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Rating Action:

Moody's affirms Landesbank Berlin AG's A1/Prime-1 ratings; changes outlook to negative

11 Mar 2014

Subordinated debt ratings downgraded to Baa3 following lowering of the baseline credit assessment

Frankfurt am Main, March 11, 2014 -- Moody's Investors Service has today affirmed Landesbank Berlin AG's (LBB) A1 long-term issuer, debt and deposit ratings and Prime-1 short-term ratings. Concurrently, the outlook on the long-term ratings was changed to negative from stable. The A1/Prime-1 long-term and short-term ratings of LBB's branch Berliner Sparkasse were also affirmed and the outlook was changed to negative from stable.

The negative outlook on LBB's long-term ratings was prompted by the negative outlook assigned to its standalone bank financial strength rating (BFSR), which was affirmed at D+. At the same time, Moody's lowered the baseline credit assessment (BCA) to ba1 from baa3.

The lowering of LBB's BCA results in a downgrade of the subordinated debt ratings to Baa3 from Baa2 while the outlook on these ratings was also changed to negative from stable.

The key drivers of today's rating action include Moody's assessment of very high probability of support, but also the challenges related to LBB's transformation plan, pressure on capital caused by regulatory changes during a period of constrained internal capital generation, and persistently high concentration risk.

LBB's Aa1/Prime-1 ratings for obligations qualifying for grandfathering of "Gewaehrtraegerhaftung" (a guarantee obligation) are not affected by today's rating action.

RATINGS RATIONALE

-- AFFIRMATION OF SENIOR RATINGS WITH NEGATIVE OUTLOOK

The affirmation of LBB's A1/Prime-1 long-term and short-term ratings reflects Moody's assumption of a very high probability of support that would be forthcoming to LBB in the event of need. The rating agency bases its view on the fact that LBB -- as a member of the Association of German Public-Sector Banks -- benefits from multiple sources of support, primarily through (1) the direct majority ownership of Sparkassen-Finanzgruppe (S-Finanzgruppe; corporate family rating Aa2 stable; BFSR C+ stable /BCA a2); and (2) Moody's expectations that the owners will support LBB during its multi-year and challenging transformation process from a diversified commercial bank to a focused retail banking institution. Following the lowering of the BCA, LBB's A1 long-term ratings now benefit from six notches of rating uplift (formerly five).

The negative outlook on the A1 long-term ratings follows the negative outlook on the BFSR and reflects Moody's view that a further deterioration of LBB's BFSR could prompt a downgrade of the bank's long-term ratings.

-- NEGATIVE OUTLOOK FOR THE BFSR / LOWERING OF THE BCA

The affirmation of LBB's standalone D+ BFSR and change of outlook to negative which resulted in the lowering of the BCA to ba1 from baa3, incorporates the three main challenges relating to execution risk associated with the bank's transformation plan, pressure on capital caused by regulatory changes during a period of constrained internal capital generation, and persistently high concentration risk:

(1) The transformation plan of the bank entails execution risk, weakening profitability and impaired capital generation capacity

The German Savings Bank Association (Deutscher Sparkassen-und Giroverband or DSGV) -- i.e., the umbrella organisation of S-Finanzgruppe -- is planning to realign and consolidate the commercial real estate, capital markets and retail banking activities of LBB. This realignment also includes LBB's subsidiary Berlin Hyp AG (unrated) and DekaBank Deutsche Girozentrale (DekaBank; deposits A1 stable; BFSR C-/BCA baa2 stable). By the end of 2017, LBB will be focused solely on its core retail activities through Berliner Sparkasse and will operate as a large savings bank with total assets of around EUR40 billion. Although Moody's regards LBB's transformation plan as credible and positive for the risk profile of the institution over the medium term, the bank is not immune to risks and challenges associated with the execution.

In Moody's view, the expected significant reduction in LBB's balance sheet should, over time, reduce higher risks typically associated with long-term asset lending and capital market activities; however, the bank's earnings (from net interest income) will also diminish, while the rating agency expects only a gradual reduction of LBB's operating costs. This reduction in business volumes in combination with substantial costs arising from the restructuring (EUR275 million in 2013) leave LBB with a lower loss absorption capacity to withstand potential losses. After the group's announcement (in its third quarter 2013 update) of a projected pre-tax loss for 2013, Moody's expects only a hesitant recovery of profits in 2014 and 2015, and hence highlights risks associated with LBB's ability to strengthen capital levels from retained earnings against the background of the phase-in of higher capital requirements under Basel III.

