Financial Review

Legal corporate structure

Bayerische Hypo- und Vereinsbank Aktiengesellschaft (HVB AG) was formed in 1998 through the merger of Bayerische Vereinsbank Aktiengesellschaft and Bayerische Hypotheken- und Wechsel-Bank Aktiengesellschaft. It is the parent company of HVB Group, which is headquartered in Munich. Bank Austria Aktiengesellschaft (Bank Austria), which took over Creditanstalt AG in 1997 to combine the two largest banks in Austria (the other being Bank Austria Creditanstalt AG), has been part of HVB Group since December 2000. HVB Group is one of Europe’s leading providers of banking and financial services.

HVB AG has been an affiliated company of UniCredito Italiano S.p.A., Genoa (UniCredit), since November 2005 and hence a major part of UniCredit Group from that date as a sub-group.

On September 12, 2006, the Management Board and Supervisory Board of HVB AG agreed to transfer HVB AG’s holdings in Bank Austria Creditanstalt AG (BA-CA) and Joint Stock Commercial Bank HVB Bank Ukraine (HVB Bank Ukraine) to UniCredit, its Closed Joint Stock Company International Moscow Bank (IMB) and AS UniCredit Bank, Riga (formerly HVB Bank Latvia AS, Riga) subsidiaries to BA-CA, and the assets and liabilities of the HVB AG branches in Tallinn, Estonia, and Vilnius, Lithuania, to AS UniCredit Bank, Riga (formerly HVB Bank Latvia AS, Riga). An Extraordinary Meeting of Shareholders of HVB AG held on October 25, 2006 approved the corresponding contracts with more than 99.4% of the votes cast in each case. The Management Board decided to complete the transactions on January 9, 2007. The gains on disposal from the transactions listed will be largely realised in the first quarter of 2007.

The ordinary shares of HVB AG are admitted to official trading on all German stock exchanges, as well as on the Vienna Stock Exchange, Euronext in Paris and the SWX Swiss Exchange. On January 23, 2007, the Board of Directors of UniCredit (the majority shareholder of HVB AG) decided to start a squeeze-out procedure with regard to HVB shares. When the annual financial statements were prepared, UniCredit held more than 95% of the capital stock.

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Information pursuant to Section 315 (4), German Commercial Code, in conjunction with the German Takeover Directive Implementation Act

The subscribed capital of HVB AG totals €2,252,097,420.00 and is divided into

1. €2,208,436,620.00 shares of common bearer stock, broken down into 736,145,540 no par shares
2. €43,660,800.00 non-voting shares of registered preferred stock, broken down into 14,553,600 no par shares.

The common bearer stock makes up 98.06% of capital stock and the preferred stock 1.94%.

The common stock consists of bearer or registered shares.

Shareholders holding shares of common bearer stock are entitled to attend the Annual General Meeting of Shareholders and exercise their voting rights subject to the conditions set out in Article 18 (2) of the Articles of Association. Each share of common stock is vested with one vote at the Annual General Meeting of Shareholders.

Each shareholder has the right to ask questions and speak at the Annual General Meeting of Shareholders, although the meeting chairman may limit the right to ask questions and speak as appropriate.

The shares of both common stock and preferred stock benefit from the equal disbursement of any profit distributions (dividend payment).

The preferred shares are non-voting and registered. They receive an advance share of profits of €0.064 per no par share, payable out of cumulative profit on a cumulative basis, as well as a further share in profits of the same amount as the shares of common stock. The claim to payment of the advance share of profits on a cumulative basis is granted to the holders of preferred stock as a separate right.

Shareholders holding shares of registered preferred stock are entitled to attend the Annual General Meeting of Shareholders subject to the conditions set out in Article 18 (1) of the Articles of Association.

In the event of a capital increase, the holders of common and preferred shares normally have a subscription right. The Management Board may exclude this subscription right if it is authorised to do so by a resolution adopted by the Annual General Meeting of Shareholders or by an amendment to the Articles of Association approved by the Annual General Meeting of Shareholders.

In addition, the holders of common and preferred shares enjoy the other rights granted by the German Stock Corporation Act.

Under Article 6 (2) of the Company’s Articles of Association, the shares of registered preferred stock may only be transferred with the Company’s approval. Compliant with Section 71 b) of the German Stock Corporation Act, treasury stock does not confer any rights to the Company. The Management Board is not aware of any restrictions regarding the exercise of voting rights or the transfer of shares that might arise from agreements between shareholders.

