Merged and ready

IFR Top 250 Borrowers 2008
5 min read

Following the highly strategic acquisition of DEPFA BANK last year, the Hypo Real Estate group has become a heavyweight in commercial real estate, public and infrastructure finance. As the second largest covered bond group, its position is unique, but it is not been without headline risk. Rachelle Horn reports.

The new Hypo Real Estate Group came into being as a result of its acquisition of DEPFA BANK late last year, a move that implied a significant strategic shift for both entities.

DEPFA span off its real estate business to Aareal in 2002 and has, over the years, successfully positioned itself as a thoroughbred public-sector covered bond issuer. Hypo Real Estate, in contrast, has primarily established itself as a real estate bank. More recently, however, it has utilised its public sector business through the Hypo Public Sector Finance Bank subsidiary.

The areas of responsibility within the new Hypo Real Estate group are divided into three main sectors. Its commercial real estate segment consists of the two subsidiary banks: Hypo Real Estate Bank International and Hypo Real Estate Bank.

Following the integration of Hypo Public Finance Bank in DEPFA BANK, public sector and infrastructure finance worldwide is handled at DEPFA BANK – a segment which also includes DEPFA Deutsche Pfandbriefbank.

All group activities relating to the capital market as well as asset management for real estate secondary products are also handled in DEPFA BANK or one of its subsidiaries.

The group funds itself on the international capital and money markets, including through mortgage and public Pfandbriefe: 47% of Hypo Real Estate's balance sheet was refinanced through Pfandbriefe and through its merger activities the group has became one of the largest covered bond groups – second only to the Commerzbank. Of the remaining 53%, 48% is funded via repo. The remaining 5% comes via the money markets, where the average life of the group’s instruments is over four months and the average cost of funding is Libor minus 14.5bp. As of June 2007, the group had an outstanding covered bond volume of nearly €160bn.

Without a doubt, the funding markets have become a major concern for the global banking industry, and Hypo Real Estate is no exception. George Funke, CEO of Hypo Real Estate Holding recently said a distinction should be made between the two platforms at the Hypo Real Estate Group.

"DEPFA has highly liquid assets mostly consisting of ECB and repo eligible papers. These are securities which are used as collateral for refinancing transactions with the European Central Bank. This means that, together with existing liquidity, there is a buffer of approximately €38bn," he said.

In the field of real estate financing, all lending is refinanced on the basis of matching maturities. The necessary question is therefore, Funke said, whether Hypo Real Estate has adequate liquidity for new business. “Simply put, one third of our real estate portfolio is financed by Pfandbriefe, one third is financed by borrowers' note loans (Schuldscheindarlehen) and one third is backed by uncovered bonds. We continue to have access to long-term uncovered funding, whereby the terms have shortened and spreads have widened as a result of the market turmoil," he said.

The Hypo Real Estate Group has not been immune from the volatility and negative write-downs plaguing the market. Its 2007 net trading income of minus €224m was affected by the widening of credit spreads and includes valuation effects of synthetic CDO's at €198m. Its net income of minus €169m (€79m FY 2006) for 2007 includes write downs of cash CDO's in Q4 of €268m.

Earnings after tax of € 457m were down by 15.7% on the previous year and the attainability of the 2008 group pre-tax profit target of between €1bn and €2bn has been doubted because of "a deterioration in market conditions since the beginning of the year."

Funke also stated that the possibility of further charges on earnings from US CDO's and other credit linked investments cannot be precluded.

In April, Hypo Real Estate International priced a new two-year German mortgage Pfandbrief at mid-swaps plus 9bp – a level the market generally deemed as generous, taking into account that secondary spreads of comparable outstanding mortgage Pfandbriefe trade at an average of mid-swaps flat. This level was attributed to the headline risk surrounding the group's exposure to write-downs of CDO's, as well as increasing new issue premiums by market professionals.

Going forward, Hypo Real Estate said it believes the massive reduction of competition from the securitisation side will increase its own the market power.