Financial Figures in m

Transcription

1 2014 Annual Report

2 Financial Figures in m New commitments Assets Real estate financing Capital markets business Liabilities Mortgage Pfandbriefe Public-sector Pfandbriefe 0 0 Other bonds 0 10 Other liabilities Results Result after taxes Portfolio Assets Real estate financing 1,213 1,093 Capital markets business* 8,445 9,462 Liabilities Mortgage Pfandbriefe Public-sector Pfandbriefe 3,090 3,529 Other bonds Other liabilities 1,089 1,220 Total assets 11,346 11,919 Equity capital** Equity base*** Core tier 1 capital Additional core capital 0 0 Supplementary capital Regulatory ratios*** Core tier 1 capital ratio 10.8% 13.2% Core capital ratio 10.8% 13.2% Total capital ratio 12.5% 16.2% *Nominal value **After consideration of the annual result *** calculated in accordance with the German Solvency Regulation valid at that time

3 Contents Foreword by the Management Board 6 Management Report 9 Business Model of Düsseldorfer Hypothekenbank 10 Market Developments 10 Business Development 15 Risk Report 23 Report on Subsequent Events 39 Report on Outlook 39 Annual Financial Statements 41 Balance Sheet 42 Profit and Loss Statement 44 Notes 45 Responsibility Statement 61 Audit Opinion 62 Report of the Supervisory Board 64 Country-by-country report pursuant to Section 26a KWG 67 Imprint 69

4 Foreword by the Management Board

5 Dear Ladies and Gentlemen, In the 2014 financial year, its 17th year in business, Düsseldorfer Hypothekenbank was able to expand its core business segment of commercial real estate financing and successfully continued strategic repositioning and portfolio optimization in the capital markets business. After a modest economic recovery and positive macroeconomic sentiment in many countries within the European Union (EU) in the first half of 2014, the markets were considerably more volatile and challenging in the second half of the year. The European Central Bank (ECB) responded to poor economic data, low inflation and emerging problems in the euro zone with an expansionary monetary policy and announced extensive measures. Overall, Düsseldorfer Hypothekenbank s core target markets in the real estate financing segment performed well in 2014 in terms of regional investment volumes, demand for real estate and associated financing, achieving record results in some areas. This success was due, in part, to the low interest rate policy in Europe. Transaction volumes in the commercial real estate markets were much higher year-onyear in all four core markets: Germany, France, the Netherlands and Spain. While the supply of available investment real estate in prime locations became increasingly scarce amid high demand, competition among financing banks and alternative lenders continued to grow, causing margins in the lending business to decline on average. The Bank expanded its position as a niche financier and grew new business volume by around 44% year-on-year while maintaining risk-adequate margins. The Bank financed a range of asset classes, primarily residential, office and retail real estate, in Germany, France, the Netherlands and Spain. To this end, the Bank continued to expand its sales structures by adding new partners in Germany and Spain. Despite some volatility in the capital markets, the Bank also successfully continued its de-risking activities. For instance, the portfolio in Hungary was completely sold off and additional exposure in crisis countries was actively divested. The Bank continued to scale back non-strategic real estate loan exposure and the MBS portfolio. As planned, total assets were reduced further to just 11.3 bn as at year-end. At the same time, the Bank made considerable targeted reductions in the derivative portfolio. Net interest and commission income improved, though profitability was still affected by legacy issues. The net loss for the year of 42.0 m led to a year-on-year decline in the capital ratios. However, earningburdening measures from prior years will have much less impact on earnings in the next few years, while the Bank should be boosted by positive effects from the new business strategy and return to sustainable profitability in the coming years. Following the Austrian Finance Minister s notification to the Austrian Financial Market Authority (FMA) that no further capital and liquidity measures will be taken at HETA ASSET RESOLUTION AG (Heta) in light of a newly identified, potential capital shortfall of up to 7.6 billion, the FMA made an unprecedented decision on 1 March 2015 to suspend payments on Heta s liabilities until 31 May This measure impacts senior unsecured receivables held by Düsseldorfer Hypothekenbank that are backed by a guarantee from the Austrian State of Carinthia. In order to neutralize the Bank s Heta risk, the German Deposit Protection Fund of the Federal Association of German Banks (Bundesverband deutscher Banken e.v. Einlagensicherungsfonds) initially issued a guarantee and then subsequently acquired the Bank. Prior to this, the buyer consortium associated with Dr. Patrick Bettscheider and Attestor Capital LLP withdrew from the proposed acquisition of Düsseldorfer Hypothekenbank. Under the new shareholders, the Bank s business will continue in accordance with the strategic reorientation. In light of the anticipated economic improvement in the euro zone and sustained high investor demand for commercial real estate in the Bank s core markets, we are confident about the Bank s further development, especially in the commercial real estate financing business. Düsseldorfer Hypothekenbank will remain an experienced and reliable financing partner for commercial real estate investors in The recent recruitment drive and process optimizations have created a solid foundation to achieve this. We would like to thank our shareholders and the Supervisory Board for their constructive support during 2014 and our dedicated and motivated staff for their contribution to the Bank s success. We would also like to thank our clients for the trust they have placed in us and look forward to further fruitful cooperation. The Management Board Düsseldorfer Hypothekenbank AG Dr. Christian Freiherr von Villiez Dr. Marcus Tusch Foreword by the Management Board 7

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7 Management Report

8 Business Model of Düsseldorfer Hypothekenbank Düsseldorfer Hypothekenbank AG (DHB) is a German Pfandbrief Bank, located in Düsseldorf, that specializes primarily in commercial real estate financing in selected countries in the euro zone. The Bank s capital markets business provides financing for selected countries and municipalities. The Bank is a member of the Federal Association of German Banks (Bundesverband deutscher Banken e.v., BdB) and the Association of German Pfandbrief Banks (Verband deutscher Pfandbriefbanken e.v., vdp). The Bank s target clients for real estate financing are professional investors, both domestic and international, seeking to purchase or refinance existing commercial real estate (particularly office, retail and logistics properties) or residential portfolios in the Bank s core markets Germany, the Netherlands, and metropolitan areans in France and Spain. The Bank offers the clients customized medium and longterm financing solutions in the low to mid-double-digit million range together with expert advice. Its product portfolio includes fixed-rate and variable-rate loans, which are now also offered in connection with client derivatives. The Bank acts as sole lender but also works with financing partners in a consortium or as an underwriter for largevolume transactions requiring syndication. The Bank therefore has access to a broad network of financing partners. The capital markets segment (including the public-sector loan portfolio) complements the real estate financing business. Non-strategic items in the portfolio are being scaled back through active portfolio management and new commitments in this area are made selectively. The focus here is on sovereign bonds from European Union (EU) countries. To obtain its long-term funding, the Bank issues Mortgage Pfandbriefe and Public-sector Pfandbriefe. The Pfandbrief market is a highly liquid market with a broad investor base. In addition, the Bank uses a range of other secured and unsecured funding instruments in the money market. Market Developments Macroeconomic Environment The capital markets have been calmer since the European Central Bank (ECB) announced its conditional bond purchase program (Outright Monetary Transactions, OMT) in mid Improved sentiment caused further declines in bond yields of peripheral euro zone countries in the first half of Increasingly, slight economic improvements in the EU played a role in this context, whereas the macroeconomic challenges of some individual EU countries receded into the background. At a political level, some have already proclaimed the end of the sovereign debt crisis. But sentiment did not remain as buoyant in the second half of the year. Market volatility increased sharply, as evidenced by temporary share price spikes on the DAX, the benchmark equity index in Germany. Volatility was caused by weak economic data, reduced expectations and emerging problems in the euro zone. At the end of 2014, risk premiums (spreads) on European sovereign bonds narrowed again, mainly due to ever-clearer indications that the ECB would resume sovereign bond purchases (quantitative easing) in the first half of Against the background of an expansionary monetary policy, the crisis countries achieved a successful return to the financial markets. Yields reached extremely low levels in some cases. For instance, at the end of 2014 there was a significant year-on-year decline in the five-year credit default swap (CDS)-spreads for Italy (137 basis points (bp) compared to 168 bp in 2013), Spain (97.5 bp compared to 147 bp), Portugal (202 bp compared to 351 bp) and Ireland (50 bp compared to 119 bp). Accordingly, calls for austerity policies to be relaxed in Europe have been getting louder, even though some countries continue to require substantial reform. Especially in Italy and France necessary structural reforms have not been initiated to a sufficient degree. This is one of the reasons for the slow pace of economic recovery in some core countries, including France and Italy. However, the longstanding strength of the single currency is not the only reason for their sluggish performance, as was emphasized repeatedly last year by both the French and Italian governments. After all, the strong currency also affects Ireland, Portugal and Spain, yet their economies have posted solid growth recently. Setting aside structural problems, previous excesses are a significant factor that will still take some time to correct. Consequently, the economic recovery in the euro zone will remain slow. 10 Düsseldorfer Hypothekenbank AG Annual Report 2014

9 Also in 2014, the ECB reacted to low inflation and continued economic problems in the euro zone by announcing extensive new measures. In early September 2014, the ECB surprisingly lowered the benchmark interest rate by 10 bp and announced plans for large-scale purchases of assetbacked securities (ABS) and covered bonds. After the euro zone went into deflation in December, the ECB announced on 22 January 2015 that it intended to undertake largescale purchases of sovereign bonds. The ECB will begin purchasing public and private assets in the amount of 60 bn each month from March 2015 until at least September The total purchase volume will be distributed to the countries based on their share of the ECB s capital. However, the bulk of risk exposure arising from the sovereign bond purchases will still be borne by the national central banks and will therefore not be redistributed within the euro zone. As of March, the national central banks will bear 80% of the risks associated with the purchases. The OMT program launched in mid-2012 remains as a safety net. The ECB s primary objective is to prevent deflation. But at the same time, the measures have already reduced bond yields in euro zone countries and caused the euro to fall sharply against the dollar and other currencies. The twofold impact should boost euro zone economies, but may also result in less pressure to reform. At the beginning of 2015, experts improved forecasts for the euro zone economy. The Ifo Economic Climate Index for the euro zone rose to points at the beginning of the year, putting the barometer back above its long-term average of points. By contrast, the index stood at points in the fourth quarter of 2014, the lowest level since mid Sentiment among euro zone industrial companies, as measured by the Purchasing Managers Index, has improved slightly as well. In January 2015, the index rose by 0.4 points to 51.0 points, slightly exceeding the growth threshold of 50.0 points. Sentiment has improved significantly in Spain, the Netherlands and Ireland. Apart from that, the focus of attention shifted to specific issues such as the Austrian Hypo Alpe Adria bank in The Austrian Government averted a collapse of the bank, but passed a special law obliging subordinated creditors and Bayerische Landesbank as the former owner to contribute to the restructuring. Since end-october 2014, Hypo Alpe Adria is being operated as the wind-down institution HETA ASSET RESOLUTION. Further information and developments around Heta are outlined in the Report on Subsequent Events within this Management Report. On the other hand, besides the already mentioned countries Spain and Ireland, developments in Portugal and Slovenia are also positive each country has returned to growth. In contrast to most euro zone countries, growth is steadily increasing. According to the Spanish Statistical Office Instituto Nacional de Estadistica (INE), Spain s gross domestic product (GDP) rose by 1.4% in 2014 year-on-year. Spain s economic growth is therefore outpacing Germany s. The pace of growth picked up towards the end of the year, with GDP advancing 0.7% against the third quarter. The prospects for 2015 are good. The majority of experts currently predicts a GDP growth of around 2%. Portugal and Ireland are also set to gain momentum in Both countries reduced the budget deficit in comparison to the previous year. Ireland s strong economy pushed growth up to 1.5% in The economy in Portugal grew by about 1.0% in 2014, exceeding most expectations, and the unemployment rate fell significantly, down from over 15% at the end of 2013 to around 13%. In addition, Portugal was the next country after Ireland to make a full-scale return to the capital markets. While the weaker exchange rate, favorable capital market refinancing terms and currently low energy prices are acting as a stimulus package in the euro zone, the Ukraine crisis and the political situation in Greece constitute economic risks. Weak global economic growth combined with these challenges could also curb the euro zone economy, especially as some countries are unlikely to be resistant to external shocks. Management Report 11

10 Essential General Conditions for the Banking Sector The European banking sector continued to stabilize at the start of This development was mainly driven by an ongoing tentative macroeconomic upturn in the euro zone. Following a downturn in 2013, slightly positive economic growth was expected for the 2014 reporting year. In this environment, various credit institutions were willing and able to place debt or equity issues and repay ECB loans successfully, not least due to the ECB s plans for a comprehensive bank review in These banks included the Bank of Ireland, the Italian Intesa Sanpaolo and Crédit Agricole of France. Investor interest was high as investors speculated on an economic recovery in Europe. But these positive expectations were only partially realized by European banks during the course of the year. Admittedly, a number of major European banks cut administrative expenses, reduced risk provisions, and in some cases even posted higher net interest and commission income. However, major challenges still persist, with income and revenues overall remaining in decline and a lack of efficiency in the sector. In this complex situation, credit institutions will remain under pressure to cut costs and adapt their business models to a market environment characterized by very low interest rates and weak demand for credit. In 2015, the macroeconomic environment will remain challenging for European financial institutions, not least because of the simmering tensions in Ukraine and Greece. Banking regulators also imposed strict requirements on credit institutions in Compliance was often expected with short implementation periods, even when the newlycreated institutions had not yet published details of the implementing provisions. The ECB s comprehensive assessment of 130 European banks, in preparation for the handover to the Single Supervisory Mechanism (SSM) under the first pillar of the European banking union from November 2014, may be emphasized here. The assessment, which consisted of an asset quality review and a forward-looking stress test of the banks balance sheets, was welcomed by most market participants. Some commentators criticized the resilience of some Italian banks to shocks and the assessment parameters used by the ECB. Further efforts were made in 2014 towards regulatory harmonization regarding restructuring and wind-up processes for credit institutions. The EU Bank Recovery and Resolution Directive (BRRD) took effect on 1 January 2015, which intends to protect taxpayers by reducing the risk of government bank bailouts. The Single Resolution Mecha- nism (SRM) is the second pillar of the banking union and is based on the BRRD. Germany, Austria and the United Kingdom have implemented the SRM as of 1 January Under the SRM, creditors must participate in the rescue (bail-in) of a failing credit institution, including senior unsecured creditors. The Directive is mandatory for all euro zone countries and optional for countries outside the euro zone from 1 January Additional measures resulting from the transposition of the Capital Requirements Directive (CRD) IV into national legislation, with amendments to the German Banking Act (Kreditwesengesetz, KWG), the German Pfandbrief Act (Pfandbriefgesetz, PfandBG) and the German Compensation Regulation for Credit Institutions (Institutsvergütungsverordnung, InstitutsVergV), together with the Capital Requirements Regulation (CRR) and the European Market Infrastructure Regulation (EMIR) have involved significant resources in the banking sector in 2014 and will continue to do so in subsequent years. The Financial Stability Board (FSB) is another initiative to curb the risks posed by the world s largest financial institutions. In November 2014, the FSB presented a proposal containing further capital requirements for 30 systemically important financial institutions. These requirements exceed the Basel III standards. Pressure from regulatory reform and the costs for banks associated with the implementation are likely to continue or even intensify in The increasing costs will have a negative impact on the profitability especially of smaller credit institutions. New Business and Funding of Pfandbrief Banks New business for banks in the Association of German Pfandbrief Banks (Verband deutscher Pfandbriefbanken e.v., vdp) has increased again in New loan commitments totaled bn, rising 5.5% versus the previous year ( bn) bn and thus the largest share of this new commitment volume was attributable to real estate financing, a gain of 6.3% compared with 2013 ( bn). New commitments in public-sector lending, on the other hand, continued to decline in 2014 and amounted to 18.6 bn, 5.2% lower than the result of the previous year ( 19.6 bn). Meanwhile, the volume of new Pfandbrief issues for funding has stabilized. After, in part, significant drops in the previous years, the newly issued volume has only moderately declined to 45.8 bn in 2014 (versus 49.5 bn in 2013). Of this amount, again, the largest share of 29.1 bn (previous year: 33.6 bn) refers to Mortgage Pfandbriefe, followed by Public-sector Pfandbriefe with 15.3 bn ( 15.6 bn). The remaining 1.4 bn relate to Ship and Aircraft Pfandbriefe. 12 Düsseldorfer Hypothekenbank AG Annual Report 2014