On November 22, 2005, UniCredito Italiano S.p.A., Genoa, informed the Company compliant with Section 21 of the German Securities Trading Act (WpHG) that it held 93.9% of the capital stock and 93.8% of the voting shares of common bearer stock in the Company, of which 0.001% indirectly, since November 17, 2005. UniCredit’s ad-hoc announcement dated January 23, 2007 indicates that its interest in the capital stock of HVB AG had in the meantime risen to 95%.

The Company has not issued any shares that confer any special influence over the Company’s executive bodies and hence any special control powers.

There is no distinction between control of voting rights and share with regard to employee holdings. Where Company employees have acquired Company shares, they can exercise their voting rights in the same way as any other shareholder: either in person or through a proxy.

The appointment and dismissal of members of the Management Board is based on the legal provisions set forth in Sections 84 and 85 of the German Stock Corporation Act. Under Section 179 of the German Stock Corporation Act, amendments to the Company’s Articles of Association require a resolution from the Annual General Meeting of Shareholders. Such a resolution requires a majority of at least three quarters of the capital stock represented when the resolution is adopted. Article 21 (2) of the Company’s Articles of Association confers to the Supervisory Board the authority to make amendments to the Articles of Association that only affect the wording but not the content (amendment of the wording).

A resolution adopted by the Annual General Meeting of Shareholders on April 29, 2004 authorises the Management Board to issue shares from the authorised capital increase (Section 202 et seq., German Stock Corporation Act) in accordance with Article 5 (2) of the Company’s Articles of Association. Article 5 (2), 1 and 2 of the Company’s Articles of Association is worded as follows: “The Management Board, with the consent of the Supervisory Board, is authorised until April 29, 2009 to increase the Company’s share capital by issuing new shares in exchange for contributions in cash or kind, one or several times but in an aggregate volume of no more than 330,000,000 shares in a total par value of €990,000,000.00. Either only common shares or common shares and non-voting preferred stock vested with the same rights as the already existing non-voting preferred stock may be issued.”

The Management Board is hereby authorised, with the approval of the Supervisory Board, to exclude the subscription rights of the shareholders in the instances listed individually in Article 5 (2) of the Company’s Articles of Association in accordance with the authorisation granted on April 29, 2004.

Moreover, a resolution adopted by the Annual General Meeting of Shareholders on May 14, 2003 authorises the Management Board until May 14, 2008 to issue equity warrant bonds, convertible bonds, dividend bonds, option certificates and convertible certificates with an option or conversion right and/or conversion obligation into shares of common bearer stock of Bayerische Hypo- und Vereinsbank Aktiengesellschaft or dividend bonds (with or without option or conversion right/obligation) compliant with Section 221 of the German Stock Corporation Act in euros or any other legal tender. The total nominal value or equivalent amount may not exceed an aggregate of €1,500,000,000.00. Under Article 5 (4) of the Company’s Articles of Association, a conditional capital of €375 million is available to grant shares of common stock to the holders of bonds and certificates issued in accordance with the authorisation granted on May 14, 2003.

Furthermore, the Management Board is authorised compliant with Section 71 (1) No. 7 of the German Stock Corporation Act to buy and sell treasury stock for trading purposes by a resolution adopted at the Annual General Meeting of Shareholders held on May 23, 2006.

Moreover, the Company is permitted to buy treasury stock in the instances provided for in Section 71 (1) Nos. 1–5 of the German Stock Corporation Act.

There are no significant agreements at HVB AG that are subject to the condition of a change of control following a takeover offer.

No compensation agreements have been reached with members of the Management Board or employees in the event of a takeover offer.

In accordance with Section 171 (2) 2 of the German Stock Corporation Act as amended by the German Takeover Directive Implementation Act of July 8, 2006, the information pursuant to Section 315 (4) of the German Commercial Code is explained in the Report of the Supervisory Board in the 2006 Annual Report.

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Main products, sales markets, competitive position and facilities

HVB Group offers a comprehensive range of banking and financial products and services to private and corporate customers as well as public-sector customers. Our range extends from mortgage loans and banking services for consumers, private banking, business loans and foreign trade finance through to fund products, advisory and brokerage services, securities transactions and wealth management.

Following the transfer of its interests and business activities in Austria, central and eastern Europe, Russia, the Ukraine and the Baltic states, HVB Group will in future focus on Germany as its core market within the UniCredit Group. Moreover, there is the possibility of entering markets in other regions of Europe (notably Scandinavia and Benelux). The aim is also to significantly expand investment banking operations and become the centre of competence for investment banking within the entire UniCredit Group.

BA-CA will continue to have operating responsibility for business in central and eastern Europe (CEE). Consolidating the CEE activities will significantly enhance the footprint and service range of the UniCredit Group. HVB Group is consequently in a position to offer its customers even better access to this region, thus enabling them to benefit from the transactions.

