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Credit Opinion: Landesbank Hessen-Thringen GZ

Global Credit Research - 20 Nov 2014


Frankfurt am Main, Germany

Ratings
Category

Outlook
Bank Deposits
Bkd Bank Deposits
Bank Financial Strength
Baseline Credit Assessment
Adjusted Baseline Credit Assessment
Bkd Issuer Rating
Senior Unsecured
Subordinate -Dom Curr
Jr Subordinate -Dom Curr
Commercial Paper -Dom Curr

Moody's
Rating

Negative(m)
A2/P-1
Aa1/P-1
D+
baa3
baa1
Aa1
A2
Baa2
Baa3 (hyb)
P-1

Main Capital Funding II Limited


Partnership

Outlook
Pref. Stock Non-cumulative

Stable
Ba2 (hyb)

Main Capital Funding Limited


Partnership

Outlook
Pref. Stock Non-cumulative

Stable
Ba2 (hyb)

Contacts
Analyst

Phone

Michael Rohr/Frankfurt am Main


49.69.707.30.700
Bernhard Held/Frankfurt am Main
Carola Schuler/Frankfurt am Main
Christina Gerner/Frankfurt am Main

Key Indicators
Landesbank Hessen-Thueringen GZ (Consolidated Financials)[1]
[2]6-14 [3]12-13 [3]12-12 [3]12-11 [3]12-10 Avg.
176,508.0 178,083.0 199,301.0 163,985.0 166,244.0 [4]1.5
Total Assets (EUR million)
241,666.0 245,388.0 262,756.8 212,876.3 223,023.6 [4]2.0
Total Assets (USD million)
7,755.5 7,594.5 7,333.3 6,284.9 4,342.8 [4]15.6
Tangible Common Equity (EUR million)
10,618.4 10,464.8 9,668.2 8,158.7 5,826.1 [4]16.2
Tangible Common Equity (USD million)
0.8
0.7
0.7
0.7
0.6 [5]0.7
Net Interest Margin (%)
1.6
1.6
1.7
1.5
1.3 [6]1.6
PPI / Average RWA (%)
0.9
0.7
0.8
0.8
0.5 [6]0.9
Net Income / Average RWA (%)
22.2
22.5
18.4
22.8
26.7 [5]22.6
(Market Funds - Liquid Assets) / Total Assets (%)
49.0
48.2
55.2
49.3
46.3 [5]49.6
Core Deposits / Average Gross Loans (%)
13.7
12.8
11.2
10.1
9.6 [6]13.7
Tier 1 Ratio (%)
14.1
14.0
12.1
11.0
7.6 [6]14.1
Tangible Common Equity / RWA (%)
64.1
61.9
55.9
58.1
62.2 [5]60.4
Cost / Income Ratio (%)
-3.5
3.0
2.7
3.0 [5]3.0
Problem Loans / Gross Loans (%)

Problem Loans / (Equity + Loan Loss Reserves) (%)


Source: Moody's

--

34.5

30.3

30.2

46.6 [5]35.4

[1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - transitional phase-in; IFRS
[3] Basel II; IFRS [4] Compound Annual Growth Rate based on IFRS reporting periods [5] IFRS reporting periods
have been used for average calculation [6] Basel III - transitional phase-in & IFRS reporting periods have been
used for average calculation

Opinion
SUMMARY RATING RATIONALE
The A2/Prime-1 long- and short-term global local currency (GLC) deposit ratings assigned to Landesbank
Hessen-Thueringen GZ (Helaba) currently reflect our assessment of a very high probability of external support
from the following sources: (1) its public-sector owners, i.e., the Federal State of Hesse (unrated) and the Free
State of Thuringia (unrated); (2) the Savings Banks and Giro Association Hesse-Thuringia (unrated); (3) crosssector support from Germany's savings banks association (Sparkassen-Finanzgruppe; Corporate Family Rating
Aa2 negative); and (4) systemic support. As a result, at present, Helaba's GLC deposit ratings benefit from a fournotch uplift from its baa3 baseline credit assessment (BCA).
We further maintain the bank's Aa1 rating for debt qualifying for 'grandfathering'.
We assign a standalone bank financial strength rating (BFSR) of D+ to Helaba, equivalent to a BCA of baa3. The
bank's BFSR is underpinned by (1) the group's relatively strong client franchise; (2) its conservative approach to
risk taking; and (3) its comfortable funding profile. At the same time, the standalone BFSR is constrained by the
bank's modest, yet stable, financial performance and the bank's substantial exposure to international commercial
real estate (CRE) markets.