11 Pfandbriefe with a total volume of bn were outstanding as at 31 December 2014, and therefore significantly less than the amount as at 31 December 2013 ( bn). The decline is primarily due to Public-sector Pfandbriefe, where high maturing volumes could not be counterbalanced by a clearly lower volume of new issues. Public-sector Pfandbriefe accounted for bn of the outstanding volume as at 31 December 2014 (previous year: bn). Mortgage Pfandbriefe accounted for bn ( bn). The remaining amount of 5.8 bn ( 5.9 bn) consists of Ship and Aircraft Pfandbriefe. Real Estate Market Germany In 2014, the German real estate market confirmed the optimistic forecasts from the start of the year and continued the previous year s upward trend in investments. While transaction volume in the residential market declined against a very strong 2013 from 14.7 bn to around 12.7 bn, the German investment market for commercial real estate rose sharply to 39.8 bn, a gain of nearly 30% from 30.8 bn in At 52.5 bn (2013: 45.5 bn), in 2014, the total national volume exceeded 50 bn for the first time since the financial crisis and the record years of 2006 and In 2014, the office asset class continued to dominate the commercial real estate market, with a 45% share of the total volume of investments. Retail real estate accounted for 21% of transaction volume, while logistics, industrial properties and hotels each accounted for 8%. These asset classes all boosted the total result of the commercial segment, with transaction volume from the logistics (about +60%) and hotel investment market (+80%) making the largest relative gains. Both segments achieved record results in International investors accounted for a significant share of the total increase and especially in the hotel segment. At the regional level, Frankfurt posted the largest transaction volume in 2014 (12% of the total volume of investments), followed by Berlin (10%) and Munich (9%). Overall, around 50% of investment volume in Germany stemmed from the top six cities (Berlin, Cologne, Düsseldorf, Frankfurt, Hamburg and Munich). Although the residential investment market in 2014 did not match the extraordinarily strong 2013 result, it still closed the year slightly above expectations at 12.7 bn thanks to a strong final quarter, ranking 2014 second in terms of transaction volumes over the last seven years. As in previous years, the bulk of transaction volume was attributable to existing diversified portfolios (71%). However, sales of individual existing properties and project developments also made relative gains. Large individual transactions in triple-digit million euro amounts were responsible for more than 60% of the total transaction volume. The German residential market will continue to be dominated by domestic investors, who accounted for 82% of the transaction volume. Due to high demand from both private and institutional buyers, particularly for properties in A and B locations, average German real estate prices are at record-high levels. Prices rose by 4% across all real estate segments (commercial and residential) in 2014, exceeding expectations. Demand was driven by sustained low interest rates, correspondingly limited investment alternatives and favorable lending rates. Accordingly, average bank margins on debt financing declined throughout the year, while, at the same time, banks often offered higher loan-to-value ratios. High demand also means that the supply of (core) properties in prime locations is becoming increasingly scarce, increasing investors risk appetite and interest in non-prime locations and properties. Investment returns in the real estate market also declined in 2014, with increased risk appetite causing yield falls in the non-prime segment to outpace yield declines in the prime segment for the first time ever. During the year, Deutsche Bundesbank repeatedly expressed its concern about a residential market bubble. Others regard the consistent price increases as a normalization in the market s price structure, a view which is supported by the recent stabilization of prices. However, average house prices are expected to rise further in Overall, demand for German real estate (both residential and commercial investments) is likely to remain high in 2015 as the business environment remains unchanged, especially among international investors. Germany continues to be an attractive and safe location for real estate with a good environment for commercial real estate financing, especially compared to other locations in Europe. Attractive financing terms support the assumption that the prospects for the German real estate market in 2015 remain positive. Although the pace of growth might slow to some extent against the backdrop of subdued economic expectations caused in part by geopolitical crises, total investments could reach new record levels in In particular, a further marked increase in transaction volume is expected in the commercial segment. Activity in both the commercial and residential segments is likely to shift gradually towards regions outside the top locations. Management Report 13

12 Real Estate Market Netherlands After bottoming out in 2013, investments in the Dutch commercial real estate market climbed steadily in The national economy has posted solid growth after a modest decline in GDP in the first quarter. The commercial real estate market has been steadily recovering and is once again a focus of interest for investors, particularly international investors. The significant increase in the market s total investment volume in office, industrial and retail real estate indicates that a structural recovery is taking place. Investor interest in the residential investment market also increased significantly in 2013, especially among domestic investors, and remained buoyant in Accordingly, housing prices have stabilized since mid-2014, following substantial falls in previous years. In the medium term, however, no further significant price increases are expected. Overall, national volumes in the commercial real estate market (commercial and residential segment) totaled around 10.0 bn in 2014, roughly double the 2013 levels. The transaction volume in the fourth quarter of 2014 alone came to more than 4 bn, with remarkable recent interest from international investors who accounted for 65% of the investment volume for the year under review. Largely due to considerable investor interest in the Amsterdam Zuidas business district, the bulk of the total transaction volume in the Dutch real estate market was attributable to the city of Amsterdam ( 2.5 bn) and the office asset class (39%). Other popular locations included Rotterdam ( 700 m), The Hague ( 400 m), Utrecht ( 200 m) and Eindhoven ( 100 m). After office real estate, the strongest asset classes in terms of transaction volume were residential (26% of total investment volume), retail (13%) and industrial properties (12%). Real Estate Market France A few large-scale transactions maintained the uptrend in the investment market for commercial real estate in France in terms of investment volume, which achieved an exceptional annual result that was well above the 10-year average. Annual investment volume for 2014 came to 26.6 bn, about 41% higher than in Despite the country s rather weak overall economic situation at present, France is seen as an attractive target market for investors and 2014 was the second best year ever for investment, surpassed only in Current good access to external financing was one contributing factor to high levels of investment activity. With a 58% share of total volume, the office asset class is by far the strongest in the French investment market, followed by retail real estate, where investment volumes doubled year-on-year to 6.4 bn (24% of total transaction volume). Investments in logistics properties were down year-on-year. The most attractive and highly liquid investment location in France remains Île-de-France (Paris region), which accounted for 72% of total investments in the French commercial real estate market in If the overall French economy improves slightly as expected and financing terms remain favorable, then in 2015, like other European markets, France should remain attractive to investors, particularly international investors, and investment volumes in France will increase even further. Forecasts predict that the Dutch real estate investment market as a whole will continue growing in The strong recovery from the recent crisis should continue and both investment volumes and investors interest are likely to grow further. 14 Düsseldorfer Hypothekenbank AG Annual Report 2014

13 Real Estate Market Spain In Spain, the country s general economic recovery has had a positive effect on its domestic commercial real estate market, which was virtually non-existent during the crisis years but experienced a veritable boom during International investors in particular have identified opportunities in the market and are still looking for promising real estate investments, especially in the metropolitan areas of Madrid and Barcelona. Demand for commercial premises and investments in commercial real estate have risen steadily but moderately overall. Current transaction volumes are the highest since As of the end of the third quarter of 2014, transaction volumes had already exceeded 5.0 bn and therefore were above annual volumes in The commercial real estate market in Madrid posted a 245% increase in transaction volume year-on-year, the highest relative growth rate in Western Europe. This development was driven by positive economic trends combined with consistently low real estate prices. Both international investors and the locations of Madrid and Barcelona accounted for around two-thirds of total investment volume. Demand for office real estate and shopping centers in prime locations is particularly high, but hotels and logistics properties are also becoming popular. Residential property sales were slightly up in 2014 compared with This represents the first signs of a modest recovery since the Spanish property bubble burst in The development was driven by Spanish as well as international investors. Spain s real estate investment market will remain dynamic in the near future due to the improved economic climate and the positive outlook for the Spanish economy over the next one to two years. There is substantial evidence suggesting that the increased demand for Spanish real estate will continue unabated with demand from international investors particularly likely to increase. Business Development Real Estate Financing Portfolio The Bank continued to increase new business in real estate financing during It collaborated on business development with German and international financing partners. In particular, the Bank has significantly expanded its direct sales efforts in relation to institutional investors in the real estate market. In line with its business and risk strategy, the Bank s sales activities focused on large-volume commercial real estate financing in Germany and major cities in selected European core markets. The current core markets are the Netherlands, France and Spain as of The Bank posted new business totaling m, comprising m related to German and m to international secured loans. In Germany, financing of commercial properties was the dominant activity at m (75.0%), against m (25.0%) for residential real estate financing. The Bank financed cross-border commercial real estate with a total value of m (75.8%) and residential real estate in the amount of 73.6 m (24.2%). Loan commitments were made only in euros. In the reporting year, the Bank disbursed or extended secured loans in Germany with a volume of m and secured loans in other countries totaling m. Repayments on euro-denominated mortgage loans totaled m. Another euro-denominated mortgage loan was, in the amount of 23.7 m, successfully placed with a debt fund. US Dollar (USD)- and Great Britain Pound (GBP)- denominated loans, which do not belong to the target portfolio, were scaled back by USD 67.2 m and GBP 22.5 m. The total real estate loan portfolio, including mortgagebacked securities (MBS), was 1.2 bn on 31 December 2014, 0.1 bn (or 11.0%) higher than the balance at 31 December 2013 ( 1.1 bn). The increase in new business more than offset the portfolio reductions, which were primarily caused by scheduled principal repayments and redemptions as well as sales of MBS tranches. Currency fluctuations had a small impact. Management Report 15

14 36% 17% 1 47% Real estate loan portfolio by region in % Germany 47 (46) EU-abroad 36 (32) Non-EU 17 (22) (Previous Year) 12% 29% 17% 2 42% Real estate loan portfolio by property type in % Office and administration 42 (56) Residental 29 (23) Retail properties 12 (10) Other business 17 (11) (Previous Year) The share of loans in Germany increased marginally to 46.8% (previous year: 46.3%). As of 31 December 2014, loans made to other countries in the EU accounted for 36.2% (31.8%) of the real estate loan portfolio. Non-EU countries (USA, Canada) accounted for 17.0% (21.9%). [C1] The composition of the loan book by property use shifted slightly in favor of the residential segment. The share of residential real estate grew to 29.5% (22.6%), while the share of commercial real estate fell accordingly to 70.5% (77.4%). [C2] Office properties continue to be the dominant component of the commercial real estate portfolio, accounting for 41.6% (55.6%) of the total volume, followed by other commercial properties with 17.2% (11.3%) and retail properties at 11.7% (10.5%). The average loan volume is 16.1 m per borrower ( 13.1 m). MBS Portfolio As at the reporting date, the real estate loan portfolio includes MBS receivables totaling 31.2 m (previous year: 66.6 m). The MBS portfolio was actively scaled back during the course of the reporting year through the sale of several tranches totaling around 20.2 m. The remaining decline relates to scheduled and unscheduled principal repayments. The MBS portfolio consists entirely of standard, single-step pass-through structures. The receivables underlying the portfolio serve exclusively to finance residential real estate located in Western Europe (residential MBS). Based on their effective capital, the three remaining tranches from three MBS issues are distributed across the following countries: Spain 28.0% (14.4%), Italy 34.0% (43.5%) and Portugal 38.0% (18.8%). Due to sales and repayments of MBS, the Bank was able to reduce further the regulatory capital commitment to these assets in the reporting period. The share of the MBS portfolio with an AA rating from at least one ratings agency was 66.7% (previous year: 64.8%) and a further 33.3% (35.2%) was rated at least investment grade. There is still no indication that risk provisioning for the MBS portfolio is necessary. None of the MBS tranches were in arrears regarding payment of interest or principal as at the reporting date. 16 Düsseldorfer Hypothekenbank AG Annual Report 2014

15 3 4 29% 46% Public-sector loan portfolio by borrower group (ordinary & substitute cover) in % Public-sector loan portfolio by credit rating (ordinary cover) in % % 1% 12% Public authorities abroad 46 (40) Banks abroad 29 (29) Private credit institutions domestic 12 (16) Public authorities domestic 12 (14) Private credit institutions domestic 1 (1) (Previous Year) AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- N.R Capital Markets Portfolio lios consist of the following: New commitments in the public-sector lending business are only made very selectively. The focus here is on risk reduction in the capital markets portfolio, which involves measures such as the sale of securities that are not in line with the Bank s target business as per the 2014 business and risk strategy. This included the sale of the entire exposure in Hungary. Other exposures such as Spanish Cédulas, multi-cédulas and Portuguese covered bonds with a total volume of m were eliminated in 2014 as a result of asset swaps, which in part had already been initiated in the previous year. An equivalent volume of bonds from the Madrid region and sovereign bonds from Spain and Portugal were purchased. The Public-sector lending sub-portfolio, which declined to 6.7 bn ( 7.2 bn), accounted for 79.6% (76.4%) of the capital markets business. This particularly includes all receivables that qualify as ordinary cover for Public-sector Pfandbriefe under the German PfandBG. Debtors in this context are public bodies (sovereigns, sub-sovereigns, regional bodies) in Germany at 25.2% (32.1%), member states of the European Union and the European Economic Area with 73.3% (66.6%), as well as Switzerland with 1.1% (1.0%) and Japan with 0.4% (0.3%). [C3] 77.1% of these claims have an investment-grade rating of BBB- or above, while 3.8% have no external rating. [C4] Overall, the portfolio declined by 1.1 bn to 8.4 bn (previous year: 9.5 bn) due to maturities and the active reduction of risk assets. Selective new business was concluded in the capital markets segment with a total volume of m in 2014 (previous year: 0.0 m). This comprised the purchase of Irish ( m) and Finnish ( 90.0 m) sovereign bonds. The Substitute cover business sub-portfolio, which consists of all securities claims from financial institutions (bank bonds) that are eligible as further cover under the PfandBG, declined to 0.5 bn (previous year: 0.6 bn). This sub-portfolio represents 5.8% (6.4%) of the capital markets business. 25.0% of this sub-portfolio is attributable to Pfandbriefe and other covered bonds from European countries. The Capital markets business segment of Düsseldorfer Hypothekenbank consists of the sub-portfolios Publicsector lending (ordinary cover), Substitute cover business and business Not eligible as cover. The three sub-portfo- The share of receivables of this sub-portfolio with an investment-grade rating reached 86.2%, while 13.8% did not have an external credit rating. [C5] Management Report 17

16 5 Substitute cover business by credit rating in % Business not eligible as cover by credit rating in % AAA AA AA- A+ A A- BBB+ BBB N.R AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC-C N.R Derivative Portfolio The Not eligible as cover sub-portfolio contains all securities claims that cannot be used as ordinary or substitute cover. The sub-portfolio decreased significantly to 1.2 bn ( 1.7 bn), accounting for 14.6% (17.2%) of the total portfolio. Not eligible as cover business consists of 46.6% (46.3%) bank bonds, 22.2% (20.9%) structured Cédulas, 27.5% (29.4%) Pfandbriefe of foreign issuers and 3.7% (3.4%) sovereign bonds (including sub-sovereigns). The Bank utilizes derivative financial instruments in the form of interest rate swaps and cross-currency swaps to hedge specific interest rate exposures and/or specific foreign currency exposures that are related to a particular asset or liability. The Bank uses simple interest rate swaps as part of its asset-liability management to manage overall interest rate risks. Cross-currency swaps are used to hedge individual foreign currency positions. The share of claims thereof with an investment-grade rating totals 86.6%; the Bank does not have any unrated claims. [C6] In accordance with German commercial law, the Bank has opted not to use valuation units for accounting purposes. The Bank has set out the guidelines for the use of derivatives in its business strategy. As at the reporting date, the nominal volume of the Bank s portfolio of derivatives totaled 12.7 bn (previous year: 17.6 bn), consisting of interest swaps with a nominal volume of 12.3 bn and cross-currency swaps with a nominal volume of 0.4 bn. In accordance with the Bank s strategy, the portfolio was reduced by a further 4.9 bn (previous year: 9.5 bn), primarily due to the scheduled maturity of commitments and ongoing targeted reduction of the derivative portfolio. [C7] 18 Düsseldorfer Hypothekenbank AG Annual Report 2014