A breakdown of our offices by region is shown in Note 82 “Offices” in the notes to the consolidated financial statements.

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Organisation of management and control

The Management Board of HVB AG is the management body of HVB Group. The Management Board provides the Supervisory Board with regular, timely and comprehensive reports on all issues relevant to corporate planning, strategic development, the course of business and the state of HVB Group, including the risk situation.

The Supervisory Board of HVB AG has 20 members and includes equal numbers of representatives of the shareholders and employees. The task of the Supervisory Board is to monitor and advise the Management Board as it conducts business. To support its work, the Supervisory Board set up three committees in the year under review: the Remuneration & Nomination Committee, the Audit Committee and the Negotiating Committee.

HVB AG conducts risk monitoring and risk management on a group-wide basis. The monitoring systems are geared to identifying risks at an early stage. In 2006, risk control and risk management were combined under the area of responsibility of the Chief Risk Officer, who reported to the Audit Committee of the Supervisory Board on a regular basis. Please refer to the Risk Report for further details.

A list showing the names of all of the members of the Management Board and the Supervisory Board of HVB AG is given in the consolidated financial statements under Note 83 “Members of the Supervisory Board and Management Board”.

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Basic features of the remuneration system

Structure of compensation paid to members of the Management Board

The compensation paid to members of the Management Board is determined by the Remuneration & Nomination Committee of the Supervisory Board. The direct compensation has three components comprising fixed and variable elements: fixed compensation, variable compensation as a bonus featuring profit-related components (short-term incentive) and a long-term incentive.

The variable components are especially important as these are linked to the achievement of the targets agreed for the financial year and the targets in the strategic plan and can exceed the fixed salary. Competitive profit-related compensation and postponing payment to the near or far future as a result of participation in the long-term incentive plan of the UniCredit Group is intended to ensure that the management is bound to the company.

To ensure that the compensation for the responsibilities assumed by Management Board members is commensurate with market conditions, an external specialist performed a market survey on behalf of HVB AG which included similar companies. The compensation payable to members of the Management Board for 2006 was stipulated by the Remuneration & Nomination Committee taking account of this survey.

The fixed salary is equivalent to the level paid in similar companies. It is disbursed in 12 monthly amounts.

The bonus is a short-term incentive, the size of which depends on certain targets agreed at the beginning of the year with all members of the Management Board being met. In 2006, these targets were specified in detail in the course of the year after completion of the three-year planning. The targets are shown in scorecards and include team targets, core targets and integration targets.

The team target for all members of the Management Board is based on the results achieved by the HVB sub-group. Some Management Board members responsible for regional divisions also have a divisional target as an additional team target. The main emphasis is placed on what are known as core targets, i.e. especially significant targets from the Management Board members’ own area of responsibility. The most important tasks arising during the process of integrating HVB AG into the UniCredit Group are covered by the integration targets.

Targets mainly relating to quantities, but also some quality targets, are agreed with the members of the Management Board. A relatively narrow range is defined for meeting the quantitative targets. If the lowest value of this range is not achieved, no points are awarded for the target. If the highest value is achieved, the Management Board member receives the highest number of points previously defined for this target. The Remuneration & Nomination Committee decides on the quality targets, taking into account the vote given for the target achievement by the head of the division or the function in which the Management Board member works.

The weighted total amount of points gained from each target results in the target achievement. A bonus is paid if a specified minimum number of points is achieved. Compliant with UniCredit’s treatment of this issue, the maximum bonus will be defined as the reference value from 2007. This maximum bonus can be utilised whenever a total number of 120 points is achieved in the scorecard. This means that the bonus has a maximum upper limit and a correspondingly lower percentage of the maximum bonus will be disbursed in future if targets are fully met.

Each Management Board member takes part in the Stock Option & Performance Shares Plan of the UniCredit Group (long-term incentive plan of the UniCredit Group). This plan consists of two components. On the one hand, each Management Board member is granted a certain number of options which can be exercised if the beneficiary is still working for the UniCredit Group after four years (vesting). In 2006, the Management Board of HVB AG was granted a total of 508,633 stock options. Each option entitles the Management Board member to purchase a UniCredit share at a price which was fixed before the option was issued. The option may be exercised within a period of nine years after vesting.

On the other hand, each Management Board member is promised a specific number of UniCredit shares (to be transferred free-of-charge) on condition that the relevant targets in UniCredit’s strategic plan are met after three years have passed and the beneficiary is still working for the UniCredit Group. The Management Board of HVB AG received 195,333 performance shares in 2006. The targets were combined in baskets. There are baskets for the UniCredit Group and for each division. Each basket has five targets, of which three must have been met.

