DBRS Comments on WestLB Interim Results and Outlook – Ratings Unchanged

DBRS has today commented that its ratings for WestLB AG (WestLB or the Bank) are unchanged following the Bank’s interim results for the nine months ended September 2008. DBRS maintains a Long-Term Debt & Deposit rating of A (high) and a Short-Term Debt & Deposits rating of R-1 (middle) for WestLB. The trend on all ratings is Stable.

WestLB reported pre-tax income of EUR 604 million and net profit of EUR 532 million for the nine months ended September 2008. This result was primarily due to the EUR 962 million pre-tax gain from the transfer of structured securities to an independent special-purpose vehicle in Q1 2008 (the risk shield transaction). WestLB’s owners guaranteed the first EUR 5 billion of losses from the transferred portfolio, enabling the Bank to record a substantial gain from the transaction. Excluding this gain, WestLB generated a loss in the first nine months of 2008.

In the first nine months of 2008, WestLB’s results suffered from losses and valuation declines due to widening credit spreads and the failure of several financial institutions. In Q3 2008, the Bank wrote down all of its EUR 196 million of exposure to Icelandic banks. Net interest income continued to grow in the first nine months of 2008, driven by improved margins. Fee and commission income declined by 10% compared with the first nine months of 2007, as higher lending-related commissions were offset by lower securities and custody fees due to the financial crisis. WestLB continues to demonstrate cost discipline: administrative expenses of EUR 284 million in Q3 2008 were down 22% from the year-ago quarter and also 28% lower on a linked-quarter basis, driven by staff reductions and lower non-linear salary components.

WestLB’s ratings continue to be based on the A (high) and R-1 (middle) floor ratings that DBRS has assigned to all members of the joint-liability scheme of Germany’s Savings Banks Finance Group (Sparkassen-Finanzgruppe). Factored into the floor ratings is DBRS’s expectation that the institutions comprising the Savings Banks Finance Group are systemically important and therefore likely to receive some form of systemic support if their combined resources prove insufficient.

WestLB’s current intrinsic fundamentals are significantly weaker than its ratings level would suggest. DBRS notes positively the progress the Bank is making toward stabilising its franchise despite the ongoing financial crisis. However, DBRS sees several near-term challenges that could further weaken WestLB’s intrinsic financial strength. These challenges include the Bank’s weakened capitalisation, liquidity pressures and the search for a new ownership structure, as demanded by the European Commission.

The Bank’s regulatory core capital ratio (under German rules) weakened to 5.4% as of September 2008, down from 6.4% as of June. The total capital ratio (under German rules) declined to 8.8% as of September 2008 from 10.4% in June. The declines were primarily due to the EUR 3.5 billion increase in risk-weighted assets (RWAs) to EUR 107.8 billion. This increase was driven by credit rating downgrades on securitised assets, which led to higher risk weightings, and by the strengthening U.S. dollar.

WestLB’s regulatory capital ratios are expected to benefit when the Bank receives credit ratings for certain notes that fund the risk shield transaction. The Bank expects ratings to be assigned in the near term and estimates a pro forma core capital ratio of 6.8% as of September 2008, taking this effect into account. However, DBRS notes that even this pro forma ratio may still appear low relative to the increased capital requirements from investors and regulators in the current financial crisis.

DBRS sees WestLB, like other financial institutions, facing the challenge of bolstering its liquidity as interbank lending markets remain disrupted and investor demand for long-term bank debt remains scarce. WestLB intends to utilise bank debt guarantees from the German Financial Markets Stabilisation Fund, which is authorised to issue up to EUR 400 billion in debt guarantees. DBRS views some form of external liquidity support as important for WestLB to bolster its liquidity, given the challenging environment for bank funding.

In DBRS’s view, the extension of additional support could be complicated by WestLB’s weakened capitalisation and the European Commission’s ongoing state evaluation of the risk shield transaction, which requires its approval. Debt guarantees under the German Financial Markets Stabilisation Fund are primarily aimed at sufficiently capitalised financial institutions, and it is unclear whether WestLB would qualify without additional capital.

Moreover, WestLB’s supervisory board announced in July 2008 its intention to explore a change in the Bank’s ownership structure in response to the European Commission’s ongoing evaluation of the risk shield transaction. DBRS views the continued lack of a clear future ownership structure for WestLB as a concern that could hinder the Bank’s efforts to stabilise its franchise.

Notes:
The applicable methodology is Analytical Background and Methodology for European Bank Ratings, Second Edition, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.