INTERIM REPORT 06.10 The binding language and version of this interim report is German, or rather the German version.
I3 DHB Interim report 06.10 Sale of Düsseldorfer Hypothekenbank With the conclusion of the purchase agreement on 30 June 2010, the lengthy process of the sale of Düsseldorfer Hypothekenbank, involving Resba Beteiligungsgesellschaft mbh (a subsidiary of the Deposit Protection Fund of the Association of German Banks (Bundesverband deutscher Banken - Einlagensicherungsfonds)) and Einlagensicherungsund Treuhandgesellschaft mbh (a subsidiary of the Auditing Association of German Banks (Prüfungsverband deutscher Banken)) on the one side and Lone Star on the other, came to a conclusion. The sale provides Düsseldorfer Hypothekenbank with a solid platform on which it can restructure its business and conclude the transition phase after the bank was taken over by the Deposit Protection Fund of the Federal Association of German Banks in spring 2008. The parties are planning to hand over control of the Bank in August/September 2010. In the course of the stock takeover, Lone Star will provide the bank with a considerable amount of liable equity capital in order to permanently strengthen its capital base. This restructuring plan also envisages the organised return of the bank s assets to mitigate risks and reduce the leverage ratio. INTERIM MANAGEMENT REPORT Sale of the subsidiary, Bankhaus Bauer, Stuttgart The process of selling the subsidiary, Bankhaus Bauer in Stuttgart, which commenced in spring 2009, reached the first milestone in January 2010 when the contractual documentation was signed. The asset deal is expected to be closed in September 2010. Bankhaus Bauer and all its employees will be taken over by a private banking-oriented investor and converted into a full-service bank.
4I DHB Interim report 06.10 The wider environment During the first six months of the fiscal year 2010, the 13th year of business for Düsseldorfer Hypothekenbank, the government debt crisis which had set in at the outset of the year led to a period of euro weakness. At the end of 2009, the euro was trading at USD 1.44, falling below USD 1.20 in June the lowest external value for over four years and closing half way through the year at USD 1.23. Historically high levels of government debt, particularly in the peripheral euro zone countries of Portugal, Italy, Ireland, Greece and Spain (the so-called PIIGS countries), coupled with a loss of confidence in the EU s capacity to act, depressed the single currency in this period. To counteract developments in the capital markets, some of them dramatic, the euro zone countries agreed a rescue package for Greece, initially comprising 30 bn, on 10/ 11 April 2010. Bi-lateral aid has been provided by almost all euro zone countries within the framework of the programme, which runs until 2012. Germany s contribution is 8.4 bn. The euro s downward slide continued when Eurostat published higher deficits for Greece and other euro zone countries on 22 April 2010 and Greece made a public appeal for financial aid from the EU one day later. Standard & Poor s withdrawal of its investment grade rating for Greek government bonds threatened to render them ineligible as collateral for ECB loans. The ECB then decided to change its collateral rules, offering to indefinitely accept the country s government bonds as refinancing collateral, regardless of the country s credit rating. At the beginning of May, euro zone countries and the International Monetary Fund (IMF) agreed on a 110 bn bailout package for Athens, up to 22.4 bn of which will be contributed by Germany. The EU Member States also believed it necessary to craft a 750 bn rescue package for the entire euro zone. A European Directive was issued granting a direct loan of 60 bn to the European Financial Stabilisation Mechanism pursuant to Article 122 of the Treaty on the Functioning of the European Union (TFEU), which it can draw upon until further notice. If this amount is not sufficient, a further 440 bn in the form of bi-lateral loan guarantees from the EU Member States will be made available. These guarantees collateralise funds made available to the capital markets via a special purpose vehicle. The IMF is also providing a loan facility of 250 bn subject to the terms of its existing stand-by arrangements. The ECB and the national central banks are supporting the programme by pur-
I5 DHB Interim report 06.10 chasing government bonds issued by selected euro zone countries. At the end of June 2010, 59 bn of government bonds had been purchased on the secondary market. The resulting additional liquidity was then absorbed from the money market by ECB measures. Doubts as to the PIIGS countries ability to consolidate their national budgets led to a run on top quality stocks, particularly German government bonds. The yield on ten-year (two-year) government bonds fell to 2.58% (0.60%) at the end of the first six months of the year, recovering slightly from an historical all-time low of 2.51% on 8 June 2010. At the beginning of the year, it had been 3.39% (1.33%). Development of itraxx SovX Western Europe during the year 2010 in bp Jan Feb Mar 0 50 100 150 200 In contrast, the yields on PIIGS country bonds increased in some cases dramatically. The downgrading of Greek government bonds to a noninvestment grade rating by Standard & Poor s at the end of April 2010 caused investors to panic sell their Greek government bonds, driving the yield on ten-year Greek bonds from 5.77% (31 December 2009) to a record high of 12.45% on 7 May 2010. At the end of the first six months of the year, the yield was 10.43%. In the other PIIGS countries, the increases in yields were not as spectacular. On 30 June 2010 (31 December 2009) the return on ten-year Portuguese government bonds was 5.70% (4.08%), Spanish government bonds 4.56% (3.98%) and Irish government bonds 5.50% (4.83%). The yield on ten-year Italian government bonds declined slightly from 4.14% to 4.09%. Apr May. Jun Even on a broader basis, spreads