(2) Regulatory changes create pressure on capital during a period of constrained internal capital generation

Moody's notes that the reported Tier 1 capital ratio at LBB's non-operating (unrated) parent company Landesbank Berlin Holding AG (which the rating agency views as a proxy for LBB's regulatory capitalisation) stood at a satisfactory 12.8% under Basel II.5 as of 30 June 2013 (unaudited). However, LBB's tangible common equity of 5.8% as a percentage of risk-weighted assets -- as of 30 June 2013 (unaudited) -- was much lower. The deviation reflects the goodwill and hybrid capital elements in regulatory Tier 1 capital, and the rating agency therefore regards LBB's tangible common equity as weak compared to similarly rated national peers.

The upcoming regulatory changes in 2014 will significantly reduce LBB's regulatory capital because of the deduction of goodwill (EUR675 million as per audited year-end financials 2012) and the phase-out of EUR700 million hybrid capital in the form of silent participations. However, Moody's expects LBB to maintain adequate capital buffers under the stricter Basel III rules which should allow it to comply with the ECB's comprehensive assessment, despite the constrained earnings retention capacity during the transformation process.

(3) Asset Quality: Still high concentration risk despite significant progress regarding the legacy portfolio

LBB's high concentrations to both commercial real estate lending activities and exposures held within its capital markets portfolio renders the bank vulnerable to adverse events. Although the bank's sizeable financial assets of EUR37 billion (33% of total assets as of 1H 2013; including some capital burdening structured credit products) have declined from more than EUR54 billion in 2008, in Moody's view these assets still represent a significant driver of income volatility for the bank.

Additionally, the level of LBB's gross problems loans relative to reserves available plus equity remains high at a level of 90%, but the volume of loans had decreased to EUR2.2 billion as of audited year-end financials 2012 (2011: EUR2.9 billion). The problem loans-to-gross loans ratio declined to 5.0% in 2012 (2009: 6.5%), but still remained slightly above the average for Moody's rated German banks.

-- DOWNGRADE OF THE SUBORDINATED DEBT RATINGS AND THE NEGATIVE OUTLOOK

The downgrade of LBB's subordinated debt ratings to Baa3 from Baa2 mirrors the one-notch lowering of the bank's adjusted BCA to baa2 from baa1. The adjusted BCA of baa2 serves as the anchor rating for LBB's subordinated debt instruments and reflects Moody's estimate of support that is likely to be made available as "going-concern support". This anchor principally applies to support from the cross-sector joint liability scheme (Haftungsverbund), which the rating agency believes is available for the benefit of all cases of debt. This assumption provides two notches of rating uplift for the adjusted BCA from LBB's ba1 BCA. The negative outlook on the subordinated debt ratings was prompted by the negative outlook on the standalone BFSR.

WHAT COULD CHANGE THE RATING UP/DOWN

There is currently no upward pressure on LBB's BFSR, given the negative outlook. Any upward rating pressure over the next 12 to 18 months would require an improved profit and capital generation capacity, a strengthening of the bank's capital and/or a significant reduction of sector concentrations.

Upwards pressure on LBB's A1 debt and deposit ratings is unlikely to develop in the foreseeable future, given (1) the negative outlook; and (2) the substantial sector support for the bank and systemic support for the savings banks sector that is already factored into these ratings.

Downward rating pressure on LBB's BFSR could ultimately develop if: (1) restructuring charges exceed current estimations, thus affecting the bank's capitalisation; or (2) LBB's asset quality deteriorates with negative implications for its capitalisation.

LBB's long-term ratings could be downgraded as a result of (1) a downgrade of the BFSR; or (2) a deterioration in the commercial and financial profile of S-Finanzgruppe, leading to a reduction in Moody's very high support assumptions.

The principal methodology used in these ratings was Global Banks published in May 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Andrea Wehmeier
Vice President - Senior Analyst
Financial Institutions Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Carola Schuler
MD - Banking
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's affirms Landesbank Berlin AG's A1/Prime-1 ratings; changes outlook to negative
No Related Data.
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