Rating Drivers
- Strong and well-diversified franchise and close co-operation with the savings banks implies that Helaba is firmly
embedded in the mutually supportive Sparkassen-Finanzgruppe (deposits Aa2 negative)
- Prudent risk management and improved capitalisation
- Improving liquidity metrics and funding from the savings banks sector, mitigating remaining wholesale
dependence
- Low, yet stable, level of risk-weighted profitability in terms of global comparison
- Continued risks posed by high sector concentrations to cyclical commercial real-estate assets partly mitigated
by sound risk controls

Rating Outlook
The outlook on Helaba's long-term debt and deposit ratings is negative taking into account the recent adoption of
the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) regulation in
the EU. In particular, this reflects that, with the legislation underlying the new resolution framework now in place
and the explicit inclusion of burden-sharing with unsecured creditors as a means of reducing the public cost of
bank resolutions, the balance of risk for banks' senior unsecured creditors has shifted to the downside. Although
our support assumptions are unchanged for now, the probability has risen that they will be revised downwards to
reflect the new framework.
The outlook on all other ratings is stable.

What Could Change the Rating - Up


There is currently no upwards pressure on Helaba's long-term ratings as expressed by the negative outlook.
However, upward rating pressure on Helaba's D+ BFSR could develop if the recent improvement in the bank's
underlying performance is sustained and Helaba can reduce its dependence on debt capital markets, resulting

from higher funds available from and cooperation with the now larger number of savings banks.

What Could Change the Rating - Down


Challenges for the bank's BFSR may arise from (1) heightened turbulence in the European debt markets leading to
widening credit spreads negatively affecting Helaba's profitability metrics; (2) a sustained weakening of its
recurring earnings power and levels of operating efficiency; and (3) a material deterioration in asset quality beyond
levels that are consistent with the bank's risk-absorption capacity.
Helaba's long-term ratings could be downgraded if we were to lower our assessment of the very high probability of
systemic support currently factored into the bank's long-term ratings. The long-term ratings could also be
negatively affected by a downgrade of its standalone BFSR, and as a result of a change in its ownership structure,
deterioration in the implied creditworthiness of its owners, and weakening cross-sector support mechanisms.
However, we would currently not expect any changes to the sector's support framework.

DETAILED RATING CONSIDERATIONS


STRONG AND WELL-DIVERSIFIED FRANCHISE COVERS 40% OF THE SAVINGS BANKS BUSINESS IN
GERMANY AND IMPLIES THAT HELABA IS FIRMLY EMBEDDDED IN THE MUTUALLY SUPPORTIVE
SPARKASSEN-FINANZGRUPPE
By assuming the central bank business for the savings banks in North-Rhine Westphalia and Brandenburg (socalled 'Verbundbank') in July 2012, Helaba significantly added to its home-market footprint by becoming the central
bank for another 116 savings banks in addition to 50 banks in Hesse and Thuringia.
In our view, this build-up as the key partner for regional savings banks intensifies the strong ties between Helaba
and its public sector owners and ensures that the group remains firmly embedded within the SparkassenFinanzgruppe. Nevertheless, we note that the core activities of central clearing and other related businesses for
the savings banks typically yields low returns. The transaction's success therefore depends on unlocking the
additional business potential through the savings banks and translating it into visible returns.
Helaba continues to build its franchise value on a coherent wholesale banking strategy, which combines regional
corporate lending with international CRE finance in selected markets. Its core wholesale activities - in particular
CRE, Corporate Finance and Financial Markets - continue to contribute the majority of the group's revenues and
earnings.
Notwithstanding the low profitability of the group's savings banks ('Verbund') business and promotional banking
activities, we view earnings stability at the group level as sound, taking into account the relative stability of preprovision income over the past five years, improving earnings diversification and increasingly steady contributions
from retail banking and asset management.
PRUDENT RISK MANAGEMENT AND IMPROVED CAPITALISATION
Unlike many other banks, Helaba did not adopt an over-ambitious growth strategy prior to the financial crisis, and
did not compromise its underwriting standards in order to maximise returns.
As of 30 June 2014, Helaba reported further strengthened its Basel III Tier 1 and total capital ratios at the group
level to 13.7 % and 17.8%, respectively (31 December 2013: 12.8% and 17.4%, respectively). The bank's fullyloaded common equity Tier 1 (CET1) stood at a solid 12.9%. To further strengthen its Tier 2 capital Helaba issued
EUR200 million of subordinated capital in H1 2014.
This solid capitalisation allowed the bank to successfully pass the European Central Bank's (ECB) asset quality
review and subsequent European Banking Authority's (EBA) stress test with a 2016 baseline scenario CET1 ratio
of 11.6% and an adverse scenario CET1 ratio of 8.2%, both well above the minimum requirements of 8.0% and
5.5% for the two scenarios, respectively.
IMPROVING LIQUIDITY METRICS AND FUNDING FROM THE SAVINGS BANKS SECTOR, MITIGATING
REMAINING WHOLESALE DEPENDENCE
Helaba is partially depending on wholesale funding for a part of its lending business and is presently a net lender in
the interbank market. However, we consider Helaba's liquidity profile as being sound. This view is based on the
bank's proven and recurring access to considerable excess liquidity of the regional savings banks and good
access to debt capital markets, even in times of stress. While not entirely immune to market shocks, we believe

