EX-1 2 dex1.htm INTERIM REPORT TO SHAREHOLDERS Interim Report to Shareholders

EXHIBIT 1

 

Brookfield

  

Q2 INTERIM REPORT TO SHAREHOLDERS

     

 

FOR THE SIX MONTHS ENDED JUNE 30, 2009

www.brookfield.com   

NYSE: BAM

  

 

TSX: BAM.A

  

 

EURONEXT: BAMA

 

    

Three Months Ended June 30

 

  

Six Months Ended June 30  

 

MILLIONS, EXCEPT PER SHARE AMOUNTS

 

  

2009

 

  

2008

 

  

2009

 

  

2008  

 

 

Cash flow from operations

 

   $            276    $        378    $        549    $        821  

  – per share

 

   0.46    0.62    0.92    1.34  

Net income

 

   $            147    $        110    $        240    $        307  

  – per share

   0.24    0.17    0.39    0.48  
 

Letter to Shareholders

OVERVIEW

After a long winter, the second quarter of 2009 brought the beginnings of a thaw in the financial markets. While the capital markets are not back to normal, they have rapidly returned to a semblance of order. Investment grade corporate spreads are still wide on a historical risk-adjusted basis, but have narrowed substantially, and more importantly, quality borrowers have access to the markets.

Although we have seen improvement in the capital markets, we believe that it is premature to assume that the financial system is fixed. The massive stimulus being injected into the global markets appears to be working, but the end results are unknown. In fact, some outcomes of these unprecedented events are quite worrisome. As a result, we continue to act cautiously and are not conducting our affairs as though the world has suddenly recovered and returned to normal. Our attitude was similar last fall, in that we were not that negative in the face of the persistent weakening in the economy. In general, we find that being overly positive or negative ensures that short-term thinking permeates business decisions and creates an inability to focus on long-term value creation.

Overall, we generated cash flow from operations of $276 million during the quarter compared to $378 million in the second quarter of 2008, with the decline due in large measure to a higher level of investment gains in 2008. We achieved solid performance throughout most of our operations. Fortunately, a large portion of our cash flows are underpinned by high quality long-term contractual arrangements that provide us with a greater level of stability than many businesses. Despite this, we have not been immune to the significant slowdown in economic activity.

Financing Markets

We have been tremendously fortunate throughout the past two years as our commercial banks and institutional partners have, virtually without exception, supported us as we continued to build our business.

In this regard, during the second quarter, we generated approximately $2 billion of cash on our own balance sheet from financings and asset monetizations, to further enhance our liquidity. Spreads on our debt issuances were high, but we were not complaining. We could have waited for spreads to tighten but decided that given the environment over the past 12 months, where the capital markets afforded little liquidity, we should not be too greedy.

Our cash resources enabled us to invest a significant amount of capital over this period, which we hope will pay off with substantial returns. In addition, we intend to put our recently enhanced liquidity and capital commitments from partners to work by acquiring high quality assets at similarly high returns. We believe the value that can be created by these acquisitions should more than offset the incremental cost of the capital. Some of the larger financings which have closed or will close shortly, are as follows:


Financing (MILLIONS)

 

  

Location  

 

  

Amount  

 

  

Term  

 

Corporate debt issue

 

   Canada      $ 450      5 years  

Preferred share issue

 

   Canada        270      Perpetual rate reset  

European bank facility

 

   Europe        160      2 years  

Suncor Energy Centre mortgage bond

 

   Canada        330      5 years  

Australian Government property mortgage bond

 

   Australia        50      3 years  

Corporate power debt issue

 

   Canada        90      3 years  

Power plant mortgage bonds

 

   Canada/Brazil        140      7 years / 10 years  

Brookfield Infrastructure bank facility

 

   U.S.        200      2 years  

Contribution of power assets to a managed fund

 

   Canada        520      Net cash generated  

Sale of interests in transmission lines

 

   Brazil        275      Net cash generated  

Contribution of timber assets to a managed fund

   Brazil        70      Net cash generated  

The Suncor Energy Centre financing is notable because we believe it was the first large loan recourse-only, single-asset real estate security that was placed in North America since the downturn of the real estate market began. The success of this placement is a reflection of the quality of the commercial office properties we own. Our thesis has always been to own great assets, in great locations, with great tenants. Our properties produce transparent low-risk cash flows which are of value to fixed income investors, in contrast to lower quality real estate assets. The offering was over-subscribed and we hope to achieve similar offerings with select other properties that are not currently financed on a long-term basis.

Another notable financing that we completed during the quarter was a retail bond financing on one of our properties in Australia. Although relatively small, this was also a first in that country since their market disruptions occurred. This $50 million financing, at 60% loan to value on a property leased to the Australian government, was well received. We expect to access this market for other properties we own in Australia.

The most substantial asset transaction, which was announced after quarter end, was the contribution of approximately $1.3 billion of Canadian power assets into our publicly traded renewable power fund, and an accompanying public equity offering. Our proceeds on closing will be C$565 million of notes and cash, with the balance consisting of units of the fund which will enable us to maintain our existing 50% ownership position in the fund. We expect to record a meaningful gain on this transaction in the third quarter. In addition, we closed the previously announced sale of our interests in a group of Brazilian transmission lines for $275 million, and seeded our Brazilian timber fund with timberlands that we had owned for many years, which generated $70 million of proceeds to us.

Debt to Capitalization

Our financial structure has been built very deliberately with each asset we own financed at an investment-grade level, and with minimal amounts of corporate debt. As a result, we came through the last two years without undue financial pressures, however, we believe we could have done better. We plan on taking what we have learned from the last two years and adapting our financial model to ensure that it is even more resilient.

Despite the above, it has become evident to us that investors’ understanding of our balance sheet is not as clear as we would wish. There appear to be two reasons for this. First, as the “general partner” of most of the partnerships that we operate for institutional investors, we are obliged to consolidate onto our balance sheet many of the assets and associated liabilities which are owned by our partners. The second item arises from the fact that we generally hold assets for long periods of time and our consolidated statements utilize GAAP accounting, which reflects historical book values for most of our assets. To address this, we are adopting International Financial Reporting Standards (“IFRS”) reporting at the beginning of next year. Under IFRS, the carrying values of assets are adjusted to reflect underlying values as opposed to utilizing their historical cost.

With respect to the first item mentioned, the accounting conventions are unlikely to change, so the best we can do is summarize the facts for you. Below are simplified balance sheets which hopefully provide you with the relevant information to assist you in making your own assessment of our financial profile. We have used our December 31, 2008 balance sheets because we have the associated valuation adjustments that we believe will be utilized in preparing our initial balance sheet under IFRS.

 

     2        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


As you can see below, our corporate debt-to-capitalization ratio on an underlying value basis is only 15%. We have $15 billion of capital and only $3 billion of debt. The ratio increases to 44% when calculated on a proportional basis, meaning that the debt related to assets we own, but which is non-recourse to us, is included based on our proportionate ownership interest. When you further include our partners’ assets and liabilities, you then arrive at our consolidated balance sheet.

Unfortunately, when we mix our other partners’ assets (where we have no downside) into our consolidated balance sheet, we believe that this makes the numbers more difficult to understand. We have nonetheless reconciled these for you so you have the facts.

 

AS AT DECEMBER 31, 2008

(MILLIONS)

 

  

Deconsolidated

Historical

Balance

Sheet

 

  

Add:

Underlying

Value

Adjustments

 

  

Deconsolidated

Underlying

Value

Balance

Sheet

 

  

Add:

Pro rata
Share of

Non-recourse

Debt

 

  

Proportionate

Balance

Sheet

 

  

Add:

Other

Partners’

Interests

 

  

Consolidated  

Balance  

Sheet  

 

 

Assets

   $ 10,618    $ 9,240    $ 19,858    $ 21,137    $ 40,995    $ 26,956    $ 67,951  
 

Liabilities

                    

Corporate borrowings

     2,284         $ 2,284         $ 2,284         $ 2,284  

Subsidiary borrowings

     733           733      2,922      3,655      1,447      5,102  

Property-specific financings

                    11,976      11,976      10,913      22,889  

Other liabilities

     1,277           1,277      5,798      7,075      5,041      12,116  

Capitalization

                    

Co-investors interests in and capital securities

     543           543      441      984      9,555      10,539  

Shareholders’ equity

     5,781      9,240      15,021           15,021           15,021  
     6,324      9,240      15,564      441      16,005      9,555      25,560  
 
   $ 10,618    $ 9,240    $ 19,858    $ 21,137    $ 40,995    $ 26,956    $ 67,951  
 

Debt-to-capitalization ratio

     28%         15%         44%         45%  
 

Intrinsic Values

The above balance sheets are adjusted for the underlying value of most of our assets based on our current IFRS methodology, but do not include the complete intrinsic value of the business (which we comment on further below). IFRS accounting sets specific rules to value some assets based on cash flows and discount rates, and these are tested over time with external valuators. As indicated before, we intend to fully adopt IFRS reporting as we believe it to be more relevant to our business than U.S. or Canadian GAAP. We are comfortable with this accounting framework as it is widely utilized in virtually every other country where we operate outside of the U.S. and Canada. In addition, we use IFRS or other fair value accounting principles in many of our funds and joint ventures with institutional clients, and we manage the operations of our business based on these metrics.

