Annual Report 2017

Portfolio

EAA is driving forward quickly with the resolution of the WestLB portfolio

Successful activities in 2017

  • Loans and securities: minus EUR 6.8 billion or minus 23%
  • Derivative financial products: minus EUR 52.7 billion or minus 20%
  • With a surplus of approx. EUR 14 million, this marks the sixth year in a row with a profit
  • Administrative expenses down sharply again by 16%
  • Future portfolio services secured through privatisation and outsourcing with service subsidiaries
  • Considerable risk reduction from conclusion of litigation concerning municipal interest rate swap procedure

At the end of the past financial year 2017, the EAA portfolio was considerably smaller and better than originally expected.

The loans and securities in the assigned banking book have meanwhile been reduced by a total of 85% to close to EUR 23 billion; the rest of the portfolio is primarily comprised of good and middle quality assets (investment grade share: 68%).

The derivative products in the acquired trading portfolio were reduced nominally by 81% to approx. EUR 206 billion at the end of the past year. Contrary to what such a still high sum would suggest, the risks for the portfolio are relatively low: 99% of the remaining assets are interest rate hedging transactions. Their market risks are neutralised by hedging. The remaining counterparty risks are very limited because the contract partners provide collateral for over 95% of all transactions, in the form of low-risk bonds, for instance.

Service strategy

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Stable conditions

Implementing the ambitious objectives of EAA in a balanced manner requires competent staff and a stable organisation. Currently, 174 employees manage the portfolio with total assets of around EUR 49 billion as at 31/12/2017. As a controlling unit, the EAA is supported by two specialist service providers.

However: the more successful the EAA is, the more likely it will dig its own grave. While a company’s success can guarantee jobs, for a wind-up agency it is associated with job cuts. A main management task is to secure the necessary expertise for winding up the rest of the portfolio. To do this, the EAA has further optimised its structures and processes, also in 2017. The privatisation of its portfolio management subsidiary EPA – today Mount Street Portfolio Advisers – was concluded. At EFS, which is responsible for IT and operations, comprehensive outsourcing measures were realised.

Both steps are linked to service agreements that shore up the services for the EAA portfolio which will be necessary in future too. At the same time, the measures have opened up new career perspectives for former employees of the EAA Group in the private sector.

Litigation with municipalities

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Massive risk reduction

The EAA very successfully pushed forward in 2017 with settlement negotiations with the municipalities that claimed advice regarding interest rate swaps transactions from the former WestLB had been faulty. At the beginning of the new financial year, the last open dispute could be brought to a close by way of settlement. Negotiations with 52 municipal contract partners of the former WestLB have therefore been concluded. The agreement represents a milestone in the reduction of the WestLB legacy and brings EAA considerably closer to its target of quick and value-preserving reduction of risk.

The interest rate swap portfolio of the former Landesbank was assigned to EAA in 2012, which consequently also had to assume responsibility for all legal disputes. The extra-judicial settlements were possible because EAA brought claims before the German Federal Supreme Court after several claims at first and second instance had returned negative judgements. The Supreme Court decision strengthened the positive of EAA. As a result, none of these initial judgements entered into force against EAA.

From the perspective of EAA, in view of current case law, the settlements ensure a fair balance of interests between the municipalities and EAA as well as those sharing liability. As a result of the settlement, the parties to the dispute also avoid various further lawsuits before higher courts in North Rhine Westphalia and considerable additional legal costs.

With the conclusion of the interest rate swap process with municipalities, EAA was able to wind up a loss potential extending to billions. The losses incurred were broadly covered by the risk provisions and were also included in the trading result 2017.

Announced and implemented

In the past financial year 2017, EAA was able to successfully implement several long-term measures for restructuring. Important progress was also achieved in winding up its investment portfolio. The key operating participations which were assigned to EAA have therefore been sold and financial and operating risks neutralised.

