Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds Lettres de Gage Publiques (LdGs)

Primary Credit Analyst: Bernd Ackermann, Frankfurt (49) 69-33-999-153; [email protected]

Secondary Contact: Bjoern Schurich, Frankfurt (49) 69-33-999-237; [email protected]

Table Of Contents

Program Overview

Major Factors

Outlook: Stable

Rationale

Program Description

Issuer-Specific Factors

Cover-Pool Specific Factors

Additional Factors

Related Criteria And Research

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds Lettres de Gage Publiques (LdGs)

Ratings Detail

Program Overview

Table 1 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds* Jurisdiction Luxembourg Covered bond type Legislation-enabled Underlying assets Public sector assets Outstanding covered bonds (bil. €)§ 2.320 Year of first issuance 2000 Rating at closing/year AAA/2000 Extendible maturities No Target credit enhancement (%) 30.52% Available credit enhancement (%)§ 15.28%

*Based on data as of Sept. 30, 2013. §This figure is subject to Standard & Poor's analytical adjustments and therefore does not equal publicly available information on HPBI's covered bond program.

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds

Major Factors

Strengths • Better-than-average credit quality of the public-sector borrowers. • Diversification of country risk exposure across multiple jurisdictions.

Weaknesses • Insufficient credit enhancement to fully cover asset-liability mismatch (ALMM) risk. • Limited flexibility to add overcollateralization to the cover pool.

Outlook: Stable

Standard & Poor's Ratings Services' stable outlook on the public-sector covered bonds ("Lettres de Gage Publiques"; LdGs) of Luxembourg-based Hypo Pfandbrief Bank International S.A. (HPBI; BBB/Stable/A-2), reflects that on HPBI. It also reflects our expectation that the covered bond program will maintain credit enhancement at least commensurate with the rating.

A rating action on HPBI, all else being equal, would result in a corresponding rating action on its covered bonds.

A downgrade could follow if ALMM risk in the program increased to our "moderate" category from "low" currently, without a commensurate strengthening of the credit enhancement. Failure to manage the ALMM percentage, our metric for measuring ALMM risk, sustainably below 15% could trigger such a revision and would result in an increase of the credit enhancement required for the current rating level. However, we see a low likelihood of this occurring because we forecast a decrease in ALMM risk over the coming quarters.

An upgrade would require an increase of overcollateralization. However, in our view, the strategy of HPBI and the parent group, Depfa, limits HPBI's ability to do so; therefore such a scenario is currently unlikely.

Rationale

In our view, Luxembourg's legal and regulatory framework isolates the assets in the cover pool from a bankruptcy or insolvency of HPBI. This allows us to assign a higher rating to the covered bonds than the rating on HPBI.

We have classified HPBI's public-sector covered bond program in Category 2 and, according to data as of Sept. 30, 2013, we consider ALMM risk to be "low." Under our criteria, this combination allows for a covered bond rating that is six notches higher than the long-term rating on the issuer.

However, the program's available credit enhancement is only commensurate with two notches of uplift. This caps the long-term rating on the covered bonds at 'A-'. Positively, the pool's asset quality is better than the average among other public-sector cover pools we rate, and we don't anticipate material changes that would affect our credit risk assessment.

Although the program's structure does not mitigate counterparty risk, this does not constrain the covered bond ratings.

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds

This is due to the account banks' strong credit quality and because derivatives comprise only a small share of the cover pool.

Country risk does not constrain the covered bond ratings because the cover pool includes assets from many jurisdictions and there are no major country concentrations.

Our methodology and assumptions for rating covered bonds are outlined in our criteria "Covered Bond Ratings Framework: Methodology And Assumptions," published on June 26, 2012, on RatingsDirect.

Program Description

The public-sector covered bonds constitute unsubordinated senior secured obligations of HPBI. As such, they provide bondholders with dual recourse, first to HPBI and second to the assets in the cover pool. The covered bonds rank equally with each other. The structure of HPBI's covered bonds is similar to that of other public-sector covered bonds we rate in Luxembourg.

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds

The cover pool of HPBI's public-sector covered bonds is effectively in run-off mode at the moment, owing to the European Commission's conditions for its approval of state aid to HBPI's parent, Depfa Bank PLC. The restructuring plan agreed with the Commission stipulates that Depfa group companies will not conduct any new banking business until they are reprivatized. We understand the German government, as the ultimate owner, plans to reprivatize the Depfa group (including HPBI) by year-end 2014.