in Europe are considerably higher, as is evident by the development of itraxx SovX Western Europe. This index represents an unweighted average of the credit default swap (CDS) spreads of 15 sovereign issuers in western Europe. It rose from 70 bp at the beginning of the year to a record high of 157 bp at the end of June. The five-year CDS spread for government bonds increased sharply from 26 bp at the beginning of the year to 45 bp on the reporting date. The German stock market was relatively unimpressed by the budget crises in many euro zone countries. The main German stock market index, the DAX, rose from 5,957 points at the beginning of the year to 5,966 points mid-year. The DAX reached a six-month low on 5 February at 5,434 points and a six-month high on 26 April at 6,332 points. This development was supported by overall positive economic data and growth forecasts. The ECB s June bulletin forecasts average economic growth in the euro zone of 1%, which is 0.2 percentage points higher than the March bulletin forecast. According to the Hamburg Institute for World
6I DHB Interim report 06.10 Economics (Hamburger Weltwirtschaftinstitut), growth of the German economy is likely to be as high as 1.5% in 2010. The German Chamber of Industry and Commerce (DIHK) is even more optimistic, forecasting 2.3% growth, while the Deutsche Bundesbank expects GDP to increase by 1.9%. According to the Deutsche Bundesbank, the growth is mainly export and inventory-driven. The robust labour market has coped relatively well with the most serious recession since the war. At the end of June the unemployment rate was 7.7% (8.1% at 31 December 2009) and stable consumer price developments have contributed to the optimism. The ECB made an important contribution to the stabilisation of the economy by leaving the base rate at 1% and providing the banking sector with adequate liquidity. The 3-month EURIBOR rate dropped from 0.70% at the beginning of the year to 0.63% at the end of the first quarter, rising again to 0.77% at the end of the period under review. The increase also reflects the ECB s discontinuation of a number of temporary support measures such as the 12-month tender of 442 bn which matured on 1 July 2010 and was not prolonged. Unsecured interbank transactions remained sluggish. The banks in the euro zone still have substantial amounts of funds deposited with the ECB at an interest rate of only 0.25%. In June, the deposit facility reached a volume of up to 369 bn, which is an indication of sustained tension in the money market. Development of the commercial property market The German property market also profited from the overall recovery of the economy in the first six months of the year. The more positive sentiment was expressed in a German Property Market Index published by an international appraisal company, which increased from 85.1 points at the beginning of the year to 104.0 points at the end of June 2010. It is two years since the index has risen above the 100 points threshold. On the six largest German office markets, Berlin, Düsseldorf, Frankfurt, Hamburg, Stuttgart and Munich, signs of recovery were evident. For the first time in six quarters the take-up of rental space showed an increase in the first quarter of the period under review. According to Jones Lang LaSalle (JLL) around 586,000 square metres were leased in the main German office markets, which is 6% more than in the first three months of the prior year. Office space take-up developed very differently from region to region. Düsseldorf recorded the most positive development with an increase of 145%; followed by Munich, a long way behind, at 10%. Berlin (105,000 sq m) and Hamburg (90,000 sq m) recorded take-up at a similar level to the previous year. Frankfurt, in contrast, experienced a significant decline of 61%, whereas Stuttgart reported a more moderate decline of 10%.
I7 DHB Interim report 06.10 The continuing restrained demand for office rental space, coupled with access to completed and vacant new buildings, led to a slight increase in the average vacancy rate from 9.9% at the end of 2009 to 10% at the end of the first quarter of 2010. Above-average vacancy rates were recorded in Frankfurt at 13.8% (Q1 2009: 12.2%) and Düsseldorf at 12.4% (10.9%), while Stuttgart s vacancy rate was only 6.6% (6.4%). Prime rents hardly changed between the end of 2009 and the end of the first quarter of 2010 which also indicates a stabilisation of the demand situation. The highest rents are seen in Frankfurt at 34 per square metre, followed by Munich at around 29 per square metre. While last year domestic investments experienced a 60% decrease as a result of a slump in the volume of transactions in the six largest property markets, the first six months of 2010 indicated an increase in the investment activity. This development was driven by the gradual recovery of the property value and the increasing willingness of banks to underwrite new loans. The retail property segment s development was particularly positive. In Germany alone, first quarter investments in this segment were 2.3 bn, which is almost 50% of the total transaction volume of 4.7 bn. The returns on properties in prime locations were in the range of 4.9% to 5.4%, which is slightly lower than in the first six months of last year when the average return was 5.4%. Other European commercial property markets also profited from the gradual stabilisation of rents. A rent price index published by Jones Lang LaSalle (JLL) based on the weighted performance of 24 European cities showed the first slight increase since 2008 and closed the first quarter of 2010 with growth of 1.2%. This positive development was due to the improvement of the economic frameworks in most countries. The recovery of the rental market also put a stop to the rising vacancy rates reported in previous periods. Overall, the average European vacancy rate for commercial properties was 10.2% at the end of the first quarter and therefore, has stabilised since the end of 2009.