There are, however, some assets which are not re-valued under IFRS. For these assets, we have provided you with an estimate of their value and you can choose whether or not to utilize this figure when you assess the value of our business. You may also wish to adjust our underlying values up or down based on whether you assess the company on a liquidation basis, or as a long-term going concern. On a liquidation basis (which we do not intend to undertake) in today’s relatively illiquid markets, you may take the view that realized values would be less than the underlying values. Alternatively, if you believe that a company should be valued as a going concern in a normal market at the value willing buyers and sellers would pay for assets or businesses, then you might conclude that achieved sales prices should be above their appraised values (this has been our experience in the past).

For reference, a 100 basis point change to property internal rates of return (“IRRs”) would add or subtract approximately $1.5 billion or about $2.25 per share to the numbers below. A 150 basis point change in IRRs of our power assets would similarly add or subtract approximately $1.5 billion or $2.25 per share to the numbers below.

The table below summarizes our underlying values but does not add the above amounts in reference to intrinsic values nor does it assume we grow or utilize our franchise to invest capital wisely in the future. We leave it for you to decide whether you should add any value for these, but we believe this organization has tremendous franchise value which cannot be captured by a pure asset value calculation and have generally proven over time that we can generate “going concern values” from our assets:

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         3    


AS AT DECEMBER 31, 2008 (MILLIONS, EXCEPT PER SHARE AMOUNTS)    Total      Per Share  

Book value per share under historical accounting at 12/31/08

   $ 4,911      $ 8.92  

Add:Underlying value adjustments to bring some, but not all of our assets to appraisal value

     9,240        15.40  
     14,151        24.32  

Add:Estimated excess value of assets over book value that are not included within the

     1,500        2.50  

IFRS fair value framework (such as historical cost land and other inventories)1

       

Add:Increase in the book equity case since 12/31/08 due to cash flows and currency movements

     1,000        1.67  

Underlying value

   $     16,651      $ 28.49  

  1    Management estimate

     

Currencies

A further factor impacting the intrinsic value of our business is the location of our investments, as we often do not hedge the full economic value of our investments outside of the U.S., back into U.S. dollars. This is due to our long investment horizons, and our views on currencies.

Currency movements over the past 18 months have been virtually unprecedented. When volatility of this nature occurs, it is not surprising we receive questions on how we are affected. The short answer is that we are generally long in the currencies of countries where we operate (because the intrinsic value of the assets we own, less the local liabilities, leaves us with an equity exposure in the local currency). As a result, to the extent that the currencies of those countries go up, we benefit and vice versa. This hurt our equity base at the end of 2008 as world-wide financial concerns led to a flight to quality, and the value of the U.S. dollar increased against most other currencies. Correspondingly, we have benefitted as these currencies reversed course in 2009.

We sometimes take a view on a currency and hedge some of this exposure. Fortunately, we closed most of our hedges out in the early part of 2009, which resulted in us being long most of our foreign currency assets. As a result, we have benefitted substantially in the last six months, as the currency realignments during this period added approximately $700 million to our equity base, and there have been significant further gains since June 30.

In summary, about 50% of our equity is invested in U.S. dollar-based investments. We are comfortable with this as we believe that the U.S. dollar will remain an extremely important global currency for many decades. This is mainly because we see no viable alternative currency which has the necessary scale, universal acceptance and a history of rule of law backing its existence.

The other 50% of our capital is invested predominantly in three healthy, commodity-based countries where we believe the odds favour the currencies doing well compared with the U.S. dollar. This is as a result of their current fiscal situation, but more importantly because the drivers of their economies (oil, iron ore, coal, copper and agricultural products) should enable them to maintain positive fiscal positions. At the current time, our investments, net of any local debt or hedges we maintain, are denominated in the following currencies: 1

 

 

U.S. Dollar investments

   50%  

Canadian Dollar investments

   20%  

Brazilian Real investments

   15%  

Australian Dollar investments

   10%  

U.K. Pound and other investments

   5%  
 

  1    Subject to change at any time

  

 

     4        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Investment of Capital

Looking forward to the next 24 months, we expect to dedicate resources to three major initiatives:

 

  (1)

Deploying capital in global real estate turnarounds. We believe this will be one of the great investment periods for these types of assets in a long time, and we have been assembling capital from some of the world’s premier investors for this purpose. Given where most distress opportunities are available, and where we have an operating base, we expect our focus will be principally on office and retail properties in the U.K., U.S., and Australia.

 

 

  (2)

Investing in select infrastructure situations with high quality assets that are encumbered by excessive debt levels. These opportunities may be pursued through Brookfield Infrastructure Partners or our established infrastructure investment funds.

 

 

  (3)

Acquiring loans on U.S. commercial real estate, possibly with funding from U.S. government programs.

 

Often people question why we invest in these distress situations when the returns look bleak, often for years. The simple answer is that we believe that this is the lowest-risk way to acquire great assets. In this regard, it is often worthwhile to reflect on investments made during past difficult periods to provide perspective. We have found that the returns from investments made in periods of distress can make a significant difference in future value creation, as dollars invested in times like these (usually at far less than replacement cost) clearly favour generating greater returns over the longer term.

U.S. Land Residential Business

One further area where we have been investing capital over the past six months is the U.S. residential business. Looking back today, it is clear to us that housing peaked in the fall of 2005. We withdrew substantial cash out of our U.S. housing operations and disposed of land through 2003 to 2006. During this period, we returned over $500 million of cash from this business to shareholders including ourselves, far greater than our original investment. But despite our conservative view, we did not expect the U.S. residential markets to get as bad as they did. Like everyone, we have struggled since with losses in the remaining residential land positions we own. The good news is that we believe we are past the worst of the down cycle for housing. Furthermore, while we do not expect a robust turn, we believe we have, or will soon see, a bottom in many of the key U.S. housing markets.

As a result, in the last six months we started to acquire residential land where we have market knowledge, people and the operations to ultimately build out the lots. First, we invested $250 million in April 2009 to increase our interest in the business through a rights offering. Second, during this year, we purchased approximately 3,200 residential lots for approximately $30 million in Riverside County, California through two court foreclosure proceedings. We know this is currently one of the worst residential markets in the U.S., however, these lots are within an hour of Los Angeles, were purchased for less than 10% of the value attributed to the land and infrastructure at the peak, and the purchase price represents only about 20% of the cash already invested in roads, sewers and grading over the past three years.

These investments will clearly be negative to our reported results in the short term even at a 7% cost of borrowing. This equates to a drag on current results of more than $20 million annually until the lots are sold. However, we are willing to bear these short-term costs in the belief that the multiples of capital earned will be substantial (we are targeting three to seven times) on ultimate sale, as values recover over the next 10 years, leading to very high returns on our net invested capital.

Brazilian Residential Business

Sales of single-family homes and condominiums in Brazil have not suffered from the same factors impacting the “developed” markets. There was no residential bubble in Brazil as there has traditionally been limited financing in the market. In contrast to the U.S., we recorded our best sales results ever in the last number of months. For the first half of 2009, comparative sales in our development business were over 55% higher compared with 2008.

Last year, we expanded our Brazilian residential operations to build not only upper-end and upper-middle class housing, but to also build for the Brazilian middle class. This is a massive growth sector, so we merged our operations with two other entities to capitalize on this opportunity. We now build for all income segments and have meaningful development operations in São Paulo, Rio de Janeiro, Brasilia and Goiânia. In this regard, over 60% of sales in the first six months of 2009 were in the middle class housing category, up from approximately 45% last year.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         5    


President Lula of Brazil launched a program several months ago to build one million new homes for the “emerging middle class.” This program is called “Minha Casa, Minha Vida” (my home, my life). We are building homes under this program in Goiânia and in suburban São Paulo. These single-family homes are predominantly sold for approximately US$20,000 – US$35,000, and will clearly change the lives of many in Brazil.

People

We believe that our most valuable asset is our people. During the last few years, we have been able to achieve our relative success because of the expertise and dedication of our team. This has contributed to advancing our standing with institutional and financial counter parties in the market, and should, as a result, enhance our “brand” over time.

During this period, we have continued to add people to our team. We believe, that like investment opportunities, this period of time is one of those special opportunities offered to those who have the resources. We have recently been able to attract a number of highly skilled individuals to the organization who, for various reasons, would not otherwise be available, because they were happily employed, or it would have been too costly to dislodge them.

In this regard, we have strengthened our teams in our global institutional marketing and advisory groups, where we have lacked scale in the past. We expect to further expand these operations over the next year in New York, London, Sydney, and Hong Kong.

We recognize that the addition of these resources to our operations will increase costs in the short term, but we believe these will be far outweighed by future value creation. In addition, these operations will continue to add to our global scale and execution capabilities, and should be highly profitable in their own right within a short period of time.

SUMMARY

We have been fortunate over the past two years to have navigated our way through the difficult period with modest financial or business setbacks. Most of the difficult issues have been put behind us, or should be easily handled in the normal course within the context of our operations over the next few years.

We have worked hard to build up substantial liquidity, and as a result, are now looking outward to find opportunities to invest this capital where we have the chance to add meaningfully to our intrinsic values over the next decade.

As always, should you have questions, comments or ideas, please do not hesitate to call.

