Fitch Affirms Aareal and WestImmo at 'BBB '; Outlook Stable
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 the VR. The VR primarily reflects the bank's company profile as a commercial real estate (CRE) lender, which exposes the bank to an inherently cyclical sector. This concentration is mitigated by the bank's resilient performance and strengthening capitalisation, which already comfortably fulfils its fully-loaded regulatory requirements under Basel III.
We view management's public commitment to maintaining comfortable capital buffers (at least 13% Tier 1 ratio and 20% total capital ratios on a fully-loaded basis) as realistic in light of the bank's strong track record as confirmed by the smooth integration of WestImmo and the former Corealcredit Bank AG (Coreal), which was merged into Aareal in 2015. Coreal and WestImmo's acquisitions show the ability of Aareal's management to seize growth opportunities within a peer group that has for several years been predominantly focused on restructuring to restore adequate internal capital generation.
At end-2015, Aareal's fully-loaded CET1 ratio of 13.1% comfortably exceeded the 8.75% pillar 2 SREP (Supervisory Review and Evaluation Process) requirement. The gradual wind-down of legacy assets inherited from WestImmo and Coreal should allow the bank to maintain solid capital buffers over the coming years despite its plans to revert to a more shareholder-friendly dividend policy.
A material deterioration of the currently benign international CRE market seems unlikely in the short-term, and Aareal is only moderately exposed to the pockets of risks that are gradually building up in the German real estate market as a result of the low interest rate environment and intense competition. The bank's performance benefits from diversification by geography and property type, which mitigates the continuous margin erosion in new domestic lending since 2013.
We expect Aareal's performance to remain solid in 2016. However, the pressure on CRE lenders' profitability and capital is likely to increase further in the medium-term, reflecting declining margins and increasing regulatory capital requirements. We also expect a normalisation of loan impairment charges (LIC) at higher but still manageable levels in the medium-term, which will moderately increase pressure on Aareal's performance.
Aareal benefits from a solid funding mix consisting of a combination of Pfandbriefe and unsecured private placements guaranteed by Germany's voluntary deposit protection fund. A key competitive advantage is Aareal's large and stable institutional housing deposit base. This results in low reliance on unsecured market funding and should create a substantial funding cost advantage when interest rates normalise and the ECB's covered bond purchase programme is terminated.
We equalise Aareal's Long-term IDR with the VR despite significant layers of subordinated debt. We have not given any uplift to Aareal's Long-term IDR relative to the VR because the bank's 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 because we believe that the bank's company profile, as a largely wholesale-funded, monoline CRE lender, constrains the 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.
KEY RATING DRIVERS - SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)
Aareal's SR and SRF reflect Fitch's view that legislative, regulatory and policy initiatives have substantially reduced the likelihood of sovereign support for banks in the European Union. The BRRD, which requires a 'bail-in' of creditors in banks under resolution before an insolvent bank can be recapitalised with state funds, came into force in Germany on 1 January 2015 and the Single Resolution Mechanism (SRM) providing resolution tools and mechanisms started on 1 January 2016. As a result, Fitch believes that extraordinary external support from the sovereign in the event that Aareal becomes non-viable - while possible - can no longer be relied upon.
KEY RATING DRIVERS - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Aareal's lower Tier 2 subordinated 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) to reflect their distributable profit trigger or annual profit trigger combined with a regulatory capital ratio trigger.
Aareal's Basel III-compliant additional Tier 1 (AT1) hybrid securities are rated five notches below the VR, ie twice for loss severity to reflect their write-down on breach of their 7% trigger, and three times for non-performance risk.
KEY RATING DRIVERS - IDRs
WestImmo's IDRs are equalised with those of Aareal, reflecting our expectation that institutional support from Aareal will remain strong. The IDRs' equalisation is supported by a control and profit-and-loss sharing agreement between the two entities that came into force shortly after WestImmo's acquisition by Aareal in 2Q15 and which obliges Aareal to compensate under certain conditions potential losses arising at WestImmo.
We have not assigned a VR to WestImmo because Aareal will continue to wind down its legacy portfolio without originating material new business. Aareal will continue to shift assets to WestImmo as the need arises to replenish its subsidiary's cover pools.
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 business model focusing on non-granular, wholesale and cyclical assets are not commensurate with a rating in the 'a' category despite the bank's solid asset quality. A higher VR would require significant diversification into lower-risk asset classes generating more predictable earnings. While we view the increasing revenue contribution of its consulting and services division positively, the resulting diversification currently remains limited.
RATING SENSITIVITIES - SR AND SRF
An upgrade of Aareal's SR and an upward revision of its SRF would be contingent on a positive change in Fitch's view of the sovereign's propensity to support its systemically important banks. While not impossible, the new regulatory environment makes this highly unlikely.
RATING SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of the lower Tier 2 subordinated notes and hybrid instruments are primarily sensitive to changes to Aareal's VR. The ratings are also sensitive to a change in their notching
RATING SENSITIVITIES - IDRs
WestImmo's IDRs are primarily sensitive to changes in Aareal's IDRs. They are also sensitive to a change of the propensity of support from Aareal, which we view as unlikely in light of the control and profit-and-loss sharing agreement.
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'
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'