8I DHB Interim report 06.10 The transaction volume in Europe almost doubled from 9.9 bn in the first quarter of last year to 17.2 bn. The majority of transactions involved prime properties with long-term secured cash flows. Most transactions are accounted for by the retail property segment at 7.6 bn ( 3.1 bn), followed by office properties at 6.3 bn ( 3.5 bn). Around 1.5 bn ( 1.4 bn) was invested in mixed use properties and around 1.3 bn ( 1.3 bn) in industrial properties. Most investments were made in the United Kingdom ( 4.8 bn), Germany ( 4.7 bn) and France ( 1.8 bn). However, the volume of investments has only increased in Germany since the fourth quarter of 2009 ( +1.6 bn). It declined in the United Kingdom and France by 4.8 bn and 2.3 bn respectively. Only a few regions in the US commercial property market showed initial signs of recovery. According to JLL, the decline in rents in the entire US office property market continued to pick up pace in the first quarter of 2010. Washington D.C. was one of only five out of forty four cities and regions where the rate of rent decline slowed. The average vacancy rate in the office property sector increased again slightly from 18% at the end of 2009 to 19% at the end of the first quarter of 2010. The transaction volume for office properties was around USD 3.8 bn at the beginning of the spring quarter, which corresponds to the prior year level. The investment focus was on fully leased properties in good to prime locations. Development of the property financing portfolio Mortgage loans by property location Portfolio 30 June 2010 (31 December 2009) East Germany 2.5% (2.5%) Abroad 61.3% (58.8%) Due to the ongoing sale process in the six month period under review and taking the current refinancing situation into account, Düsseldorfer Hypothekenbank did not effect any new property financing transactions in the first six months of 2010. Although loan repayments of 43.0 m were made, the portfolio of mortgage loans valued at the rate on the reporting date remained almost constant. The total property financing portfolio (not including Bankhaus Bauer) including securitised loans (mortgage-backe securities/ MBS) had a volume of 1,793 m on 30 June 2010, which is 3.0 m lower than the volume on 31 December 2009 ( 1,796 m). There were slight displacements in the portfolio as a result of exchange rate fluctuation and repayments. The proportion of mortgages to finance properties in western Germany, including Berlin, declined to 36.2% (38.7%), while the proportion of mortgages to finance east German properties remained constant at 2.5% (2.5%). 28.4% (28.7%) comprises loans for properties in other EU countries and the remaining 32.9% (30.1%) pertains to other foreign countries (USA, Canada, Switzerland). West Germany (incl. Berlin) 36.2% (38.7%)
I9 DHB Interim report 06.10 The lending portfolio has also remained constant in terms of property use. The proportion of mortgage loans for residential properties declined slightly to 20.9% (21.1%) while loans for commercial property increased slightly to 79.1% (78.9%). The majority of commercial properties are office properties 53.9% (52.3%), followed by wholesale and retail properties at 13.3% (15.2%) and operator properties (hotels, retirement homes) accounted for 11.9% (11.4%) of the portfolio. The average financing package totalled 12.5 m per borrower ( 12.2 m). Mortgage loans by use of property Portfolio 30 June 2010 (31 December 2009) Residential 20.9% (21.1%) Commercial properties 13.3% (15.2%) The property financing portfolio includes 322 m ( 327 m) of MBS. This slight decline is due to scheduled and some unscheduled repayments. The MBS portfolio consists of traditional, single step pass-through structures. The underlying receivables serve exclusively to finance properties in western Europe, 50% of which are residential properties (residential MBS) and 50% of which are commercially used properties (commercial MBS). The total of 24 tranches from 17 MBS issues are spread amongst the following countries: mixed EU 20.8%, United Kingdom 20.8%, Spain 17.2%, Italy 15.5%, Ireland 6.6%, France 6.1%, Portugal 5.4%, Greece 5.3% and Germany 2.3%. A total of 48.1% of the portfolio is eligible as collateral for ECB loans. Two of the 24 MBS tranches had their rating downgraded in the period under review. One result of this was a higher level of equity tie-up. Other business 11.9% (11.4%) Office and administration 53.9% (52.3%) On 30 June 2010, 56.1% (60.6%) of the portfolio had an AAA rating confirmed by at least one rating agency, 19.6% (13.8%) had an AA rating; another 14.8% (14.2%) had a single A rating and 9.5% (11.4%) was rated at BB or B. There is still no indication of any need to write-down the MBS portfolio. The repayment profile shows that 76% of the current loans will be repaid by the end of 2014, assuming scheduled repayments. Development of the capital market portfolio The Düsseldorfer Hypothekenbank s capital market business segment consists of the public-sector lending portfolio (ordinary coverage), substitute cover business and business not eligible for the cover pool. In accordance with the business objective of progressively scaling back capital market business and conducting it merely as a complementary business line to property financing business in future, the total volume of the capital market business portfolio declined as a result of scheduled repayments by 0.5 bn to 17.2 bn ( 17.7 bn). No new capital market business commitments were entered into.
10I DHB Interim report 06.10 Capital market business by segment Portfolio 30 June 2010 (31 December 2009) Public-sector lending 64.3% (64.3%) The public-sector lending portfolio value declined to 11,040 m ( 11,409 m) and it accounted for 64.3% (64.3%) of capital market business at the end of the first six months of the year. It comprises all loans and advances which qualify as ordinary cover for public-sector Pfandbriefe under the German Pfandbrief Act (Pfandbriefgesetz). The debtors are public bodies (states, regional governments, regional bodies) in Germany (46.7%), European Union and EEC Member States (50.4%), Switzerland (1.7%), Canada (0.6%), the USA (0.4%) and Japan (0.2%). 89.6% of the loans and advances have an investment grade rating of BBB- or higher and 3.5% have a BB+. 6.9% are not rated. The substitute cover portfolio, which dropped to 4,534 m ( 4,718 m) and consists of all securities receivable from banks (bank bonds) that are eligible under the rules of the Pfandbrief Act as substitute cover, accounts for 26.4% (26.6%) of capital market business. 23.1% of this portfolio segment comprises Pfandbriefe and other covered bonds from European countries. 90.7% of the loans have an investment grade rating; 1.1% have a BB+ or BB rating and another 8.2% are not rated. Not eligible for the cover pool 9.3% (9.1%) Substitute cover 26.4% (26.6%) The non-eligible for cover portfolio contains all securities that are not eligible for ordinary cover or substitute cover. It declined to 1,593 m ( 1,617 m) and is composed of the following elements: 35.0% bank bonds, 30.7% structured cédulas, 13.2% public-sector loans, 14.1% profit participation certificates/ hybrid bonds and 7.0% corporates. 92.4% of receivables have an investment grade rating and 1.1% are unrated.