Table 2 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds Participants

Role Rating Rating dependency Issuer BBB/Stable/A-2 Yes Swap provider A-/Negative/A-2 No Bank account provider AA-/Stable/A-1+ Yes Bank account provider AA+/Stable/A-1+ Yes Bank account provider AAA/Negative/A-1+ Yes

Issuer-Specific Factors

Legal and regulatory risks In our view, Luxembourg's covered bond framework sufficiently addresses the relevant legal aspects of our covered bond criteria (segregation of assets, accelerated payments, payment moratorium, overcollateralization limits, and access to funding). This enables us to assign ratings to the covered bonds that are higher than the long-term rating on HPBI.

Under Luxembourg's banking law if a covered bond issuer became insolvent, the assets, liabilities, and derivatives in the cover pool are separated from the general insolvency estate and reserved for the covered bond holders. The collateral pool would be unchanged and administered by the banking regulator until the last covered bond matures. Furthermore, interest and principal on LdGs and registered derivatives would become due in accordance with their original terms. Also, the general bankruptcy administrator would have no direct access to the assets in the cover pool, including any overcollateralization above the legal minimum, and there's no payment moratorium or forced restructuring.

Changes to Luxembourg's covered bond framework in June 2013 had no impact on our conclusions (see "Luxembourg's Covered Bond Law Amendments Increase Clarity For Investors, But Have No Rating Impact," published on June 19, 2013).

Our analysis of legal risk follows the methodology in "Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance," published Sept. 13, 2013, and "Covered Bond Ratings Framework: Methodology And Assumptions," published on June 26, 2012.

Operational and administrative risks We expect that HPBI will maintain credit enhancement commensurate with the current rating and limit risks in the cover pool. We base this conclusion on our understanding of how the bank plans to meet upcoming liability

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds redemptions. We also understand that issuance activity will be low and focused on managing cash flow timing mismatches. However, in light of current business restrictions, HPBI's and the Depfa group's strategy may indirectly limit HPBI's flexibility to add overcollateralization to the cover pool, if needed, without recourse to the group. Also, failure to reprivatize the group might reduce the strategic importance of its access to new covered bond funding. In such a scenario, we believe the group would remain in run-off.

Our analysis of operational and administrative risks follows the criteria in "Covered Bond Ratings Framework: Methodology And Assumptions," published on June 26, 2012, and "Principles Of Credit Ratings," published on Feb. 16, 2011.

Cover-Pool Specific Factors

Asset credit quality We view the pool's asset credit quality as stronger than that of pools in other European public-sector cover bonds we rate. This is reflected in a scenario default rate (SDR) of 11.8% under a 'AAA' stress as of Sept. 30, 2013 (see table 4). This figure compares favorably with an average SDR of 29.04% for European public-sector cover pools. The SDR is our gross default probability metric.

Asset credit quality benefits from a high average rating on exposures and international diversification. HPBI's cover pool consists mainly of public-sector assets of European sovereign governments, states, municipalities, and other eligible public sector authorities, as well as a small amount of swaps (see table 3). In view of the new-business restriction, we project that the pool's asset composition and, therefore, the SDR will remain fairly stable over the coming quarters, all else being equal.

Table 3 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds Pool Composition --Sept. 30, 2013-- --Jan. 31, 2013--

Asset type Value (mil. €) Percentage of cover pool (%) Value (mil. €) Percentage of cover pool (%) Public-sector assets 2,674 100 2,718 98.36 Substitute assets 0 0 45 1.64 Total 2,674 2,763

In the event of borrower defaults, we assume that ultimate recoveries in the pool would be high, but only after a significant delay. During this period, cash flows from the pool's performing assets would service the covered bonds. However, we note that public-sector issuers can often rely on support from the government if they are in financial difficulty. However, this support may not be timely or through an explicit guarantee. We assess the effect of delayed recoveries in our cash flow analysis below.

We have analyzed the cover pool's credit quality using our criteria in "Surviving Stress Scenarios: Assessing Asset Quality of Public Sector Covered Bond Collateral," published on Sept. 30, 2003.

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds

Table 4 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds Key Credit Metrics

Sept. 30, 2013 Jan. 31, 2013 Weighted-average cover pool asset rating A+ A Weighted-average loan asset maturity (months) 5.48 5.86 Largest obligor (% of the cover pool) 8.67 8.39 Five largest obligors (% of the cover pool) 28.95 27.78 20 largest obligors (% of cover pool) 69.02 66.31

Credit analysis results: Scenario default rate (SDR) (%) 11.83 12.24 Asset default risk (%) 10.43 W/H

European public sector cover pool averages: Weighted-average asset rating BBB+ BBB+ SDR (%) 29.04 24.83 Asset default risk (%) 13.75 N/A

W/H--Withheld at issuer's request. N/A--Not applicable.

