Despite its satisfactory operating performance, Landesbank Baden-Württemberg (LBBW) saw net income decline significantly last year. This was mainly due to the severe turmoil in the financial markets caused by the crisis in the US subprime market, a market from which LBBW was unable to decouple as an international bank.
LBBW is publishing its consolidated financial statements for the first time according to the International Accounting Standards (IFRS). According to the preliminary figures, the consolidated net income was EUR 311 million. LBBW had already published its first income guidance of at least EUR 300 million as early as mid-January. In 2006 the net income after adjustments for exceptionals due to hedge effects resulting from the first-time application of IFRS was EUR 878 million.
‘Naturally, we are not satisfied with our group income. However, the bank’s sound performance at the operating level is overshadowed by what we believe are temporary pressures resulting from the crisis in the financial markets. In particular, the corporate customer business developed very gratifyingly. The Financial Markets growth project also chalked up some successes,’ said Dr. Siegfried Jaschinski, Chairman of LBBW’s Board of Managing Directors.
Market turmoil leads to valuation losses on structured products.
The difficult environment in the financial markets led to impairment losses of EUR 452 million on structured securities.. In the revaluation reserve, the turmoil in the markets led to valuation haircuts of EUR 635 million on the ABS portfolio amounting to EUR 22 billion. Under IFRS, temporary value adjustments on securities and investments are entered under this position without affecting income. On balance, the revaluation reserve was reduced last year by EUR 278 million to EUR 695 million, as the valuation adjustments were compensated by, amongst others, value increases in equity investments.
Besides the repercussions of the financial markets crisis on structured products, the group income was also impaired by valuation adjustments of EUR 387 million (previous year: EUR +30 million) on Credit Default Swaps (CDS). This balance sheet item is reported for first time under IFRS. A large part of this relates to first-class issuers in the banking and sovereign segments where no defaults are expected.
Overall, LBBW assumes that the bulk of all valuation haircuts–including those recognised in the income statement as well as those booked to the revaluation reserve–is of only a temporary nature. ‘The current market turmoil leads to significant fluctuations in valuations under IFRS. These are sustainable for LBBW thanks to its good capital backing and strong liquidity. We are in a position to hold the securities until maturity. From today's point of view, LBBW will writeback the lion's share of the value adjustments as we expect only a small volume of genuine defaults,’ said Dr. Siegfried Jaschinski.
Strong market position buoys operating business
LBBW’s operating business benefited from the bank’s strong position in the core markets of Baden-Württemberg and the Rhineland Palatinate and the good economic performance last year. The net interest income, for example, remained virtually stable at EUR 2.127 billion (previous year: EUR 2.185 billion) despite the pressure on margins as a result of the tough competition in the credit sector. Risk provisions increased slightly by EUR 23 million. But at EUR 186 million they remained very moderate, thus reflecting the bank’s consistently conservative risk policy and the high quality of the LBBW Group’s loan portfolio. With regard to its net commission income, LBBW continued the gratifying performance of the previous year, reporting a 16.8 percent increase to EUR 584 million. Increased commissions from the lending and guarantee business as well as in the international business contributed to this growth.
The negative valuation results–due especially to the fair value valuation carried out in accordance with IFRS as of 31 December 2007–were mainly reflected in the trading profit, which came in at minus EUR 615 million (previous year: EUR 190 million). Other operating income, which includes, amongst others, the group’s real estate business, increased to EUR 202 million after EUR 125 million in the previous year.
Administrative expenses increased in 2007 throughout the group by EUR 109 million (7.1 percent) to EUR 1.650 billion. The increase was due to start-up expenses for strategy and growth projects as well as costs incurred for preparations for new regulatory requirements such as the conversion to IFRS accounting or Basle II. The increase also reflects the hiring of around 300 new employees, bringing the group’s current headcount to 12,300. The investment result was down by EUR 124 million. This is mainly due to impairment losses on asset-backed securities from the ‘AfS’ category (Available for Sale).
A net income before tax of EUR 347 million was posted for the group (-73.1 percent). The bank’s total assets increased to EUR 443.4 billion. LBBW’s on-balance sheet equity increased slightly last year to EUR 10.45 billion. The regulatory capital ratio was 10.2 percent.
The LBBW subsidiary LRP Landesbank Rheinland-Pfalz reported a negative group income of minus EUR 91 million last year. This is EUR 238 million less than in the previous year. LRP has so far been operated as a subsidiary of LBBW. In the next few months it is to be integrated completely as a dependent public law institution within LBBW (‘Anstalt in der Anstalt’ –AidA).
Integration of Sachsen LB and LRP offers opportunities
LBBW is bullish as regards its operating business in the current year. ‘Corporate and retail banking operations have both got off to a good start in the new year. With the integration of LRP and Sachsen LB, we are taking a major step forwards this year. In Saxony the SME business offers particularly attractive potential. We also expect the integration of LRP to bring substantial synergies,’ says Dr. Siegfried Jaschinski. LBBW expects additional business potential from the on-going additions to its international office network, including in Jakarta, Dubai and Seoul. In addition, attention will also be focussed in the current year on the further expansion of the SME and Private Wealth business.
Nevertheless, the turmoil in the financial markets, which has continued unabated since the beginning of the year, will continue to preoccupy LBBW in the next few months. To quote Dr. Siegfried Jaschinski again: ‘We are aware that the environment in the capital markets is likely to remain extremely challenging at least until the middle of the year. If stock prices continue to fall across a broad front, then this will not leave LBBW unscathed. LBBW has, however, proven that it can also weather extreme market conditions thanks to its sustainable business model.’