I11 DHB Interim report 06.10 Refinancing and liquidity The ECB s Covered Bond Purchase Programme was commenced in July 2009 and closed at the end of June 2010 with purchases of Covered bonds amounting to a nominal value of 61.1 bn. The objective of stabilising the issue spreads of covered bonds was achieved. At the end of the first six months of the year, the issue spread for ten-year terms was 24 bp above the swap curve for mortgage Pfandbriefe and 17 bp above the swap curve for public-sector Pfandbriefe, which had stood at 31 bp and 24 bp respectively at the end of 2009. In the first six months of 2010, covered bonds in the jumbo segment of 91.3 bn were re-issued by a total of 49 banks, including seven banks in Germany, which accounted for a volume of 14 bn. The outstanding jumbo bonds increased from 880 bn at the beginning of the year to 913 bn half way through the year. For some time now, there has been a trend of issuing covered bonds below the jumbo format limit of 1 bn. The preferred issue volumes are between 500 and 750 m. The issue of Pfandbriefe played a subordinate role for Düsseldorfer Hypothekenbank during the period under review due to the fact that it had suspended new loans business. In the first six months of 2010, mortgage Pfandbriefe of 80 m ( 110 m) were issued and there were no publicsector Pfandbrief issues. One of the Bank s important pillars for securing liquidity was once again open market business with the ECB, which amounted to a total mid-year volume of 5.9 bn ( 5.5 bn at the end of 2009). Repo business with other banks increased to 2.6 bn from 1.8 bn at the end of 2009. Other sources of funding were fixed-term deposits and customer deposits, as well as issues of short-term bonds. The volume of loans taken up increased by 63% to 1.1 bn, compared with the same period last year ( 727 m). In the first six months of 2010, a total of 1.3 bn ( 3.3 bn) in funding was taken up in all maturity bands. 93.8% (96.7%) was accounted for by unsecured funds and 6.2% (3.3%) by mortgage Pfandbriefe. The previous year s figure of 3.3 bn included bearer bonds of 2.5 bn which were guaranteed by the SoFFin [ Sonderfonds Finanzmarktstabilisierung : a federal agency managing the special fund to stabilise the financial
12I DHB Interim report 06.10 Funding structure % 30 Jun 2010 31 Dec 2009 Public-sector Pfandbriefe 38% 42% Mortgage Pfandbriefe 4% 4% Securities: ECB lending against (tender) 28% 24% Securities: Banks' lending against (repo) 12% 8% Other bank liabilities 2% 2% Client deposits 10% 9% Bearer bonds 6% 11% Subordinate liabilities 0% 0% 100% 100% markets]. The first SoFFin-guaranteed tranche of 1.25 bn was repaid on 12 March 2010 and the second tranche of the same amount expires on 11 March 2011. SoFFin granted Düsseldorfer Hypothekenbank an adjusted guarantee of 2.4 bn at the middle of the year, taking the still outstanding SoFFinguaranteed tranche into account. 0.8 bn has a term of one year and 1.6 bn a term of three years. Utilising this guarantee, the Bank issued a SoFFin-guaranteed bond of 0.8 bn with a 364-day term on 29 July 2010. It was well-accepted in the market with a re-offer spread referenced to the one-year mid-swap rate of -24.6 bp. Ratings The voluntary commitment to public-sector Pfandbrief creditors published in September 2004 by Düsseldorfer Hypothekenbank, in which it undertook to uphold specific minimum standards, was revoked on 30 April 2010. Due to the complete revision of rating agency concepts for the valuation of Pfandbriefe and amendments to German Pfandbrief Act, these minimum standards were no longer current. For example, the rating agencies requirements of the net present value of cover stock now exceed the requirements in the undertaking. The other minimum standards, such as the hedging of variable interest rate positions, are no longer evaluated in isolation by the rating agencies, but within the framework of integrated management concepts. Finally, the undertaking to ensure the liquidity of cover stock (by holding an adequate number of securities eligible as collateral for ECB loans to cover the maximum cash outflow within the next 180 days) has been a statutory requirement of Pfandbrief quality since the most recent amendment to the German Pfandbrief Act.
