WestLB rescue

In a last-minute deal reached Tuesday, German regulators and WestLB agreed that the bank should split itself into a "good bank" and a "bad bank." The bad bank, which will be spun off by April 2010, will take on 85 billion euros ($128 billion) worth of problem portfolios, allowing the government's SoFFin financial markets stabilization fund to recapitalize the healthy part of the business.

The bad bank will receive 3 billion euros in capital from WestLB and 1 billion euros in guarantees from the owners to cover potential losses stemming from the risky assets. SoFFin will take a "silent participation" (capital contribution without voting rights) worth 3 billion euros in the healthy WestLB core bank, which can be converted into shares starting from July 1, 2010, the bank said. The contribution may result in the government holding a 49 percent stake in the Duesseldorf-based lender.

"In the case of WestLB, I think it's a very sensible solution," said Martin Ruckes, professor at the University of Karlsruhe's Institute for Finance and Banking. "The local savings banks (Sparkassen) have been the major owner in WestLB, and they will have to bear some of the risk of these toxic assets which are expected to be associated with losses. But it's not realistic that these losses will happen immediately, so the bad bank allows the savings banks to bear the risks over a longer period, and also accumulate reserves they could use to compensate for any losses."

Last-minute deal

The deal came just days before financial guarantees propping up the bank were set to expire, and ended a dispute between the bank's main shareholders, the government, and regional lenders over who should pay for a fresh bailout. Since February 2008, WestLB has received 11 billion euros in guarantees to finance its restructuring program.

But analysts say that there was never any real danger that WestLB would have been allowed to fail. "In terms of size alone, WestLB didn't really warrant the status of 'system relevant,' but allowing a large bank to fail would have sent a negative signal," Ruckes said. "In the end, it was a political decision. The Landesbanken (state-owned banks) have a special status, and a WestLB failure would have been very difficult for savings banks in North Rhine-Westphalia, and been very disruptive to the infrastructure of that state."

WestLB must reduce its assets by half, shed risky businesses and ensure a change of ownership by 2012 under conditions imposed by the European Commission when it approved state aid. According to officials, the federal government does not intend to get involved in managing WestLB.

West LB is not the only state-owned bank to have been hit hard by the financial crisis. Like LBBW, BayernLB and others, it began moving into risky investment banking activities with higher returns in 2005 after the European Commission imposed a ban on state guarantees. As a result, the banks were exposed to billions of euros in writedowns in the financial crisis, forcing them to seek rescue funds to avoid collapse.

Reporter: Deanne Corbett
Editor: Sam Edmonds