Table 5 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds Asset Distribution By Geography

Sept. 30, 2013 Jan. 31, 2013

Top five country risk concentrations --Percentage of cover pool (%)-- Austria 27.06 26.08 U.S. 19.95 19.58 Germany 19.34 19.55 Spain 8.09 7.84 Canada 7.84 8.37 Other 17.72 18.58 Total 100 100

Table 6 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds Asset Distribution By Rating*

Sept. 30, 2013 Jan. 31, 2013 --Percentage of cover pool (%)-- AAA 18.36 17.49 AA 49.16 43.76 A 22.04 27.26 BBB 6.66 5.65 BB 3.78 4.20 B or lower 0 1.64 Total 100 100

*The figures refer to Standard & Poor's credit ratings or credit estimates and therefore do not equal public information on the covered bond program.

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds

Payment structure and cash flow mechanics Our analysis of the covered bonds' payment structure shows that cash flows from the cover pool assets would be sufficient, at the given rating, to make timely payment of interest and principal to the covered bond holders. Nevertheless, the lack of sufficient credit enhancement to fully cover ALMM risk is the key constraint to our ratings on HPBI's covered bonds.

The program's structure does not eliminate mismatches in the timing of cash flows relating to assets and liabilities. However, in our view, the covered bonds are currently exposed to "low" ALMM risk. As of Sept. 30, 2013, the pool's ALMM percentage (the maximum cumulative mismatch, which is our metric to measure ALMM risk) stood at 15.03% of the outstanding covered bonds. According to our criteria, 15% is the lower threshold of the range for our "moderate" ALMM category. Nevertheless, we maintain our "low" ALMM risk assessment because we project the ALMM metric to be lower than 15% by year-end 2013 and to continue decreasing. This is based on the cover pool's fairly stable composition and our understanding of how HPBI will manage near-term maturities.

In addition, we have assigned HBPI's covered bond program to Category 2 because we believe Luxembourg LdGs have access to a range of funding options to obtain third-party liquidity or sell assets to fund any mismatch if the issuing bank fails. However, most LdG issuers are subsidiaries of foreign banks and the majority of financings are assets outside Luxembourg. This reduces the systemic importance of covered bonds, in our view, so Luxembourg is not in Category 1 (the strongest category). Also, covered bonds in Luxembourg have a shorter track record than would be commensurate with Category 1.

According to our criteria, the maximum potential rating on a covered program in Category 2 with "low" ALMM risk is six notches above the rating on the issuer. This means the maximum potential covered bond rating is 'AA' if the available credit enhancement is at least equal to our target credit enhancement, and neither counterparty nor country risk constrain the rating.

Our target credit enhancement for HPBI's covered bonds, based on data as of Sept. 30, 2013, is 30.5%. This compares with the program's available credit enhancement of 15.3%. The target for HPBI is higher than the median of 14.7% for other European public-sector covered bonds we rate because of larger cash-flow timing mismatches. These result partly from scheduled near-term redemptions of liabilities that exceed cash inflows in the corresponding period. This poses, among others, the risk of HBPI having to sell assets under stressed conditions to cover the shortfall. In later years, there is also the risk of loss from reinvesting cash at lower interest rates than those on the liabilities. This is because the liabilities' weighted-average time to maturity is about six years longer than that of assets, mainly owing to large long-dated zero coupon liabilities, which we consider at their par value on the final legal maturity date.

The program's credit enhancement therefore covers credit, interest rate, and foreign exchange risk, but only about one-fifth of the ALMM risk. This limits the potential notches of uplift above the 'BBB' long-term rating on HPBI to two, resulting in a covered bond rating of 'A-'.

All else being equal, if we reclassified ALMM risk to "moderate," this would reduce the maximum potential notches of uplift and increase our target credit enhancement for the current rating.

We analyzed the cash flows according to our criteria in "Revised Methodology And Assumptions For Assessing

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds

Asset-Liability Mismatch Risk In Covered Bonds," published on Dec. 16, 2009, and "Assessing Asset-Liability Mismatch Risk In Covered Bonds: Revised Methodology And Assumptions For Target Asset Spreads," published on April 24, 2012.