I13 DHB Interim report 06.10 Standard & Poor s rating of public-sector Pfandbriefe was withdrawn from the bank on 16 June 2010. This withdrawal as a result of Standard & Poor s new rating method was associated with a rating downgrade for public-sector Pfandbriefe from AAA to AA-. The withdrawal of the rating is associated with a decline in the significance of public-sector loans in the new business strategy. As a result of the lower funding requirements in this business sector, a valuation of public-sector Pfandbriefe by one rating agency is now considered to be fully adequate. In future, the Bank will only collaborate with FitchRatings because this agency rates both the Bank s public-sector Pfandbriefe and its unsecured loans. When the sale of Düsseldorfer Hypothekenbank to Lone Star was announced, FitchRatings downgraded the Bank s rating from A- to BBB- with stable outlook, the short-term institute rating from F1 to F3 and the support rating from 1 to 2. It did, however, upgrade the individual rating from F to E and the public-sector Pfandbrief retained its AAA (watch negative) rating. In accordance with a new voluntary commitment published on 1 July 2010, the Bank undertakes to maintain voluntary nominal overcoverage of at least 7.4% in respect of public-sector Pfandbriefe in circulation. The Bank reserves the right to change the parameters of this commitment or withdraw it completely subject to four weeks notice. The currently effective version of the voluntary commitment can be viewed on the internet at www.duesshyp.de. Own funds and total assets Liable capital as defined by section 10 of the German Banking Act (KWG) amounted to 365 m ( 364 m) as at 30 June 2010. 299 m ( 299 m) of this amount qualifies as core capital and 66 m ( 65 m) as supplementary capital. The core capital ratio was 7.5% (7.4%) and the total capital ratio was 9.1% (9.0%). On the reporting date, the Bank s total assets amounted to 22.5 bn, down from 24.2 bn at the end of 2009. This decline is mainly due to maturities in public-sector lending and securities business, and the maturity of a SoFFin-guaranteed bearer bond of 1.25 bn on 12 March 2010. It has been agreed that Lone Star, as the new owner, will provide liable capital immediately after closing the contract of purchase in the amount of 525 m to strengthen the Bank s capital base:
14I DHB Interim report 06.10 375 m will be furnished to the bank in the form of a silent partnership interest to meet the core capital requirements of section 10, para. 2a, 1.8 and para. 4 of the German Banking Act (KWG). 60 m of the amount was contributed in July 2010. A further 150 m will be made available by subscription to a mandatory convertible bond to satisfy the supplementary capital requirements pursuant to section 10, para. 2b, 1.5 of the German Banking Act (KWG). A mandatory conversion into share capital will be effected should the Bank s core capital ratio falls below 8%. The Düsseldorfer Hypothekenbank s extraordinary meeting of shareholders on 21 July 2010 passed a resolution in favour of this corporate action. Earnings position Income statement 30 June 2010, Million 2010 2009 Net interest income 1.7 34.9 Net commission income -6.3-6.0 Net interest and commission income -4.6 28.9 Other operating result 0.2 1.1 Administrative expenses -11.6-13.3 Gross income -16.0 16.7 Valuation result -0.7-13.6 Operating income -16.7 3.1 Extraordinary result -6.3 0.0 Result before taxes -23.0 3.1 Taxes 0-0.4 Result after taxes -23.0 2.7 In the first six months of 2010, the main factors determining the Bank s earnings position were still the profit-depressing activities in prior years (up to and including 2007) in the form of swap close-outs the approximately two-year suspension of new property financing and public-sector lending business and the more problematic funding framework. Net interest income declined to only 1.7 m from 34.9 m in the prior year. As in the previous year, it does not contain any contribution to earnings from the premature close-out of derivatives. The first time application of the German Accounting Law Modernisation Act (Bilanzrechtsmodernisierungsgesetz, BilMoG) also had a negative impact on the earnings position. Current effects of -6.1 m were incorporated in the net interest income and first-time application effects of -6.3 m in the extraordinary result. Both of these effects are predominantly related to the accounting treatment of valuation units pursuant to section 254 of the German Commercial Code, new version. Commission income decreased to -6.3 m ( -6.0 m) mainly due to the payment of guarantee commissions to SoFFin. Net interest and commission income therefore declined in the period under review by -4.6 m ( 28.9 m). Personnel expenses remained stable at 3.5 m ( 3.5 m) with a slight increase in the average number of employees to 81 (78). In contrast, nonpersonnel expenses declined from 9.7 m in the previous year to 8.1 m. The largest portion of administrative expenses includes an adjustment to
I15 DHB Interim report 06.10 the allocations required by the Deposit Protection Fund of the Federal Association of German Banks of 2.0 m, consulting expenses of 1.5 m and IT expenses of 1.2 m. Legal expenses, court costs and insurance premiums amounted to approximately 0.7 m. Total administrative expenses (including depreciation of property, plant and equipment) amounted to 11.6 m ( 13.3 m). Other operating income amounted to 0.2 m ( 1.1 m). The valuation result includes both risk provisioning for property lending business and for public-sector loans and securities, plus all income and expenses from the netting option pursuant to section 340 f (1) of the German Commercial Code, HGB and amounted to -0.7 m ( -13.6 m). At the end of the six month reporting period, the Bank generated a loss of -23.0 m ( 2.7 m). RISK REPORT Risk categories and types of risks Development of credit risk (CVaR) during the year 2010, limit utilisation in % The Bank has identified its main risk categories as market risk, credit risk, liquidity risk and operational risk. It has also identified other risks such as strategic risk, reputation risk and marketing and income risk. In contrast to the main risk categories, other risks are not managed by a special system of measures and limits. Jan Feb 0 20 40 60 80 100 Credit risk Mar The monthly quantification of the credit risk is performed using a defaultbased credit risk model. The credit risk is expressed as Credit Value at Risk (CVaR), and calculated on the basis of estimated risk factors for probability of default (PD) and loss given default (LGD) in conjunction with external (capital market) and internal (property financing business) ratings according to recognised mathematical-statistical processes. CVaR expresses the maximum loss for a holding period of one year which, with a probability of 99%, will not be exceeded on the basis of the defined parameters. Apr May. Jun Development of credit value at risk The CVaR on the reporting date was 127.1 m, which is only slightly higher than at the end of the prior year ( 126.0 m); the average of the monthly values in the first six months of 2010 was 117.9 m.