17 7 Derivatives Derivative counterparties by credit rating in % AA+ AA- A+ A A- BBB+ BBB BBB Funding structure in % Public-sector Pfandbriefe Mortgage Pfandbriefe 6 5 Securities: ECB lending (tender) Securities: Banks lending (repo) Other bank liabilities 1 1 Client deposits Bearer bonds 0 0 Subordinated liabilities Funding and Liquidity As in prior years, no further Public-sector Pfandbriefe were issued in view of the ongoing reduction of the capital markets business. The Bank funded its real estate financing business in the reporting year by issuing Mortgage Pfandbriefe totaling m (previous year: 67.5 m). Since June 2012, the Bank has had an issuance program endorsed by the Commission de Surveillance du Secteur Financier (CSSF) for both secured and unsecured bearer bonds and thus has the option of issuing ECB-eligible Pfandbriefe. The issuance program is updated once a year. The program was updated in spring 2014 and endorsed by the regulatory authorities in Luxembourg on 20 June Issuing Pfandbriefe is an essential component of the Bank s long-term funding. As at 31 December 2014, Public-sector Pfandbriefe totaling 3.1 bn (previous year: 3.5 bn) and Mortgage Pfandbriefe in the amount of 0.7 bn ( 0.5 bn) were outstanding. (Einlagensicherungsfonds, ESF) totaling 2.7 bn (previous year: 2.9 bn), open market business with the ECB in the amount of 2.5 bn ( 2.1 bn), Eurex repo trading with a volume of 1.7 bn ( 1.8 bn) and repo business with financial institutions with a nominal volume of 30.0 m ( 0.2 bn). [C8] Since March 2013, the Bank s bonds have been listed on the Primary Market for over-the-counter trading on the Düsseldorf Stock Exchange, a quality segment with high transparency requirements. As a result, the bonds issued by the Bank are not traded on an organized market under the German Securities Trading Act (Wertpapierhandelsgesetz, WpHG). Moreover, the Bank has made no application for admission of its bearer bonds for trading on an organized market. The Bank is therefore not capital market oriented in accordance with the provisions of the German Commercial Code (Handelsgesetzbuch, HGB). As at the end of 31 December 2014, important sources for the Bank s liquidity procurement were customer deposits protected by the German Deposit Protection Fund Management Report 19

18 9 10 Balance sheet total in bn Core capital* in m *as per regulatory reporting, *before consideration *of the annual result Total Assets and Own Funds As at 31 December 2014, the Bank s total assets were reduced by 5.0% to 11.3 bn (previous year: 11.9 bn) due to maturities and the strategy-driven reduction of risk assets. [C9] Accordingly, the balance sheet items Cash reserve and Receivables from banks both decreased by around 0.1 bn. In addition, Bonds and other fixed-income securities were reduced significantly again, down 0.4 bn in the reporting year. As in previous years, the decline was attributable both to the ongoing strategic reduction of the securities portfolio and maturities. In line with the asset portfolios, Liabilities to customers in particular declined by 0.7 bn, whereas Securitized liabilities advanced 0.1 bn due to new Mortgage Pfandbriefe issues. 11.5% (12.8%), whereas the total capital ratio stood at 13.2% (prior year: 16.1%). Taking into account the annual result for 2014, the Bank s equity capital is m, of which m is core tier 1 capital and 32.6 m supplementary capital. Consequently, this would result in a core tier 1 capital ratio of 10.8% and a total capital ratio of 12.5%. [C10] The Bank continued to have comfortable equity ratios in As at 31 December 2014, equity capital pursuant to the Capital Requirements Regulation on prudential requirements for credit institutions and investment firms (Regulation (EU) No. 575/2013, CRR) was m (previous year: m pursuant to Section 10 KWG). Of this amount, m ( m) qualifies as core tier 1 capital and 32.6 ( 65.4 m) as supplementary capital. The core capital ratio was 20 Düsseldorfer Hypothekenbank AG Annual Report 2014

19 Development of Earnings Net Interest Income The Bank s net interest and commission income in 2014 continued to be impacted by measures from prior years (up to and including 2007) that had a negative effect on earnings. Nevertheless, clear improvements were made, due in part to higher net interest income from the growth in new real estate financing business and the maturities of portfolio items with a negative effect on earnings. In addition, net commission income was boosted by the repayment in 2013 of the German Financial Markets Stabilization Fund (SoFFin)-guaranteed bond which eliminated payments for guarantee commissions in Net interest income deteriorated 40.7 m year-on-year to m. However, net interest income reported in 2013 ( 6.1 m) was boosted by non-recurring income (swap closings, prepayment penalties, etc.) totaling 69.4 m, which was counterbalanced by opposing expenses in the valuation result, whereas net interest income in the reporting year 2014 contained similar non-recurring effects of just 1.5 m. After adjustments for non-recurring effects, net interest income hence actually improved by 27.2 m in the year under review. Valuation Result The valuation result for the financial year was primarily impacted by measures to scale back the capital markets portfolio. It includes the risk provisions for all recognizable and latent risks from the real estate financing business and the capital markets business, and all income and expenses from the netting option pursuant to Section 340f (3) HGB. The valuation result closed with a profit of 15.9 m ( m). The real estate financing business (without MBS) had a negative effect on the valuation result totaling -3.4 m ( m). It is mostly impacted by the allocation to the general loss provision for lending totaling 2.8 m in accordance with Section 15 of the German Regulation on the Accounting Requirements for Financial Institutions and Financial Service Providers (Kreditinstituts-Rechnungslegungsverordnung). The Bank established additional net loan loss provisions for a total of 0.6 m to cover identified risks in the real estate financing business. The valuation result from the capital markets business totaling 19.3 m contains income from the sale of securities totaling 20.3 m and a redemption loss of 1.0 m resulting from the early redemption of a public registered Pfandbrief. Net commission income of 2.6 m is in positive territory, up 17.6 m year-on-year. This improvement was primarily due to the lack of commission payments for the SoFFin guarantees. In addition, the Bank s focus on real estate financing and the commissions received in this context totaling 3.7 m (previous year: 1.2 m) had a positive effect. Personnel expenses rose to 7.5 m ( 6.3 m) because of additional staff in real estate financing. An increase in administrative expenses (including amortization and de preciation on intangible and tangible assets) to 18.9 m (previous year: 18.1 m) was mostly the result of an adjustment of 0.8 m to the bank levy paid to the Association of German Banks (BdB s) Deposit Protection Fund. After adjustments for this increased bank levy, administrative expenses were virtually unchanged year-on-year despite the challenging circumstances (including projects to restructure the Bank and fulfil new regulatory requirements). As in previous years, the bank levy paid to the BdB-Deposit Protection Fund accounted for the largest share of these costs. Other operating income came to 0.5 ( -0.7 m) and primarily consists of partial releases of provisions established in previous years ( 0.7 m) and expenses from foreign currency conversion of -0.2 m. Management Report 21

20 11 Income statement in m Net interest income Net commission income Net interest and commission income Other operating result Administrative expenses Gross income Valuation result Operating income Loss before taxes Taxes Net loss for the year Loss carried forward from previous year Withdrawals from profit participation rights Balance sheet loss Net Loss The Bank posted a 42.0 m net loss for the year under review (previous year: 59.6 m), which was in line with expectations. [C11] The Bank s segment result, which is calculated based on imputed assumptions and from which the overall result is derived, breaks down operations into the segment Real estate financing, composed of the sub-portfolios Mortgage loan business and MBS, and the segment Capital markets business, composed of the sub-portfolios Publicsector lending (ordinary cover), Substitute cover and Not eligible as cover. After allocating their pro rata share of administrative expenses and offsetting the valuation result, the pre-tax result of the real estate financing segment was 4.0 m (previous year: m) while the capital markets business segment reported a pre-tax result of m ( 13.6 m). The pre-tax result of other activities totaled m ( m). Report on Affiliated Companies Pursuant to Section 312 of the German Stock Corporation Act (Aktiengesetz, AktG), the Management Board prepared a report on relationships with affiliated companies for the period under review, which was audited and certified by Ernst & Young GmbH, Wirtschaftsprüfungsgesellschaft. This report concludes with the following declaration by the Management Board: Based on the information available to us at the time transactions were concluded with affiliated companies, the Bank always received adequate consideration. No measures were taken or omitted that disadvantaged our company in favor of or at the request of affiliated companies. Ratings On 28 February 2014, Fitch Ratings confirmed Düsseldorfer Hypothekenbank s issuer rating for long-term unsecured liabilities as BBB- with a stable outlook. The support rating remained unchanged at 2; the viability rating was upgraded two notches from c to ccc. Fitch intends to adjust its issuer ratings in 2015 in light of EU reforms, which are likely to reduce European countries willingness and ability to adopt support measures for financial institutions. In March 2014, Fitch therefore downgraded the outlook to negative for the Long-Term Issuer Default Rating for most German Pfandbrief issuers, including Düsseldorfer Hypothekenbank. 22 Düsseldorfer Hypothekenbank AG Annual Report 2014

21 Participating Interests In October 2014, Düsseldorfer Hypothekenbank fully sold its 24.9% ( 2.5 m) stake in MHB-Bank AG, Frankfurt am Main. Personnel Report In 2014, Düsseldorfer Hypothekenbank had 68.9 employees on average. Compared to the prior year (59.2), the number of staff was increased, primarily in real estate financing, in order to support the Bank s strategic reorientation. With regard to human resources development, the Bank relies on individually-tailored internal and external training measures with a practical focus. Regular appraisal interviews between employees and their supervisors provide the basis for analyzing employee training needs. In 2014, employees benefitted from further training in the form of numerous seminars and professional courses. In addition, the Bank supported continuing professional training via development programs and offered in-house foreign language training. In order to harmonize the demands placed on employees with their professional and family situation as much as possible, the Bank partly offers employees the opportunity to work from home, in addition to its flex-time and part-time solutions. The Bank reviewed the salary and remuneration system effective 1 January 2014 to verify compliance with regulatory requirements in accordance with the InstitutsVergV. The Bank is not classified as a significant institution pursuant to Section 17 (1) InstitutsVergV. Risk Report The Bank s risk management guidelines and structures are set out in its business and risk strategy and defined in detail in the risk handbook. In 2014, both documents were adapted and revised in line with the Bank s objectives and are available to employees via the internal Bank intranet. These documents form the basis for the Bank s standard processing and internal communication on all major types of risks and support the targeted management of risk by the Bank. Objectives of the Risk Management/Limit System Risks are managed based on the business and risk strategy approved by the Supervisory Board. The primary objective of risk management is to secure the Bank s long-term ability to absorb risks. The term risk-bearing capacity describes the ability to absorb the risks incurred in the event that they actually materialize. This requires the Bank not only to measure the various types of risk but also to identify its risk-covering potential and to allocate this as needed to the individual types of risk (limit system). If the risk-covering potential (risk capital) is constantly higher than the quantified cumulative risks (risk capital requirements), the Bank is able to bear its risks over the risk horizon. The banking supervision has defined two relevant ap proaches to measuring and managing risk depending on the objectives to be achieved: the going-concern approach and the liquidation approach. The Bank has decided to implement both overarching approaches. The following information relates to the going-concern approach, as the leading approach implemented in the Bank. In this case, the Bank determines its risk-covering potential from an accounting perspective on a monthly basis as well as from a present value perspective on a daily basis. The Bank has developed an extensive set of tools to support the risk management process. These were enhanced and expanded further in 2014 in light of the constant increases in regulatory requirements. For instance, the Bank revised its model for determining long-term risk-bearing capacity as part of the capital planning process, optimized the calculation methods for determining risk-covering potential from an accounting perspective and further tightened the calculation parameters used in its value at risk (VAR) models. The limit architecture was adapted to the Bank s business strategy objectives for 2014 and incorporated into the risk strategy. The Bank was still in the advanced stages of the restructuring process in The negative effects of restructuring were easily offset in terms of risk-bearing capacity from an accounting perspective, which is essential as the strategic, long-term and limit-oriented risk-bearing capacity calculation Management Report 23

22 and has been the main risk management approach as of The utilization of the risk limit was in the moderate to tolerable range at all times, based on the Bank s business and risk strategy. The Bank s positive performance is recognizable in the Bank s risk-covering potential from a present value perspective, which is essential for the daily and detailed management of market risks as well as their limitation. For instance, the deterioration of the Bank s present value risk-covering potential has been effectively halted and remained unchanged year-on-year. The negative effects resulting from the legacy portfolio for the present value risk-covering potential were almost completely offset by portfolio optimization amid simultaneous risk reduction across all major types of risks and the expansion of new commitments in the real estate financing business. Nevertheless, the overall positive trend was not sufficient to return the limit utilization for this approach to measuring risk to an adequate tolerance range. The Supervisory Board and the regulatory authorities were informed about the developments in a timely and comprehensive manner. Organization of Risk Management The Management Board is responsible for the management of risks. It is also the highest decision-making committee in risk-related questions. It is supported in this task by the Bank s Asset-Liability Committee, which meets once a month, and by the Capital Market Committee. There is also a Risk Committee meeting quarterly, which analyzes the Bank s strategic risk position, identifies new risks and suggests measures to control risks where necessary. The Supervisory Board is regularly updated on the current risk situation during Supervisory Board meetings on the basis of a comprehensive quarterly risk report that is discussed during the standard agenda topic entitled Risk Report. Great importance is attached to the design and structure of processes within risk management. The Bank has clearly defined the duties, authorities and responsibilities of its staff. Work flows and processes are organized to ensure that activities which cannot be combined from a regulatory perspective are performed by separate organizational units based on a clearly defined segregation of duties. Risk Categories and Types of Risk The Bank has defined its main risk categories as credit risk, market risk, liquidity risk, operational risk and earnings risk. The Bank believes that risk-covering potential is not a suitable basis for assessing liquidity and earnings risk. Liquidity risks are monitored and managed on a daily basis using special management control instruments. No standard has yet been established so far to measure earnings risks beyond the already known risks (credit risk, etc.). For this reason, these risks are not reported separately in the Bank s quantitative risk-bearing capacity concept. Earnings risks are highlighted in quarterly assessments and as part of the Bank s medium-term financial and capital planning. In addition, the Bank has identified other risks, such as the risk from participating interests, cover pool risk and model risk. In accordance with the German Regulation on the Minimum Requirements for Risk Management (Mindestanforderungen an das Risikomanagement, MaRisk), the assessment of these other risks is not performed using separate limit systems. Credit Risk Strategy Credit risk is defined as the danger of default by a counterparty on contractually agreed payments of interest and principal and the related impairment of the underlying asset. The real estate financing business and the capital markets business are always associated with credit risk. The objective of credit risk management is to identify these credit risks, assess them and control them appropriately. As a core element of the Bank s business and overall risk strategy, the credit risk strategy creates a binding framework for the management of existing credit risks and the assumption of new ones depending on the Bank s risk-bearing capacity. The core of the credit risk strategy is a multi-layered system of limits to minimize credit risk concentrations at the portfolio and individual borrower level. The management of country risk takes a special role within the credit risk strategy. The Bank s system of country limits is based on general criteria such as individual country credit ratings, political stability, strength of the economy, transparency, legal 24 Düsseldorfer Hypothekenbank AG Annual Report 2014