In the reduction of participations and loan commitments, the EAA has secured assets to a considerable extent, respectively increased their value catch-up potential. Price gains from securities and gains from the selling of investments led in 2017 again to an improved result from financial assets and shareholdings.

Restructuring of non-performing loans

EAA requires a range of specialists with good knowledge of various sectors of industry or international markets. In particular, decisions regarding restructuring measures and their practical implementation requires specialists with long-term experience in dealing with non-performing loans. In order to be successful, EAA also makes use of the expertise of managers with experience in the asset management or private equity sector.

All good things are worth waiting for… – Persistence saves millions

The exposure: In 2001, the former WestLB, together with another bank, provided finance for medical-technical equipment for a medium-sized German company. It provided almost half of a loan in two-digit million range.
By 2007, the company entered into difficulty and as a result the banks called in their loans. No liquidation measures were taken as the banks involved could not agree on the approach to be taken given the particular complexity of the entire

The problem: EAA experts quickly noted that medium-sized companies without new investors and without cooperation partners had no long-term success and their old liabilities would not be serviced. For this reason, EAA accompanied the search for new investors on a cooperative basis. Ultimately, however, individual shareholders on the borrower’s side opposed this. Enforcement measures continued to be blocked by syndicate partners.

The solution: EAA proved in this case that it takes the long view and decided to accompany the search for an investor solution also in the face of resistance. After years of persistent negotiations with consultants, prospective investors and stakeholders in the company, in 2017 the option to sell the loan to an investor with a plan for the company opened up. Result: Ten years after calling in the loan, EAA generated an extraordinary gain of around nine million euros – from a claim which had already been almost completely written off by WestLB.

Detailed assessment pays off – protracted restructuring on the straight

The exposure: The former WestLB participated in 2008 in a syndicated loan for a Western European waste disposal and utility company. Its share of the loan stood at approx. EUR 50 million, it was a minority lender in the circle of participating banks.

The problem: Unfavourable market performance, high debt and operational weaknesses saw the company enter difficulty in 2012. Many things pointed in favour of a quick sale: The threat of insolvency loomed over the company. The state in which the company was located held around a third of the company and this dominance was considered an additional disadvantage as regards creditor interests. A distress sale would, however, have meant a loss of a good 60 percent of the loan sum.

The solution: After thorough analysis of the company’s chances of survival, EAA managers decided against a rapid sale of the loan and to take an active role in restructuring negotiations. Together with other lenders, they worked out a restructuring plan. This included the acquisition of the entire company. Under new management, the operational restart was secured. Five years later, this path has proved very successful for EAA: Meanwhile, it sold the mezzanine finance tranche acquired within the framework of the restructuring (special credit agreement which combines features of debt and equity) and generated additional income through relatively high interest payments of the company. In addition, it retained senior loans in the amount of EUR 28 million, whose value already stands at close to 100 percent. At the very latest next year, they can be completely repaid. Overall, the decision for the complex restructuring ensures repayments of almost 100 percent and – compared to an early sales of the loan – avoids losses in the order of EUR 30 million.

The course set correctly – tough battle for nine-figure sum shows success

The exposure: In 2006/2007, the former WestLB participated with more than EUR 100 million in a loan to two power plant companies and their holding in Southern Europe.

The risks of the commitment rose sharply over the subsequent period. Shortly after the assignment of the loan to EAA, the borrowers applied for their first payment moratorium for a finance volume totalling around EUR 2 billion. The tug-of-war concerning the rescue plan began.

The problem: Since the operating performance of the power plant companies as well as the entire group was too weak, the company’s first attempt at restructuring was a quick and spectacular failure, despite the use of various consultants. Here, it had been agreed that the creditor banks convert part of their loan claims to equity (debt-equity swap). For EAA, this resulted in a write-down of more than EUR 20 million. At the beginning of 2016, another payment moratorium was agreed as the business plans were clearly inadequate in all sections of the company.