16I DHB Interim report 06.10 Risk provisions for property finance business Real Estate by risk class Portfolio 30 June 2010 (31 December 2009) Normal loans 95.5% (95.1%) Loans with risk 1.8% (1.6%) Non-performing loans 2.7% (3.3%) On the reporting date, 95.5% (95.1%) of the total property finance portfolio was classified as normal exposure (risk category (RC) I to III), 1.8% (1.6%) as problem exposure (RC IV and V) and 2.7% (3.3%) as non-performing (RC VI). As a result of the Bank s conservative risk policy, the impacts of the global financial and economic crisis on the property finance portfolio s credit quality were moderate. In a number of loans, the property values were adjusted to changed market conditions. When the Bank had arranged loan-to-value covenants, this led in some cases to restructuring agreements, resulting in improved conditions for the Bank due to higher margins, partial loan repayments or the provision of additional collateral. During the period under review, no breaches of covenant led to defaults on loans. Under application of conservative benchmarks, the provisions for risks were increased by 1.0 m ( 6.7 m) at 30 June 2010. As a result of the rescue acquisition of a property within Germany, it was necessary to draw upon the risk provision formed in the prior years of 12.0 m. 7.8 m was used in respect of interest-bearing receivables and 4.2 m in respect of interest receivables. Risk provisions for property financing business totalled 19.9 m ( 29.3 m) on the reporting date; which corresponds to 1.1% (1.6%) of the entire property finance portfolio. Risk provisions for capital market business As a result of changes in the portfolio and taking drawdowns, additions and reversals, plus a provision for general banking risks into account, the absolute balance of risk provisions was 37.8 m as compared with 40 m at the end of last year. The provisions for risks still amount to 0.2% (0.2%) of the total capital market business portfolio. Capital market and MBS exposure in PIIGS countries Düsseldorfer Hypothekenbank s exposure in the PIIGS countries amounted to 4.8 bn, including MBS, at 30 June 2010. Spreads increased, often considerably, in the first six months of the year. Five-year credit default swap spreads on Greek government bonds reached record levels. Starting the year at 283 bp, they fluctuated strongly, rising to 910 bp on the reporting date.
I17 DHB Interim report 06.10 The credit default swap spreads on Portuguese, Spanish, Irish and Italian government bonds also rose substantially during the six month period. The following five-year spreads applied as at 30 June 2010 (4 January 2010): Portugal 310 bp (92 bp), Spain 261 bp (114 bp), Ireland 266 bp (157 bp) and Italy 190 bp (109 bp). The highest PIIGS exposure is accounted for by Spain at 2.2 bn, including 335 m unsecured bonds issued by Spanish savings banks. Founded in 2009, the Fund for Orderly Bank Restructuring FROB facilitates the restructuring of Spanish banks at risk. It also provides liquidity guarantees and capital endowment. The initial capital endowment approved by the Spanish parliament is 99 bn. 34 of the 45 Spanish savings banks are involved in 11 separate restructuring processes, which is making an important contribution to the stabilisation of the banking sector and has the objective of improving the banks strength and efficiency. As a result of the Spanish savings banks relevance to the banking system and the FROB s extensive support measures, the probability of default on loans and advances to Spanish savings banks can be assumed to be low. Italy exposure amounts to 1.6 bn of which 50 m pertains to MBS and mainly includes Italian government bonds and sub-sovereigns. Italy s relatively high level of national debt, which had risen to 115.8% of GDP at the end of 2009, is compensated to some extent by the low level of private sector debt. Italy s property market has also been stable for many years and it has a banking sector which has only been moderately impacted by the financial crisis. Exposure in Greece of 440 m is accounted for almost exclusively by government bonds, the exceptions being 45 m loans and advances to banks and 17 m MBS. The budget consolidation measures required by the EU and IMF are being pro-actively implemented. The budget deficit in the first half of the 2010 was, in fact, below the required 5.8% of GDP at 4.9%. At the end of the 2010, the budget deficit of 13.6% of GDP is to be reduced to 8.1%. The purchase of government bonds and their acceptance as collateral for open market operations by the ECB, despite the downgrading of the rating to non-investment grade, underlines its confidence in the success of Greek national budget restructuring measures. Even though there are still some doubts as to whether Greece will actually be capable of maintaining its tough savings policy, the EU s rescue package guarantees Greece s solvency until the end of 2012. The capital market has also honoured Greece s attempts at restructuring by lowering the risk premiums.