 

LOGO

 

J. Bruce Flatt

Senior Managing Partner & CEO

August 7, 2009

 

     6        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Interim Report contains forward-looking information within the meaning of Canadian provincial securities laws and other “forward-looking statements” within the meaning of certain securities laws including Section 27A of the U.S. Securities Act of 1933, as amended, Section 21E of the U.S. Securities Exchange Act of 1934, as amended, “safe harbor” provisions of the United States Private Securities Litigation Reform Act of 1995 and in any applicable Canadian securities regulations. We may make such statements in this report, in other filings with Canadian regulators or the SEC or in other communications. The words “hope,” “sometimes,” “soon,” “possibly,” “leading,” “plan,” “ensure,” “unlikely,” “increasing,” “achieve,” “strategy,” “contracted,” “intend,” “extend,” “projected,” “periodically,” “enable,” “enhance,” “maintain,” “objective,” “pursue,” “generate,” “build,” “capitalize,” “create,” “largely,” “continue,” “believe,” “typically,” “expect,” “potential,” “primarily,” “generally,” “anticipate,” “goal,” “might,” “estimated,” “expand,” “usually,” “often,” “scheduled,” “backlog,” “seek,” “tend”, “opportunity,” “targets,” “forecast,” “customarily,” “likely,” “growth,” “regularly,” derivations thereof and other expressions of similar import, or the negative variations thereof, and similar expressions of future or conditional verbs such as “would,” “may,” “will,” “can,” “should,” or “could” are predictions of or indicate future events, trends or prospects, do not relate to historical matters or identify forward-looking statements. Forward-looking statements in this Interim Report include, among others, statements with respect to our views on the state of the capital markets, our plans to use recently enhanced liquidity and capital commitments from partners, future transaction closings, value creation through acquisitions, expected gains on transactions, our plans with respect to our financial model, the length of time that we hold assets, our beliefs about the franchise value of the company; our ability to generate going concern values from our assets; our views on the intrinsic value of our business and the shares of the company, our hedging practices, the economic value of our investments in the currencies of countries where we operate, the future importance of the U.S. dollar as a global currency, the impact of potential U.S. currency losses on the value of our assets, the ability of currencies of other countries where we have invested to maintain positive positions against the U.S. dollar, our planned future initiatives, the condition of the U.S. housing cycle, expected returns on invested capital, future value creation through highly-skilled additions to our people resources, generating long-term cash flows and opportunities for value creation for us and our partners, creating value for shareholders by increasing cash flows, our ability to protect and enhance the long-term value of our existing businesses and to better position the company to capitalize on opportunities that we expect will arise in the coming years, future lease expiries in our commercial properties portfolio, our contracted renewable power generation, our ability to mitigate the impact of low energy prices, our ability to exceed our renewable power generation targets arising from above-average reservoir levels, our beliefs about our financing strategy, our ability to pursue business and investment opportunities given our liquidity levels, the development of specialized mandates to capitalize on opportunities, the ability of the company’s approach to business to mitigate the impact of the current economic environment on its operating margins, investment gains and operating returns, our beliefs about future opportunities to invest capital in existing operations, new assets and businesses to generate increased cash flow and shareholder value over the longer term, the ability of our businesses to withstand the short-term environment and invest and build for the future, our ability to meet long-term performance objectives for cash flow growth and value creation and to continue to build the company as a world-class asset manager, our ability to store water in reservoirs to protect against short-term changes in water supply, our ability to achieve our short-time and long-term objectives, procedures and assumptions that we intend to follow in preparing our pro-forma opening balance sheet for our adoption of IFRS, our commercial office strategy and goals, our ability to lock-in lower underlying interest rates, our ability to maintain or increase our net rental income in the coming years, our ability to attract new tenants to fill excess in our vacant office property space, our ability to retain the benefit and risk of electricity price increases and decreases through purchases of electricity generated through Great Lakes Hydro Income Fund, our strategy of forward selling generation to reduce the impact of short term fluctuations in market prices, our ability to optimize generation selling prices by generating and selling power during higher-priced peak periods, expansion of our infrastructure activities into new sectors that provide similar characteristics as the timber and electricity transmission sectors, completion of the sale of our North American power distribution assets, investment in and completion of the development of our Texas transmission system joint venture project, future returns from our real estate opportunity funds, future performance of the U.S. residential real estate markets, timing of our residential real estate construction financing renewals, future generation of revenues through contracted real estates sales in Brazil, backlog at our U.S. residential operations, future margins in our Australian residential real estate sales, occupancy date of the Bay Adelaide Centre, construction on our development land on Ninth Avenue in New York City, conversion of our higher and better use lands, our Middle East and Australian construction workbook revenue backlog, future returns in our restructuring funds, our ability to react quickly to potential investment opportunities and adverse changes in economic circumstances, focusing on owning high quality assets, backing revenue streams with long-term contractual arrangements, match funding long life assets with long-term financings and maintaining a high level of liquidity and such focus benefiting us during volatile times, the forecast for natural gas and electricity prices during the balance of 2009 and 2010 and impact on our renewable power operations, our ability to renew expired leases in our commercial office portfolio in 2009 and 2010 in the normal course, a reduction in cash flows resulting from the current economic downturn leading to tenant bankruptcies and lower market rents, achieving our 2009 office property operating targets, operating returns in 2009 for our transmission businesses, expectations for our timber operations in 2009 and the future effects of reduced harvest levels, our timber harvest levels in the U.S. and Canada in 2009 relative to 2008, contribution from our Brazilian operations in 2009 and beyond, long-term growth from deployed capital from our new funds, the effect of the current difficulties in credit markets on our restructuring operations and real estate finance group in the short-term and our ability to monetize investments and recognize disposition gains, our goals for our asset management activities including growth in asset management income, contribution from base management fees in 2009, reducing leverage in certain areas of our business and the effects of doing so, our ability to invest our capital on a favourable basis for the balance of 2009 through 2011, achieving the key elements of our capital strategy, our ability to manage our financial commitments and to capitalize on opportunities to invest capital at attractive returns, our ability to refinance or roll over our corporate and subsidiary debt maturities and fund reductions with current liquidity, cash flow and asset monetizations, our ability to maintain debt levels on any particular asset or group of assets throughout a business cycle, our ability to refinance debt maturities at current borrowing levels on an overall basis and maintain ample liquidity to deliver individual properties if necessary, our ability to reduce our liabilities by a meaningful discount, benefit underlying values, improve cash flow from operations on a per share basis and give rise to accounting gains through debt repurchases or other initiatives, the form of borrowings within the businesses that we manage, our ability to permanently finance our Australian business with corporate facilities and asset-specific mortgages on its properties prior to maturity of our Brookfield Australia bank facility in 2010, future payments by us under our indemnification obligations, the level of seasonality of our various operations, our intention to prepare our financial statements in accordance with IFRS for periods beginning January 1, 2010 and the potential and expected impacts of doing so on our balance sheets, statements of income and cash flows, as well as the outlook for the company’s businesses and other statements with respect to our beliefs, outlooks, plans, expectations and intentions.

Although Brookfield believes that the anticipated future results, performance or achievements expressed or implied by the forward-looking statements and information are based upon reasonable assumptions and expectations, the reader should not place undue reliance on forward-looking statements and information because they involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the company to differ materially from anticipated future results, performance or achievement expressed or implied by such forward-looking statements and information.

Factors that could cause actual results to differ materially from those contemplated or implied by forward-looking statements include: economic and financial conditions in the countries in which we do business; rate of recovery of the current economic downturn; the behaviour of financial markets, including fluctuations in interest and exchange rates; availability of equity and debt financing; strategic actions including dispositions; the ability to effectively integrate acquisitions into existing operations and the ability to attain expected benefits; the company’s continued ability to attract institutional partners to its specialty funds; adverse hydrology conditions; timber growth cycles; environmental matters; regulatory and political factors within the countries in which the company operates; tenant renewal rates; availability of new tenants to fill office property vacancies; tenant bankruptcies; acts of God, such as earthquakes and hurricanes; the possible impact of international conflicts and other developments including terrorist acts; changes in accounting policies to be adopted under IFRS; and other risks and factors detailed from time to time in the company’s form 40-F filed with the Securities and Exchange Commission and Management’s Discussion and Analysis of Financial Results as well as other documents filed by the company with the securities regulators in Canada and the United States.

We caution that the foregoing list of important factors that may affect future results is not exhaustive. When relying on our forward-looking statements to make decisions with respect to Brookfield, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. Except as may be required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements or information, whether written or oral, that may be as a result of new information, future events or otherwise.

CAUTIONARY STATEMENT REGARDING USE OF NON-GAAP ACCOUNTING MEASURES

This Interim Report makes reference to cash flow from operations on a total and per share basis. Management uses cash flow from operations as a key measure to evaluate performance and to determine the underlying value of its businesses. Brookfield’s consolidated statements of cash flow from operations provides a full reconciliation between this measure and net income. Readers are encouraged to consider both measures in assessing Brookfield’s results. Operating cash flow is not a generally accepted accounting principle measure and differs from net income, and may differ from definitions of operating cash flow used by other companies. We define operating cash flow as net income prior to such items as depreciation and amortization, future income tax expense and certain non-cash items that in our view are not reflective of the underlying operations.