23 security, and with regard to the real estate financing business market specific criteria such as volatility, liquidity and the maturity of the national real estate markets. Specialist departments prepare a risk report that is presented to the Bank s mana gement on a quarterly basis and also on an ad hoc basis in the event of special circumstances. This report provides a high level of transparency about risks and supports the implementation of, and adherence to the credit risk strategy. Organization A key requirement for the organization of the lending business is to segregate sales and customer-related functions (front office) on the one hand, and risk analysis and risk management functions (back office and risk controlling) on the other. The Bank adheres to this principle by rigorously segregating the front office from the back office and controlling units along organizational lines up to the Management Board level. Real estate loans are always processed by the back office side of the Bank. Starting from the loan inquiry i.e. well before a loan application is prepared or approved the back office is involved in all risk-relevant processes. It does this by inspecting the property, making an independent, special assessment of the exposure, performing special control procedures and by assuming a concrete responsibility for processes. Every loan decision in real estate financing requires a second vote providing consent from the back office unit responsible for credit risk in real estate financing. Non-performing loans are generally also processed by the back office. Risk management in the capital markets business has multiple levels: before the front office can conduct a securities transaction, it must request a limit. The Capital Markets Financing Credit Risk department analyzes the creditworthiness of the counterparty, develops an assessment and prepares a loan protocol. New capital market business requires the approval of the back office by a second vote. Thereafter, the Management Board approves the credit line in accordance with the rules of procedure (if necessary, with the consent of the Supervisory Board) for the potential borrower. The Treasury Operations & Cover Management organizational unit monitors compliance with credit limits. This ensures that the specialist department that is voting does not control compliance with limits and that the capital markets business is subject to the same separation of front and back office functions as the real estate financing business. The ongoing processing and monitoring of the portfolio of all outstanding loans, like the establishments of limits, also follows a defined loan process on the back office side. The riskier the exposure is judged to be by the back office, the more detailed and timely is its monitoring. The development of credit risk and significant measures to control the risks are reported monthly in the Asset- Liability Management Committee and quarterly at the meeting of the Risk Committee. The Risk Controlling department measures credit risk, monitors portfolio risk limits and reports on credit risk for the Bank as a whole. Measurement Methods A precondition for a risk-oriented portfolio management covering all business segments is a standard credit risk measurement for the entire loan portfolio subject to counterparty risks. This portfolio consists of the capital markets, real estate financing, money market and derivatives businesses. The primary credit risk metric for determining risk-bearing capacity is the credit value at risk (CVAR) of the loan portfolio. CVAR is also used to measure the risk contribution of individual countries, partial and sub-portfolios, sectors and individual borrowers, and serves to identify and limit risk concentrations. The monthly quantification of credit risk, as expressed in CVAR, uses a default-based one-factor credit risk model. The primary risk parameters of this model are volume (exposure at default, EaD), probability of default (PD) and loss given default (LGD), depending on external (capital markets business) and internal (real estate financing business) ratings determined using recognized mathematical-statistical methods. In order to simplify comparability between business segments, an internal Bank master rating scale has been implemented based on the probability of default. Credit risks determined in this way are then compared to the corresponding assigned limits. If a limit has been exhausted in a critical way or a limit has been exceeded, special measures are defined in the Bank s risk management process. Management Report 25

24 12 Credit risk CVaR in m Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. Stress Tests The standard credit risk measurement is supplemented with regularly performed stress tests to estimate the impact of external risk factors on the Bank s risk-bearing capacity and to assess the Bank s ability to cope with crisis scenarios. First, the sensitivity of the CVaR to unexpected rating downgrades is analyzed for both the total loan portfolio and for individual sub-portfolios. This multi-layered simulation includes both higher default probabilities arising from a modest recession as well as massive downgrades resulting from a financial market crisis. Counterparty concentrations and low portfolio granularity result in higher risk. A crisistype fall in the rent index is simulated for the commercial real estate loan portfolio; the fall implies increases in both PD and the LGD. Second, inverse stress tests are performed to analyze which stress factors would lead to a utilization of the free riskcovering potential. This simulation takes into account the following stress factors: counterparty concentration by risk contribution, early warning indicators credit spreads in the capital markets business, current debt service coverage ratios in the real estate financing business and segments that, based on internal assessments, are particularly sensitive to macroeconomic, political, or market-related stress. Development of Credit Risk As at 31 December 2014, CVAR totaled m, around 9.1% below the value at the end of 2013 ( m). The Bank s policy of scaling back the capital markets portfolio and improvements in the structure of the real estate loan portfolio are the primary reasons for this decline. [C12] Exceedances of the credit risk limits (based on present value measurements) continue to be essentially attributable to the negative effects impacting the Bank s risk-covering potential resulting from the financial crisis and its consequences. Loan Loss Provisions in Real Estate Financing Business The Bank classifies the real estate loan portfolio into measures-oriented risk categories based on its early warning system. This allows the Bank to recognize risks promptly and systematically, thereby enabling it to take action to mitigate risks before they become acute. The Bank divides its real estate financing business into three categories comprising six risk classes (RC) in total: The normal exposure class includes RC I no risk, RC II low risk and RC III identifiable risk. Management measures are stepped up for loans classified as RC II and above. 26 Düsseldorfer Hypothekenbank AG Annual Report 2014

25 3% 13 97% Real estate loan portfolio by risk class in % Normal loans 97 (95) Problem loans 0 (0) Non-performing loans 3 (5) (Previous Year) Non-performing loans Non-performing loans in m Share in % Exposures in arrears Exposures in arrears in % 0 0 Net additions to loan loss provisions in m Risk costs (bp) The problem exposure class contains RC IV elevated risk and RC V acute risk. Category V includes, among others, all loans that have at least one installment in arrears for 90 days or more but which do not present a risk for the repayment of principal because of existing collateral ( default with no need for an individual loan loss provision ). In this case, it does not matter if other risk characteristics or early warning signals arise. Risk class VI includes all non-performing loans (loans with an individual loss provision for principal). A loan is assigned to this category if it is not (or is no longer) expected that an amount will be collected to cover the receivable ( default with a need for an individual loan loss provision ). Loans in risk categories IV, V, and VI are reviewed at regular intervals, but at least quarterly, to determine any need to recognize a loan loss provision. The need for a risk provision exists if repayment of the principal no longer appears secure after taking into account rents to be collected, the value of any collateral, and the credit rating. Regardless thereof, a provision is established for the entire amount of any interest in arrears that is overdue more than 90 days. A loan loss provision for principal is reviewed at least quarterly and adjusted if necessary. As at the reporting date, 97.3% (previous year: 94.7%) of the total real estate loan portfolio (including loans due and MBS) was classified internally as normal exposure (RC I to III), 0.0% (0.0%) was included in the problem exposure class (RC IV and V) and 2.7% (5.3%) was classified as nonperforming (RC VI). [C13] [C14] In the reporting period, two new additions to individual loan loss provisions for principal were made as part of the Bank s risk provisioning for the lending business. In addition, one existing individual loan loss provision for principal was increased. Existing loan loss provisions totaling 17.6 m (previous year: 16.5 m) were utilized and 2.3 m ( 0.7 m) was released. In total, the sum of the individual loss provisions in the real estate financing business decreased during the year from 31.8 m to 14.7 m. This represents 1.2% (2.3%) of the total portfolio of real estate loans. There were no additions to individual loss provisions for the MBS portfolio. A loss of 0.3 m (previous year: 6.7 m) was realized in the reporting period when four MBS tranches were sold. The percentage of exposures in arrears, expressed as the ratio between the total sum of all interest in arrears (> 30 days) and the total real estate loan portfolio, was 0.0% (under 0.1%). [C15] Management Report 27

26 Loan Loss Provisions in Capital Markets Business In the capital markets business, the Bank also classifies its entire portfolio of securities into six risk categories (RC): RC I: normal exposure without significant risks RC II: normal exposure RC III: normal exposure with elevated spreads RC IV: problem exposure RC V: problem exposure with elevated spreads RK VI: non-performing loans (exposures in this category are subject to an individual loss provision). The basis for allocating a security to a risk category is its rating and its current risk premium (swap spread) relative to the swap curve. This method ensures that both analystsupported expertise (ratings) and market-based information (swap spreads) are considered appropriately in the risk classification. Items included in risk class V are reviewed separately and if they are allocated to non-current assets written down if necessary. The analysis of the portfolio during the reporting period at first determined that no write-down was needed. For further information on the Heta-Exposure the Bank refers to the Report on Subsequent Events which is part of this Management Report. As at the reporting date, 81.7% (previous year: 86.5%) of the total capital market portfolio was classified internally in RCs I to III, i.e. normal exposure, 13.7% (12.3%) in RC IV and 4.6% (1.2%) in RC V. No exposure was classified in RC VI m year-on-year). At the end of 2014, the nominal volume in regions and municipalities remained virtually unchanged at m ( m). In Italy, exposure to sovereign bonds and regions/municipalities decreased only marginally due to maturities. The reduction in exposure to banks was more pronounced, down from m to m. In Portugal and Slovenia, nominal volume as at the end of 2014 was m (previous year: m) and 80.0 m ( 80.0 m) respectively. At m ( m), the Portuguese exposure remains mostly comprised of sovereign bonds and bonds of public corporations. The increase was driven by asset swaps (sale of bank bonds and sovereign bond purchases). The Slovenian portfolio consists largely of sovereign bonds. In the financial year 2014, Düsseldorfer Hypothekenbank was not impacted by the troubling developments at Austrian HETA ASSET RESOLUTION, formerly Hypo Alpe Adria, at first. The Bank s portfolio exclusively contained, and still contains, exposures classified as senior unsecured in the amount of m (year-on-year increase of the exposure of 3.3 m due to currency fluctuations), which are backed by a statutory guarantee from the Austrian state of Carinthia. The Bank s total exposure in Austria including Heta amounted to 1.8 bn nominal at the end of The Hetaexposure, as well as the additional exposure at Austrian state banks and Italian regions/municipalities in particular, will continue to be closely monitored under the risk management process, especially with regard to current developments of credit spreads and ratings. [C16] Capital Market and MBS Exposure, Particularly in Southern and South-Eastern European Peripheral Countries The Bank s total exposure in Italy, Spain, Portugal and Slovenia, including MBS, totaled 3.3 bn as at 31 December 2014 (previous year: 3.4 bn). The reduction of the portfolio is primarily attributable to maturities. As at year-end 2014, Spain is the Bank s largest exposure in the EU peripheral countries with a nominal volume of 1.4 bn (previous year: 1.5 bn), followed closely by Italy at 1.4 bn ( 1.5 bn). There was no new business in these countries. However, as a result of an asset swap to optimize the portfolio, the structure of the Bank s exposure in Spain changed slightly. Exposure to credit institutions was reduced year-on-year (from m in 2013 to m in 2014) in favor of sovereign bonds (increased from m to 28 Düsseldorfer Hypothekenbank AG Annual Report 2014

27 16 Peripheral Exposure in m* Banks Sovereigns Subsovereigns MBS Total Total Italy ,363 1,482 Portugal Slovenia Spain ,442 1,479 Hungary Total 521 1,372 1, ,259 3,432 *on the basis of ultimate-risk and including promissory notes Market Risk Strategy The Bank defines market risk as the risk that current or future net assets or earnings of the Bank might deteriorate because of changes in interest rates (interest rate risk), risk-free interest rate (general interest rate risk), spreads (specific interest rate risk spread risk), currencies and exchange rates (currency risk), option sensitivities, e.g. volatility (option risk including cancellation risk), share prices (share market risk) or commodity prices (commodity price risk). The real estate financing business and the capital markets business are always associated with market risk. The objective of market risk management is therefore to identify these market risks, assess them and control them appropriately. The market risk strategy describes the measures taken to manage and limit the Bank s market risk at both the portfolio and individual exposure level taking into account the Bank s business strategy and its risk-bearing capacity. As part of its asset-liability management, the Bank may incur interest rate risks within the predefined limits, as long as these risks are consistent with the business strategy. The assumption of spread risks is a consequence of the Bank s business activities in the capital market. Accordingly, the Bank distinguishes between a limit for the general interest rate risk, which is determined on the basis of the total portfolio, and a limit for the spread risk. Spread risk is determined for the total portfolio and is then limited for the portfolio assigned to current assets in accordance with the approved risk strategy. In contrast to the Bank s non-current assets, there is no intention here to hold the assets to maturity. Realization of the spread result therefore cannot be ruled out. The Bank held no current assets as at 31 December The assumption of currency risks is not within the scope of the Bank s business and risk strategy. In general, open currency positions are not actively entered into, but in the interest of business efficiency they cannot be completely avoided. The existing minimal currency risks are measured and limited on a daily basis. Open foreign currency positions are shown in a portfolio report and regularly reported. The deliberate assumption of option risks likewise forms no part of the Bank s market risk strategy. If the performance of asset and liability transactions is associated with the assumption of option risks (e.g. termination rights), these Management Report 29

28 are hedged accordingly. Existing, smaller option risks are measured and limited on a daily basis. The Bank does not participate in any transactions whose performance is linked to share and commodity prices, nor will it engage in such transactions in the future. Organization The principle of segregation of duties, particularly those dealing with the conclusion of a transaction (front office) on the one hand, and settlement of the transaction and risk assessment (back office and risk controlling) on the other, is fundamental to the way in which the Bank handles its trading business within the meaning of MaRisk. The Bank s organization observes this principle by rigorously segregating the front office from the back office and controlling units up to the Management Board level. The Treasury department is responsible for concluding money market and capital market transactions, while the Real Estate Financing Sales department handles the real estate financing business. Concluded transactions are processed and controlled by the Treasury Operations & Cover Management and Real Estate Financing Credit Risk departments, which are two of the back office units that are organizationally segregated from the front office units and not subject to their instructions. In addition, the Risk Controlling department makes a supplementary recommendation on the hedging of risks in the case of complex transactions. Moreover, the Risk Controlling department is responsible at the overall Bank level for measuring, monitoring and reporting on the risks incurred. The Risk Controlling department also reviews and enhances the Bank s measurement tools on an ongoing basis. Measurement Methods To measure and manage market risk, the Bank uses the present value going-concern approach to calculate the value at risk (VAR) resulting from all on and off-balance-sheet interest-bearing transactions on a daily basis using a variance-covariance method. In the present value-oriented approach to measuring risk, VAR measures the maximum potential loss in the net present value of a portfolio that will not be exceeded within a holding period of ten to twenty days (depending on the risk type) based on a calculation using an observation period of 250 trading days and a probability of 99.0% (safety/confidence level). The quality of the VAR forecast from the previous day is compared on a daily basis with the actual market value change (clean & dirty backtesting). If there is a significant breach of a model parameter, this is adjusted accordingly in a review of the modeling process. The number of negative breaches was below the tolerance threshold during the reporting period, demonstrating the quality of the model s forecasting. In its approach to measuring risk from an accounting perspective, the Bank determines interest rate risks using a scenario analysis. When determining future net interest income, the Bank simulates the effects of an interest rate shock, which is, with a 99.0% probability, not exceeded within a holding period of 250 days. In the (complementary) liquidation approach, the parameters for determining risk vary and are made stricter based on the objective of this approach to measuring risk. The Bank thus meets the requirements set by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) to work with additional methods to determine risk-bearing capacity in order to address the limitations of each method in an appropriate manner. Market risks determined in this way are then compared to the corresponding assigned limits. If a limit has been exhausted in a critical way or a limit has been exceeded, special measures are defined in the Bank s risk management process. In addition, sensitivity analyses are carried out daily, and hypothetical or historical stress scenarios are simulated quarterly. The latter tests quantify the impact of extreme market fluctuations on the net assets and earnings of the Bank. The Bank scales its stress tests in accordance with, among other things, the recommendations of the regulatory authorities. For instance, the Bank simulates the BaFin stress test on interest risks in the investment book. Here the effects of a parallel shift in the yield curve by +200 bp/-200 bp on the net present value of the Bank are calculated on a daily basis. In accordance with MaRisk, an inverse stress test for market risks is performed as a supplement to the hypothetical and historical stress tests. This inverse stress test simulates the net present value losses that could occur because of changes in the yield curve and thereby exhaust the Bank s risk limits. 30 Düsseldorfer Hypothekenbank AG Annual Report 2014

29 17 Market risk Limit utilization in m Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. Development of Market Risk The Bank generally held its market risk at a very low level during the reporting period, with risk assets declining even further as the year progressed. Nevertheless, as was the case with credit risk, the Bank was generally not in compliance with the reduced limits due to the negative effects from the past that impact risk-covering potential. As at the reporting date, VAR reached 1.3 m ( 3.4 m); during the year under review it averaged 3.0 m ( 7.0 m). The highest daily VAR measured during the 2014 financial year was 4.3 m ( 10.3 m). [C17] There was one day (clean) on which the actual change in the value of interest-bearing positions exceeded the forecast VAR. The backtesting of the spread VAR identified just two days when the actual falls in value exceeded the VAR forecast. The simulation of the BaFin interest rate shock for the investment book resulted in no outliers in this reporting year. The 20% limit of liable capital was not exceeded in the stress scenario +/-200 bp on the yield curve at any time; in fact, the average annual utilization calculated under this scenario was 43.7% (48.9%) of this limitation. Liquidity Risk Strategy Liquidity risk describes the risk that the Bank is not able to fulfill completely its maturing payment obligations at a specific point in time. The primary objective of the liquidity risk strategy is to ensure the Bank s solvency at all times. In addition, the Bank must ensure that it complies at all times with the liquidity ratio in accordance with Section 2 of the German Liquidity Regulation (Liquiditätsverordnung, LiqV). A secondary objective is to minimize the cost of obtaining liquidity. Organization A central requirement for the organization of liquidity management is to ensure that responsibilities for liquidity management and liquidity monitoring are separated. The Bank complies with this requirement by adhering to a strict organizational segregation of duties. The Treasury department is responsible for managing the Bank s liquidity. The Treasury department is likewise responsible for regularly reviewing the relevant sources of funding regarding their availability, taking into account the corresponding funding costs. The Treasury Operations & Cover Management department is responsible for monitoring liquidity, and for preparing and validating the plausibility of the documents needed to manage liquidity. Its responsibilities include the Management Report 31