18I DHB Interim report 06.10 Portugal exposure of 435 m mainly comprises government bonds and bonds issued by state-owned enterprises. Unlike Spain, Portugal is not suffering as a result of a slump in property prices. The banks have managed to cope relatively well with the financial crisis until now, they have negligible sub-prime risk exposure and relatively healthy structures. At the same time, the country has substantial budget deficits and has been downgraded by Moody s to A1. Drastic cost-cutting measures have been introduced to reduce the budget deficit from 9.4% of GDP (2009) to 3% in 2012. The lowest PIIGS exposure of 146 m is in Ireland. The Bank has bank loan commitments of 125 m and MBS commitments of 21 m in Ireland. The Irish government's decision to support some Irish banks has had a stabilising effect on the banking sector. The guarantees issued by the government, plus its transfer of high risk assets to bad banks show that a consistent strategy is being implemented to overcome the crisis. Market risk Development of interest rate risk during the year 2010, limit utilisation in % Jan Feb Mar Apr 0 20 40 60 In order to measure and control market risk, the Bank calculates value at risk (VAR) using a variance/co-variance approach of all balance sheet and off-balance sheet interest risks on a daily basis. VAR shows the loss, determined over an observation period of 250 stock market trading days which, with 99% probability, will not be exceeded within ten days. The VAR forecast is then compared on a daily basis with the actual losses in value which are incurred (back-testing). The bank maintained its market risk at a low level in the six month period under review. The given VAR limit was not exceeded at any time. On the reporting date, VAR was 3.7 m ( 6.5 m), with the six month average VAR being 6.3 m ( 9.8 m). This corresponds to an average utilisation of the VAR limit of 23.1%. The highest daily VAR measured in the first six months of 2010 was 9.7 m ( 14.5 m). May. Jun The actual change in value of interest-bearing items did not exceed the forecast VAR on any day. The simulation of the interest shock did not result in any outliers in the period under review. The 20% limit was not exceeded at any time. In fact, the average for the six month period under review was less than 14% of this limit.
I19 DHB Interim report 06.10 Liquidity risk The Bank has a comprehensive range of tools for the analysis and management of liquidity. It ensures the timely recognition of potential liquidity shortages so that suitable and targeted measures to safeguard liquidity can be initiated. A short-term liquidity forecast is prepared each day. It provides information on the current liquidity status and the Treasury department s liquidity plan for a planning horizon of at least three months. Additionally, at the end of each month, a long-term liquidity forecast covering a period of at least three full calendar years is prepared. Various scenarios are calculated and analysed on this basis. To date, no standard has been established in the banking sector for the quantification of liquidity risk. In accordance with MaRisk (the minimum requirements for risk management), the liquidity risk will not be taken into account in the Bank s risk tolerance concept for the time being. The liquidity ratio reported pursuant to the Liquidity Ordinance (LiqV) was between 1.1 and 1.5 in the first six months of the year and therefore above the limit of 1.0. In the period under review, the Bank had an adequate liquidity level at all times supported by the stabilisation measure granted by SoFFin. Operational risk The most important instruments for identification and mitigation of operational risks are the self-assessment and the loss database. Details of all losses incurred are entered and evaluated in a loss database. This provides the basis for the identification and analysis of loss causes, from which appropriate measures can then be derived and implemented. The historic data records are also used as a source of information about measures that have already been implemented and to judge their effectiveness. To measure operational risks, the Bank applies the basic indicator approach pursuant to sections 270 et seq. of the Solvency Regulation, SolvV. The operational risk of the bank did not exceed the given limit at any time. At the end of the first six months of the year the limit was utilised by 43.8%.
20I DHB Interim report 06.10 Risk management of cover funds The German Pfandbrief Act (PfandBG) requires that cover funds are covered at all times by funds with a present value exceeding the exposure by at least 2%. The Bank monitors compliance with this legal requirement on a daily basis. The net present value of the cover funds, taking account of the regulatory stress tests described above, are used to calculate the surplus in cover required by section 4 (1) PfandBG. In this way the required surplus is ensured even in the event of extreme interest and foreign exchange fluctuations (section 4 of the Regulation on Ensuring Adequate Cover of Pfandbriefe, PfandBarwertV). The Bank applies the dynamic method for its stress testing. The Bank complied with additional liquidity requirements on cover, imposed by the amendment to the Pfandbrief Act in 2009 to include the 180 days liquidity ruling, at all times. Risk position of the Düsseldorfer Hypothekenbank Risks which were significant for assessing the overall risk exposure of the Bank in the first six months of 2010 have been included in the preceding sections of this report. Further significant risks were not discernible in the period under review. The Bank has made an appropriate provision for all discernible risks. Outlook At the beginning of the second half of 2010, it is becoming increasingly evident that the euro zone countries economies are still in the process of recovery. The Economic Sentiment Index, which is widely recognised as an early indicator of economic development, rose from 99.0 to 101.3 points (July 2010) reflecting the more positive sentiment of the business and consumer sectors in the euro zone. The biggest increase is accounted for by Germany, where the sub-index rose 4.0 points to 110.1 points compared with the prior month. Parallel to this, the German IFO economic index increased by a substantial 4.4 points to 106.2 points in July 2010, which puts it on a par with the index level before the global financial and economic crisis. The ECB is likely to continue making a positive contribution to this growth by leaving the base rate at 1% for the remainder of the year and probably beyond. The ECB s longer-term refinancing transactions are likely to be restricted to three months again, and there are no plans to re-introduce six and twelve month tenders. However, the banks are likely to return to the bulk tender process with full allocation in the coming months.