the bank has sufficient liquidity buffers to survive specific stress scenarios of a shutdown in wholesale markets, in
addition to assumed outflows in retail and corporate deposits, which supports its credit rating.
Notably, funding requirements will remain modest over the foreseeable future, given the group's strategy of
actively reducing its current liability overhang and re-allocating longer-term funds to higher-margin business areas
over time. This approach results in a broadly matched funding profile for its medium- and long-term lending
business. The bank typically issues approximately EUR12-15 billion in medium- and long-term debt instruments
per year, placed with a broad and diversified investor base. We also note positively that a growing portion of
Helaba's unsecured wholesale debt issued is placed with savings banks and their retail clients.
LOW LEVEL OF RISK-WEIGHTED PROFITABILITY, BUT CORE EARNINGS IMPROVE
Helaba generally displays a fairly stable operating performance and recently reported improving profitability levels
on the back of rising core business margins and positive effects from the integration of the Verbundbank. Still,
Helaba's performance metrics remained slightly below those of its international peers, largely as a result of the
group's promotional banking activities, which are run on a cost-coverage basis rather than on return targets.
As of 30 June 2014, Helaba reported a pre-tax profit of EUR322 million (audited IFRS), down 4.2% year-over-year.
The result was negatively influenced by a normalisation in trading income to EUR94 million from overly high levels
of EU248 million in H1 2013 that benefitted from narrowing of own credit spreads at that time.
This was compensated for by net interest income and net fee and commission income increasing by 9.9% and
9.2% year-over-year, respectively. This, together with a significant decline in risk charges to EUR45 million (H1
2013: EUR123 million), supported yet another stable operating result in a challenging market environment.
We believe that the ongoing repositioning of the bank's operations as well as the integration of the Verbundbank
business will - over time - yield some further improvement of risk-adjusted returns. However, regulation-related
expenses and the integration of the Verbundbank business will continue to burden the operating costs of Helaba
and will only start to yield positive results from 2015 onwards. At the same time, the group's revenues will likely
remain subject to market volatility and thus remain difficult to predict.
CONTINUED RISKS POSED BY HIGH SECTOR CONCENTRATIONS TO CYCLICAL COMMERCIAL REALESTATE ASSETS PARTLY MITIGATED BY SOUND RISK CONTROLS
In our view, the group's still high - yet improving - balance sheet leverage ratio of 3.9% as of 30 June 2014 and its
dependence on market funding requires prudent risk management.
The bank's total exposure to the commercial real-estate sector amounted to EUR32.4 billion as of end-June 2014,
resulting in considerable concentration risk especially when compared to the group's reported Tier 1 capital of
EUR7.5 billion .
Roughly half of the aforementioned exposure is to markets outside Germany, with a focus on the US. Despite
these large exposures rendering Helaba vulnerable to some capital pressure in our highly adverse scenario, the
total portfolio has a relatively sound history of low credit losses in comparison with the bank's peers, owing to
Helaba's focus on prime locations and properties with a high level of pre-arranged rental agreements. Furthermore,
risk-related charges declined further to very low levels during the first half of 2014.
In our view, the group's corporate finance loan book is well diversified, and includes equally-sized lending activities
with multinational corporates, asset-based lending focused on aircraft and (to a lesser degree) ship finance,
structured and project finance and leasing. In this context, we note Helaba's comparatively low exposure to
shipping finance loans of EUR1.8 billion as of year-end 2013 (and unchanged to date), which forms part of the
bank's total transportation finance exposure of EUR5.6 billion. The group has further portfolios of structured trade
and commodity finance, acquisition finance as well as structured credit products. However, none of these
portfolios represent any undue concentration risks and generally focus on the bank's own clientele.
We estimate that almost half of Helaba's EUR2.4 billion non-performing loans (NPLs) at end-June 2014 related to
the real-estate sector. Total NPLs further decreased year-on-year, largely driven by successful work-out of
problem exposures. Non-performing loans as a proportion of gross loans stood at 2.6% as of 30 June 2014, down
from 2.8% a year earlier, and in-line with its closest banking peers.