BUSINESS ENVIRONMENT AND RISKS

Factors that impact Brookfield’s financial results include: the performance of each of our operations and various external factors influencing the specific sectors and geographic locations in which we operate; macro-economic factors such as economic growth, changes in currency, inflation and interest rates; regulatory requirements and initiatives; and litigation and claims that arise in the normal course of business. These and other factors are described in Management’s Discussion and Analysis of Financial Results in the Corporation’s 2008 Annual Report which is available on our web site and at www.sedar.com.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         7    


Management’s Discussion and Analysis of Financial Results

 

 

CONTENTS
          Page

Part 1

  

Introduction

   8

Part 2

  

Performance Review

   10

Part 3

  

Capitalization and Liquidity

   37

Part 4

  

Analysis of Consolidated Financial Statements

   46

Part 5

  

Supplemental Information

   52

PART 1 – INTRODUCTION

The information in this Management’s Discussion and Analysis of Financial Results (“MD&A”) should be read in conjunction with the most recent issued Annual Report of the company. The Annual Report, and additional information, including the company’s Annual Information Form, is available on the Corporation’s web site at www.brookfield.com and on SEDAR’s web site at www.sedar.com.

BUSINESS OVERVIEW

Brookfield is a global asset management company, with a primary focus on property, power and infrastructure assets. We have established leading operating platforms in these sectors and, through them, own and manage a broad portfolio of high quality assets that generate long-term cash flows and opportunities for value creation for us and our partners. We create value for our shareholders by increasing, over time, the cash flows generated from the capital that we have invested in them as well as income from managing these assets for our partners. Part 5 of the MD&A in our 2008 Annual Report describes our Business Strategy in further detail.

BASIS OF PRESENTATION

We have organized this MD&A on a basis that is consistent with how we operate the business. We organize our activities into a Corporate Group and individual Operating Platforms which focus on specific business segments. We segregate our financial results between Asset Management (i.e., what we earn as the manager of the assets or operations) and Operations (i.e. what we earn as an investor in the assets or operations). We also segregate our financial results and our assets, liabilities and capital by Operating Platform. Operating Platforms include commercial properties, renewable power generation, infrastructure, development and other properties and specialty funds. We also have an investment management group which manages fixed income and equity securities on behalf of institutional clients. The results of the investment management activities are included within our Asset Management segment, along with the asset management activities associated with the Operating Platforms, including property management services as well as investment banking services.

We present invested capital and operating cash flows on a “total” basis, which is similar to our consolidated financial statements and a “net” basis which represents our pro rata interest in the underlying net assets and cash flows. The net basis includes the operations of the company and Brookfield Properties Corporation (“Brookfield Properties”) collectively, and is presented on a deconsolidated basis meaning that assets are presented net of associated liabilities and non-controlling interests. Similarly, cash flows are presented net of carrying charges associated with related liabilities and cash flow attributable to related non-controlling interests such as minority shareholders and investment partners. Net invested capital and net operating cash flows, in our view, represent a more consistently comparable basis of presentation than our consolidated financial statements which include the operations conducted through subsidiary or affiliated entities under various methods, including equity accounting, proportionate consolidation and full consolidation. Please refer to Part 5 of the MD&A in our 2008 Annual Report which includes a description of our financial measures and a glossary of terms.

We provide reconciliations between the basis of presentation in this MD&A and our consolidated financial statements. In particular, we reconcile operating cash flow and net income on page 13. The tables on pages 49 to 51 provide a reconciliation between our consolidated financial statements and the basis of presentation used herein.

 

     8        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


The underlying values presented or discussed in this MD&A are prepared using the procedures and assumptions that we intend to follow in preparing our pro-forma opening balance sheet for our adoption of International Financial Reporting Standards (“IFRS”) and are as at December 31, 2008, the anticipated date of our opening balance sheet for IFRS adoption. Please refer to the MD&A in our 2008 Annual Report for further information. The underlying values reflect most of our tangible assets at fair value as of that date, with corresponding adjustments to minority interests and shareholders’ equity, but do not include any adjustments to reflect value attributable to our asset management franchise and do not reflect any upward revaluation of land and other inventories to reflect current value. We have not adjusted the carrying values of our borrowings at this time. The underlying values are reduced by accounting provisions in respect of the theoretical tax liability that might arise if we were to liquidate the business based on the underlying values at the balance sheet date, consistent with IFRS accounting principles. Our intention, however, is to hold most of our assets for extended periods of time or otherwise defer this liability. The deferred tax balance is similar in this sense to the float in an insurance company which is available for investment for extended periods of time or even indefinitely. Accordingly, we also provide our underlying values on a pre-tax basis because, in our opinion, these are more reflective of the capital that is actually deployed on behalf of shareholders.

Unless the context indicates otherwise, references in this MD&A to the “Corporation” refer to Brookfield Asset Management Inc., and references to “Brookfield”, “the company”, “we”, “us” and “our” refer to the Corporation and its direct and indirect subsidiaries and consolidated entities. All financial data included in the MD&A has been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”) and specified non-GAAP measures unless otherwise noted. All figures are presented in U.S. dollars, unless otherwise noted.

 

LOGO            LOGO

Brian D. Lawson

     

Sachin G. Shah

Managing Partner and Chief Financial Officer

     

Senior Vice President, Finance

August 7, 2009

     

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         9    


PART 2 – PERFORMANCE REVIEW

SUMMARY

Most of our operations met their expectations during the second quarter of 2009, notwithstanding the difficult economic environment. We also completed a number of initiatives to protect and enhance the long-term value of our existing businesses and to better position the company to capitalize on opportunities that we expect will arise in the coming years.

Our financial results reflected the stability and continued strong performance of our two largest business units: renewable power generation and commercial office properties. Operating cash flow totalled $276 million for the second quarter of 2009, or $0.46 per share, compared with $378 million or $0.62 per share in the second quarter of 2008.

Our strategy of locking in future revenue streams in the majority of our operations protected our cash flows against the current economic downturn, as intended. Nevertheless, lower electricity prices did impact a portion of our hydroelectric generation, we experienced reduced volumes and margins in our timber and North American residential businesses and we realized a lower level of investment gains. Our commercial office business, however, experienced an increase in cash flows on a “same store” basis due to the high quality of our buildings, leases and tenants.

We increased our liquidity by approximately $300 million since the end of the first quarter to approximately $3.1 billion, through a number of financings and asset monetizations. These include $520 million of liquidity expected to be received in the third quarter through the issuance of equity in our Canadian renewable power business as part of a broader reorganization of this business. We also issued $725 million of corporate preferred shares and debentures and completed $600 million of property-specific and subsidiary level financings during the quarter. The proceeds were used to reinvest in our business at what we believe to be very attractive prices, to refinance near-term maturities on a longer term basis and to supplement our group liquidity.

The following table summarizes our underlying values and net invested capital and net operating cash flows from our operations for the second quarter of 2009 and 2008:

 

     Underlying Value 1     Net Invested Capital 2        Net Operating Cash Flow 2    

AS AT AND FOR THE THREE MONTHS ENDED

 

  

Dec. 31 

 

  

June 30 

 

  

Dec. 31 

 

  

June 30 

 

  

June 30 

 

(MILLIONS, EXCEPT PER SHARE AMOUNTS)    2008     2009     2008     2009     2008 

Asset management income

                $      123     $      113 

Operating platforms

                  

Commercial properties

   $      7,485     $      4,885     $      4,575     221     156 

Renewable power generation

   6,639     1,361     1,215     91     143 

Infrastructure

   974     726     761     15     40 

Development and other properties

   3,313     3,945     3,334     52     102 

Specialty funds

   903     933     870     15     71 

Investments

   701     743     704     56     51 

Cash and financial assets

   1,073     842     1,073     45     30 

Other assets

   2,650     2,817     2,551     —     — 
     $    23,738     $    16,252     $    15,083     $      618     $      706 

Liabilities

                  

Corporate borrowings/interest

   $      2,284     $      2,241     $      2,284     $        35     $        41 

Subsidiary borrowings/interest

   733     762     733     22     20 

Capital securities/interest

   1,425     1,494     1,425     22     23 

Other liabilities/operating expenses

   3,267     2,626     2,654     157     142 
     7,709     7,123     7,096     236     226 

Capitalization

                  

Co-investor interests in consolidated operations2

   3,228     2,229     2,206     106     102 

Shareholders’ equity/operating cash flow

   12,801     6,900     5,781     276     378 
     16,029     9,129     7,987     382     480 
     $    23,738     $    16,252     $    15,083     $      618     $      706 

Per share

                  

– including future tax liability

   $      20.62     $      10.44     $        8.92     $      0.46     $      0.62 

– excluding future tax liability

   $      24.32                     
  1

Prepared using procedures and processes expected to be followed in preparing IFRS financial statements. See “Introduction – Basis of Presentation”

 

  2

Includes the operations of Brookfield Properties Corporation

 

     10        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Operating Cash Flow

The operating results from our two largest operating platforms, commercial properties and renewable power generation, were largely as expected, given the contractual nature of their revenue streams and competitive position of the assets. Together, these two operations produced $312 million of net operating cash flow, compared to $299 million in the second quarter of 2008.

Commercial properties generated net operating cash flow of $221 million in the second quarter of 2009 representing a 42% increase over the comparable 2008 results of $156 million. The increase of $65 million includes a $24 million increase in “same store” rents. The impact of lower interest rates on floating rate debt was largely offset by lower exchange rates during the quarter on our non-U.S. operations. Within our North American portfolio, we leased 2.5 million square feet during the first six months of 2009, at an average rate of $17.33 per square foot, replacing expiring leases that averaged $15.30 per square foot. The global portfolio remains well leased with an overall occupancy level of 95%, an average lease term of 7.5 years and average in-place rents that are, by our estimation, 12%-15% below comparable average market rents, and we experienced virtually no tenant issues in the portfolio since our last report. Expiries are limited to 2% and 4% of our space over the balance of 2009 and 2010, respectively.

