DBRS Downgrades Volkswagen to “A” & R-1(low), ST Tr Now Stb

Note: The ratings of Volkswagen Canada Inc. and VW Credit Canada, Inc. are based on a guarantee of Volkswagen AG.

DBRS is downgrading the Corporate Rating of Volkswagen AG (“VW” or the “Company”), the Senior Unsecured Debt of VW Credit Canada, Inc. and the Corporate Rating of Volkswagen Canada Inc. from A (high) to “A”, with the trends remaining Negative. DBRS is also downgrading the Commercial Paper rating of VW Credit Canada, Inc. and Volkswagen Canada Inc. from R-1 (middle) to R-1 (low), with both trends changed to Stable. The rating actions reflect the deterioration of the financial profile of the Company caused by poor operating performance of its automotive business, and a full recovery is not expected in the near term.

Profitability and the associated internal cash generation at VW have declined sharply since 2002, well below DBRS’s expectation. Heavy capital spending to fund product renewal further added to the stress. The balance sheet and debt protection measures have weakened markedly and become too aggressive for the ratings. Factors weighing on the Company’s profitability include the following: (1) An aging key product line-up is eroding VW’s competitiveness causing market share loss in western Europe and North America, its major markets. (2) A high proportion of VW’s manufacturing base is located in high-cost Germany, which is another setback. The sharp appreciation of the euro against the U.S. dollar further amplified the problem. (3) The need to renew the aging product line caused a sharp increase in capital expenditures. However, internal cash generation, which declined along with earnings, was well short of capital funding needs. The deficit in free cash flow weakened the balance sheet and all associated coverage ratios. The resultant weakened credit metrics are no longer compatible with the prevailing ratings. In the near term, the operating environment in the Company’s major markets remains hostile. Even though VW has an aggressive new model launch plan in the next few years, it will take a few years before the aging line-up is fully replaced in Europe and even later in North America. The new Golf, VW’s most important model, launched in October 2003 is only available in Europe (2005 in North America). In addition, proliferation of new competing models, increasing use of sales incentives, and expanded presence of Japanese producers in Europe would add to the challenge of a successful product-led recovery. The euro is expected to stay strong in the near future. The strong currency would neutralize some of the savings from cost reduction. Although capital expenditures have peaked in 2003, internal cash generation would be stretched to meet ongoing spending on product renewal for the next two years with little free cash for debt reduction. The balance sheet is not expected to show meaningful improvement. Nevertheless, the Company continues to have a strong position in Europe despite the recent setback. A recovering market in Brazil and continuing strong contribution from Chinese operations provide solid support for earnings. The roll-out of new models in the next few years and accelerated cost-reduction initiatives should help gradually restore margins. The Company still has ample liquidity available to provide financial flexibility to execute the recovery plan.

Dominion Bond Rating Service (DBRS) will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, please contact us at: info@dbrs.com.

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