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Rating Action:

Moody's reviews WestLB's A2 senior debt ratings for downgrade

08 Dec 2009

Grandfathered debt, Prime-1 ST affirmed; outlook on BSFR changed to developing

Frankfurt, December 08, 2009 -- Moody's Investors Service today placed the A2 senior unsecured debt and deposit ratings and A3 subordinated debt ratings of WestLB AG on review for possible downgrade. Moody's review will focus on the impact of WestLB's changing business profile and the likelihood of a gradual decline in its systemic relevance after the completion of the "bad bank" structure in April 2010. These developments may trigger a downward revision of the rating agency's external support assumptions and a slowly deteriorating probability of support from the bank's current owners over the next few years.

At the same time, Moody's affirmed WestLB's Prime-1 short-term ratings and changed the outlook on its E+ unsupported bank financial strength rating (BFSR, which maps directly to a B2 baseline credit assessment, BCA) to "developing" from "negative". Additionally, the Caa1 rating on WestLB's Tier 1 hybrid capital securities (silent participations/"Stille Einlagen") and the B3 rating on its Tier 2 junior subordinated debt ("Genussscheine") were also affirmed.

Concurrently, Moody's placed on review for possible downgrade the A2 senior debt and deposit ratings of WestLB Covered Bond Bank plc, Dublin (WestLB CBB), as the bank's ratings are aligned with those of its parent bank, based on an unconditional guarantee from WestLB that covers all of the subsidiary's obligations.

At the same time, Moody's affirmed the Prime-1 short-term ratings of WestLB and WestLB CBB. West LB's Aa1 rating for obligations that qualify for the grandfathering of "Gewaehrtraegerhaftung" (a guarantee obligation) were unaffected by today's rating action.

REVIEW TO FOCUS ON GRADUALLY CHANGING SUPPORT PARAMETERS

Moody's rating action follows the recent decision of WestLB's owners to support a bad bank solution for EUR85 billion of WestLB's non-core assets and exposures, which requires substantial commitments from the owners to free the bank from all related risks. While the short-term ratings have been affirmed following this decision, Moody's review will primarily focus on the probability of future support from the current owners and co-operative support, as both potential sources of external assistance may not be available for renewed support actions in the medium term, should they be required.

"We fully recognise that WestLB will remain in the hands of public sector owners for the time being and that the government's Financial Market Stabilisation Funds (SoFFIN) is now available to support the bank at this challenging time," says Katharina Barten, a Vice President and senior analyst for WestLB Group at Moody's in Frankfurt. "However, at the current B2 intrinsic strength rating level, WestLB enjoys a substantial debt rating uplift of nine notches. Moody's believes that systemic support in particular will gradually reduce over time and, thus, the amount of uplift the long-term ratings receive will have to be revisited," adds Ms. Barten.

BASIS FOR THE REVIEW: A ROADMAP FOR A GRADUAL REDUCTION IN SYSTEMIC SUPPORT

Moody's believes that, in a post-crisis situation with more normal market conditions and a potentially better capitalised banking system, single banks in distress may be less likely to receive support than in the past. Ultimately, this will lead to downward rating pressure, unless the banks are able to offset this reduction in systemic support by strengthening their levels of stand-alone financial strength and exerting upward pressure on their BFSRs.

Over the next few quarters Moody's will carefully monitor the stand-alone financial profiles of rated banks and reassess the systemic relevance of the institutions. Accordingly, BFSRs will be revisited and any improvements taken into account with appropriate ratings actions. Such reviews would affect not only WestLB, but also other banks that currently enjoy material rating uplifts based on high probabilities of systemic support.

With such a roadmap, Moody's seeks to take account of its expectation that systemic support is unlikely to quickly fade in the short term and that most banks should have sufficient time to rebuild (or further improve) their levels of financial strength and to re-establish convincing business models with competitive advantages. Thus, for many institutions, rating stability can be maintained.

REVIEW OF DEBT RATINGS REFLECTS LIMITED POTENTIAL FOR WESTLB'S BFSR TO IMPROVE

WestLB's BFSR remains constrained, although Moody's understands that the bank has shown positive momentum to improve its financial and risk profile and that senior management will strive to achieve further improvements. An important step has been taken by creating a sizeable bad bank that enables WestLB to offload a large proportion of its non-core assets and activities. Moody's also recognises that the bank is improving its risk management, reducing its market risk and working down certain synthetic positions, all of which may eventually result in positive pressure on the BFSR over time. However, at this stage, several factors (and concerns) are still constraining upward rating pressure, the most important ones being:

(i) a worsening of the bank's efficiency levels as revenues decline significantly with the transfer of assets into the bad bank, while further cost cutting will take some time;

(ii) continued earnings volatility given the bank's high reliance on investment banking profits and modest prospects for the bank's ability to turn around those segments that generate stable revenues but inadequate returns; and

(iii) a potentially extended period of challenging market conditions for WestLB's specialised finance and investment banking activities.

Given these constraints, there are uncertainties about the direction of movement in WestLB's BSFR. Nonetheless, if the BFSR were to move upwards, Moody's believes that this would likely be limited to only a few notches. Moreover, the rating agency cautions that positive rating migration of the BFSR may not fully offset the expected gradual decline in external support. Today's rating action reflects this view.

DEVELOPING OUTLOOK ON E+ BFSR DUE TO CONTINUED UNCERTAINTIES

Moody's changed the outlook on the E+ BFSR to developing from negative to reflect the anticipated benefits of the bad bank solution, but also the ongoing uncertainties in terms of any improvement to WestLB's stand-alone profile. Moreover, the developing outlook reflects the uncertainty regarding whether WestLB will be successful in selling several subsidiaries at or near book value, in particular Westdeutsche ImmobilienBank AG, Mainz (unrated), as, even after the creation of the bad bank, WestLB will need to divest significant bank assets and participations to comply with the European Commission's far-reaching compensation measures for state aid.

SUMMARY OF RATINGS AND RATING ACTIONS: WestLB

- A2 rating for senior unsecured debt and deposits: on review for downgrade

- A3 rating for senior subordinated debt: on review for downgrade

- Prime-1 short term rating: affirmed

- E+ BFSR (B2 BCA): affirmed, outlook changed to developing from negative

- Aa1 rating for grandfathered obligations, stable outlook: unaffected

- B3 rating for profit participation rights (Genussscheine), negative outlook: affirmed

- Caa1 rating for silent participations issued by Hybrid Capital Funding I and II, negative outlook: affirmed

SUMMARY OF RATINGS AND RATING ACTIONS: WestLB Covered Bond Bank plc

- A2 rating for senior unsecured debt and deposits: on review for downgrade

- Prime-1 short term rating: affirmed

- E+ BFSR (B2 BCA): affirmed, outlook changed to developing from negative

RATING HISTORY AND MOODY'S METHODOLOGIES

The last rating action on WestLB was on 26 March 2008 when Moody's withdrew the rating of a credit-linked note issued by WestLB AG through its EMTN programme.

The principal methodologies used in rating WestLB were "Moody's Bank Financial Strength Ratings: Global Methodology", published in February 2007, "Incorporation of Joint-Default Analysis into Moody's Bank Ratings", published in March 2007, and " Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt", published in November 2009, which are available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

WestLB reported total assets of EUR258.8 billion as of the end of September 2009 and reported net profit of EUR184 million for the nine-month period.

Frankfurt
Katharina Barten
Vice President - Senior Analyst
Financial Institutions Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Frankfurt
Carola Schuler
Managing Director
Financial Institutions Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's reviews WestLB's A2 senior debt ratings for downgrade
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