Our renewable power generating operations produced $91 million of net operating cash flow during the quarter, compared with $143 million in the same quarter of 2008. The 2008 quarter was an exceptional quarter for us in terms of both generation and realized prices. Generation was slightly above long-term averages in the current quarter. The cooler than average weather and the economic slowdown resulted in lower than expected spot prices during the quarter, which impacted the percentage of generation that we do not sell forward because of potential water fluctuations. Prices are locked in for 80% of the power that we expect to generate over 2009 and 2010 based on long-term averages, which should largely mitigate the impact of low energy prices. In addition, our reservoir levels are estimated to be 6% above long-term averages for this time of year, which should enable us to exceed generation targets if water flows are consistent with long-term averages for the balance of the year.

The strong performance of these two businesses provides significant stability to our results during the current economic environment, and the stable contracted revenue profiles of these businesses provide us with a high level of visibility for the remainder of the year and 2010, and confidence in our ability to achieve our long-term objectives in future years as well.

We recorded lower contributions from several of our business units that have been more directly impacted by the slowdown in the U.S. economy and homebuilding sector, notably our timberland and residential operations.

The contribution from our infrastructure operations, which include timberland and transmission, declined to $15 million in the quarter from $40 million in the second quarter of 2008. Net operating cash flows from our timberlands declined to $3 million from $13 million in the same quarter last year as we elected to reduce harvest levels in order to preserve long-term value by allowing the trees to continue to grow until prices and margins improve. Transmission operations contributed $12 million in the 2009 quarter compared to $27 million in the second quarter of 2008. The 2008 results from our transmission operations included several “onetime” items arising from rate-base adjustments and the contribution from Brazilian transmission interests that were sold prior to the second quarter of 2009.

Our development operations include commercial and residential development as well as construction activities. Our commercial development activities primarily relate to the completion of office properties that are substantially pre-leased, most of which are almost complete. The contribution from residential activities was positively impacted by continued growth and activity in our Brazilian operations, which more than offset a slowdown in our Canadian operations. U.S. operations recorded a small loss during the quarter, consistent with the 2008 quarter. Our construction activities recorded lower cash flow in the quarter compared to the second quarter of 2008, which included several large completion payments.

Specialty fund results in the second quarter of 2008 included $39 million of valuation gains that were not replicated in the current quarter and a higher level of capital deployed in our bridge lending operations. As a result, the 2008 results from these operations, at $71 million, were significantly higher than the $15 million recorded in 2009. In addition, investments in the forest products and building products sectors held within our restructuring funds recorded losses during the quarter. The results from our investment segment benefited from a disposition gain.

During the past two and a half years we have implemented a number of strategies to help mitigate the impact of a worsening economic environment. In this regard, we have hedged some of our credit exposures in the market, in particular with respect to credit spreads. This benefited us significantly over the period but with the improvement in market sentiment, we have closed most of these hedges. The contribution from our cash and financial assets was $45 million in the recent quarter compared to $30 million in the second quarter of 2008. Interest charges at the corporate level were lower during the quarter due to declines in floating rates,

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         11    


although the effect is relatively modest because most of our debt is fixed rate. The average currency exchange rates for most of our non-U.S. operations declined quarter-over-quarter, which decreased the contributions from these regions in U.S. dollars.

Balance Sheet, Capitalization and Liquidity

The composition of our balance sheet remained largely unchanged over the first half of 2009, with the fluctuations due primarily to the impact of changes in currency rates on the carrying values of our non-U.S. operations, which decreased relative to the U.S. dollar in the first quarter, and then increased to a higher level by the end of the second quarter.

The following table provides a summary of key balance sheet items:

 

     Underlying Value     Book Value
    

Dec. 31 

 

  

June 30 

 

  

Mar. 31 

 

  

Dec. 31 

 

(MILLIONS )    2008     2009     2009     2008 

Total consolidated assets

   $    67,951     $    55,972     $    52,803     $    53,597 

Net invested capital

   23,738     16,252     14,786     15,083 

Liabilities 1

   7,709     7,123     6,778     7,096 

Capitalization 1

   16,029     9,129     8,008     7,987 

1      Net invested capital basis

           

Our financing strategy is to maintain relatively low levels of debt at the corporate level. The large majority of our debt capital is secured by individual assets and has no recourse to the Corporation. In addition, accounting guidelines require that we include this debt on our consolidated balance sheet even if it is attributable to others. We believe that the most appropriate bases on which to assess our financial position are deconsolidated, which includes only our corporate obligations, and proportionately consolidated, which includes our proportionate beneficial interest in the underlying assets and liabilities of our operations. We also believe that our capitalization is most appropriately assessed using underlying values, because our carrying values under GAAP are based in many cases on purchase prices from many years ago and in many cases are significantly below current underlying values. Accordingly, we have included a table on page 39 that reconciles our deconsolidated, proportionately and fully consolidated balance sheets based on the underlying values that we expect to use in our IFRS reporting as at December 31, 2008 (the most recent period for which we have published underlying values).

We believe our debt-to-capitalization ratios represent an appropriate, investment grade level given the nature of our assets and the quality of the associated cash flows. The deconsolidated ratio on this basis was 15% at year-end, meaning that our corporate obligations were more than six times covered by the capital invested in our operations, much of which is in a monetizable form. The proportionately consolidated ratio of 44% is consistent with our overall financing approach given that most of our borrowings are in the form of well secured mortgages and project financings on high quality assets that typically support financings in the 50% to 70% level.

We continue to undertake a number of measures to strengthen our liquidity and capitalization. In aggregate, we completed $1.5 billion of financings throughout our operations since the end of first quarter to extend existing maturities and provide liquidity to pursue business opportunities.

Our core liquidity at the date of this report is approximately $3.1 billion, of which $2.5 billion was in place at quarter end and a further $0.6 billion represents transactions in process at that time. As a result, we believe that we are in a strong position to capitalize on investment opportunities that may arise and to manage near-term financing obligations.

Net Income

The following table presents net income for the second quarter of 2009 and 2008 determined in accordance with GAAP. We do not utilize GAAP net income as a key metric in assessing the performance of our business because, in our view, it contains measures that may distort the ongoing performance and intrinsic value of the underlying operations. Nevertheless we recognize the importance of net income as a key measure for many users and provide a discussion of net income and a reconciliation to operating cash flow.

 

     12        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


     Total      Net 1  

FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS )

   2009       2008        2009       2008       Variance   

Operating cash flow and gains

   $       276       $       378        $       276       $       378       $      (102

Non-cash items

                

Depreciation and amortization

   (300    (328    (174    (192    18   

Equity accounted results

         (21          (21    21   

Revaluation and other items

   (73    (46    (66    (70    4   

Future income taxes

   97             111       15       96   

Non-controlling interests

   147       124                      

Net income

   $       147       $       110        $       147       $       110       $         37   

Per share

   $      0.24       $      0.17        $      0.24       $      0.17       $      0.07   

1      Net of non-controlling and minority interests

              

Net income was $147 million in the second quarter of 2009 compared with $110 million in the comparable quarter last year. The increase reflects a number of positive variances in the impact from non-cash charges such as depreciation, which decreased due to lower levels of depletion expense consistent with lower harvest levels in our timber operations, and reduced intangible asset amortization due to the shorter amortization period for those assets. We also recorded a higher level of tax benefits, including the credits associated with the non-cash charges in the foregoing table. The net impact of revaluation and other items, which include mark-to-market adjustments on hedging or forward sale arrangements relating to some of our physical assets that are not marked-to-market, and adjustments to the carrying value of certain development assets to reflect lower recoverable values was relatively unchanged from the 2008 quarter.

We provide additional information on net income beginning on page 32.

Asset Management Activities

The following table presents key metrics relating to our asset management activities over the second quarter of 2009 and 2008:

 

(MILLIONS)    2009    2008

Asset management revenues (for the three months ended June 30)

   $         123    $         113

Third-party capital commitments (as at June 30 and December 31)

     

– Unlisted fund and specialty issuers

   $      8,902    $      9,174

– Public securities

   18,822    18,040
     $    27,724    $    27,214

Asset management income increased to $123 million from $113 million in the 2008 quarter due to higher transaction and property service fees, offset by lower base management fees in our specialty funds and public securities platforms due to a lower level of invested assets.

We made continued progress in developing our asset management activities during the quarter. Capital committed by third-party clients increased by $0.5 billion since year-end and was $27.7 billion at the end of the quarter. Capital committed to our unlisted funds and specialty issuers declined by $0.3 billion as capital distributions from mature funds were largely offset by new commitments of $0.4 billion. Public securities under management increased by $0.8 billion, due to higher market values and new mandates. We are continuing to develop specialized mandates that are intended to capitalize on opportunities in the current economic downturn.

We provide additional information on our asset management activities beginning on page 29.

Outlook

In the short term, we recognize that the current economic environment will likely result in continued downward pressure on operating margins and our ability to record investment gains, and therefore provide fewer opportunities to increase reported operating returns. We believe, however, that our approach to business, which includes backing revenue streams with contractual obligations and the use of long-term fixed rate financings, among other strategies, is an important mitigating factor and should provide considerable stability in our cash flows from year to year.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         13    


We also believe that there will be a number of opportunities over the next two to three years to invest capital in our existing operations as well as in new assets and businesses on values that will generate increased cash flow per share and shareholder values over the longer term.