Global Local Currency Deposit Rating (Joint Default Analysis)


We assign a long-term GLC deposit rating of A2 to Helaba. The rating currently reflects our assessment of a very

high probability of external support from the following sources: (1) its public-sector owners, i.e., the Federal State
of Hesse and the Free State of Thuringia); (2) the Savings Banks and Giro Association Hesse-Thuringia; (3)
cross-sector support from Germany's savings banks association (Haftungsverbund); and (4) systemic support.
As a result, at present, our support assessments give Helaba's GLC deposit ratings a four-notch uplift from its
baa3 BCA.

Notching Considerations
SENIOR SUBORDINATED DEBT
Helaba's senior subordinated debt is rated Baa2, one notch below the bank's adjusted BCA. The adjusted BCA of
baa1 is the anchor rating for Helaba's subordinated instruments and reflects our estimate of support likely to be
made available as 'going-concern support'. This principally applies to support from the cross-sector joint liability
scheme (Haftungsverbund), which we believe will continue to remain available for the benefit of all cases of debt,
and excludes systemic support.
HYBRIDS
Helaba's silent participations (non-cumulative preferred securities) issued by Main Capital Funding Limited
Partnership and Main Capital Funding II Limited Partnership, are rated Ba2(hyb), four notches below the adjusted
BCA, reflecting their non-cumulative coupon skip mechanism that has a net loss trigger. One EUR300 million
Genussschein (junior subordinated debt) is rated Baa3(hyb), i.e., two notches below the adjusted BCA, reflecting
its cumulative coupon deferral feature with a balance sheet trigger, which is considered a soft trigger in
comparison with the net loss trigger of the Tier 1 instruments.
Furthermore, Helaba never failed to service all hybrid and subordinated capital instruments.

Foreign Currency Deposit Rating


Helaba's foreign currency deposit ratings are A2/Prime-1, outlook negative.

Foreign Currency Debt Rating


Helaba's foreign currency debt ratings are A2/Prime-1, outlook negative.

ABOUT MOODY'S BANK RATINGS


Bank Financial Strength Rating
Our Bank Financial Strength Ratings (BFSRs) represent our opinion of a bank's intrinsic safety and soundness
and, as such, exclude certain external credit risks and credit support elements that are addressed by our Bank
Deposit Ratings. BFSRs do not take into account the probability that the bank will receive such external support,
nor do they address risks arising from sovereign actions that may interfere with a bank's ability to honor its
domestic or foreign currency obligations. Factors considered in the assignment of BFSRs include bank-specific
elements such as financial fundamentals, franchise value, and business and asset diversification. Although
BFSRs exclude the external factors specified above, they do take into account other risk factors in the bank's
operating environment, including the strength and prospective performance of the economy, as well as the
structure and relative fragility of the financial system, and the quality of banking regulation and supervision.
Global Local Currency Deposit Rating
A deposit rating, as an opinion of relative credit risk, incorporates the BFSR as well as our opinion of any external
support. Specifically, our Bank Deposit Ratings are opinions of a bank's ability to repay punctually its deposit
obligations. As such, they are intended to incorporate those aspects of credit risk relevant to the prospective
payment performance of rated banks with respect to deposit obligations, which includes: intrinsic financial
strength, sovereign transfer risk (in the case of foreign currency deposit ratings), and both implicit and explicit
external support elements. Our Bank Deposit Ratings do not take into account the benefit of deposit insurance
schemes which make payments to depositors, but they do recognize the potential support from schemes that may
provide assistance to banks directly.
According to our joint default analysis (JDA) methodology, the global local currency deposit rating of a bank is
determined by the incorporation of external elements of support into the bank's Baseline Credit Assessment. In
calculating the Global Local Currency Deposit rating for a bank, the JDA methodology also factors in the rating of

the support provider, in the form of the local currency deposit ceiling for a country, our assessment of the
probability of systemic support for the bank in the event of a stress situation and the degree of dependence
between the issuer rating and the Local Currency Deposit Ceiling.