30 18 Liquidity situation Liquidity ratio pursuant to LiqV 2,0 1,5 1,0 0,5 0 Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. daily actual-to-plan variance analysis of the liquidity status and the day-to-day monitoring and reporting on the liquidity position of the Bank as a whole. Measurement Methods The Bank possesses a comprehensive set of tools for analyzing and managing the Bank s liquidity (liquidity structure analysis). This ensures that possible liquidity shortages can be identified early on so that suitable and targeted countermeasures can be initiated to ensure the availability of liquidity. A short-term liquidity forecast is prepared on a daily basis. It contains the current liquidity status and the liquidity planning from the Treasury department for a planning horizon of at least six months. In addition, a long-term liquidity forecast is prepared at the end of every month for at least three full calendar years. In addition, the Bank manages its liquidity based on the requirements set out in LiqV. Its provisions stipulate that liquidity is considered secured when the weighted average balance of cash and cash equivalents in the first maturity band (daily up to one month) covers the weighted average payment obligations that could be called during this period. To date, no standard model has become established in the banking sector for quantifying liquidity risk. Therefore, as permitted by MaRisk, liquidity risk is not taken into account in the Bank s risk tolerance concept until further notice. Stress Tests Stress tests, which are tailored to the Bank s unique circumstances and are based on various premises, are conducted based on the Bank s short and long-term liquidity forecasts. These stress tests illustrate the impact of extreme market conditions on the Bank s liquidity position. Development of Liquidity During the period under review, the reported liquidity ratio pursuant to LiqV was between 1.3 and 1.6 at all times and therefore always above the minimum regulatory requirement of 1.0. The Bank had adequate liquidity at all times during the year under review. [C18] Ongoing Development of Liquidity Risk Management As part of the CRR s standardization of international liquidity risk standards, further work is being done via a long-term project to enhance liquidity management tools. In 2014, the Bank implemented the new stress metrics Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) and reported the corresponding data in accordance with regulatory requirements. 32 Düsseldorfer Hypothekenbank AG Annual Report 2014

31 Operational Risk Strategy Operational risk (OpRisk) is defined as the risk of direct or indirect loss resulting from the inappropriateness or failure of internal processes, people or systems, or from external events. It includes legal risks and the risks associated with outsourcing activities and processes, but it does not cover strategic or reputational risks. The Bank s objective is to avoid or minimize losses from operational risks. This involves efforts to continuously improve the risk management process and adapt it to the constantly changing business environment. Organization The Bank defines high-risk processes and analyzes incurred losses in order to identify operational risks. The objective here is to optimize the quality of business processes and prevent the occurrence of operational risks or minimize any losses that occur. To realize these objectives, each department has a risk officer who is responsible for reporting operational risks and monitoring the measures implemented to counter them. In addition, employees are trained by the OpRisk-manager in how to identify and handle risks. Furthermore, an anti-money laundering officer acting as a central coordinator has been appointed to deal with the prevention of money laundering, financing of terrorism and other internal and external criminal acts detrimental to the Bank as defined by Section 25h KWG. Risk management in this area is based on an analysis performed at least annually of the specific risk situation of the Bank and the determination of necessary preventive measures. Measurement Methods The most important tools for mitigating operational risks are self-assessment, the loss database, assessment of stress scenarios, preliminary examination when outsourcing activities for the first time and annual monitoring thereof, or when insourcing currently outsourced activities. For self-assessment, which is an ex-ante tool, a structured questionnaire is issued to the Bank s department heads to identify potential operational risks in the risk categories established by the regulatory authorities (internal processes, people, systems, external events). Weaknesses and areas exposed to risks are determined from the survey results. Appropriate measures are then put in place and their implementation is monitored in order to avoid incurring operational risks or to minimize any resulting loss. All losses identified that exceed a minimum limit are recorded in detail in a loss database, an ex-post tool, and then analyzed. This provides the foundation for identifying and examining the causes for the loss, thereby enabling appropriate countermeasures to be identified and implemented. Moreover, the database of historical information is also used to track measures that have already been implemented and to measure their effectiveness. The Bank has established a separate process for risks associated with the outsourcing of activities and processes because this is a unique form of operational risk. To measure operational risks, the Bank applies a model that determines a risk value based on data from the loss database. Operational risks that have occurred are compared with the allocated limit. If a limit has been exhausted in a critical way or a limit has been exceeded, special measures are defined in the Bank s risk management process. Management Report 33

32 Stress Tests The existing stress scenarios are reviewed by a panel of experts based on historically observed or hypothetical stress scenarios. Where appropriate, the stress scenarios are adjusted to reflect the current business environment. The objective is to identify appropriate scenarios which the Bank believes are extreme but nevertheless possible within the risk categories of internal processes, people, systems and external events. The expected impact on the Bank is quantified by estimating the size of the loss in the various scenarios, and suitable measures are developed to reduce or avoid the losses. The stress tests are performed annually. In addition, plausible potential loss events have been defined as reverse stress scenarios and are simulated quarterly. Development of Operational Risk In the 2014 reporting year, the reported losses caused by operational risks were well below 0.1 m (gross). By comparison, the stated risk value used in the Bank s internal risk-bearing capacity calculations was 1.0 m. Earnings Risk Strategy Earnings risk (also known as profit or financial risk) is generally understood to be the risk of insufficient or un - sustainable profitability due to inadequate management of existing and future financial and non-financial risks, poor business decisions or deficiencies in asset-liability management. Earnings risk therefore combines all risks that could have a negative effect on the Bank s profit in case they are realized. As a result, every type of risk is also an earnings risk if it impacts the Bank s profit and loss statement. These types of risk can be both financial (credit risk, market risk, liquidity risk) and non-financial (operational risk, other risks). The danger resulting from earnings risk must therefore be seen in light of the Bank s individual transactions, portfolios and overall structure. The risk can either stem from decisions already taken (legacy issues) or from future decisions (new commitments) that reduce or increase risk. Organization To identify risks to future results of operations, financial position and net assets, the Bank distinguishes between parameters that are primarily under its control and external parameters. The main parameters that the Bank can directly influence are new commitments, legacy balances and interest positions. The general market situation (interest rate environment, credit spreads, economic performance) is the primary external parameter that can have a material influence on the Bank s earnings. Factors that can be influenced by the Bank therefore indirectly determine the effects of any change in the external parameters on the results of operations, financial position and net assets of the Bank. The Management Board is responsible for assessing the earnings risk that the Bank can directly influence. The Management Board s decision-making powers are linked to the objectives of the Bank s business and risk strategy and existing resources (e.g. equity, employees). The assessment of earnings risk resulting from external parameters that cannot be influenced must be made at the respective individual risk level. 34 Düsseldorfer Hypothekenbank AG Annual Report 2014

33 Measurement Methods The current earnings situation is primarily identified when the monthly financial statements are prepared in accordance with German commercial law (profit and loss statement, balance sheet). The future earnings situation is based on the medium-term financial and capital planning, which is updated annually or when needed. Deviations between current planning and the actual net profit under commercial law in the profit and loss statement are illustrated monthly in an actual-to-plan analysis of earnings. The predicted net interest income is also compared to the forecast of the previous month in order to explain all relevant, interestrelated variances. In addition, an actual-to-plan analysis of the most important parameters such as new commitments, portfolios, equity and the income statement is performed quarterly to identify adverse developments promptly. Stress Tests Adverse developments and its effects on medium-term financial and capital planning, which in turn forecasts the Bank s future results of operations, financial position and net assets, are illustrated using suitable scenario calculations, thereby demonstrating inherent risks to earnings. The Bank has defined four such scenarios, in which the most important parameters deviate from the values expected in the base version. The changes in the planned parameters are applied ceteris paribus, i.e. the effects of changes in the parameters are each reviewed individually while all other conditions remain constant. In this way, the Bank can identify inappropriate approaches to managing earnings risk in advance and therefore avoid making the mistakes. Compliance The basis of the Bank s operations is the trust of its clients, business partners and the public in the Bank s integrity, which is primarily dependent on compliance with applicable legal, regulatory and internal provisions. The focus is on preventing and combating insider trading and market abuse, money laundering, financing of terrorism and other illegal acts, but data protection is also important. The purpose of compliance, which is an integral component of the Bank s internal control system, is to promptly identify, assess and monitor compliance risks and prevent them as far as possible. To this end, a permanent and effective compliance organization has been established that can perform its duties independently. The Bank continuously enhances its compliance risk management and adapts it to current developments and requirements in order to address the growing complexity of the regulatory and legal business environment. The new compliance function implemented in 2013 pursuant to MaRisk was integrated during the reporting year into the Bank-wide risk management process and was enhanced by the creation of a regular Compliance Committee. With the client derivatives product for the real estate financing business being launched in 2014/2015, the Bank is subject to the German Minimum Requirements for the Compliance Function and Additional Requirements Governing Rules of Conduct, Organization and Transparency pursuant to Sections 31 et seq. WpHG for Investment Services Enterprises (MaComp). Development The Bank posted an annual result of m for the total year of 2014, which was in line with the annual earnings forecast of a low double-digit million loss. Management Report 35

34 Internal Audit Internal Audit is a significant element of the Bank s internal monitoring system. The Management Board is responsible for the establishment and functionality of Internal Audit. This responsibility cannot be delegated. Organizationally, Internal Audit reports to the Management Board member responsible for back office functions. On his behalf, it provides independent and objective auditing services and also acts as an advisor regarding significant Bank projects. Internal Audit is an independent organizational unit. To fulfill its responsibilities, Internal Audit has complete and unrestricted access to information at all times. The auditing activities of Internal Audit, as a matter of principle and based on a risk-oriented audit approach, cover all activities and processes of the Bank. Shortly after completing its audit procedures, Internal Audit prepares a written audit report presenting the scope of the audit, the audit findings, an assessment of the audit findings and a listing of remedial actions, the implementation of which is monitored. On the basis of its long-term audit plan, Internal Audit monitors and assesses all Bank business and operational processes, including the functioning, effectiveness, economic efficiency and appropriateness of the internal control system, reporting, informational systems, and accounting, compliance with applicable legal and regulatory requirements and regulations, compliance with business requirements (rules of procedure, organizational policies), as well as the proper functioning of all business and operational processes as well as precautions to protect assets. Senior management is informed about any significant findings. Once a year, Internal Audit provides a comprehensive report on all significant findings and the current implementation status of remediation measures. No serious findings were identified. Since the end of the first quarter of 2014, Internal Audit has reported to the Bank s Management Board and Supervisory Board at appropriate intervals, but at least quarterly, in accordance with Section 25c (4a) number 3g KWG. In 2014, Internal Audit was involved in all of the Bank s significant projects. Internal Controlling and Risk Management System with Regard to the Accounting Process Strategy The Bank pursues accounting-related and other controlling objectives with its internal controlling and risk management system for the accounting process. These accounting-related control objectives are intended to ensure that the Bank s internal and external accounting is prepared in a proper and reliable manner. In this regard, the focus is on the completeness and accuracy of documentation, prompt recording of transactions, reconciliation between IT systems and compliance with accounting requirements. Other controlling objectives include ensuring the implementation of management decisions, taking account of the necessary approvals and compliance with business strategy, the economic efficiency of operations, as well as the accounting system s compliance with applicable laws and regulatory requirements. Organization The Accounting department, which is a corporate staff function independent of the operating business, comprises the following functions: financial accounting and planning/ controlling, loan and investment accounting, and reporting. To fulfill the aforementioned strategy, integrated business processes have been established that are divided between error-preventing and error-detecting measures. Preventive measures include in particular compliance with segregation of duties, access restrictions, work policies and plausibility reviews. Examples of detection measures are controls for completeness and accuracy and the principle of dual control. When implementing new laws and regulations, support is regularly obtained from external advisors. The process for new products requires that, prior to any product launch, it must first be determined that the new product can be appropriately represented in the accounting system in compliance with regulations. Internal Audit regularly performs process-independent reviews of the accounting records. Furthermore, the Bank s accounting is reviewed by the independent external auditor at year-end. The German Society for Bank Assessment (Gesellschaft für Bankbeurteilung) also performs a review of the accounting records when rating the Bank. Overall, the Bank has put in place a risk management system for its accounting process that incorporates the measures needed to identify and assess significant risks as well as the corresponding risk-mitigating measures to ensure that the financial statements comply with all appropriate requirements. The Bank s risk management system is audited regularly by the Internal Audit. 36 Düsseldorfer Hypothekenbank AG Annual Report 2014

35 19 Present value of overcollateralization of Public-sector Pfandbriefe Stress scenario in % % 0 Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. Risk Management of the Cover Pool Section 27 (1) PfandBG requires that a risk management system is put in place for Pfandbrief business. This system must contain suitable tools and rules for managing, monitoring and controlling risks in the Pfandbrief business. The Bank has installed such a risk management system in accordance with Section 27 PfandBG. In order to comply with the reporting and transparency requirements pursuant to Section 28 PfandBG, the Bank discloses key information about the mortgage and public-sector cover pool quarterly on its website and annually in the Notes to the annual financial statements. PfandBG stipulates that a net present value overcollatera - li zation of the cover pool of at least 2% must be maintained at all times. The Bank calculates its compliance with this legal requirement on a daily basis. When calculating the statutory overcollateralization in accordance with Section 4 (1) PfandBG, the net present value of the cover pool is used, taking into account the regulatory required stress tests. In this way, the required overcollateralization is also ensured in the event of extreme interest and currency fluctuations (Section 4 of the German Regulation on Ensuring Adequate Cover of Pfandbriefe, Pfandbrief-Barwertverordnung). The Bank utilizes the dynamic method in its stress testing. The annual average net present value overcollateralization by stress scenario (respectively the risk net present value overcollateralization) that is available at all times totaled 6.8% (9.2%) for the Bank s Public-sector Pfandbriefe and 20.2% (8.7%) for its Mortgage Pfandbriefe. This means that the Bank comfortably exceeded the legally required overcollateralization for both the Public-sector Pfandbriefe and the Mortgage Pfandbriefe. The development of the net present value overcollateralization of the Pfandbriefe and the principal measures taken to manage the cover pools are reported monthly at the Asset-Liability Management Committee. In order to counteract a possible loss of confidence by the capital market in the Public-sector Pfandbrief in the wake of the ongoing sovereign debt crisis, a vdp credit quality differentiation model has been applied since 31 December This model, which was developed by the vdp in collaboration with its member institutions, limits the inclusion of claims against those EU and EEA governments and their sub-sovereign entities with a noninvestment grade rating in the cover calculation by applying rating-dependent haircuts. The effects of this model are published on the websites of the respective institutions as a supplement to the existing cover pool calculations pursuant to Section 28 PfandBG. In accordance with Section 4 (1a) PfandBG, the Bank must ensure that the maximum liquidity requirement for the next 180 days can be met through assets that can be used for statutory overcollateralization and other liquid cover assets. The Bank also complied at all times with this regulation to limit the short-term liquidity need ( 180 day liquidity ). [C19] [C20] Management Report 37

36 20 Present value of overcollateralization of Mortgage Pfandbriefe Stress scenario in % % 0 Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. Risk Position of Düsseldorfer Hypothekenbank Düsseldorfer Hypothekenbank made extensive changes to its risk management and controlling system during the reporting year. Among other things, the Bank expanded the risk calculation scenarios and optimized the measurement of risk-covering potential. Measures necessary because of new or stricter legal and regulatory requirements, particularly in connection with CRR and CRD IV, were implemented as scheduled within the framework of extensive projects and IT extensions. Through ongoing monitoring the Bank will be able to promptly recognize and implement all legal requirements. Values calculated for the net present value risk-bearing capacities are adversely impacted primarily by the legacy portfolio. This negative effect will steadily decrease through the maturities in the portfolios and the new business. It does not, however, impact the positive forecast for the Bank as a going-concern. Going forward, risk measurement methods and risk management processes will be continuously improved. Risk exposures that were significant for the overall assessment of the Bank s risk situation in the 2014 financial year have been presented in the previous sections of this report. No further significant risks were recognizable in the reporting year. Taking into consideration the guarantee discussed in the Report on Subsequent Events, the Bank has established appropriate provisions for all identifiable risks. 38 Düsseldorfer Hypothekenbank AG Annual Report 2014