As a result, we believe that our businesses are well positioned to not only withstand the current difficult short-term environment but to invest and build for the future. This provides us with confidence that we will meet our long-term performance objectives with respect to cash flow growth and value creation, and continue to build Brookfield as a world-class asset manager.

REVIEW OF OPERATING PLATFORMS

Commercial Properties

The following table summarizes the invested capital and operating cash flows contributed by our commercial property operations:

 

     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  
AS AT AND FOR THE THREE MONTHS ENDED
(MILLIONS)
   June 30
2009
   Dec. 31
2008
    June 30
2009
   Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
    June 30
2008
 

Office properties

   $ 20,609    $  19,657       $ 4,792    $ 4,485       $ 440    $ 408       $ 222      $ 159   

Retail properties

     1,618    1,326        93      90        25      25        (1 )        (3 )   
     $ 22,227    $  20,983      $ 4,885    $ 4,575      $ 465    $ 433      $ 221      $ 156   

Underlying value

          $  23,877             $ 7,485                                  

Our commercial property operations contributed $221 million of net operating cash flow in the second quarter of 2009 compared to $156 million in the second quarter of 2008. The increased results reflect a modest increase in net rents on re-leasing and lower interest expense on floating rate debt, offset by the impact of a stronger U.S. dollar on operations outside the U.S. Consolidated assets and net invested capital increased from year end due primarily to the completion of office properties that were previously included within our development activities.

Office Properties

We own and manage one of the highest quality commercial office portfolios in the world, located in major financial, energy and government centre cities in North America, Australasia and Europe. Our strategy is to concentrate our operations in high growth, supply-constrained markets that have high barriers to entry and attractive tenant bases. Our goal is to maintain a meaningful presence in each of our primary markets so as to build on the strength of our tenant relationships. As at June 30, 2009, we owned, directly and indirectly, over 160 properties containing total leasable area of 94 million square feet. Our net leasable area on a consolidated basis was approximately 70 million square feet.

The following table shows the sources of operating cash flow by geographic region:

 

     Operating Cash Flow  
     2009     2008  

FOR THE THREE MONTHS ENDED JUNE 30

(MILLIONS)

   Total    Interest
Expense
   Co-investor
Interests
     Net     Total    Interest
Expense
   Co-investor
Interests
     Net  

North America

   $ 374    $ 139    $ 42 1     $ 193       $ 340    $ 157    $ 39 1     $ 144    

Australasia

     56      26              30        58      44              14   

United Kingdom

     10      11              (1     10      9              1   
     $ 440    $ 176    $ 42       $ 222      $ 408    $ 210    $ 39       $ 159   
  1

Includes $18 million (2008 – $19 million) attributable to co-investor interests classified as liabilities and interest expenses for accounting purposes

 

     14        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


The following table sets out the variances in operating cash flows and presents the current period results reflecting the average exchange rates during the second quarter of 2009 as well as those in place during 2008 to enhance comparability:

 

FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS)    2009      2008      Variance  

Current properties (excluding impact of foreign exchange)

        

United States

   $ 287       $ 280       $ 7   

Canada

     55         60         (5

Australasia

     68         50         18   

United Kingdom

     14         10         4   
     424         400         24   

Other

     40         8         32   

Impact of foreign exchange

     (24              (24 )   

Total operating cash flow

     440         408         32   

Interest expense

     (187      (210      23   

Co-investor interests

     (42      (39      (3

Impact of foreign exchange

     11                 11   

Net operating cash flow

   $ 222       $ 159       $ 63   
  1

Based on average exchange rates during comparative quarter

Operating cash flow from current properties increased by $24 million, representing a 6% increase in net rental income. The contribution from recently completed properties in Australia and the U.K., as well as higher net rents in North America was offset by a reduction from our Canadian operations due to the sale of the Canada Trust Tower in Toronto in the second half of 2008. We leased 2.5 million square feet in our North American portfolio during the first six months of 2009 (0.7 million in the second quarter) at an average net rent of $17.33 per square foot, replacing expiring leases that averaged $15.30 per square foot. Other income of $40 million includes a $39 million gain relating to the restructuring of our U.S. fund that was undertaken to simplify our ownership structure.

Net operating cash flow benefited from a $23 million decrease in interest expense in the second quarter of 2009 due largely to the impact of lower interest rates on floating rate debt. The maturity profile of our borrowings is relatively modest for the next two years and we continue to roll over existing maturities in the normal course of business, and are also taking steps to lock in lower underlying interest rates. Foreign exchange revaluation of non-U.S. revenues and expenses reduced our total and net operating cash flows by $24 million and $13 million, respectively, in the quarter.

Our global portfolio occupancy rate at the end of June 30, 2009 was 95.4% (March 31, 2009 – 96.0%), and the average term of the leases was 7.5 years up from 7.2 years at December 31, 2008. Annual lease expiries average 5% over the next four years with only 2% and 4% expiring in 2009 and 2010, respectively. We have continued our strategy of pre-leasing space that expires in future years. As a result, while current occupancy levels have declined by 0.6% since March 31, 2009, the aggregate expiries over the next three years have been reduced by 1.3% resulting in a 0.7% decrease in leasing requirements over this period and an increase in the average lease term.

 

     Current    Average    Net Leasable    Currently    Expiring Leases (000’s Sq ft)  
AS AT JUNE 30, 2009    Occupancy    Term    Area    Available    2009    2010    2011    2012    2013    2014    2015    2016+  

United States

   94%    7.4    42,433    2,659    605    1,607    2,623    3,497    7,143    2,975    3,922    17,402   

Canada

   98%    7.1    16,299    281    147    881    1,353    1,327    3,208    490    2,610    6,002   

Australasia

   98%    7.7    10,074    180    504    459    434    293    364    715    803    6,322   

United Kingdom

   95%    15.6    1,661    87    7    53    17    57    24    304       1,112   

Total/Average

   95%    7.5    70,467    3,207    1,263    3,000    4,427    5,174    10,739    4,484    7,335    30,838    

Percentage of Total

                  5%    2%    4%    6%    7%    15%    6%    11%    44%   

In North America average in-place net rents across the portfolio remained unchanged at $23 per square foot from the end of last year, reflecting increases in local currency rents offset by lower exchange rates into U.S. currency for rents in Canadian markets. Our in-place rents continue to be at a significant discount to the average rents in our markets, which we estimate to be $28 per square foot. This discount provides greater assurance that we will be able to maintain or increase our net rental income in the coming years, notwithstanding the present difficult economic environment.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         15    


Average in-place rents in our Australasian portfolio are $30 per square foot, approximately 12% below market rents. Our eighteen largest tenants have a weighted average lease life of nine years and account for approximately 60% of our leasable area. These tenants have an average rating profile of A+.

The high quality of our properties has enabled us to sign long-term leases with high quality tenants that have strong credit profiles. The contractual terms of these leases provide a high level of assurance that rents will be paid as expected unless a bankruptcy event occurs. Notwithstanding the recent economic turmoil, only approximately 12,000 square feet were returned to us as a result of credit events since the end of the first quarter (approximately 500,000 square feet in the last 12 months, most of that re-leased already). Furthermore, the competitive positions of our properties in their respective markets enable us to attract new tenants from lower quality buildings to fill any excess in vacant space.

The following table sets out the consolidated assets and net capital invested in our office property operations by region:

 

    June 30, 2009     December 31, 2008  
(MILLIONS )   Consolidated
Assets
  Consolidated
Liabilities
  Co-Investor
Interests
    Net Invested
Capital
    Consolidated
Assets
  Consolidated
Liabilities
  Co-Investor
Interests
    Net Invested
Capital
 

Office properties

                 

North America

  $    7,919   $      5,811   $         —      $    2,108       $      7,887   $      5,675   $         —      $    2,212    

U.S. Core Office Fund

  7,372   5,685   935 1    752      7,395   5,729   923 1    743   

Australasia

  3,361   1,611   122      1,628      2,458   1,283   102      1,073   

United Kingdom

  1,082   878        204      986   642        344   

Other assets and liabilities

               

Intangible items

  787   689        98      841   761        80   

Working capital

  88   86        2      90   57        33   
    $    20,609   $    14,760   $    1,057      $    4,792      $    19,657   $    14,147   $    1,025      $    4,485   
  1

Includes $427 million (December 31, 2008 – $711 million) of co-investor interests that are classified as liabilities for accounting purposes

Consolidated office property assets increased to $20.6 billion from $19.7 billion at year end. Consolidated assets in Australia increased by $575 million as five properties reached practical completion and were transferred from commercial developments to operating properties. In addition, the strengthening Australian dollar increased the value of our assets by $355 million ($155 million net of the impact of debt and minority interests denominated in the same currencies.) The consolidated carrying value of our North American properties is approximately $251 per square foot, substantially less than the estimated replacement cost of these assets.

During the quarter we completed $0.5 billion of financings to replace near-term maturities. Core office property debt at June 30, 2009 had an average interest rate of 6% and an average term to maturity of six years, generally matching the lease profile. The debt to capitalization based on the underlying values as at December 31, 2008 is approximately 60%.

Intangible items include a portion of the purchase price of properties totalling $787 million that has been attributed to items such as above-market leases and tenant relationships, as well as $689 million of deferred credits in respect of items such as below-market tenant and land leases.

