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Fitch Affirms Aareal and Places COREALCREDIT on Positive Watch on Announced Acquisition
December 27, 2013 / 3:57 PM / 4 years ago

Fitch Affirms Aareal and Places COREALCREDIT on Positive Watch on Announced Acquisition

(The following statement was released by the rating agency) FRANKFURT/LONDON, December 27 (Fitch) Fitch Ratings has affirmed Germany-based Aareal Bank AG's (Aareal) Long-term Issuer Default Rating (IDR) at 'A-' and its Viability Rating (VR) at 'bbb'. The Outlook on the Long-term IDR is Stable. At the same time, the agency has placed COREALCREDIT BANK AG's (COREALCREDIT) Long- and Short-term IDRs of 'BBB-' and 'F3' on Rating Watch Positive and affirmed its VR at 'bb'. A full list of rating actions is provided at the end of this commentary. The rating actions reflect Aareal's planned acquisition of COREALCREDIT from a company owned by the US financial investor Lone Star. The announced purchase price of EUR342m is subject to contractually agreed adjustments up until the closing date. According to current plans, the transaction - which is subject to the approval of the respective authorities - will be completed during the first half of next year. KEY RATING DRIVERS - AAREAL'S IDRs, VR, SUPPORT RATING, SUPPORT RATING FLOOR AND SENIOR DEBT The affirmations of Aareal's Long-term IDR, Support Rating, Support Rating Floor and senior debt ratings reflect Fitch's view that its status as one of Germany's largest, independent active Pfandbrief issuers continues to result in a very high probability that state support would be forthcoming if necessary. State support, in Fitch's view, is even more certain in the short-term and so Aareal's Short-term IDR at 'F1' is at the higher of two potential Sort-term ratings mapping to its 'A-' Long-term IDR. The Stable Outlook is based on Fitch's view that support will continue to be forthcoming, although this is sensitive to evolving developments around support for EU banks. The affirmation of Aareal's VR reflects Fitch's expectation that the bank's recurring earnings and capitalisation could benefit slightly from the acquisition of the much smaller, Germany-focused COREALCREDIT, which is being purchased at a material discount to the net fair value of its assets and liabilities. On the other hand, the rating also takes into account execution risk on the acquisition. Taxation and legal risks are by nature difficult to quantify with certainty and the acquisition will absorb considerable management capacity at least in the short-term. Fitch expects that Aareal will not release upfront accounting profit from this transaction through dividend payments in the early years before the full economic impact of the transaction materialises. Therefore, the affirmation of the VR is based on assumptions that potential legacy risks at COREALCREDIT are sufficiently ring-fenced and that cash collateral is trapped at the financial institution in an escrow account. On balance, Fitch believes that Aareal's management team is experienced in structuring complex financial transactions and expects that Aareal will extract some net profit from the transaction, including the substantial negative goodwill it will book upfront. KEY RATING DRIVERS - COREALCREDIT'S IDRs, VR, SUPPORT RATING, SUPPORT RATING FLOOR AND SENIOR DEBT The Rating Watch Positive on COREALCREDIT's IDRs and senior debt reflects Fitch's expectation that the acquisition will close successfully in 1H14 and the positive impact of support it will receive from Aareal. The future rating level will factor in a very strong propensity for Aareal to support COREALCREDIT, underpinned by a profit and loss sharing agreement between the two financial institutions. The ratings will also factor in Aareal's ability to provide support either from its own resources or via state support to COREALCREDIT through Aareal. Once COREALCREDIT becomes a subsidiary of Aareal, Fitch's analysis will be based on an institution (Aareal) being the source of support, rather than on the state. The affirmation of COREALCREDIT's VR reflects Fitch's view that its financial position will not be affected negatively by the transaction nor be significantly changed from March when the VR was last reviewed. Once the acquisition is approved by the authorities, Fitch expects that the bank's capitalisation will improve before potential capital transfers to Aareal. COREALCREDIT's profitability for the purpose of consolidation into Aareal's accounts, once the transaction is complete, will depend substantially on the pull-to-par fair value of assets and liabilities and Aareal's management's ability to deliver synergies according to plan. Fitch expects that COREALCREDIT's liquidity will benefit from Aareal's ready access to funding sources. The profit and loss sharing agreement will neutralise any profit or loss between the two banks. RATING SENSITIVITIES - AAREAL's IDRs, SUPPORT RATING, SUPPORT RATING FLOOR AND SENIOR DEBT Aareal's IDRs, Support Rating, Support Rating Floor and senior debt ratings are sensitive to any change in Fitch's assumptions about the on-going availability of extraordinary sovereign support for the bank. In Fitch's view, there is a clear intention ultimately to reduce implicit state support for financial institutions in the EU, as demonstrated by a series of legislative, regulatory and policy initiatives, most recently agreement between the European Council and Commission on the Bank Recovery and Resolution Directive. In September 2013, Fitch commented on its approach to incorporating support in its bank ratings in light of evolving support dynamics for banks worldwide (see 'Fitch Outlines Approach for Addressing Support in Bank Ratings', 'Bank Support: Likely Rating Paths', and 'The Evolving Dynamics of Support for Banks' available at www.fitchratings.com) and followed this with an update in December (see ''Sovereign Support for Banks Update on Position Outlined In 3Q13') . Aareal's Support Rating Floor would be revised lower and its Support Rating, IDRs