37 Report on Subsequent Events In February 2015, a voluntary conversion of the remaining 40 million in mandatory convertible bonds took place. This resulted in an increase in the Bank s core tier 1 capital. On 1 March 2015, the Austrian Financial Market Authority (FMA) unexpectedly imposed a payment moratorium at HETA ASSET RESOLUTION (Heta). This means that the outstanding liabilities of the wind-up agency for the former Hypo Alpe Adria will not be serviced until at least 31 May 2016 and payments coming due will not be made. Numerous German credit institutions, primarily with portfolios in the double and triple-digit million euros, are directly impacted by this payment moratorium. The resulting Heta risk for Düsseldorfer Hypothekenbank in the amount of million (currency-related increase in the exposure as of the date of the payment moratorium compared with year-end 2014), which was built up between 2004 and 2007 and covers solely senior unsecured receivables with a guarantee of the Austrian State of Carinthia, has been neutralized with a guarantee by the German Deposit Protection Fund of the Federal Association of German Banks (Bundesverband deutscher Banken e.v. Einlagensicherungsfonds). For this guarantee, the Bank pays a guarantee commission. The Heta-bonds were removed from the cover for outstanding Public-sector Pfandbriefe in the first quarter of The Bank is currently initiating legal action against Austria s decision to impose a payment moratorium at Heta. In connection with the measure to shield the Bank from the risk associated with Heta, the shares of the Bank were transferred effective as of 24 March 2015 from the previous owner, Lone Star, to holding companies of Bundesverband deutscher Banken e.v. Einlagensicherungsfonds (Resba Beteiligungsgesellschaft mbh, Berlin, for 94.6%) and Prüfungsverband deutscher Banken e.v. (Einlagensicherungs- und Treuhangesellschaft mbh, Cologne, for 5.4%). After the change in shareholders, the Bank will continue its restructuring and new business strategy. Previously, Fitch had lowered its viability rating for the Bank to c due to the events in March, after having confirmed the rating in February The issuer default rating, which was placed on a negative outlook due to the global review of the assumptions regarding public support measures for banks, was placed on Watch Negative in light of the implementation time line. There were no further significant events subsequent to the conclusion of the financial year from which the Bank expects a material effect on its results of operations, financial position and net assets. Report on Outlook This report contains forward-looking statements pertaining to Düsseldorfer Hypothekenbank s future business development and results of operations, which are based on current plans, estimates, forecasts and expectations. These statements contain risks and uncertainties. There are numerous factors impacting the Bank s business that are largely beyond its own control. In particular, these factors include economic developments, the state of the European and global financial markets, regulation-related changes in the business environment of market participants, and potential loan defaults. All forecasts are based on the assumption that the previous key points of the business and risk strategy will be continued under the new owners. Actual events and developments may differ materially from those expressed or implied by these forward-looking statements. They are therefore only valid at the time of their publication. The Bank assumes no obligation to update these forward-looking statements in view of new information or unexpected events. Amid a dynamic environment, the Bank successfully utilized the opportunities available to it in the previous financial year and not only strengthened its positioning in its core markets but also sharply scaled back its non-strategic capital markets business. By expanding its sales activities the Bank was able to achieve its planned growth targets in commercial real estate financing and realize its targeted volume and margin in the market. Spain was introduced as a new market for real estate financing business, in addition to Germany, the Netherlands and France, and new commitments were successfully concluded. The client derivatives product in the real estate lending business was launched as well. In addition, the Bank expanded its marketing activities and added to its team of real estate experts by recruiting highly qualified personnel. Thanks to its strategic positioning and flat hierarchies, the Bank is a niche provider that is able to offer solution-oriented and flexible financing options with short decision-making processes. In real estate financing, the Bank will be able to continue the success it had in the previous financial year with new business acquisition, and carry forward this trend to the current year. This means that the Bank is continuing its strategy in real estate financing. New commitments are made taking into account earnings and risk objectives. The main factors influencing the development of the real estate financing business in 2015 remain the level of competition and the economic conditions in the respective market. Management Report 39

38 The recovery on the capital markets had a beneficial impact on the reduction of the non-strategic capital markets portfolio and contributed to a reduction in hidden liabilities and an increase in hidden reserves. By actively scaling back and realigning the capital markets portfolio, the Bank was able to reduce the risk in this segment. The planned reduction targets in the derivatives portfolio were also far exceeded primarily because of the active reversal of macro-hedges with a reasonable economic effect. In 2015, the Bank intends to rigorously continue its current restructuring activities in the capital markets business segment. The total portfolio in the capital markets business including derivatives positions will be scaled back further during 2015 using a risk- and return-oriented active approach to portfolio management. A further recovery in the capital markets would have a favorable effect on both the planned, active reduction of non-strategic securities in the capital markets business segment and the active reduction of the derivatives portfolio. Portfolio reallocations resulting from measures to scale back individual positions in favor of less risky exposures offer the opportunity to mitigate adverse tendencies. Economic, political and regulatory developments harbor risks that could influence the ability and willingness of issuers (countries, municipalities and credit institutions) in the Bank s portfolio to fulfill their obligations. In addition, the portfolio and valuation of Düsseldorfer Hypothekenbank may be affected if ratings agencies change their rating methodology. The funding situation continues to depend on developments in the money and capital markets. Opportunities are arising from the ECB s expansionary monetary policy and the reputation of the Pfandbrief as a proven investment vehicle for investors. The emergence of new risks, especially in the financial sector, through economic, political and regulatory developments may lead to market uncertainties. The adverse effect of measures from prior years that had a negative effect on net interest income was also partially offset by gains from portfolio reallocations. Due to the positive impact of new business in real estate financing, combined with a decrease in the negative interest rate effect caused by maturities in the non-strategic business, the Bank expects net interest income will continue to improve even without non-recurring effects. The significant improvement in net commission income will probably continue thanks to commission income from real estate lending business. The valuation result may be impacted by de-risking measures as well as the establishment or reversal of risk provisions and the establishment of a provision for loss-free valuation, which is largely determined by factors such as the level of interest rates, new commitments and funding spreads. The Bank s annual result of m was in line with the forecasted loss, which was anticipated to reach a lower double-digit million amount. The expected moderate reduction in total assets has almost been achieved and will remain moderate in the next several years due to the issuance of new real estate financing amid a simultaneous reduction in capital markets business. Following the securing of the Heta-bonds and the ownership change and amid otherwise constant conditions, there are no specific risks that are recognizable for the 2015 financial year in terms of the Bank s equity and liquidity position. The focus is now to build on the measures initiated in connection with the acquisition of the Bank by the German Deposit Protection Fund of the Federal Association of German Banks (Bundesverband deutscher Banken e.v. Einlagensicherungsfonds). For the financial year in progress, the Bank continues to anticipate it will post a loss that will reach a double-digit million amount. The negative effects of legacy issues and the current low level of interest rates will have an adverse effect on the valuation result. However, net interest income and the valuation result will increasingly recover as the year progresses through the onset of the positive effect of new commitments. Equity capital is sufficient to comply with current regulatory minimum capital requirements. The Bank remains convinced that the restructuring measures taken to date, also in 2015, will continue to support the journey back to profitability 40 Düsseldorfer Hypothekenbank AG Annual Report 2014

39 Annual Financial Statements

40 21 Balance Sheet Assets in k Cash reserve 28, ,493 of which: with Deutsche Bundesbank 28,778 (100,492) Receivables from banks Public-sector loans 983,192 1,315,464 Other receivables 1,516,598 2,499,790 1,291,993 of which: payable on demand 1,247,442 (928,775) collateralized against securities 0 (0) Receivables from customers Mortgage loans 1,179, ,762 Public-sector loans 643, ,085 Other receivables 8 1,823, of which: collateralized against securitites 0 (0) Bonds and other fixed income securities Bonds and notes of public-sector issuers 3,945,745 3,441,991 of which: eligible as collateral with Deutsche Bundesbank (3,372,949) (3,287,475) of other issuers 2,937,757 6,883,502 3,935,217 of which: eligible as collateral with Deutsche Bundesbank (2,657,614) (3,477,149) Own debt instruments 100,013 6,983,515 0 Nominal amount 100,000 (0) Shares and other variable-yield securities Participating interests 8 2,494 of which: in banks 8 (2,494) Intangible assets 839 1,206 of which: purchased licenses, industrial property rights, similar rights and values as well as licenses for such rights and values 839 (1,206) Tangible assets Other assets 1,273 1,554 Deffered Items from issuing and lending business 5,137 6,389 other 2,961 8,098 3,589 Total assets 11,346,238 11,919, Düsseldorfer Hypothekenbank AG Annual Report 2014

41 Balance Sheet Liabilities in k Liabilities to banks Registered Mortgage Pfandbriefe issued 61,494 66,693 Registered Public-sector Pfandbriefe issued 82,493 97,535 Other Liabilities 4,471,252 4,615,239 4,450,639 of which: payable on demand 111,709 (83,350) Liabilities to customers Registered Mortgage Pfandbriefe issued 338, ,865 Registered Public-sector Pfandbriefe issued 2,808,961 3,209,586 Savings deposits 1 1 with agreed withdrawal notice of 3 months 1 (1) with agreed withdrawal notice of more than 3 months 0 (0) Other Liabilities 2,695,980 5,843,302 2,940,990 of which: payable on demand 669 (488) Securitized liabilities Bonds issued Mortgage Pfandbriefe 260, ,268 Public-sector Pfandbriefe 264, ,505 Other bonds 10, ,877 10,185 Other liabilities 37,049 21,867 Deferred items from issuing and lending business 698 1,057 other 1,341 2,039 1,728 Provisions Tax provisions 0 0 other 3,369 3,369 2,581 Subordinated liabilities 92,010 95,111 Fund for general banking risks 30,000 30,000 Capital Subscribed capital 361, ,000 Capital reserve 362, ,412 Revenue reserve Other revenue reserves 48,893 48,893 Balance sheet loss -583, , ,907 Total Liabilities 11,346,238 11,919,009 Contingent liabilities Liabilities from guarantees and indemnity agreements 0 24 Other commitments Irrevocable loan commitments 361, ,598 Annual Financial Statements 43

42 22 Profit and Loss Statement in k Interest income from lending and money market transactions 441, ,024 from fixed-income securities and debt register claims 222, , ,370 Interest paid -698,901-34,633-1,132,357 Income from shares and other variable-yield securities 0 0 Participating interests Commission income 4,429 1,600 Commission paid -1,833 2,596-16,552 Other operating income 788 6,756 General administrative expenses Staff expenses Wages and salaries -6,521-5,512 Compulsory social security contributions and expenses for pensions and other staff benefits , of which: pensions -157 (-129) Other administrative expenses -18,512-25,971-17,716 Depreciation and valuation adjustments of intangible and tangible assets Other operating expenses Depreciation and valuation adjustments ,456 of receivables and certain securities as well as additions to the provision for possible loan losses -2,621-55,471 of which: allocation to the fund for general banking risks 0 (-30,000) Income from write-ups for participating interests, shareholdings in affiliated companies and securities treated as fixed assets 18,474 29,662 Operating loss -42,048-59,836 Extraordinary result 0 0 Result before taxes -42,048-59,836 Tax from income and earnings 4 45 Other taxes, not included under other operating expenses Net result for the year -42,045-59,611 Retained loss brought forward -541, ,874 Withdrawals from silent partnerships 0 14,578 Balance sheet loss -583, , Düsseldorfer Hypothekenbank AG Annual Report 2014

43 Notes Accounting and Valuation Principles The financial statements were prepared in accordance with the applicable provisions of the German Commercial Code (Handelsgesetzbuch, HGB), the German Stock Corporation Act (Aktiengesetz, AktG), the German Pfandbrief Act (Pfandbriefgesetz, PfandBG) and the German Bank Accounting Regulation (Verordnung über die Rechnungslegung von Kreditinstituten, RechKredV). The same accounting and valuation principles were applied in the preparation of these financial statements as in the financial statements as at 31 December Receivables are stated at nominal value in accordance with Section 340e (2) HGB; any difference between the nominal amount and disbursements is shown under Deferred items. All recognized individual risks in lending are taken into consideration by the formation of individual loan loss provisions. A special allocation for general banking risks pursuant to Section 340g (1) HGB was established in the previous year in the balance sheet item Fund for general banking risks in order to hedge the special risks associated with banking transactions. In addition, general loss provisions were established to take into account latent risks in the lending business. Bonds recorded under current assets are valued using the strict lowest value principle at the average value calculated continually or at the lower current market price as at the balance sheet date. Bonds classified as non-current assets are valued at cost plus a pro rata temporis release of the difference to the face value. Acquired zero-coupon bonds are recognized at amortized cost, with the interest income resulting from write-ups recorded in profit and loss. The pro rata temporis release of premiums or debt discounts is included in net interest income. In the event of any specific indications of a potential default, securities valued as non-current assets are written down to the most probable amount expected to be realized. No write-downs on bonds allocated to non-current assets were required in the reporting year. In 2014, eight securities included in the liquidity reserve with a nominal volume of m were transferred to non-current assets. At the time of the transfer, the market value of these securities exceeded the carrying amount by 22.4 m. Profit participation rights reported under shares and other floating rate securities are assigned to non-current assets and recognized at cost. Provisions are established in the event of a probable permanent impairment. No extraordinary write-downs were required in the reporting year. In the 2014 financial year, one security with a nominal volume of 0.3 m was transferred to non-current assets. At the time of the transfer, the market value of the security corresponded to its carrying amount. Participating interests are accounted for at cost. In the event of a probable permanent impairment, participating interests are written down to their reduced fair value. Tangible and intangible assets are stated at cost less depreciation/amortization calculated on a straight-line basis over their expected service lives. In the event of a probable permanent impairment, extraordinary write-downs are recorded. Low-value assets are depreciated in full in the year of acquisition. Liabilities are recorded at their settlement amount. The difference between the nominal value and disbursements is shown under Deferred items. Zero-coupon bonds are measured at issue price plus the pro rata temporis share of interest in accordance with the return on the issue. Pursuant to Section 253 (1) sentence 2 HGB, provisions are recognized at their necessary settlement amount with consideration of future price and cost increases. Provisions with a maturity of more than one year are discounted using an interest rate that matches their maturity and equals the average market rate for the past seven financial years as published by the Deutsche Bundesbank pursuant to the German Regulation on the Discounting of Provisions (Rückstellungsabzinsungsverordnung). Provisions are established for taxes and contingent liabilities based on the estimated amount needed to settle the obligations. Balance sheet items denominated in a foreign currency and currency hedges are converted in accordance with Section 340h HGB in conjunction with Section 256a HGB using the European Central Bank s (ECB) reference exchange rate on the balance sheet date. If offsetting currency hedging transactions are concluded in order to hedge currency fluctuations on transactions denominated in a foreign currency, these transactions are considered to be specially covered. Derivative financial transactions that are concluded to hedge against interest rate and exchange rate fluctuations are generally not subject to the principle of individual valuation and are not recognized in the financial statements because they are judged to be pending transactions. Hedging relationships that exist for risk management purposes are not treated as a valuation unit for commercial law purposes since the Bank has utilized its accounting option pursuant to Section 254 HGB in conjunction with the statement from the Main Technical Committee of the German Institute of Public Auditors (Institut der Wirtschaftsprüfer, IDW) Annual Financial Statements 45