Retail

The following table summarizes invested capital and operating cash flow in our retail property operations:

 

     Invested Capital     Operating Cash Flow  
     Total        Net        Total        Net   

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

   June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
     June 30
2008
 

Retail properties

   $ 1,186    $ 962      $ 1,186       $ 962      $ 25    $ 25       $ 25       $ 25   

Working capital/operating costs

     432      364        72         (136            (5      (4 )   

Borrowings/interest expense

            (995      (614 )               (22      (31

Co-investor interests

                    (170      (122                    1         7   
     $ 1,618    $ 1,326       $ 93       $ 90      $ 25    $ 25      $ (1    $ (3

 

     16        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Total operating cash flows were $25 million in the second quarter of 2009, consistent with the same quarter in 2008. We experienced higher net rental income within existing properties, however a meaningful portion of the portfolio continues to be under redevelopment and therefore is not contributing towards current results.

Total rents are comprised of a fixed monthly rent plus a percentage of sales. Rents per gross leasable area averaged R$18 per square foot in the second quarter of 2009 versus R$17 per square foot in the second quarter of 2008. Same store retail sales within the portfolio averaged R$289 per square foot in the second quarter of 2009, compared to R$280 per square foot in the second quarter of 2008, representing an increase of 3%.

Consolidated assets and liabilities increased due to a higher exchange rate for the Brazilian currency while net invested capital was largely unchanged from the end of 2008. Borrowings include $126 million of debt which is guaranteed on a several basis by the obligations of ourselves and our partners to subscribe for capital equal to the outstanding balance.

Underlying Value

The underlying values of the consolidated assets and net equity of our commercial portfolio were determined to be $23.9 billion and $7.5 billion, respectively, as at December 31, 2008. The key metrics used in each geographic region are set out in the following table:

 

     North America     Australia     United Kingdom  
      Minimum    Maximum    Average     Minimum    Maximum    Average     Minimum    Maximum    Average  

Discount rate

   6.5%    13.0%    8.2%       6.3%    9.4%    7.0%       5.5%    8.5%    6.2%    

Terminal capitalization rate

   5.7%    9.0%    6.9%      8.5%    11.0%    8.9%      5.5%    8.5%    6.2%   

Exit date

   2010    2041    2017      2018    2018    2018      n/a1    n/a1    n/a1   
  1

U.K. valuations assume properties held in perpetuity

The underlying value of our combined commercial office and retail portfolio represents a 7.2% “going in” capitalization rate based on the 2008 total operating cash flows, excluding gains. The valuations are most sensitive to changes in the discount rate. A 100 basis point change in the discount rate results in a $1.4 billion change in the calculated underlying value of our common equity after reflecting the interests of minority shareholders.

Renewable Power Generation

We have assembled one of the largest privately owned hydroelectric power generating portfolios in the world. Our power generating operations are located on river systems in the U.S., Canada and Brazil. As at June 30, 2009, we owned and managed 163 conventional hydroelectric generating stations with a combined generating capacity of approximately 3,155 megawatts. We also own and operate two natural gas-fired plants, a 600 megawatt pumped storage facility and a 189 megawatt wind energy project. Overall, our assets represent 4,159 megawatts of generating capacity and annual generation of approximately 15,600 gigawatts based on long-term averages.

The following table summarizes our invested capital at the end of the second quarter of 2009 and end of last year, and the net operating cash flow generated by our power generating operations during the second quarter of 2009 and 2008:

 

     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

   June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
     June 30
2008
 

Hydroelectric generation

   $ 4,493    $ 4,223       $ 4,493       $ 4,223      $ 195    $ 240       $ 195       $ 240   

Wind, pumped storage and co-generation

     507      479        507         479        16      24        16         24   

Development

     249      253        249         253                              
     5,249      4,955        5,249         4,955        211      264        211         264   

Cash and financial assets

     376      357        376         357                         

Working capital

     1,326      1,161        448         335               (5      (11

Unsecured corporate power borrowings

            (884      (653            (15      (11

Property-specific debt

            (3,574      (3,587 )               (76      (71

Co-investor interests

                    (254      (192                    (24      (28 )   
     $ 6,951    $ 6,473      $ 1,361       $ 1,215      $ 211    $ 264      $ 91       $ 143   

Underlying value

          $ 12,051               $ 6,639                                   

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         17    


Net operating cash flow declined to $91 million in the second quarter of 2009. Generation remained relatively unchanged from last year but lower electricity prices and the lower average Canadian and Brazilian currency exchange rates during the period reduced the net operating cash flow from our hydroelectric facilities by $45 million. Water flows during the period were slightly higher than average, but well below the generation level during the second quarter of 2008 which were significantly above average.

On July 6, 2009, we announced the sale of substantially all of our directly-held Canadian hydroelectric generation assets to our 50%-owned Great Lakes Hydro Income Fund (“Fund”) for proceeds of C$945 million. Once completed, this will reduce our interest in the assets by approximately 50%, however, we will retain the benefit and risk of electricity price increases and decreases, as we purchase a substantial part of the electricity generated by the Fund on a fixed price basis and then re-sell it along with the electricity produced by the balance of our operations.

Realized Prices and Operating Margins

The following table illustrates revenues and operating costs for our hydroelectric facilities:

 

     2009     2008  

FOR THE THREE MONTHS ENDED JUNE 30

(GIGAWATT HOURS AND $ MILLIONS)

   Actual
Production
   Realized
Revenues
   Operating
Costs
   Operating
Cash Flows
    Actual
Production
   Realized
Revenues
   Operating
Costs
   Operating
Cash Flows
 

United States

   1,972    $    139    $    36    $    103       1,834    $    157    $    38    $    119    

Canada

   1,253    75    25    50      1,583    106    21    85   

Brazil

   700    57    15    42      556    50    14    36   

Total

   3,925    $    271    $    76    $    195      3,973    $    313    $    73    $    240   

Per MWh

        $69    $    19    $50           $      79    $    19    $60   

Our strategy of forward selling generation (described below under “Contract Profile”) reduces the impact of short-term fluctuations in market prices on our results. During the quarter, 30% of our generation was sold using financial contracts relative to selling into the spot market. In addition, approximately 50% of our generation was sold pursuant to long-term contracts. Realized prices also reflected the impact of a stronger U.S. dollar on our Canadian and Brazilian operations, lowering the U.S. equivalent of revenues in those jurisdictions. Operating costs remained consistent with last year on an aggregate and per unit basis.

Cash flow from our non-hydro facilities declined to $16 million compared with $24 million in the second quarter of 2008. Results were negatively impacted by higher fuel costs at our gas-fired facility located in Ontario due to expiration of our long-term, low-cost supply agreement at the end of 2008. Last year’s results were positively impacted by the resale of the low-cost contracted gas at higher market prices in that period.

Generation

The following table summarizes generation during the second quarter of 2009 and 2008:

 

           Actual Production     Variance to  

FOR THE THREE MONTHS ENDED JUNE 30

(GIGAWATT HOURS)

   Long-Term
Average
    2009    2008     Long-Term
Average
     Actual
2008
 

Existing capacity

   3,565       3,588    3,788       23       (200

Acquisitions – during 2008 and 2009

   347      337    185      (10    152   

Total hydroelectric operations

   3,912      3,925    3,973      13       (48

Wind energy

   129      120    117      (9    3   

Co-generation

   222      104    227      (118    (123 )   

Pumped storage

   96      94    125      (2    (31

Total generation

   4,359      4,243    4,442      (116    (199

Hydroelectric generation from existing capacity (i.e., “same store” basis) during the second quarter was in-line with our long-term average plans, though 200 gigawatt hours lower than the comparable quarter, in which we experienced water flows that were well above average. This variance was largely offset by recently acquired or commissioned assets which increased generation by 152 gigawatt hours.

Our geographic distribution provides diversification of water flows to minimize the overall impact of hydrology fluctuations. In North America, most of our systems have access to water reservoirs in which we can store approximately 21% of our annual generation, providing partial protection against short-term changes in water supply and enabling us to optimize selling prices by generating and selling power during higher-priced peak periods.

 

     18        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Almost all of our facilities in Brazil participate in a national program that levels hydrology results among regions, resulting in particularly stable generation results. This further minimizes the impact of water variations on almost 20% of our generation.

Contract Profile

Consistent with our strategy to establish lower volatility revenue streams, the prices for approximately 80% of our projected generation for 2009 and 2010 are contracted pursuant to long-term bilateral power sales agreements or shorter-term financial contracts. The remaining generation is sold into wholesale electricity markets when certainty of generation is confirmed.

Our long-term sales contracts, which account for approximately 50% of total generation, have an average term of 12 years. The majority of our counterparties are investment grade in nature, including a number of government agencies. The financial contracts typically have a term of less than two years and are with high credit-worthy counterparties or otherwise supported by credit-mitigation features such as parental guarantees or collateral arrangements.

The following table sets out the profile of our contracts over the next five years from our existing facilities, assuming long-term average hydrology:

 

     Years Ended December 31  
      Balance of
2009
   2010    2011    2012    2013  

Generation (GWh)

              

Contracted

              

Power sales agreements

   3,972    8,308    7,820    7,060    6,826    

Financial contracts

   2,216    3,276            

Uncontracted

   953    3,649    7,453    8,210    8,425   
     7,141    15,233    15,273    15,270    15,251   

Contracted generation

              

% of total

   87%    76%    51%    46%    45%   

Revenue ($ millions)

   444    892    627    593    587   

Price ($/MWh)

   72    77    80    84    86   

The average selling price for contracted power increases over the next five years to $86 per megawatt hour from $72 per megawatt hour, reflecting contractual step-ups in long duration contracts with locked-in prices and the expiry of lower-priced contracts during the period.

