lower-risk asset classes generating more predictable earnings. We view the rising revenue contribution of its consulting and services division positively, but the resulting diversification currently remains limited. WI's IDRs are primarily sensitive to changes in Aareal's IDRs. They are also sensitive to a change in the propensity of support from Aareal, which we view as unlikely in light of the control and profit-and-loss sharing agreement. SR AND SRF An upgrade of Aareal's SR and an upward revision of its SRF would require a higher propensity of sovereign support. An upgrade of WI's SR would require an upgrade of Aareal's VR. A downgrade of WI's SR could result from lower propensity of support from Aareal. While not impossible, any of these scenarios is highly unlikely, in Fitch's view. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The ratings of Aareal's Tier 2 notes and hybrid instruments are primarily sensitive to changes to Aareal's VR. The ratings are also sensitive to a change in their notching. DCR AND DEPOSIT RATINGS Aareal's DCR and Deposit Ratings are primarily sensitive to changes in its IDRs. They are also sensitive to the subordinated and vanilla senior debt buffers relative to the recapitalisation amount likely to be needed to restore viability and prevent default on more senior derivative obligations, deposits and structured notes. The rating actions are as follows: Aareal Bank AG: Long-Term IDR: affirmed at 'BBB+'; Outlook Stable Short-Term IDR: affirmed at 'F2' Viability Rating: affirmed at 'bbb+' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Derivative Counterparty Rating: affirmed at 'A-(dcr)' Deposit Ratings: affirmed at 'A-'/'F2' Debt issuance programme: affirmed at 'BBB+'/'F2' Senior unsecured notes: affirmed at 'BBB+' Subordinated debt: affirmed at 'BBB' Additional Tier 1 securities (DE000A1TNDK2): affirmed at 'BB-' Capital Funding GmbH (DE0007070088): affirmed at 'BB' Aareal Capital Funding LLC (Delaware) (XS0138973010): affirmed at 'BB' Westdeutsche ImmobilienBank AG: Long-Term IDR: affirmed at 'BBB+'; Stable Outlook Short-Term IDR: affirmed at 'F2' Support Rating: affirmed at '2' Contact: Primary Analyst Patrick Rioual Senior Director +49 69 76 80 76 123 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 60311 Frankfurt am Main Secondary Analyst Sebastian Schrimpf, CFA Associate Director +49 69 76 80 76 136 Committee Chairperson Claudia Nelson Senior Director +44 20 3530 1191 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. 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