44 23 Maturity structure by residual term in m Payable on demand 3 months > 3 months 1 year > 1 year 5 years > 5 years Total Receivables from banks 1, ,500* from customers ,846* Total receivables 1, , ,346 Liabilities to banks 112 3,238 1, ,615 to customers ,280 1,593 2,147 5,843 Total liabilities 113 4,060 2,384 1,754 2,147 10,458 *Residual claim without loan loss provision (IDW RS HFA 35 note 12 from 10 June 2011). Accordingly, the effectiveness of the hedging relationships is not determined, nor are any provisions for potential losses established for any potentially ineffective portions of the hedging relationships. The statement IDW RS BFA 3 of the IDW s Banking Experts Panel has been taken into account when performing lossfree valuation of interest rate-related transactions in the bank book. The Bank uses the periodic (income statementoriented) approach for this. The need for a provision for potential losses is determined by deducting administrative expenses and risk costs from the balance of the discounted earnings contributions from the business with interestbearing financial instruments in the bank book. As the Bank s situation means that it is unable to make distributions to its shareholders for an extended period of time, a zero interest rate is assumed for the portion of the notional net assets through equity. A recalculation of the loss-free valuation performed as at year-end 2014 did not identify any need for provisions. netted amount are not capitalized in accordance with the accounting option available to the Bank pursuant to Section 274 (1) sentence 2 HGB. There are no receivables from customers whose maturity is undetermined, nor are there any other securitized liabilities. The item Bonds and other fixed income securities includes amounts that are due in the year following the balance date totaling 1.0 bn. The Heta-bonds affected by the Austrian moratorium are considered with the maturity date as valid at the time of issuance. The sub-item Bonds issued contains amounts that are due in the year following the balance sheet date totaling m. There are no amounts included in receivables or liabilities related to companies in which participating interests are held. When reporting risk provisions and the result from financial investments, the Bank utilizes the possibility of cross compensation in accordance with Section 340f (3) HGB and Section 340c (2) HGB. Pursuant to Section 274 HGB, deferred taxes are calculated using the balance sheet approach taking into account any tax loss carry-forwards. Deferred tax liabilities are netted with deferred tax assets. Deferred tax assets in excess of the 46 Düsseldorfer Hypothekenbank AG Annual Report 2014

45 24 Fixed assets Development in m Bonds and notes Participating Interests Intangible Assets Tangible Assets Total Historical cost of acquisition and production 7, ,031 Additions in Disposals in Accumulated depreciation* Book value as at , ,779 Depreciation in *The accumulated depreciation represents the expenses and income from securities held in the portfolio at balance sheet date. Cash Reserve The Cash reserve item includes 28.8 m deposits at central banks and 2.6 k cash on hand. Marketable Securities All bonds and other fixed income securities totaling 6.8 bn are marketable on the stock exchange. Of this amount, 6.7 bn are listed on the stock exchange. The profit participation rights reported under Shares and other variable-yield securities in the amount of 42.8 k are marketable and listed on the stock exchange, whereas the participating interests of 7.7 k are not marketable. Tangible Assets Tangible assets totaling 0.4 m relate exclusively to office equipment, furniture and fixtures. The change compared with the prior year is essentially due to scheduled depreciation. Participating Interests During the reporting year, the Bank sold its stake in MHB- Bank AG, Frankfurt am Main, at its carrying amount of 2.5 m. As a result, as at 31 December 2014, only one participating interest remained: a stake in Liquiditätskonsortialbank GmbH, Frankfurt am Main, which has a carrying amount of 7.7 k. Of the bonds, 1.7 bn are designated as cover for Pfandbriefe in circulation. Bonds in the amount of 6.8 bn are not measured using the strict lowest value principle as at the balance sheet date. These include bonds with a carrying amount of 1.8 bn that have a fair value as of the balance sheet date that is m below their carrying amount due to price fluctuations on the capital markets considering the guarantee discussed in the Report on Subsequent Events. They are counterbalanced with regard to the interest component by items in liabilities and derivatives valued at market prices. Compared with the position at 31 December 2013, the portfolio of third-party bonds has declined by 6.7%. In addition to maturities, this decline is due to the active reduction of the public-sector lending portfolio. Annual Financial Statements 47

46 Other Assets and Liabilities Other assets totaling 1.3 m primarily comprise tax receivables of 1.3 m. Other liabilities total 37.0 m and include, besides tax liabilities of 1.6 m and current account liabilities of 0.5 m, primarily foreign exchange conversion effects totaling 34.9 m that result from the conversion of financial instruments denominated in a foreign currency using the ECB s reference rate as at the balance sheet date. They are counterbalanced by items in receivables and liabilities or third-party debt which provided they are denominated in a foreign currency are also valued using the exchange rate prevailing on the balance sheet date. Deferred Items from the Issuing and Lending Business Deferred assets include issue discounts on bonds in the amount of 2.3 m, premiums on receivables of 2.8 m, paid upfront premiums of 2.0 m and prepaid administrative expenses of 1.0 m. Deferred liabilities comprise issue premiums on bonds of 0.1 m, discounts on receivables of 0.6 m and upfront premiums received of 1.3 m. Provisions Compared with the prior year, provisions have increased by 0.8 m, which was primarily due to the adjustment of the bank levy paid to the BdB s Deposit Protection Fund. Subordinated Liabilities No subordinated liabilities were issued during the reporting period. The portfolio decreased due to maturities and consists of bearer certificates in the amount of 20.0 m, registered bonds totaling 40.0 m and promissory notes of 30.0 m. The pro rata share of interest totaling 2.0 m is also reported in this balance sheet item. In the event of insolvency or liquidation of the Bank, subordinated liabilities may not be settled until all claims of non-subordinated creditors have been satisfied. Early repayment is not permitted. The subordinated registered bonds totaling 40.0 m are convertible bonds. In addition to the bearer s right to conversion at any time, the issue conditions include the obligation to make a conversion if the issuer announces that it is insolvent, files for insolvency, or its core capital ratio drops to 8% or less. No creditors exercised their conversion right during the reporting year and no conversion-triggering events occurred. All funds raised in this manner fulfill the requirements from Section 63 CRR. Subordinated liabilities are considered as liable equity deducting pro rata debt discounts in accordance with Section 64 CRR and adhering to the limits of Section 4 (1) number 71 CRR. Interest and debt discount expenses on all subordinated liabilities total 6.6 m. Five subordinated loans exceed 10% of the total reported balance. [C25] Fund for General Banking Risks In order to take into account the special risks associated with the banking sector, a risk provision reserve in accordance with Section 340g (1) HGB was established in 2013 for the first time and applied to the Fund for general banking risks. As at the reporting date, this special item remained unchanged year-on-year at 30.0 m. 48 Düsseldorfer Hypothekenbank AG Annual Report 2014

47 25 Subordinated Liabilites >10% of the Total In m Interest rate in % Issue date Maturity Subscribed Capital and Retained Earnings The balance sheet loss of the prior year in the amount of m was carried forward to new account. Subscribed capital totaled m as at the balance sheet date. It is divided into 361,000,000 registered shares of 1 each. The reserves totaling m consist of the capital reserve in the amount of m and other retained earnings of 48.9 m. Contingent Liabilities and Other Commitments There were irrevocable loan commitments in the amount of m relating to 22 real estate loans. Assets Assigned as Collateral As at the balance sheet date, securities totaling 27.0 m were assigned within the framework of repurchase agreements (non-recourse repurchase agreements). The carrying amount of bonds transferred as security for open market loans and other loans totaled 4.9 bn. Annual Financial Statements 49

48 26 Cover pool (nominal) Mortgage Pfandbriefe in m Receivables from customers (mortgage loans) Substitute cover Total cover Mortgage Pfandbriefe requiring cover Overcollateralization Cover pool (present value) Mortgage Pfandbriefe in m NPV Risk-adjusted NPV Cover assets Mortgage Pfandbriefe Overcollateralization Principal maturities by years Mortgage Pfandbriefe in m Total Cover Mortgage Pfandbriefe years > 0.5 years 1 year > 1 year 1.5 years > 1.5 years 2 years > 2 years 3 years > 3 years 4 years > 4 years 5 years > 5 years 10 years > 10 years Total Real estate loan portfolio by size classes Mortgage Pfandbriefe in m > > > Total Düsseldorfer Hypothekenbank AG Annual Report 2014

49 30 Real estate loan portfolio by property type and country Mortgage Pfandbriefe in m Germany France Netherlands Great Britain USA Total Residential Owner-occupied flats One and two family houses Multi-familiy dwellings Commercial Offices Retail Other Total days or more in arrear 0 0 Receivables with arrears 5% Supplementary cover Mortgage Pfandbriefe in m Germany Finland France Austria Poland Total Compensation claims in acc. with 19 (1) Nr. 1 PfandBG Monetary claim in acc. with 19 (1) Nr. 2 PfandBG thereof covered bonds in acc. with EU-Regulation 575/ Bonds in acc. with 19 (1) Nr. 3 PfandBG Total Other key figures Mortgage Pfandbriefe Mortgage Pfandbriefe m thereof fixed-interest bearing % Cover pool assets m thereof total receivables exceeding limits acc. to 13 (1) PfandBG m 0 0 thereof total receivables exceeding limits acc. to 19 (1) Nr. 2 PfandBG m 0 0 thereof total receivables exceeding limits acc. to 19 (1) Nr. 3 PfandBG m 0 0 thereof fixed-interest bearing cover pool assets % Net present value in acc. with 6 PfandbBarwertV per foreign currency: CHF m 4 4 Net present value in acc. with 6 PfandbBarwertV per foreign currency: GBP m Net present value in acc. with 6 PfandbBarwertV per foreign currency: USD m volume-weighted average age of receivables years weighted average LTMLV* % 49.9 n/a *These data have been assessed for the first time as per Therefore, no comparable historical data is available. Annual Financial Statements 51

50 33 Cover pool (nominal) Public-sector Pfandbriefe in m Receivables from banks 852 1,122 Receivables from customers (public-sector loans) Receivables from customers (mortgage loans) 1 1 Bonds and other fixed-income securities 1,697 1,570 Ordinary cover 3,102 3,495 Substitute cover Total cover 3,361 3,814 Public-sector Pfandbriefe requiring cover -3,090-3,529 Overcollateralization Cover pool (present value) Public-sector Pfandbriefe in m NPV Risk-adjusted NPV Cover assets 3,928 4,266 3,752 4,481 Public-sector Pfandbriefe -3,709-4,020-3,527-4,230 Overcollateralization Principal maturities by years Public-sector Pfandbriefe in m Total cover Public-sector Pfandbriefe ,5 years > 0,5 years 1 year > 1 year 1,5 years > 1,5 years 2 years > 2 years 3 years > 3 years 4 years > 4 years 5 years > 5 years 10 years > 10 years Total 3,361 3,814 3,090 3, Düsseldorfer Hypothekenbank AG Annual Report 2014

51 36 Public-sector loan portfolio by country and borrower Public-sector Pfandbriefe in m Central government Regional authorities Local authorities Other Total Austria Belgium Bulgaria Canada Greece Czech Republik Cyprus Denmark France Germany Hungary Iceland Ireland Italy Japan Latvia Lithuania Luxembourg Netherlands Norway Poland Portugal Rumania Spain Slovakia Slovenia Switzerland Czech Republik United Kingdom USA Total , ,467 1,547 3,102 3, days or more in arrear 0 0 Reveivables with arrears 5% 0 0 Annual Financial Statements 53

52 37 Supplementary cover Public-sector Pfandbriefe in m Germany France Austria Total Compensation claims in acc. with 20 (2) Nr.1 PfandBG Monetary claims in acc. with 20 (2) Nr.2 PfandBG thereof covered bonds in acc. with EU-Regulation 575/ Total Other key figures Public-sector Pfandbriefe Pfandbriefe outstanding m 3,090 3,529 thereof fixed-interest bearing % Cover pool assets m 3,361 3,814 thereof total receivables exceeding limits acc. to 20 (2) PfandBG m 0 0 thereof fixed-interest bearing cover pool assets % Net present value in acc. with 6 PfandbBarwertV per foreign currency: CHF m -4-8 Net present value in acc. with 6 PfandbBarwertV per foreign currency: GBP m 0 0 Net present value in acc. with 6 PfandbBarwertV per foreign currency: USD m Düsseldorfer Hypothekenbank AG Annual Report 2014

53 Personnel Expenses, Remuneration of the Governing Bodies and Employees Personnel expenses totaled 7.5 m in the reporting year. This includes total remuneration for the Management Board in the amount of k. In accordance with the Articles of Association of Düsseldorfer Hypothekenbank, the members of the Supervisory Board did not receive remuneration for their services. The average number of employees during the year, excluding members of the Management Board, was 69, including nine part-time employees (converted to a full-time basis). Auditing and Consulting Fees The total annual auditor s fee in the 2014 financial year was k k of this amount was attributable to the year-end financial audit, 7.7 k to other audit services and k to advisory services. Other Operating Result Other operating income of 0.8 m consists primarily of income from the release of provisions in the amount of 0.7 m. Aside from operating costs paid in 2014 relating to own property that was sold in 2013 ( 44.4 k), the bulk of other operating expenses totaling 0.3 m stem from expenses for the foreign currency conversion in the amount of 0.2 m. Taxes on Income Taxes on income originate from the result of ordinary business activities. Appropriation of Profits and Losses The balance sheet loss of m will be carried forward to new account. Foreclosures, Seized Properties and Interest in Arrears As at the balance sheet date as well as during the whole financial year 2014, no foreclosure proceedings were pending for mortgages serving as cover. Repayments of Mortgage Loans Mortgage loans totaling m were repaid in the financial year. For commercial properties, m was attributable to scheduled amortization, 24.7 m to premature repayments and 23.7 to placements. For residential properties, an amount of 14.5 m was amortized and 40.0 m was repaid due to other reasons. Cover Pool Public-sector Pfandbriefe There were no payments in arrears on receivables used as cover for Public-sector Pfandbriefe as at the balance sheet date. Foreign Currency Positions The total value of receivables denominated in foreign currencies amounted to m as at the balance sheet date. The liabilities include m that is not denominated in euro. Outsourced Areas The Bank has outsourced significant functions for the purpose of cost reduction. IT outsourcing includes the transfer of data processing functions for the core banking system, IT infrastructure services and the provision of interfaces pursuant to Section 24c KWG (automatic search of account information) to an external partner working under contract. In addition, the processing of payment transactions, the archiving of documents subject to mandatory archiving requirements and payroll processing were outsourced to third parties. The common factor for all outsourcing is that none of these services could be performed in-house by the Bank at such a low cost. The associated costs can be reliably calculated, no internal personnel capacity needs to be allocated to these tasks and the Bank can benefit from the experience and expertise of the contractual partners. Apart from the usual disadvantages associated with outsourcing, the Bank does not perceive any special risks that could arise from outsourcing these functions. The Bank considers the most significant outsourced processes to be the data processing for the core banking system and the provision of IT infrastructure services by third parties. These led to cash-outflows of k for the reporting year. Between 1 October 2013 and 30 September 2014, there were no interest or principal payments in arrears among the mortgage receivables serving as cover for Mortgage Pfandbriefe. Annual Financial Statements 55

54 39 Derivatives Residual term in m Nominal amount <1 year 1-5 years >5 years Total Market value Interest rate swaps 1,697 4,390 6,222 12,309-1,007 Cross-currency interest rate swaps Total 2,037 4,399 6,312 12,748-1, Derivatives Composition in m From micro-hedging From macro-hedging Earnings Current Market value compensation Costs Current Market value compensation Total Derivative Financial Instruments As at the balance sheet date, the following interest and currency-driven forward transactions were outstanding: interest rate swaps, cross-currency interest rate swaps, short swap option positions, promissory notes with put and call options, Pfandbriefe with call options, and interest rate cap agreements. All derivatives are intended to hedge against interest rate and exchange rate fluctuations. [C39] From an overall perspective, the negative fair values of these derivative financial instruments are also offset against positive market values from the underlying hedged items in so far as they are related to the interest component of the derivative. The market value compensation for derivatives results from early closures of contracts. Swaps with a nominal value of 1.8 bn were liquidated during the reporting year, leading to net interest income totaling 0.3 m. The income was generated in relation to the sale or early redemption of the underlying hedged items, whereby derivative financial instruments with a positive market value of 1.3 m and a negative market value of 1.6 m were closed early. In addition, as part of the macro-hedging of interest rate risks, contracts with a positive market value totaling m and negative fair values totaling were liquidated. [C40] Other Reporting Obligations Pursuant to the reporting requirements of the AktG, LSF5 German Investments II, L.P., Delaware, USA, as well as Lone Star Partners V, L.P., Hamilton, Bermuda, and Lone Star Management Co. V, Ltd., Hamilton, Bermuda, directly or indirectly own more than 25% of the shares of the Bank. The Spokesman of the Management Board, Dr. Christian Freiherr von Villiez, was a member of the Supervisory Board of MHB-Bank AG, Frankfurt am Main, during the reporting year until he resigned his position effective 8 October 2014, when the Bank sold its participating interest in MHB-Bank AG. 56 Düsseldorfer Hypothekenbank AG Annual Report 2014