Table 7 Hypo Pfandbrief Bank International S.A. Public-Sector Covered Bonds ALMM Metrics

Sept. 30, 2013 Jan. 31, 2013 Asset WAM (years) 5.48 5.86 Liability WAM (years) 11.22 11.42 Maturity gap (years) (5.74) (5.56) ALMM (%) 15.03 12.49 ALMM classification Low Low Maximum uplift above issuer rating (notches) 6 6 Target credit enhancement for maximum uplift (%) 30.52 W/H Target credit enhancement for first notch of uplift (%) 10.43 W/H Available credit enhancement (%) 15.28 W/H

European public sector cover pool medians: ALMM percentage (%) 2.41 N.A. Target credit enhancement (%) 14.67 N.A. Available credit enhancement (%) 19.79 N/A

ALMM--Asset-liability mismatch. WAM--Weighted average maturity. W/H--Withheld at issuer's request. N/A--Not applicable. N.A.--Not available.

Additional Factors

Counterparty risk We have identified two main counterparty risks to HPBI's covered bonds: commingling and bank account risk, and default risk regarding derivatives. In our view, these risks are not structurally addressed. However, the account banks' very strong creditworthiness and the small amount of derivatives in the cover pool do not constrain the maximum potential covered bond rating.

Commingling and bank account risk: Luxembourg legislation does not address commingling risk, that is, the risk of payment delays or loss if collections relating to the covered bonds go into the issuer's general accounts. HPBI addresses this risk by maintaining its accounts for the cover pool's cash flows separate from those for its general business and at other institutions. This exposes the cover pool to the risk of the bank account providers becoming insolvent, which however is mitigated by those banks' very strong creditworthiness, in our view. Because the bank account agreements do not contain provisions for a replacement bank in line with our counterparty criteria, bank account risk limits the long-term rating on HPBI's covered bonds to the lowest rating on the bank account providers, currently 'AA-' (see table 2).

Derivatives: HPBI has registered a small number of swaps as market risk hedges in the cover pool, which poses the risk of counterparty default. Also, because the swaps rank pari passu with the covered bonds, termination payments on the swaps may have to come from the assets securing the covered bonds. However, these derivatives represent less than 5% (notional value) of the outstanding covered bonds and we believe this figure will be even lower by midyear 2014. According to our criteria, this amount is too small to affect the maximum potential notches of uplift to derive the

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1237346 | 300027913 Transaction Update: Hypo Pfandbrief Bank International S.A.'s Public-Sector Covered Bonds covered bond rating.

We have assessed counterparty risk using our criteria articles "Counterparty Risk Framework Methodology And Assumptions," published June 25, 2013, and "Covered Bonds Counterparty And Supporting Obligations Methodology And Assumptions," published May 31, 2012.

Country risk Country risk does not constrain the covered bond ratings because the cover pool contains assets from 16 jurisdictions, and there are no major country concentrations. About 84% of all country risk exposure relates to sovereigns whose creditworthiness would support the maximum potential covered bond rating of 'AA'. The largest single concentration (27%) relates to Austria, which we rate 'AA+'. In addition, the two largest country risk exposures that would not support the maximum potential covered bond rating together account for only 11% of the cover pool assets. We consider therefore that our asset credit analysis fully captures country risk.

We consider country risk using our criteria in "Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," published on June 14, 2011.

Related Criteria And Research

Related Criteria • Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance, Sept. 13, 2013 • Counterparty Risk Framework Methodology And Assumptions, June 25, 2013 • Covered Bond Ratings Framework: Methodology And Assumptions, June 26, 2012 • Covered Bonds Counterparty And Supporting Obligations Methodology And Assumptions, May 31, 2012 • Assessing Asset-Liability Mismatch Risk In Covered Bonds: Revised Methodology And Assumptions For Target Asset Spreads, April 24, 2012 • Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions, June 14, 2011 • Principles Of Credit Ratings, Feb. 16, 2011 • Revised Methodology And Assumptions For Assessing Asset-Liability Mismatch Risk In Covered Bonds, Dec. 16, 2009 • Surviving Stress Scenarios: Assessing Asset Quality of Public Sector Covered Bond Collateral, Sept. 30, 2003

Related Research • Global Covered Bond Characteristics And Rating Summary Q4 2013, Dec. 12, 2013 • Luxembourg's Covered Bond Law Amendments Increase Clarity For Investors, But Have No Rating Impact, June 19, 2013 • Depfa Bank PLC, April 25, 2013 • Advance Notice Of Proposed Criteria Change: Ratings Above The Sovereign--Structured Finance, April 12, 2013 • Credit FAQ: What Factors Do We Consider When Analyzing Commingling And Account Bank Risk In Covered Bonds?, Nov. 26, 2012

Additional Contact: Covered Bonds Surveillance; [email protected]

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