DBRS Comments on WestLB’s 2008 Result and Progress on the Restructuring Plan

DBRS has today commented that its ratings for WestLB AG (WestLB or the Bank) are unchanged, following the last week’s announcement of the Bank’s full-year 2008 results and an update on its restructuring efforts. DBRS maintains Long-Term Debt & Deposit rating of A (high) and Short-Term Debt & Deposit rating of R-1 (middle) for WestLB, both with a Stable trend. These ratings are based on the floor ratings DBRS has assigned for all members of the joint liability scheme of the German Savings Banks Finance Group (SBFG). As a member of the joint liability scheme, WestLB benefits from these floor ratings.

WestLB reported net income of EUR 18 million for 2008 after a net loss of EUR 1,597 million in 2007. Extraordinary items, both positive and negative, affected results significantly. The Bank benefited in 2008 from the transfer of a structured credit portfolio of nominal EUR 23 billion to an off-balance sheet vehicle. The transfer, which was facilitated by a loss guarantee (risk shield) of EUR 5 billion from WestLB’s owners, resulted in a one-time gain of EUR 962 million. The Bank also had EUR 400 million mark-to-market gains on its own liabilities. These positive effects of a combined EUR 1,362 million were more than offset by negative extraordinary effects totalling EUR 1,424 million. Negative items included EUR 540 million in valuation losses on sovereign bonds, U.S. student loans and similar exposures, EUR 280 million in losses from equities and equity derivatives trading, EUR 153 million impairments on Icelandic banks exposures, as well as restructuring charges, negative valuation mismatches and increased loan loss provisions due to the financial crisis.

Excluding these extraordinary effects, WestLB recorded underlying pretax earnings of approximately EUR 88 million in 2008. DBRS notes that WestLB’s core customer franchise generated acceptable underlying income under difficult conditions. Net interest income increased 10%, as margins widened. Lending volumes remained solid, as WestLB gained market share in subdued syndication and project finance markets. Net fee and commission income declined by 17%; driven by substantial declines in securities and custody-related fees. Lending-related fees declined only moderately. Payments commissions remained stable, demonstrating WestLB’s ability to generate a level of fee income even under stressed conditions. Trading income and income from financial investments were at low levels due to the financial crisis.

DBRS views positively WestLB’s success in reducing costs, which helps improve the Bank’s relatively modest underlying profitability. Administrative expenses declined 15% in 2008 compared to 2007, and the Bank reported continued cost-cutting momentum for the first two months of 2009. Cost cuts are primarily driven by headcount reductions in the back and middle office areas.

WestLB’s profitability continues to be negatively affected by higher credit risk provisioning due to the financial crisis, but also due to deteriorating corporate credit quality. DBRS expects loan loss provisions to remain elevated or even rise further in 2009, as the recession in Germany deepens.

In DBRS’s view, WestLB’s restructuring efforts address key challenges, such as its vulnerability to markets turmoil due to its large investment portfolios, the Bank’s tight capitalisation and the unresolved evaluation of the risk shield transaction by the European Commission (EC). As such, DBRS views WestLB’s restructuring as likely to protect its franchise value that is important to ensure continued owner support.

DBRS views positively WestLB’s progress in executing its restructuring plan, as demanded by the EC. The EC is demanding a substantial reduction of WestLB’s risk-weighted assets (RWA) and a change in ownership as a condition to approve the risk shield transaction. However, DBRS notes that the EC has yet not approved the EUR 5 billion risk guarantee provided by WestLB’s owners, posing a source of uncertainty. While not expected, a negative decision by the EC could make the risk shield transaction void, which would likely trigger a need for substantial support for WestLB. In such a scenario, DBRS would expect the Bank’s owners and the German government to provide support.

Separately, WestLB has placed approximately EUR 73 billion of non-core assets into a run-off portfolio that the Bank intends to spin off. The separation of these non-core assets and WestLB’s proposal to arrange a non-discriminatory bidding procedure of its remaining core operations address the demands of the EC. In the view of DBRS, however, these steps will likely require a capital infusion and may be difficult to execute in the current environment.

DBRS notes that WestLB’s capitalisation is tight, given the difficult environment. The Bank’s core (tier 1) capital ratio at year-end 2008 of 6.4% remained below the 7% threshold that the German Financial Markets Stabilisation Fund (Soffin) generally views as a minimum for banks to be eligible for support from Soffin. DBRS views a further improvement of WestLB’s capitalization as important to ensure access to Soffin support, bolster the Bank’s loss-absorption capacity and to enable it to support its core client businesses. Moreover, additional capital will likely be needed to facilitate the planned spin-off of non-core assets.

Note:
All figures are in Euros unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.