DBRS Confirms WestLB AG’s Long-Term Debt at A (high), Trend Stable

DBRS has today confirmed the ratings for WestLB AG (WestLB or the Bank). DBRS rates WestLB’s Long-Term Debt & Deposit at the A (high) and its Short-Term Debt & Deposit at R-1 (middle), which are the floor ratings for all members of the joint liability scheme of Sparkassen-Finanzgruppe. The trend on all ratings is Stable.

The ratings also consider the Bank’s ongoing access to various forms of support from the German federal government, the state and savings banks owners, and the Sparkassen-Finanzgruppe. In DBRS’s view, this support and WestLB’s position as a member of the joint liability scheme allows for significant uplift in the final rating. Indeed, DBRS maintains WestLB’s intrinsic rating at BB (low), reflecting the uncertainties as to the future prospects of the Bank and the ultimate level of support available to the Bank, after its European Commission (EC) stipulated change in majority ownership. Further, the intrinsic ratings consider DBRS’s concerns as to the timing and form of the pending EC final approval for State-aid, and the risk that any additional requirements imposed may impact the prospects or franchise of the Core Bank. Further, the intrinsic ratings reflect WestLB’s reduced earnings generation ability attributed to the narrowed business focus, and the remaining earnings volatility potential. These negatives are somewhat offset by the Core Bank’s still solid, albeit evolving franchise, the reduced risk profile, and WestLB’s ability to demonstrate a modest level of profitability.

While WestLB has made significant progress in executing on its restructuring plans, the ratings consider the risks and challenges that remain. First and foremost, WestLB’s ownership structure will need to change by December 2011, as prescribed by the EC. In DBRS’s view, the change in majority ownership may affect WestLB’s access to support, however, the Bank’s systemic importance and the most recent support from the federal government provides a level of comfort. Further, the change in ownership leads to uncertainly regarding future business prospects and WestLB’s continued membership in the joint liability scheme. WestLB sources a sizable amount of funding, liquidity and customer activity from the regional savings banks. Importantly, should the Bank exit the joint liability scheme, existing/outstanding debts will be grandfathered and protected by the joint liability scheme.

On a positive note, DBRS views the Core Bank’s franchise as still solid, albeit not without risks as discussed above. The franchise strength is underscored by WestLB’s position in German corporate banking, debt capital markets and transaction banking, complimented by the growing business with savings banks. Profitability however, remains modest and a level of volatility remains. The modest level of profitability allows limited flexibility for the Bank to manage through any renewed market-wide disruptions or company-specific event risks. Nonetheless, WestLB returned to profitably in the first quarter 2010. To this end, WestLB recorded EUR 114 million in profit before tax (PBT) for the first half. Importantly, the Core Bank generated a PBT of EUR 304 million for the same period. While DBRS recognises the improving trends in profitability, given the still difficult environment and the resulting muted business activity and elevated funding and credit costs, DBRS expects a level of earnings pressure to persist in the near-term.

DBRS notes the risk reducing benefits gained from the transfer of nominal EUR 77 billion of higher-risk exposures to the unrelated workout entity (EAA) and from the ongoing restructuring. DBRS recognises, however, that WestLB’s core activities in corporate banking and capital markets remain exposed to economic and market cycles. Further, the wholesale-funded nature of the funding profile negatively influences the rating. This is somewhat offset by the benefits from the funding relationships with the savings banks. The savings banks have proved to be a stable and dependable source of funding, which has allowed WestLB to navigate through the most current market disruption without explicit guaranteed funding. DBRS is, however, concerned that further change in ownership may alter the relationship with the savings banks, and thereby potentially remove a steady source of funding.

WestLB’s capital position has improved with the transfer of the non-strategic assets. The removal of some EUR 30 billion of risk weighted assets (RWA) positively impacted regulatory capital ratios, even though the quantum of equity was largely unchanged from the end of 2009. At June 30, 2010, Core Tier 1 ratio stood at 10.1%. Further, DBRS views the quality of capital, after the EAA transfer, as weak, consisting mainly of silent contribution certificates, with only a small amount of fully loss-absorbing ordinary share capital. DBRS notes that in the recent stress test conducted by the Committee of European Banking Supervisors, WestLB’s Tier 1 ratio remains at 8.9% in the most adverse stress scenario, which is well in excess of the benchmark ratio of 6.0%.

The Stable trend on WestLB’s ratings considers DBRS’s view that WestLB will continue to have access to support, including from the federal government. The trend also reflects the Stable trend on the floor ratings for the members of Sparkassen-Finanzgruppe’s joint liability scheme. Given the important role of support in the ratings, indications that WestLB’s access to support is eroding could cause downward ratings pressure.

Notes:
All figures are in Euros unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This rating did not include issuer participation and is based solely on publicly available information.