National Scale Rating


National scale ratings are intended primarily for use by domestic investors and are not comparable with our
globally applicable ratings; rather they address relative credit risk within a given country. A Aaa rating on our
National Scale indicates an issuer or issue with the strongest creditworthiness and the lowest likelihood of credit
loss relative to other domestic issuers. National Scale Ratings, therefore, rank domestic issuers relative to each
other and not relative to absolute default risks. National ratings isolate systemic risks; they do not address loss
expectation associated with systemic events that could affect all issuers, even those that receive the highest
ratings on the National Scale.
Foreign Currency Deposit Rating
Our ratings on foreign currency bank obligations derive from the bank's local currency rating for the same class of
obligation. The implementation of JDA for banks can lead to high local currency ratings for certain banks, which
could also produce high foreign currency ratings. Nevertheless, it should be noted that foreign currency deposit
ratings are in all cases constrained by the country ceiling for foreign currency bank deposits. This may result in
the assignment of a different, and typically lower, rating for the foreign currency deposits relative to the bank's
rating for local currency obligations.
Foreign Currency Debt Rating
Foreign currency debt ratings are derived from the bank's local currency debt rating. In a similar way to foreign
currency deposit ratings, foreign currency debt ratings may also be constrained by the country ceiling for foreign
currency bonds and notes; however, in some cases the ratings on foreign currency debt obligations may be
allowed to pierce the foreign currency ceiling. A particular mix of rating factors are taken into consideration in order
to assess whether a foreign currency bond rating pierces the country ceiling. They include the issuer's global local
currency rating, the foreign currency government bond rating, the country ceiling for bonds and the debt's eligibility
to pierce that ceiling.
About Moody's Bank Financial Strength Scorecard
Our bank financial strength model (see scorecard below) is a strategic input in the assessment of the financial
strength of a bank, used as a key tool by our analysts to ensure consistency of approach across banks and
regions. The model output and the individual scores are discussed in rating committees and may be adjusted up or
down to reflect conditions specific to each rated entity.

Rating Factors
Landesbank Hessen-Thueringen GZ

Rating Factors [1]


Qualitative Factors (50%)
Factor: Franchise Value
Market share and sustainability
Geographical diversification
Earnings stability
Earnings Diversification [2]
Factor: Risk Positioning
Corporate Governance [2]

- Risk Management

Total Score Trend


CD+
Improving

x
x
x
D+

- Ownership and Organizational Complexity


- Key Man Risk
- Insider and Related-Party Risks
Controls and Risk Management

Neutral

- Controls

Financial Reporting Transparency

- Global Comparability
- Frequency and Timeliness
- Quality of Financial Information

x
x
x

Credit Risk Concentration

- Borrower Concentration
- Industry Concentration

x
x

Liquidity Management
Market Risk Appetite
x
Factor: Operating Environment
Economic Stability
Integrity and Corruption
Legal System
x
Financial Factors (50%)
Factor: Profitability
PPI % Average RWA (Basel II)
Net Income % Average RWA (Basel II)
Factor: Liquidity
(Market Funds - Liquid Assets) % Total Assets
Liquidity Management
Factor: Capital Adequacy
Tier 1 Ratio (%) (Basel II)
11.37%
Tangible Common Equity % RWA (Basel II)
12.36%
Factor: Efficiency
Cost / Income Ratio
Factor: Asset Quality
Problem Loans % Gross Loans
Problem Loans % (Equity + LLR)
Lowest Combined Financial Factor Score (15%)

Economic Insolvency Override


Aggregate BFSR Score
Aggregate BCA Score
Assigned BFSR
Assigned BCA

x
B

Neutral

CD+

Neutral

D-

Improving

Improving

Neutral

D+

Neutral

x
x

1.61%
0.73%
21.27%
x

58.62%
3.04%
31.66%
DNeutral
Cbaa1/baa2
D+
baa3

[1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information.
[2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral.

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