July 02 -
-- On March 30, 2012, the European Commission reversed its decision that Commerzbank AG sell Eurohypo AG as a condition of its approval of state aid. Eurohypo will instead become a run-off entity within the Commerzbank group.
-- We assess Eurohypo as having weak business and risk positions, adequate capital and earnings, average funding, and adequate liquidity.
-- We are affirming our 'A-/A-2' ratings on Eurohypo and its core Luxembourg subsidiary EUROHYPO Europaeische Hypothekenbank S.A.
-- The ratings include four notches of group support owing to our view of Eurohypo's "highly strategic" importance to Commerzbank.
-- The negative outlook reflects some remaining uncertainty regarding Eurohypo's future ownership, as well as the negative outlook on our rating on Commerzbank.
On July 2, 2012, Standard & Poor's Ratings Services affirmed its 'A-' long-term and 'A-2' short-term counterparty credit ratings on Germany-based bank Eurohypo AG and its fully owned core subsidiary, Luxembourg-based EUROHYPO Europaeische Hypothekenbank S.A. (Eurohypo Luxembourg). The outlook is negative.
The rating actions follow our review of Eurohypo after the European Commission reversed its decision requiring Commerzbank to divest Eurohypo. Instead, Eurohypo will become a run-off entity within the Commerzbank group.
Under our bank criteria, we use our Banking Industry Country Risk Assessment's economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. Our anchor for a commercial bank operating only in Germany is 'a-', based on an economic risk score of '1' and an industry risk score of '3'. We assessed the economic risk for Eurohypo by analyzing its weighted exposure at default in strategic customer loans to nonbanks in each country in which it operates. Eurohypo maintains a "weak" business position that we consider inferior to that indicated by the industry risk score of '3' for German banks.
We consider Eurohypo's business model dependent on ownership and indirect government support. Our view is based on Eurohypo's wholesale banking model and focus on commercial real estate (CRE), which make it highly sensitive to investor confidence and expose it to significant concentration and tail risks.
In our view, the bank's capital and earnings are "adequate" because ongoing group support--mainly through a profit-and-loss transfer agreement--largely immunizes it against the deterioration of its capital ratios. We revised Eurohypo's stand-alone credit profile (SACP) to 'bb+' from 'bb' because we now project a stronger capital position than we previously anticipated.
Our risk-adjusted capital (RAC) ratio for Eurohypo as of year-end 2011 was 8.6%. This significantly exceeds our original forecast and stems from an unexpected capital increase from Commerzbank under the profit-and-loss transfer agreement. This agreement obliges Commerzbank to offset Eurohypo's losses as measured under German generally accepted accounting principles (GAAP), largely neutralizing the risk to Eurohypo's capital buffer. However, differences between German GAAP and IFRS can lead to a change of IFRS retained earnings, which happened in 2011 when Eurohypo's retained earnings improved by EUR720 million. This positive development in 2011 was only partly offset by the deterioration of the revaluation reserve. Barring significant declines in the revaluation reserve and absent extraordinary dividends to Commerzbank, we project improvements to Eurohypo's RAC ratio as its assets are run off.
We assess Eurohypo's risk position as "weak," as defined in our criteria, because the quality of its regional assets is below the industry average, in our view. The bank is also vulnerable to material tail risk from CRE and public finance business, economic downturns, and capital market volatilities. In addition, we see a potential for risks not covered by our RAC ratio, due to material risk concentrations, underperformance of many CRE assets, low risk weights under our RAC framework for the public finance book, and credit spread risk. This is partly mitigated by ongoing restructuring and downsizing efforts, which include exiting riskier exposures and substantial work-out measures.