Is WestLB on Its Last Legs?

A plan to help the troubled Landesbank make it to 2005 could still fall apart. And after that, there's no plan

It's no secret that Germany's lumbering Landesbanks, set up in the 19th century to act as clearing houses for transactions by savings banks in their regions and to help fund public works, are in serious trouble. Costs are high, staffs are bloated, and years of misguided lending and ill-considered expansion have left them wallowing in red ink and widely regarded as an endangered species. But none is as forlorn as WestLB. Once heralded as a leader in German banking, it's now known for being one of Germany's most troubled financial institutions. After backing away from a disastrous attempt to become a global player in corporate and investment banking in the 1990s, the bank lost $1.9 billion in 2002 and $221.5 million in the first six months of this year.

Düsseldorf-based WestLB is under intense pressure to stem the bleeding from its two principal shareholders -- the government of the state of North Rhine-Westphalia, which owns a 43.2% stake, and the region's powerful savings banks, which own most of the rest. At the same time, it's the subject of fierce political wrangling in North Rhine-Westphalia, which is governed by a coalition of Social Democrats and Greens. Jürgen Rüttgers, leader of the opposition Christian Democrats, says: "WestLB is the worst banking crisis in the country's history," while Gerhard Papke, leader of the liberal Free Democrats, insists it must be privatized.

No wonder acting Chief Executive Johannes Ringel and Bernd Lüthje, WestLB's supervisory board chairman, looked tired and defensive as they testified about the bank's latest restructuring plans before a state parliament session on Sept. 25. The two bankers, both WestLB veterans, are struggling to cut costs, streamline WestLB's structure, improve risk management, and hone a new strategy. "That will improve the overall stability of WestLB," says Ringel, who was named interim CEO in June after his predecessor, Jürgen Sengera, was ousted.

The clock is ticking for WestLB to get its house in order. The European Commission has ruled that the state guarantees that give the Landesbanks an advantage over private banks in lending and raising money must end by July 18, 2005. Rating agencies concur that WestLB faces a tough slog to get in shape by then. Standard & Poor's on Aug. 1 downgraded WestLB's credit rating a notch, from AA+ to AA with a negative outlook, and hinted that further demotions could be on the way. "We calculate that the implicit backing of the state is worth up to three notches," says S&P analyst Stefan Best in Frankfurt. "WestLB and the other Landesbanken will almost certainly be downgraded to A or below when they finally lose their guarantees."

GLOBAL PLAYER. What happens at WestLB, Germany's fifth-largest bank, won't just have an impact on German banking. WestLB is still an important international player, with lending and investment-banking operations in London, New York, and other financial centers. So any change in its strategy or performance has international ramifications. Moreover, if WestLB doesn't straighten itself out, it will likely be forced into a merger with another public-sector or even a private-sector bank. However disruptive that might be for North Rhine-Westphalia, analysts think it could have a positive effect on the banking system by triggering a wave of long-awaited consolidation, first in Germany and then across the EU. "In many ways, what happens to the Landesbanks is key to the future development of German and European banking," says Herbert Lohneiss, managing director at Siemens Financial Services Inc., a banking unit of the giant electronics group.

Not that WestLB is contemplating a merger -- at least in the near future. Instead, it is still sorting out last year's complicated restructuring conducted under European Union auspices to keep its commercial activities legally separate from state-backed policy initiatives. That reform effectively cleaved an entity called Westdeutsche Landesbank Girozentrale into WestLB, which handles private-banking transactions, and its operationally separate parent Landesbank NRW, which funds public works, often at subsidized rates.

Any potential suitor would be well advised to take a long, hard look at WestLB's $330 billion balance sheet. While the bank doesn't disclose its bad loans, analysts say it has been weakened by years of unwise lending. It made provisions against bad loans of $2.2 billion for 2002 and $595 million more for the first six months of this year. Then there are the bad bets in its investment portfolio. Among them: It bought more than $700 million in junk bonds issued by Britain's money-losing television-rental business Boxclever. Germany's leading financial-sector regulator, known as BaFin, forced the bank to raise the $485.9 million it had set aside against its lending to Boxclever by another $248.6 million. In one swoop, that wiped out all of the profits the bank made in the first six months of this year. Ringel now dolefully admits there's little chance WestLB will be in the black before 2004.

WestLB's prospects for righting itself could be seriously impaired by the complicated structure under which it operates and the sometimes conflicting interests of its shareholders. In May, for example, the bank's management board turned to consultant McKinsey & Co. for strategic advice. Landesbank NRW apparently didn't want McKinsey and consulted with Rothschild instead. Meanwhile, the savings banks and the state government had their own ideas. Only after months of wrangling did the four players settle their differences. Now the bank has adopted a "three-pillar" strategy, which calls on management to focus on its savings-bank shareholders, on advising and lending to the Mittelstand-Germany's smaller manufacturers -- and on operating a slimmed-down international network.

At the same time, the bank will jettison riskier activities such as its principal finance unit in London, whose high-profile chief Robin Saunders oversaw the disastrous Boxclever deal. WestLB's workforce will be slashed from 8,000 today to 6,200 by the end of 2005. And Ringel emphasizes that the bank will apply a new risk-management system that makes it easier to say no to bad deals. "Staff have a clear guideline as to how they operate, and they will be, as far as possible, risk-averse," he says.

The change in course was confirmed in what insiders say was an "emotional" supervisory board meeting on Sept. 16. But Ringel points out that it is just Phase One of the bank's strategic review and is designed to see the bank through to 2005. WestLB still needs to devise a Phase Two for the more distant future. But that could generate renewed tensions among the bank's shareholders. Some of the savings banks are leery of WestLB's attempts to cozy up to them, fearing it will try to steal their best loan customers. The government may also apply pressure to lend to weak businesses in North Rhine-Westphalia -- just the kind of transactions that are at the heart of the bank's troubles.

What is clear is that Ringel won't be around to pick up the pieces. Lüthje is scouring Europe for a permanent replacement for Sengera. Given the bank's problems, there aren't likely to be too many applicants.

By David Fairlamb in Düsseldorf

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