I21 DHB Interim report 06.10 According to the IMF, German GDP growth will be 1.4% in 2010 compared with 1.0% growth in the euro zone. Growth is likely to be slightly lower than in the first six months of 2010 because world-wide economic recovery programmes are coming to a conclusion and measures to alleviate the debt crisis in Europe could slow recovery there. Confidence in the European Member States ability to reduce their high levels of national debt will play an important role in this respect. Greece s consolidation efforts are already bearing first fruits. In the first six months of 2010, the Greek budget deficit was reduced by more than 40%. There have been some fears, however, that the reduction of national debt - if implemented too quickly and rigorously - could slow European economic recovery. On the other side of the Atlantic, recent economic data is disappointing and the economic indicators have fallen again. This has resulted in fears about a double dip that could spread to Europe. However, one indication that the US economy is not on the verge of another recession is the high growth rates in winter 2009/ 2010 which were influenced to a great extent by inventory cycle effects. These naturally ebb over time. The declines could therefore reflect growth once the economy is in full swing again. This is why many analysts and the IMF are still forecasting 3.3% growth in the USA. Against this background, which is associated with economic imponderables, there is no indication of any substantial improvement to the interest curve by the end of the year. Due to the pending rise of money market interest rates, it is more likely that the interest curve will flatten out. The yield on ten-year German government bonds is likely to be around 3% in the second six months of 2010. The forward rate at the end of 2010 for ten-year interest swaps was 3.03% (as at 4 August 2010). Economic recovery in Europe will have a positive impact on the property market. The trend of stabilisation is likely to continue, albeit moderately and with regional differences. The fall in rents is likely to slow down across a wide front and slight growth will be recorded in some regions. The German investment market has already picked up pace and by mid year the volume increased substantially. According to BNP Paribas Real Estate, there has been around 9 bn volume of transactions in the six largest German commercial property markets, which is equal to a growth of 5.4 bn compared with the same period last year. The lion s share of this growth is accounted for by 6.7 bn ( 3.0 bn) in individual sales and 2.3 bn ( 0.6 bn) is accounted for by portfolio acquisitions. Total investments of around 15 bn are expected in Germany over the year as a whole, which is 4.5 bn more than in the prior year. The recovery of the other European investment markets also continued in the first six months of the year. Investments of approximately 43 bn in European commercial properties are more than 80% higher than in the previous year. According to JLL, it is possible that the 100 bn threshold will be crossed in the year as a whole.
22I DHB Interim report 06.10 After the conclusion of the purchase agreement between the former owners of Düsseldorfer Hypothekenbank and the Lone Star Group, and the planned transfer of control in August or September, the second six months of 2010 will be dominated by restructuring measures and the revision of the Düsseldorfer Hypothekenbank s business strategy. According to existing management plans, which are entirely subject to acceptance by the new shareholder, the focus will be on the commercial property financing business. New business activities will only consist of permanent financing which will mostly need to be eligible for the cover pool. The regional focus will be on Germany. Although direct financing business will be built up in Germany, foreign business will continue to be conducted primarily by syndicated partners. The Bank still has a broad network of partners in this respect. The Bank will continue to concentrate on selected segments which correspond to both risk exposure requirements and profit targets. Private customer business has been discontinued since the sale of the Stuttgart branch (Bankhaus Bauer). Internal restructuring activities at the Bank will be in accordance with the new business policy and associated with moderate personnel adjustments. Public-sector loans will likely be conducted as an insignificant, complementary line of business. The portfolios are to be reduced in an organised manner. This is why new business with securities eligible as cover will only be pursued to a limited extent and it will not offset maturities. Securities which are not eligible as cover will not be purchased. According to the preliminary plans, the portfolio of securities in this sector will decline to around 15 bn at the end of 2010 and to around 10 bn by the end of 2014 as a result of maturities. The Bank is to be repositioned as an investor-oriented Pfandbrief issuer. It is expected that it will concentrate on mortgage Pfandbriefe in small batches. There are no plans to issue jumbo Pfandbriefe. During a period of up to three years, the Bank will also utilise the stabilisation funds granted by SoFFin in mid-2010 in an amount of up to 2.4 bn, 1.6 bn thereof with a term of three years.
I23 DHB Interim report 06.10 As at 30 June 2010, the bank reported a loss of 23 m. Since there are no expectations of (substantial) revenues from new business or maturity transformations or other special effects, no current net interest income is expected based on the progress balances (portfolio income) in 2010 which can be used to cover administrative expenses and any necessary writedowns. A manageable loss in the second half of the year leads to the expectation of a net loss for the year as a whole. It is also possible that the markets will not recover as expected. Additional write-downs and depreciation may be necessary. However, distinct balance sheet asset and derivative portfolio effects may result in connection with the change of shareholder and business strategy if comprehensive repositioning or the portfolio items disposals are implemented. Reservations on forward-looking statements 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 involve risks and uncertainties. There are many factors which influence our business operations, the majority of which are beyond our control. These factors include the pending conclusion of the sale of the Bank, economic development, the state of the financial markets and possible defaults on loans. The actual events and developments may differ materially from those expressed or implied by these forwardlooking statements. They are therefore only valid at the time of their publication.
24I DHB Interim report 06.10 e Balance sheet Assets in thousand 30 Jun 2010 31 Dec 2009 Cash reserve 827 51,090 of which: with Deutsche Bundesbank 388 (50,726) Claims on banks Public-sector loan 2,657,675 2,717,665 other claims 1,695,990 4,353,665 1,628,324 Claims on customers Mortgage loan 1,477,726 1,469,177 Public-sector loans 2,054,356 2,140,607 other claims 23,975 3,556,057 25,278 Bonds and other fixed income securities Bonds and notes of public-sector issuers 4,505,245 4,622,046 of other issuers 8,441,677 12,946,922 8,802,768 Own debt instruments 1,492,669 14,439,591 2,586,153 Shares and other variable-yield securities 13,604 14,923 Participating interests 16,087 15,336 Intangible assets 770 1,008 of which: licences purchased, commercial and similar rights and assets as well as licences to such rights and assets 770 Tangible assets 16,651 16,888 Other assets 39,474 27,967 Deferred items from issuing and lending business 25,916 30,804 others 19,901 45,817 19,932 Total Assets 22,482,543 24,169,966