The solution: In this situation, EAA vehemently argued for another and more professional restructuring. As the largest foreign creditor, it took on a role in the steering committee and pushed, amongst other things, for better corporate governance and more meaningful reports. In order to create pressure for a rapid solution, it also secured an agreement which allowed creditors to sell their claims insofar as the agreed targets were not achieved on time. At the end of 2017, a restructuring of various credit tranches was implemented. For EAA, in a first step, this ensured repayment of EUR 36 million and allowed it to reverse risk provision of EUR 20 million. At the same time, the situation of the power plant companies and its company group had improved considerably: Market performance, cost discipline at company level as well as an adjustment to the business model under new management contributed to this. The prospect of repayment of the remainder of the loan claim held by EAA in the amount of EUR 86 million has therefore improved. In view of the persistent wave of consolidation on the European energy market, EAA sees good opportunities for new investors or an IPO of the power plant companies. This opens up options for an exit from the long-term loan commitment at some point significantly prior to maturity.

Reduction of key participations

The EAA was assigned more than 320 participations – 120 direct and approx. 200 indirect investments. The range spanned from banks, through to private equity companies to business schools.

For the management of the large domestic and foreign investment portfolio, which is broadly diversified both in regional terms and as regards the sectors and participation book values, specialists for sales, transfers of undertakings and for the separation and spin-off of company components are required. The participation managers at EAA focus in particular on winding up operating participations and other large commitments with high management requirement as quickly as possible in order to sustainably reduce risk.

At the end of the past financial year, 120 participations were recorded, 63 direct and 57 indirect investments. In the year 2017, EAA wound down 20 direct participations, the lion’s share of these were sold, some liquidated or merged. This way, considerable hidden reserves could be raised – for instance on the reduction of an investment within the framework of the closure of EAA Japan K.K, the sale of the investment in Concardis GmbH, the sale of claims in favour of WestLB Asset Management US LLV as well as the dissolution of complex structures in WestLeasing Westdeutsche Leasing Holding GmbH.

Also, contracts for the sale of the EAA Covered Bond Bank (EAA CBB) were already signed in the year 2017. However, approval from supervisory authorities is still awaited, the transfer to the private investor could therefore not yet be completed. As regards EAA CBB, this is the last larger equity investment held by EAA with operating business whose management was the responsibility of EAA. The deal therefore not only reduces the financial risk, but also reduces operating risks significantly.

Portfolio 2018 – the starting point

The trading portfolio is mainly made up of interest derivatives with a nominal volume of approx. EUR 203 billion, accounting for a share of 99 percent.

The remaining banking book portfolio of nearly EUR 23 billion is made up of loans and securities.

  • The credit portfolio, which at the end of the past year still contained assets of almost EUR 11 billion, has a focus comprised of positions in the energy sector, primarily finance for large power plant projects based on conventional and alternative energy sources.
  • At the end of the year, structured loans stood at almost EUR 12 billion. This segment is dominated by commitments that are connected to loans in the US housing market (65%).
  • At the end of 2017, tradable securities with nominal volume of EUR 5.5 billion were included in the EAA portfolio. At approx. 80 percent, government bonds and comparable securities issued by public borrowers dominate.

Portfolio 2018 – the perspective

  • The rest of EAA’s portfolio will reduce by around a third by 2020, alone as a result of maturities. This applies both in respect of loans and securities as well as derivative products in the trading portfolio.
  • A major portion of the current rest of portfolio is basically marketable and the reduction can be accelerated if necessary following a comprehensive review of opportunities and risks.
  • Important positions in the remainder of the portfolio have residual maturities of more than ten years and can be reduced early only with steep discounts. Following the restructuring they can continue to be managed within the framework of a passive management approach until maturity.
  • Against the backdrop of this portfolio structure, EAA is currently making an intensive assessment of whether and how it can achieve the resolution target, originally planned for 2027, ahead of schedule.