Frankfurt, December 16, 2008 -- Moody's Investors Service today downgraded the bank financial strength
rating (BFSR) of Hypo Real Estate Bank AG to E+ from C-.
The BFSRs of Depfa Bank Plc, Depfa Deutsche Pfandbriefbank AG,
Depfa ACS Bank and Depfa-Bank Europe plc have also been downgraded
to E+ from D+, resulting in an alignment of all BFSRs
in the group. The outlook on these ratings is now negative.
The Tier 1 preferred securities of Depfa Funding II, III and IV
LP were downgraded to Caa1 from Ba3, and the upper Tier-2
securities (profit participation rights, or "Genussscheine")
of Hypo Real Estate Bank AG and the former Hypo Real Estate Bank International
AG (recently merged into HRE Bank AG) were downgraded to Caa2 from Baa3.
These ratings also carry a negative outlook.
The A2 senior unsecured debt and deposit ratings and the Prime-1
ratings for short-term debt of the five entities remain on review
for possible downgrade. Moody's expects to conclude this
review, which was initiated on 30 September 2008, shortly,
following the anticipated announcement on the details of a capital increase,
liquidity and other support decisions.
Notwithstanding the pending recapitalisation of the banks by the German
government, Moody's decision to downgrade their BFSRs reflects
serious challenges to the longer-term viability of their commercial
real estate lending and public sector finance businesses, constrained
profitability, and continued restricted market access.
The downgrade of the non-cumulative perpetual preferred securities
linked to the performance of Depfa Bank plc reflects Moody's views
of the increased risk of several years of coupon deferrals for the years
2009, 2010 and 2011, with the loss calculated on a ten-year
horizon. The rating on the profit participation rights is constrained
not only by the risk of two to three years of deferred coupons,
but also by an expectation that the principal of these instruments may
not be fully repaid upon maturity in 2010 and 2011. The Caa2 rating
on the profit participation rights therefore reflects a higher expected
loss compared to the Caa1-rated instruments, which face coupon
deferrals but no principal write-downs.
DOWNGRADE OF THE BFSRs TO E+
Moody's commented that today's decision to downgrade the banks'
BFSRs to E+ (translating into a baseline credit assessment of B3)
has been driven by the following considerations:
1) The very constrained funding flexibility of HRE Group. The Depfa
entities previously relied on a high portion of medium-term and
short-term, partly unsecured debt for the funding of their
long-term assets. They now fully depend on external support
to be able to refinance these shorter-term debt maturities.
2) The extended time it will take the group to become profitable again.
The group will be burdened not only by higher funding costs, but
also by higher provisioning costs stemming from the expected deterioration
of commercial real estate activities. This is coupled with the
additional burden of the debtor warrant, which will accumulate extra
costs of EUR455 million per year as long as the EUR50 billion consortium
facility is fully drawn. These warrant costs will be payable out
of future profits and will restrict the group's capital generation
capacity until 2015.
3) The uncertain long-term viability of both of HRE's core
business models: commercial real estate lending and public finance.
Both businesses face higher capital requirements, without incurring
incremental risks (funding, interest rates etc.).
Public finance margins will most likely be too low to generate sufficient
returns on such higher capital levels, whereas the stability/volatility
assumptions for commercial real estate finance that have underpinned such
business models also need to be revised.
4) As a consequence of these issues, it may take several years for
HRE as a standalone, unsupported entity to be able to tap the capital
markets again. Market access will likely remain limited until the
group (i) delivers results in line with budgeted plans and (ii) is closer
to or is displaying a turnaround in profitability. Moody's
considers these deliverables a major challenge in the current market environment
as future profits are difficult to predict given the persisting volatility
in various macroeconomic parameters.
Moody's said that the downgrade of the entities' BFSRs to
E+ also incorporates the expectation that HRE group will shortly
be appropriately recapitalised by the German Financial Market Stabilisation
Funds (SoFFin). This is expected not only to result in a regulatory
capital level that meets the minimum expectations of the SoFFin,
but also to include additional amounts of capital to absorb likely losses
that Moody's expects for the next two years. Although an initially
strong Tier-1 ratio is factored into the E+ BFSRs, they
are notably constrained at this level by the issues of franchise impairment
as described above, coupled with the high uncertainty over HRE's
future success, which is heavily dependent on the recovery of the
global financial markets.
The negative outlook on the E+ BFSRs reflects Moody's view
that, despite the expected recapitalisation, the potential
for further downward pressure remains. This is based on the rating
agency's view that (i) an extended period of market distortion could
place particular pressures on HRE Group and could delay the targeted recovery
process significantly; and (ii) HRE's exposure to the commercial
real estate markets in Spain, the UK and the US could result in
major credit losses over the next two years, as the adverse developments
observed in these markets appear more severe than had been previously
REVIEW OF SENIOR UNSECURED DEBT AND DEPOSIT RATINGS CONTINUES
The ongoing review for downgrade of the A2 long-term and Prime-1
short-term senior unsecured debt and deposit ratings of the HRE
group entities mentioned above will focus on the nature and extent of
the government support provided to meet HRE's immediate and medium-term
capital requirements. It will also take into account the resulting
change in the shareholder structure.
Moody's fully recognises the strong systemic support rendered to
date, amounting to facilities and commitments of EUR80 billion.
However, the ratings will need to reflect the German government's
long-term strategy towards HRE, including its long-term
commitment or exit strategy, the strength and tenor of the support
provided to all creditors, as well as an assessment of the entity's
systemic relevance in a few years once the market crisis has abated.
As such, they will need to incorporate Moody's assessment
of the long-term risks for senior unsecured bondholders and the
degree to which government support will continue to mitigate the group's
intrinsic weakness for an extended period of time beyond the maturity
of the current medium-term guarantee.
The ratings could face a multiple-notch downgrade, as the
final rating outcome for senior unsecured debt will have to take into
account the weak baseline credit assessment of B3, which reflects
the banks' intrinsic financial strengths without government support.
Moody's may also consider assigning backed ratings that directly
reflect any government guarantees. Please refer to Moody's
publication "Moody's to assign backed Aaa ratings to new debt
securities covered by German government guarantee" dated 15 December
Moody's will separately review any potential impact on the current
ratings of HRE / Depfa entities' covered bonds, which are
not covered by this Press Release.
The last rating action on one of Hypo Real Estate Group's rated
entities was on 8 December 2008, when Hypo Real Estate International's
BFSR was withdrawn upon the merger of this entity into Hypo Real Estate
Headquartered in Munich, HRE Group reported consolidated total assets
of EUR400 billion and a pre-tax profit of EUR587 million as of
31 December 2007. For the nine months to September 2008,
the group reported a pretax loss of EUR3.1 billion.
The principal methodologies used in rating the single entities of HRE
group are "Bank Financial Strength Ratings: Global Methodology"
and "Guidelines for Rating Bank Junior Securities",
which can be found on www.moodys.com in the Credit Policy
& Methodologies directory, in the Ratings Methodologies subdirectory.
Other methodologies and factors that may have been considered in the process
of rating the issuers can also be found in the Credit Policy & Methodologies
Vice President - Senior Analyst
Financial Institutions Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's downgrades HRE's BFSR and hybrids; continues review of debt and deposit ratings
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454