Members of the Management Board involved in operating activities receive the shares only if the division has achieved its target. They receive 50% of the shares if only the division has met its targets but 100% of the shares if the Group has also met its targets. The other Management Board members receive the shares if the Group has achieved its targets. HVB AG reimburses the cost of participating in the long-term incentive plan to UniCredit.

Exceptions have been made to the rules set out above for individual members of the Management Board, depending on their personal contractual arrangements. Please see the Compensation Report elsewhere in the Annual Report for further details in this regard.

Compensation paid to members of the Management Board for positions on supervisory boards of Group companies is surrendered to HVB AG.

Information on the amount of compensation paid to members of the Management Board is provided in Note 79, “Information on relationships with related parties”, in the notes to the consolidated financial statements.

The Annual General Meeting of Shareholders of May 23, 2006 invoked what is referred to as the opt-out clause of the Act on the Disclosure of Management Board Remuneration and resolved that the remuneration received by Management Board members will not be disclosed on an individualised basis.

Besides direct remuneration, Management Board members have received pension commitments. Except for three members of the Management Board, the Management Board members take part in the fund-linked deferred compensation scheme (FDC) which is also available to the Bank’s employees. HVB AG has fixed the contribution as 20% of the fixed salary and the short term incentive, subject to a cap of €200,000 per year. It has been agreed with the members of the Management Board that this amount of their pay would be converted, which means that, instead of a disbursed sum of money, the Management Board member receives a pension commitment to the same value from HVB AG. HVB AG credits the deferred compensation amounts to the Management Board member’s capital account and invests them in a fund, currently the Pioneer Total Return Fund. HVB AG guarantees an annual return of 2.75%. A higher yield is initially used for allocation to a fluctuation reserve amounting to 10% of the separate funds for FDC. Any surplus return is credited to the Management Board member in due proportion. The fluctuation reserve is used to offset any actuarial losses. When the beneficiary becomes entitled to receive benefits, the capital credit balance is converted into a pension for life. A commitment for a fixed amount was agreed with one member of the Management Board. Contributions will be paid to a pension fund for another member of the Management Board. HVB AG has not agreed a pension commitment with a further member of the Management Board.

In addition, there are commitments in the event of the termination of Management Board activities. If a contract is not extended for reasons for which the member of the Management Board is not responsible, a transitional allowance of at least one year’s salary (fixed salary and bonus), but a maximum of three years’ salary depending on the length of service, is usually paid; the maximum amount is paid after 20 years. The transitional allowance is limited to the annual salaries (fixed salary and bonus) still outstanding until the age of 62 in each case. In the event that his contract is not extended, one member of the Management Board will not receive any benefits from HVB AG on account of another contract he has in the corporate group; another can receive a retirement pension.

Compensation paid to members of the Supervisory Board

The compensation paid to members of the Supervisory Board is regulated in Article 15 of the Articles of Association of HVB AG. The compensation is divided into a fixed and a variable, dividend-dependent component. Under the terms of the arrangements, the members of the Supervisory Board receive fixed compensation of €25,000 payable upon conclusion of the financial year and dividend-dependent compensation of €400 for every €0.01 dividend paid above the amount of €0.12 per no-par share. The chairman of the Supervisory Board receives twice the compensation stated, the deputy chairmen one and a half times the compensation stated. Furthermore, the Supervisory Board is entitled to a fixed annual compensation of €120,000 payable upon conclusion of the financial year, which is used to compensate committee members on the basis of a corresponding Supervisory Board resolution. According to this, the members of the Audit Committee receive annual compensation of €20,000 each for the 2006 financial year. The chairman of the committee receives twice this amount. Where they sit on the Management Committee of UniCredit, the members of the Supervisory Board surrender to UniCredit the compensation they receive for Supervisory Board work, as the performance of Supervisory Board functions at subsidiaries is considered a typical management duty.

Information on the amount of compensation paid to members of the Supervisory Board is provided in Note 79, “Information on relationships with related parties”, in the notes to the consolidated financial statements.

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Internal management

One of HVB Group’s most important objectives is a sustained increase of corporate value. To take account of capital market requirements and the necessity of value-based management, we have implemented the concept of dual steering. The overriding goal of value creation in the sense of shareholder value can thus be transferred to the operating divisions.

Essentially, this concept requires a return from two capital resources. One is the regulatory (or used core) capital and the other risk capital, in other words the economic capital actually required to cover risks identified on the basis of internal models. Both resources are expected to yield an appropriate return, which is derived from the expectations of the capital markets and is expected to be earned by our business units. In 2007, the dual steering will continue to be harmonised with the steering of the UniCredit Group. A detailed description of this issue is given in the Risk Report under the section entitled “Overall bank management”.

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