55 41 Segment report in m Real estate financing Public-sector lending Other activities Total Net interest income Net comission income Administrative expenses* Valuation result Taxes Net loss for the year Allocated equity Cost-income ratio 60% 92% -14% -64% -211% -93% -83% -274% Return on equity 5.4% -37.0% -68.4% 12.6% -18.4% -95.4% -22.3% -25.9% *including other operating results As at the reporting date there were no loans to members of the Supervisory Board. The disclosures required under Section 26a (1) sentence 1 KWG in conjunction with Articles 435 to 455 of EU Regulation No. 575/2013 can be found in the 2014 Disclosure Report, which will be published on the Bank s homepage. Transactions with Related Parties There were no transactions at non-market prices during the reporting period with individuals or companies that currently qualify or formerly qualified as related parties. Nevertheless, for reasons of materiality, it is mentioned at this point that as at the balance sheet date subordinated convertible bonds with a nominal volume of 40.0 m were securitized in the name of affiliated companies. The interest expense for the convertible bonds in the reporting year was 4.2 m. The subordinated convertible bonds represent equity capital for the Bank as defined in the CRR for credit institutions and investment firms (EU Directive No. 575/2013, CRR). Segment Reporting The method applied for segment reporting is based on the income statement and allocates all expenses and income to the individual business segments that caused them. The respective result per segment comprises net interest income, net commission income, administrative expenses, the valuation result and taxes. The valuation result consists of risk provisions and the result from financial investments (refer to the Management Report for further explanations). [C41] Annual Financial Statements 57

56 42 Statement of changes in equity in m Subscribed capital Silent partnerships Capital reserve Revenue reserve Balance sheet loss/ income Total Net profit Repayments Capital increases Allocation to revenue reserves Distributions for the financial year Withdrawals from silent partnerships Net profit Repayments Capital increases Allocation to revenue reserves Distributions for the financial year Withdrawals from silent partnerships Statement of Changes in Equity The statement of changes in equity shows the development of the different components of reported equity during the course of the reporting year. [C42] Cash Flow Statement The cash flow statement breaks down the change in cash and cash equivalents into cash flows from operating activities, investing activities and financing activities. It is prepared in accordance with German Accounting Standard (Deutscher Rechnungslegungs-Standard, DRS) 21 from 8 April investing activities is mostly due to payments made in connection with the acquisition of financial assets. The cash flow from financing activities represents the cash flows from transactions with equity providers. Cash and cash equivalents comprise the cash reserve, which is made up of cash-on-hand and deposits at central banks. As a rule, the informative value of a bank s cash flow statement is limited. Therefore, it does not replace the liquidity or financial planning, nor is it used as a management controlling instrument. [C43] Cash flows are allocated to operating activities in line with the composition of the operating result. The cash flow from 58 Düsseldorfer Hypothekenbank AG Annual Report 2014

57 43 Cash flow statement in m Cash flows from operating activities Profit for the period Depreciation, amortisation and write-downs of and valuation allowances on receivables and items of fixed assets/reversals of such write-downs and valuation allowances Increase/decrease in provisions Other non-cash expenses/income Gain/loss on diposal of fixed assets Other adjustments (net) Increase/ decrease in receivables from credit institutions in receivables from customers in securities (unless classified as long-term financial assets) in other assets relating operating activities in liabilities to credit institutions in liabilities to customers in securitised liabilities ,544.8 in other liabilities relating to operating activities Interest expense/interest income Expenses for/income from extraordinary items Income tax expense/income Interest and dividend payments received ,317.0 Interest paid ,294.0 Cash receipts from extraordinary items Cash payments for extraordinary items Income taxes paid Cash flows from investing activities Proceeds from disposal of long-term financial assets ,293.8 of tangible fixed assets of intangible fixed assets Payments to acquire long-term financial assets tangible fixed assets intangible fixed assets -0.2 Proceeds from disposals of entities included in the basis of consolidation 2.5 Payments to acquire entities included in the basis of consolidation Changes in cash funds relating to other investing activities (net) Cash receipts from extraordinary items Cash payments for extraordinary items Cash flows from financing activities Proceeds from capital contributions by shareholders of the parent entity 60.0 by minority shareholders Cash payments to shareholders of the parent entity from the redemption of shares to minority shareholders from the redemption of shares Cash receipts from extraordinary items Cash payments for extraordinary items Dividends paid to shareholders of the parent entity to minority shareholders Changes in cash funds relating to other capital (net) Cash flows total Cash funds at beginning of period Cash funds at end of period Annual Financial Statements 59

58 Boards and Further Functions Supervisory Board Dr. Karsten von Köller Chairman of the Supervisory Board Chairman Lone Star Germany Aquisitions GmbH Frankfurt am Main Bruno Scherrer Deputy Chairman of the Supervisory Board Consultant Lone Star Europe Acquisitions LLP London (until 29 January 2015) Dr. Andreas Tuczka Member of the Supervisory Board Managing Director Aldridge Capital Partners GmbH Wien (until 29 January 2015) Benjamin Dickgiesser Member of the Supervisory Board Management Board Dr. Christian Freiherr von Villiez Spokesman of the Management Board Starnberg Dr. Marcus Tusch Member of the Management Board Gauting Executive Vice President Jürgen Jung Member of the Extended Management Board Eschborn Cover Pool Monitors Wolfgang Barchewitz Lawyer Peter Preuß Lawyer Director Lone Star Europe Acquisitions LLP London (since 29 January 2015) William D. Young Member of the Supervisory Board Senior Vice President Hudson Advisors UK Ltd. London (from 29 January 2015 to 24 March 2015) Dr. Thomas A. Lange Member of the Supervisory Board Chairman of the Management Board NATIONAL-BANK Aktiengesellschaft Essen (since 25 March 2015) 60 Düsseldorfer Hypothekenbank AG Annual Report 2014

59 Responsibility Statement To the best of our knowledge, and in accordance with the applicable reporting principles for annual financial reporting, we confirm that these Annual Financial Statements give a true and fair view of the net assets, financial and earnings position of the Bank, and provide a fair review of the development and performance of the business and the position of the Bank, together with a description of the principle opportunities and risks associated with the expected development of the Bank. Düsseldorf, 9 April 2015 The Management Board Dr. Christian Freiherr von Villiez Dr. Marcus Tusch Annual Financial Statements 61

60 Audit Opinion

61 Audit Opinion We have audited the annual financial statements, comprising the balance sheet, the income statement and the notes to the financial statements, together with the bookkeeping system and the management report of Düsseldorfer Hypothekenbank AG, Düsseldorf, for the fiscal year from 1 January 2014 to 31 December The maintenance of the books and records and the preparation of the annual financial statements and management report in accordance with German commercial law are the responsibility of the Company s management. Our responsibility is to express an opinion on the annual financial statements, together with the bookkeeping system and the management report, based on our audit. We conducted our audit of the annual financial statements in accordance with Section 317 of the German Commercial Code (Handelsgesetzbuch, HGB) and German generally accepted standards for the audit of financial statements promulgated by the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer, IDW). Those standards require that we plan and perform the audit such that misstatements materially affecting the presentation of the net assets, financial position and results of operations in the annual financial statements in accordance with German principles of proper accounting and in the management report are detected with reasonable assurance. Knowledge of the business activities and the economic and legal environment of the Company and expectations as to possible misstatements are taken into account in the determination of audit procedures. The effectiveness of the accounting-related internal control system and the evidence supporting the disclosures in the books and records, the annual financial statements and the management report are examined primarily on a test basis within the framework of the audit. The audit includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the annual financial statements and management report. We believe that our audit provides a reasonable basis for our opinion. Our audit has not led to any reservations. In our opinion, based on the findings of our audit, the annual financial statements comply with the legal requirements and give a true and fair view of the net assets, financial position and results of operations of the Company in accordance with German principles of proper accounting. The management report is consistent with the annual financial statements and as a whole provides a suitable view of the Company s position and suitably presents the opportunities and risks relating to future development. Düsseldorf, 9 April 2015 Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft Lösken Auditor Gundelach Auditor Audit Opinion 63

62 Report of the Supervisory Board

63 In the 2014 financial year, the Supervisory Board performed its duties in accordance with its legal obligations, the Articles of Association and the Bank s rules of procedure. It advised the Management Board on its corporate management and continually monitored the conduct of business. As part of the quarterly written reporting on the business and risk situation of the Bank and at three meetings in April, August and November in Düsseldorf, the Supervisory Board was kept regularly, promptly and comprehensively informed by the Management Board, both verbally and in writing, of all issues related to strategic corporate management and planning, business development, profitability and liquidity, the risk situation and risk management. This reporting also included information regarding variances between actual and planned business performance. Between meetings, the Spokesman of the Management Board maintained ongoing contact with the Chairman of the Supervisory Board and provided him with immediate and detailed reports about important events and business transactions. The Chairman of the Supervisory Board had ongoing written and verbal contact with the other members of the Supervisory Board between meetings. The Supervisory Board was involved in transactions and decisions of major importance to the Bank. All matters which required the consent of the Supervisory Board were presented to the Supervisory Board in good time for decision. When a resolution was required between the meetings, this was passed by written circular. All members of the Supervisory Board took part in the meetings and voted on all resolutions. The main focus of the meetings was the progress achieved in the strategic repositioning of the Bank. The expansion of the commercial real estate financing business, the gradual reduction of the capital markets portfolio, the development of the risk situation, the trend in total assets and the return to sustainable profitability were regularly and intensively discussed. In view of its size, the Supervisory Board decided not to create risk, audit, nomination or remuneration control committees in the year under review, but rather to perform the functions of these committees itself in accordance with Section 25d (7-12) KWG. The Management Board reported regularly and comprehensively on the Bank s risk-bearing capacity, the limit system, credit risk in real estate lending and capital markets business, market risk, liquidity risk, operational risk and investment risk. The Supervisory Board received prompt, regular and detailed reports on the Bank s liquidity position. The Supervisory Board discussed developments on the financial and real estate markets at all meetings. An additional focus of attention was the implementation and observance of new and existing legal and regulatory requirements, particularly against the background of the entry into force of the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD IV), and the developments in the ongoing audits. At the meeting convened in April 2014 to deliberate on the annual financial statements, the Supervisory Board discussed the presented annual financial statements for the 2013 financial year, which received an unqualified audit opinion. Representatives of the auditors took part in the meeting and reported in detail on the main findings of their audit. The annual financial statements were approved and thus adopted. The proposed resolutions for the agenda of the Annual General Meeting and the Report of the Supervisory Board were discussed and adopted. In addition, the allocation of responsibilities for the Management Board was expanded to include the newly established Compliance organization, and the annual reports of the Internal Audit department and the Compliance Officer were accepted. There were no significant or material findings. At the meeting in August 2014, the Management Board explained the business development and the interim results for The Supervisory Board reviewed the appropriateness of the remuneration system for the Management Board and employees, which had been revised with the involvement of external remuneration consultants based on the amended German Remuneration Ordinance for Institutions (Institutsvergütungsverordnung, InstitutsVergV). In addition, it dealt with the remuneration report and the setting of the total amount of variable remuneration. At the meeting in November 2014, the Management Board presented the business and risk strategy as well as the medium-term financial and capital planning, and discussed both subjects in detail with the Supervisory Board. A discussion was held about the findings from the efficiency review that was conducted with the support of an external consultant to determine the effectiveness of the composition and activities of the Supervisory Board and the Management Board, and the corresponding written report was subsequently accepted. During the reporting period, the Supervisory Board satisfied itself of the efficacy of the risk management system, particularly of the internal control system and the Internal Audit department. The members of the Management Board and the Supervisory Board participated in an ongoing and independent manner in professional education and training necessary for their duties. As part of a capital increase from contingent capital, the Bank s share capital was raised in February 2015 from million to million in compliance with the Report of the Supervisory Board 65

64 requirements of the Bank s Articles of Association. The new shares were transferred to LSF5 DHB Debt Holdings LLC, resulting in the following breakdown of share ownership: LSF5 German Investments II L.P., Delaware (84.6%), LSF5 DHB Debt Holdings LLC, Dallas (10.0%), and LSF5 Riverside Ltd. & Co. KG, Frankfurt/Main (5.4%). The accounting and annual financial statements for the 2014 financial year, together with the corresponding management report, were audited by the auditors Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Düsseldorf, as appointed by the Annual General Meeting and mandated by the Supervisory Board. The annual financial statements were given an unqualified audit opinion. The audit report and all relevant appendices and documents were sent to the members of the Supervisory Board in good time prior to the meeting in April 2015 at which the annual financial statements were discussed. Representatives of the auditors took part in the Supervisory Board meeting called to adopt the annual financial statements, and the auditors reported in detail on the main findings of their audit. They made themselves available to the members of the Supervisory Board to answer questions. Following its own review, the Supervisory Board raised no objections and approved the results of the audit of the annual financial statements by the auditors. appointments as members of the Supervisory Board, and Benjamin Dickgiesser and William D. Young were elected as their successors. After William D. Young resigned his position in March 2015, Dr. Thomas A. Lange was elected to be his successor in the Supervisory Board at an extraordinary shareholders meeting on 25 March The Supervisory Board supported the acquisition of the shares of Düsseldorfer Hypothekenbank AG by Resba Beteiligungsgesellschaft mbh, Berlin, in the amount of 94.6% and by Einlagensicherungs- und Treuhandgesellschaft mbh, Cologne, in the amount of 5.4%. This acquisition was carried out on 24 March 2015 following a guarantee issued by the German Deposit Protection Fund of the Federal Association of German Banks (Bundesverband deutscher Banken e.v. Einlagensicherungsfonds) to secure the Bank s receivables against HETA ASSET RESOLUTION AG. The Supervisory Board would like to thank Bruno Scherrer, Dr. Andreas Tuczka and William D. Young for their commitment as well as the members of the Management Board and all employees of the Bank for their work and dedication during the past year to reposition the Bank in the market as a Pfandbrief bank for commercial real estate financing. Düsseldorf, in April 2015 Supervisory Board The Supervisory Board approved the annual financial statements prepared by the Management Board at its meeting on 28 April The annual financial statements for 2014 have therefore been adopted. Pursuant to Section 312 AktG, the Management Board prepared a report on relationships with affiliated companies and presented it to the Supervisory Board along with the auditors report. After reviewing the Management Board report, the Supervisory Board approved it together with the related auditors opinion. The opinion reads as follows: Dr. Karsten von Köller Chairman Based upon our audit and evaluation undertaken in accordance with our professional duties, we confirm that 1. the factual statements in the report are correct, 2. with regard to the legal transactions mentioned in the report, the consideration paid by the Bank was not unduly high. There were no changes to the Management Board or the Supervisory Board during In 2014 the Supervisory Board extended the appointment of Dr. Christian von Villiez. At an extraordinary shareholders meeting on 29 January 2015, Bruno Scherrer and Dr. Andreas Tuczka resigned their 66 Düsseldorfer Hypothekenbank AG Geschäftsbericht 2014

65 Country-by-country report pursuant to Section 26a KWG

66 44 Country-by-country reporting in m Germany Revenue Result before taxes Taxes 0.0 Received public aid 0.0 Employees (amount) 74 Foundations The requirement to provide country-specific reporting in accordance with Article 89 of EU Directive 2013/36/EU (CRD IV) has been transposed into German law in Section 26a (1) KWG. The required disclosures relate to the separate financial statements under German commercial law of Düsseldorfer Hypothekenbank with its registered office in Germany. Geographical segmentation is based on the legal domicile of the reporting entity. During the reporting year the Bank had neither branches nor representative offices. Reporting Düsseldorfer Hypothekenbank AG operates as a credit institution. Its revenue in the financial year was m and its result before taxes amounted to m; the Bank had 74 employees. [C44] Return on equity The Bank s return on equity in accordance with section 26a (1) sentence 4 KWG amounts to -0.37%. The required amount of revenue is defined in this report as the sum of net interest income, net commission income and other operating income. Taxes relate to taxes on income. The data on the number of employees relates to full-time equivalent positions as of 31 December 2014; part-time positions are converted on a full-time basis. 68 Düsseldorfer Hypothekenbank AG Annual Report 2014

67 Imprint

68 Editor Düsseldorfer Hypothekenbank AG Berliner Allee Düsseldorf HRB Düsseldorf Nr Contact Corporate Communication & Human Resources Barbara Hugo-Dilworth T: F: E: Layout and Conceptual Design Amt für Gestaltung, Berlin Goss + Partner, Köln The binding version of this Annual Report is the German Geschäftsbericht 2014 of Düsseldorfer Hypothekenbank AG. 70 Düsseldorfer Hypothekenbank AG Annual Report 2014