DBRS Downgrades Hypo Real Estate LT Ratings, Places Under Review with Negative Implications

DBRS has today downgraded its long-term ratings for Hypo Real Estate Holding AG (Holding) and related entities (together Hypo Real Estate or the Group), including the Senior Unsecured Long-Term Debt rating for Holding, which was downgraded to A (low) from “A”. Concurrently, all ratings have been placed Under Review with Negative Implications. DBRS’s rating action follows the announcement of Hypo Real Estate’s Q3 2008 results, the announcement of an additional EUR 20 billion short-term debt guarantee and of additional information about the Group’s liquidity challenges, earnings outlook and pending application for more comprehensive external support.

The downgrade and the Under Review – Negative status reflect DBRS’s concern that Hypo Real Estate’s franchise has been weakened by its ongoing liquidity challenges. The Group’s lack of access to market funding currently restricts its ability to write new business and requires it to seek more comprehensive support, demonstrating the weakening of its intrinsic fundamentals.

Today’s rating action also reflects DBRS’s concern that the support Hypo Real Estate has received so far is short-term in nature and insufficient to stabilise the Group over the longer term. Moreover, DBRS views Hypo Real Estate’s EUR 3.105 billion pretax loss in Q3 2008 as large relative to its average pretax earnings of EUR 110 million per quarter between Q3 2007 and Q2 2008. The loss is also considered large relative to the Group’s EUR 6.6 billion of core regulatory capital (under German rules) as of September 2008.

The Group announced on 21 November 2008 that it has received a short-term guarantee from the Fund of EUR 20 for debt to be issued by the subsidiary Hypo Real Estate Bank AG. This guarantee came in addition to the EUR 50 billion liquidity support from a consortium of the German financial sector, the government and the Bundesbank, which became fully available on 13 November 2008. The EUR 20 billion guarantee covers debt expiring through 15 January 2009, while the EUR 50 billion liquidity support has an initial maturity of March 2009. In the view of DBRS, these short-term measures show that support is available to Hypo Real Estate, but they are not sufficient to stabilise the Group. The Group has stated that it needs more comprehensive capital and liquidity support and that it is currently negotiating about a comprehensive support package with the German Financial Markets Stabilisation Fund (SoFFin).

Hypo Real Estate’s ratings are currently driven by the systemic support it is receiving. As such, current ratings are higher than the Group’s underlying fundamentals would suggest. DBRS views Hypo Real Estate as a systemically important institution that is likely to receive additional support as needed due to its position as one of the largest issuers of covered bonds in Europe. Moreover, a robust framework to provide support exists in Germany, as the federal government has established SoFFin which is authorised to issue government guarantees on up to EUR 400 billion of new bank debt issuance and to inject up to EUR 80 billion in capital into financial institutions.

In DBRS’s view, comprehensive support is crucial for Hypo Real Estate to avoid permanent impairment of its franchise, which could lead to multiple-notch downgrades. DBRS has today downgraded its Trust-Preferred Securities rating for Hypo Real Estate International I by three notches, to BB (high) from BBB (high). This reflects DBRS’s view that securities qualifying as regulatory capital may be subject to losses as part of the Group’s necessary restructuring.

In the view of DBRS, Hypo Real Estate requires a substantial capital injection to re-emerge as a viable institution on a stand-alone basis. Hypo Real Estate’s core capital ratio (under German rules) declined to 6.8% as of September 2008, down from 7.0% as of June 2008. DBRS views a significant capital injection as necessary for the Group to avoid further downgrades.

Hypo Real Estate’s earnings outlook is negative. The Group projects the cost of its EUR 50 billion liquidity support at EUR 466 million annually, plus EUR 455 million due to a debtor warrant (Besserungsschein), which becomes payable when Hypo Real Estate returns to profitability. In addition, the EUR 20 billion debt guarantee carries a fee of 1.5% for any drawn amount and a commitment commission of 0.1% of the unutilised amount. Moreover, DBRS expects credit costs in commercial real estate (CRE) to stay high. Hypo Real Estate booked EUR 105 million in portfolio-based loan loss provisions in Q3 2008 to cover future CRE losses. DBRS also views further losses on Hypo Real Estate’s exposure to bank bonds, structured credit and public-sector assets as likely. In Q3 2008, the Group sustained losses of EUR 257 million due to its exposures Lehman Brothers, Icelandic banks and its stake in investment firm Babcock & Brown.

In the near term, ratings momentum for Hypo Real Estate primarily depends on its ability to secure more comprehensive liquidity and capital support and to develop a credible strategy to re-emerge as a viable institution. Ratings are unlikely to move higher in the near term; however, multi-notch downgrades are likely if Hypo Real Estate fails to secure more comprehensive, longer-term support. Consequently, all ratings have been placed Under Review with Negative Implications.

Notes:
All figures are in euros unless otherwise noted.
This rating is based on public information.