AAREAL BANK AG
Fitch Ratings has downgraded
The Outlook on the Long-Term IDR is Stable. The Short-Term IDR has been affirmed at 'F2'.
The downgrade reflects our expectation that the challenges in the US office property market are weighing on Aareal's asset quality and operating profitability.
The Stable Outlook reflects Fitch's expectation that Aareal's pre-impairment operating profit will continue to provide a sufficient buffer for higher loan impairment charges in the coming quarters, which should allow the bank to generate adequate operating profitability. It also incorporates Fitch's view that Aareal's funding and liquidity, which benefits from a stable deposit base and the bank's established role as a Pfandbrief issuer, remains sound.
Key Rating Drivers
Concentrated Business Profile: The ratings reflect Aareal's core business as an international commercial real estate (CRE) lender and our expectation that capitalisation will remain sound despite pressure on profitability and asset quality. Profitability and revenue diversification benefit from services to the institutional housing sector, which also gives it access to a stable deposit base.
Tested Underwriting Standards: Aareal mainly finances properties in prime locations. The underwriting standards and collateralisation of its loan book are broadly in line with market practice. The bank's risk profile is also underpinned by its centralised, sophisticated risk control framework and good record of impaired loans work-out, which we view as crucial for weathering the current challenging conditions in real estate markets.
Asset Quality Deterioration: Aareal's asset quality has come under additional pressure, especially in its sizeable US office portfolio, which accounted for
The bank's asset quality could deteriorate further if valuation pressure in the US office sector persists longer than expected, or if the quality of the bank's European office portfolio, which to date has performed solidly, weakens.
Adequate Profitability Albeit Under Pressure: The bank's revenue generation improved materially in 9M23 as higher interest rates resulted in improved deposit margins. Fitch expects higher loan impairment charges to weigh on Aareal's operating profit/risk-weighted assets (RWAs) ratio.
Resilient Capitalisation: We expect Aareal's capitalisation to remain a relative rating strength, with its end-3Q23 CET1 ratio of 19.4% comfortably exceeding regulatory requirements and a Basel III leverage ratio (end-3Q23: 6.3%) that is adequate and above that of European peers. Our assessment of capitalisation incorporates Aareal's high single-borrower and sector concentrations and our view that asset quality deterioration could result in RWA inflation.
Diversified Funding: Aareal's funding profile benefits from its established covered bond franchise, stable deposits from the institutional housing sector and to a lesser extent, retail term deposits collected through independent online platforms, which reduce the bank's reliance on unsecured debt market funding. We expect covered bond issuance to remain resilient even in periods of market stress but consider Aareal's deposit funding more price- and confidence sensitive.
Aareal's Short-Term IDR is the higher of the two short-term ratings that maps to its Long-Term IDR and reflects our assessment of its funding and liquidity.
Rating Sensitivities
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Aareal's ratings would likely be downgraded if the bank's gross impaired loan ratio increases above 6% for an extended period with no credible reduction plan or if elevated loan impairment charges weigh on its operating profitability in the longer term.
The ratings would also come under pressure if we do not see a clear path for the bank's operating profit/RWA ratio to sustainably remain around 1.5%. This could result from an additional severe stress in the US office property market or spill-over to European property markets or specific sectors that are sensitive to higher rates and widening spreads. Significantly higher funding costs or signs of challenges to access the wholesale funding market or instability in its deposit base could also impair Aareal's profitability and funding and result in a downgrade.
Aareal's Short-Term IDR is sensitive to a downgrade of the Long-Term IDR or a downgrade of the funding and liquidity score.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
An upgrade of Aareal's Long-Term IDR is unlikely in the near term, given that Aareal's business profile is concentrated on CRE. In the longer term, an upgrade would require a sustainable recovery of US office property markets and resilient asset quality in the bank's other property segments and regions.
An upgrade would also be contingent on the bank significantly strengthening its profitability, with an operating profit/RWA ratio sustained above 2%, and improving its impaired loans ratio to around 3% on a sustained basis.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
DCR, Deposit and Senior Debt Ratings: The one-notch downgrades of Aareal's Derivative Counterparty Rating (DCR), long-term deposit rating, senior preferred debt rating and long-term senior non-preferred debt rating mirror the downgrade of the Long-Term IDR. The senior preferred rating remains one notch above the Long-Term IDR, and the long-term senior non-preferred debt rating remains aligned with the Long-Term IDR. This reflects the large and sustainable layer of non-preferred and junior debt that provides preferred creditors and counterparties with additional protection in a resolution.
The short-term senior preferred and senior non-preferred debt and deposit ratings are the lower of the two options mapping to the respective long-term ratings.
Subordinated Debt: The one-notch downgrades of the Tier 2 debt and additional Tier 1 (AT1) ratings mirror the downgrade of the VR. The Tier 2 debt rating remains two notches below the VR to reflect higher loss severity relative to senior creditors in a resolution. The AT1 notes are rated four notches below the VR (two notches for loss severity and two notches for non-performance risk) to reflect our expectation that Aareal will maintain large capital buffers above the notes' mandatory coupon omission triggers.
Government Support Rating (GSR): Aareal's GSR of 'no support' reflects Fitch's view that senior creditors cannot rely on full extraordinary state support. This is driven by the EU's resolution framework that is likely to require senior creditors participating in losses, if necessary, instead, or ahead, of a bank receiving government support.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
A downgrade of the Long-Term IDR would trigger a downgrade of the DCR, long-term senior preferred and senior non-preferred debt and deposit ratings. We could also downgrade these ratings if the bank no longer retained a senior non-preferred and junior debt buffer that is large enough to cover its total resolution buffer requirement, and if at the same time the senior non-preferred and junior debt buffer declines below 10% of RWAs.
An upgrade of Aareal's IDRs would trigger an upgrade of the DCR, senior preferred and non-preferred debt and deposit ratings, unless the buffer of junior and senior non-preferred debt decreases below the level required to maintain the senior preferred ratings' one-notch uplift above and the senior non-preferred debt's alignment with the Long-Term IDR. Short-term debt ratings are sensitive to changes to the Short-Term IDR.
A downgrade of the VR would lead to a downgrade of the Tier 2 and AT1 notes. The ratings of AT1 notes could also be downgraded if we perceive a heightened risk that capital cushions above the maximum distributable amount trigger points could fall below 100bp.
An upgrade of the GSR would require a higher propensity of sovereign support. While not impossible, the EU's resolution regime makes this highly unlikely, in Fitch's view
VR ADJUSTMENTS
The capitalisation & leverage score of 'a-' has been assigned below the 'aa' implied category score due to the following adjustment reason(s): risk profile and business model (negative).
The funding & liquidity score of 'bbb' has been assigned below the 'a' implied category score due to the following adjustment reason(s): non-deposit funding (negative).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
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