and senior debt ratings downgraded if Fitch concludes that potential sovereign support has weakened relative to its previous assessment. Given Aareal's VR is 'bbb', any support-driven downgrade of the bank's Long-term IDR and senior debt ratings would be limited to two notches. RATING SENSITIVITIES - COREALCREDIT's IDRs, SUPPORT RATING, SUPPORT RATING FLOOR AND SENIOR DEBT Fitch expects to resolve the Rating Watches once the transaction is successfully closed. Fitch's considerations on support for EU banks will affect the rating decision. If support considerations are excluded, COREALCREDIT's Long-term IDR would be equalised with Aareal's VR. This would mean a one-notch upgrade for COREALCREDIT's Long-term IDR and senior debt ratings and either an affirmation or one-notch upgrade of its Short-term IDR. COREALCREDIT's Support Rating and Support Rating Floor are sensitive to similar support considerations as those for Aareal. In addition, if the acquisition by Aareal fails to go ahead, its IDRs and senior debt ratings will be sensitive to changes to Fitch's view about state support. RATING SENSITIVITIES - VRs Aareal's 'bbb' VR is the highest for a German monoline commercial real estate lender and benefits from its resilient performance since 2008. The non-performing loan (NPL) ratio will deteriorate once Aareal consolidates COREALCREDIT. COREALCREDIT has a large, albeit rapidly shrinking, NPL portfolio which, combined with its weak profitability, is one of the main reasons for its VR being at 'bb'. However, COREALCREDIT has fairly high NPL coverage with loan loss reserves compared with its German peers, and the terms of the acquisition include further cash collateral against unexpected deterioration of collateral value. Fitch understands that Aareal has conducted extensive due diligence on COREALCREDIT's loan portfolio, covering most commercial real estate loans. If Aareal's assessment proves to be inadequate - which is not Fitch's base case - it could be negative for COREALCREDIT's VR. Aareal has negotiated protection in the form of cash collateral and fair value adjustments for potential taxation and legal risks. If Aareal's assessment has not been sufficiently conservative, the upside for Aareal's profitability and capital generating capacity through this acquisition would be reduced. In addition, if Aareal's calculation of the net gain of the acquisition has been too optimistic, this would be neutral to negative for the VR, but if risks emerge that have not been identified by Aareal in its due diligence, this would be negative for the VR. COREALCREDIT's capital, funding and liquidity will be managed at a consolidated level and the profit and loss sharing agreement will mutualise the two banks' earnings. Consequently, Fitch would most likely withdraw COREALCREDIT's VR once the acquisition is successfully closed. KEY RATING DRIVERS AND SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Aareal's and COREALCREDIT's Lower Tier 2 subordination securities are notched down one level from the banks' respective VRs to reflect higher loss severity compared with senior unsecured debt instruments in line with Fitch's criteria. Aareal's hybrid securities, issued by Capital Funding GmbH and Aareal Capital Funding LLC (Delaware), are rated 'BB-'. The instruments' distributable profit trigger or an annual profit trigger combined with a regulatory capital ratio trigger are reflected in the notes being rated four notches below Aareal's VRs, two notches for high loss severity risks and two notches for high non-performance risks. Subordinated debt ratings and hybrid ratings are sensitive to the potential changes of the banks' respective VRs. When the acquisition is closed, the anchor VR for COREALCREDIT's subordinated debt is likely to be Aareal's, rather than COREALCREDIT's, VR. RATING ACTIONS Aareal Bank AG: Long-term IDR: affirmed at 'A-', Outlook Stable Short-term IDR: affirmed at 'F1' Viability Rating: affirmed at 'bbb' Support Rating: affirmed at '1' Support Rating Floor: affirmed at 'A-' Debt Issuance Programme: affirmed at 'A-'/'F1' Senior unsecured notes: affirmed at 'A-' Subordinated debt: affirmed at 'BBB-' Capital Funding GmbH (DE0007070088): affirmed at 'BB-' Aareal Capital Funding LLC (Delaware) (XS0138973010): affirmed at 'BB-'. COREALCREDIT BANK AG: Long-term IDR: 'BBB-' placed on Rating Watch Positive Short-term IDR: 'F3' placed on Rating Watch Positive Viability Rating: affirmed at 'bb' Support Rating: affirmed at '2' Support Rating Floor: affirmed at 'BBB-' Senior unsecured notes: 'BBB-' placed on Rating Watch Positive Subordinated debt: 'BB-' placed on Rating Watch Positive Contact: Primary Analyst Michael Dawson-Kropf Senior Director +49 69 76 80 76 113 Fitch Deutschland GmbH Taunusanlage 17 60325 Frankfurt am Main Secondary Analyst Krista Davies Analyst +44 203 530 1579 Committee Chairperson Bridget Gandy Managing Director +44 203 530 1095 Media Relations: Hannah Huntly, London, Tel: +44 20 3530 1153, Email: hannah.huntly@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria 'Global Financial Institutions Rating Criteria', dated 15 August 2012, 'Evaluating Corporate Governance', dated 12 December 2012, 'Assessing and Rating Bank Subordinated and Hybrid Securities', dated 5 December 2012 and 'Rating FI Subsidiaries and Holding Companies', dated 10 August 2012 are available at www.fitchratings.com. Related Research: Sovereign Support for Banks Update on Position Outlined In 3Q13 Support is Key to German Pfandbrief Issuers' Ratings Applicable Criteria and Related Research: Global Financial Institutions Rating Criteria here Evaluating Corporate Governance here Assessing and Rating Bank Subordinated and Hybrid Securities here Rating FI Subsidiaries and Holding Companies here 2014 Outlook: German Banks - Amended here No Signs of Real-Estate Bubble in Germany here Bank Support: Likely Rating Paths here The Evolving Dynamics of Support for Banks here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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