Financial Position

Consolidated assets increased due to higher exchange rates at quarter end relative to the end of 2008 and investments in the development of new capacity, offset by accounting depreciation.

During the quarter, we issued C$100 million of corporate unsecured notes which bear interest at 7.88% and mature in 2012 to replace an equivalent amount of notes that are due in December 2009.

Property-specific debt has an average interest rate of 7%, an average term of 12 years and is all investment grade quality. The corporate unsecured notes bear interest at an average rate of 6% and have an average term of seven years.

Underlying Value

The underlying value of our power generation portfolio was determined to be $6.6 billion as at December 31, 2008 in total after deducting borrowings and minority interests. The total valuation of our hydroelectric facilities of $12.1 billion represents a “going-in” capitalization rate of 7.6% based on 2008 cash flows adjusted to reflect long-term average hydrology. The valuations are impacted primarily by the discount rate and long-term power prices. A 100-basis point change in the discount rate and a 10% change in long-term power prices will each impact the value of our net invested capital by $0.9 billion.

Infrastructure

Our infrastructure activities are currently concentrated in the timber and electricity transmission sectors, although we intend to expand into new sectors that provide similar investment characteristics. Our operations are located primarily in the United States, Canada, Chile and Brazil and are primarily owned through funds and specialty listed issuers that we manage. The invested capital and net operating cash flows contributed by these operations are summarized in the following table:

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         19    


     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

   June 30
2009
   Dec. 31
2008
    June 30
2009
   Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
   June 30
2008
 

Timberlands

   $ 3,576    $ 3,557       $ 463    $ 439       $ 16    $ 39       $ 3    $ 13    

Transmission

     625      856        263      322        33      56        12      27   
     $ 4,201    $ 4,413      $ 726    $ 761      $ 49    $ 95      $ 15    $ 40   

Underlying value

          $ 5,059             $ 974                                 

Timber

Timber operations contributed $16 million of total operating cash flow during the second quarter of 2009 compared to $39 million in 2008. Net operating cash flow was $3 million in 2009 compared to $13 million in 2008. Consolidated assets held within our timber operations and related borrowing levels were relatively unchanged during the quarter. In the quarter, we seeded a Brazilian timber fund that we manage with timberlands that we owned for cash proceeds of $67 million and a $7 million gain which is included in the second quarter results.

 

     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  
AS AT AND FOR THE THREE MONTHS ENDED
(MILLIONS)
   June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
     June 30
2008
 

Timberlands

                          

Western North America

   $ 2,611    $ 2,613              $       8    $    36         

Eastern North America

     158      150             1    1        

Brazil

     88      63                       7    2                
     2,857      2,826      $ 2,857       $ 2,826      16    39      $    16       $    39   

Working capital/other expenses

     719      731        154         158                      

Property-specific debt/interest expense

            (1,553      (1,550 )             (23    (23 )   

Co-investor interests

                    (995      (995              10       (3
     $ 3,576    $ 3,557      $ 463       $ 439      $    16    $    39      $      3       $    13   

Underlying value

          $ 4,164               $ 613                           

The decline in operating cash flow was due largely to lower demand for timber, which led to lower prices in both the domestic and export markets in 2009. In response, we elected to defer harvesting until prices recover and allow the trees to continue to grow, which we believe will maximize the value of this business over the long term. We were able to selectively focus our harvest levels to capture market opportunities in both domestic and export markets, which limited the decline in realized prices across our operations to approximately 25% compared to the second quarter of 2008. Operating margins increased slightly due to lower operating and fuel costs. Interest costs were in line with the prior year as the debt is long term and fixed rate, while co-investor interests in operating cash flows declined due to the reduction in operating cash flows. The following table summarizes the sales results from our timber operations:

 

     2009     2008  
FOR THE THREE MONTHS ENDED JUNE 30   

Sales

(000’s m3)

   Revenue
per m3
  

Revenue

($ millions)

    Sales
(000’s m3)
   Revenue
per m3
   Revenue
($ millions)
 

Western North America

                  

Douglas fir

   404    $    75    $    31       638    $    88    $      56   

Whitewood

   162    61    10      309    61    19   

Other species

   173    76    13      192    115    22   
   739    72    54      1,139    85    97   

Eastern North America and Brazil

   522    19    10      474    27    13   
     1,261    $    51    $    64      1,613    $    68    $    110    

We sold 1.3 million cubic metres of timber during the second quarter of 2009, compared to 1.6 million cubic metres in the second quarter of 2008. We continue to reduce harvest and sales levels in North America as margins on high quality timber such as Douglas fir and Whitewood species remained low. We increased harvest levels moderately in Brazil reflecting the relative strength in that market.

 

     20        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


We intend to continue harvesting our Western North American timberlands at reduced levels for the remainder of 2009 in order to preserve inventory and maximize future value. Accordingly, we expect harvest levels in Canada and the U.S. to be approximately 30% and 50% below 2008 levels, respectively.

Transmission

Transmission operations contributed $33 million of total operating cash flow during the second quarter of 2009 compared to $56 million in the same period in 2008. Net operating cash flow totalled $12 million in the second quarter of 2009 compared to $27 million in the same period in 2008. The 2008 results reflect $13 million of non-recurring revenue and higher currency exchange rates.

 

     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  
AS AT AND FOR THE THREE MONTHS ENDED
(MILLIONS)
   June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
    June 30
2009
     June 30
2008
    June 30
2009
     June 30
2008
 

Transmission facilities and investments

                          

Chile

   $    368    $    324              $    13       $8        

North America

   165    158             7       10        

Brazil

      207                   14       39                
   $    533    $    689      $    533       $    689      $    34       $    57      $    34       $    57   

Working capital/other expenses

   92    167      78       116      (1    (1 )      (11    (9 )   

Property-specific debt/interest expense

              (103    (237 )                 (4    (1
   625    856      508       568      33       56      19       47   

Co-investor interests

              (245    (246              (7    (20
     $    625    $    856      $    263       $    322      $    33       $    56      $    12       $    27   

Underlying value

        $    895             $    361                             

Our transmission operations generate stable revenues that are largely governed by regulated frameworks and long-term contracts. Accordingly, we expect this segment to produce consistent revenue and margins over the long-term that should increase with inflation and other factors such as operational improvements.

We also expect to achieve continued growth in revenues and income by investing additional capital into our existing operations. The 2008 quarter results reflect a $13 million contribution from Brazilian operations that were sold in the second quarter of 2009. The operating margin at our Chilean transmission operations was 84%, which is in line with historical levels.

Consolidated assets and net invested capital held within our transmission operations decreased during the quarter, following the completion of the sale of our Brazilian transmission lines and associated reduction in borrowings. We received total proceeds of $275 million inclusive of hedge proceeds.

On June 23, 2009, we entered into an agreement to sell our North American distribution assets for C$68 million. The transaction is subject to regulatory approval and is expected to close at the end of 2009.

Through one of our funds, we are in the initial stages of developing a $500 million transmission system in the state of Texas with a 50% joint venture partner although we do not expect to invest any meaningful level of capital until late 2010. The development is expected to be completed in 2011.

Underlying Value

The underlying value of the net invested capital in our infrastructure operations was determined to be $1.0 billion as at December 31, 2008 after deducting borrowings and minority interests.

The valuations of our timberlands are based on independent appraisals. Key assumptions include a weighted average discount and terminal capitalization rate of 6.5% at a terminal valuation date of 72 years on average. Timber prices were based on a combination of forward prices available in the market and the price forecasts of each appraisal firm.

The valuation of our transmission operations is based on the contractual sale price for our Brazilian interests, an independent valuation of our Chilean transmission business, and an internal valuation of our Northern Ontario operations based on the regulated

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         21    


rate base. In valuing our Chilean transmission business, key assumptions included a weighted average discount rate of 11.0%, a terminal capitalization rate of 8.6% and an average terminal valuation date of 2023.

Development and Other Properties

Development and other properties include our opportunity investment funds, residential operations, properties that are under development and held for development, and construction activities.

 

     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  
AS AT AND FOR THE THREE MONTHS ENDED
(MILLIONS)
   June 30
2009
   Dec. 31
2008
    June 30
2009
   Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
   June 30
2008
 

Opportunity investments

   $ 1,288    $ 1,295       $ 153    $ 183       $ 15    $ 47      $ 5    $ 21    

Residential

     4,731      3,820        733      171        51      49        28      42   

Under development

     1,799      1,970        808      742        13      (22 )        7        

Held for development

     2,349      2,260        1,567      1,693                           

Construction activities

     1,434      1,299        684      545        12      39        12      39   
     $ 11,601    $ 10,644      $ 3,945    $ 3,334      $ 91    $ 113      $ 52    $ 102   

Underlying value

          $ 10,619             $ 3,313                                 

Opportunity Investments

We manage niche real estate opportunity funds with $516 million of committed capital (Brookfield’s share – $224 million).

Total property assets within the funds were approximately $1.3 billion at June 30, 2009 unchanged from year end. The portfolio of 85 properties is comprised predominantly of office properties in a number of cities across North America as well as smaller investments in industrial, student housing, multi-family and other property asset classes.

Net operating cash flows were $5 million in the current quarter compared to $21 million in the second quarter of 2008. The 2008 quarter included disposition gains of $25 million (our share – $14 million). Due to the focus on value enhancement and the relatively short hold period for properties, we expect that most of our returns will come from disposition gains, as opposed to net rental income.

Residential

We reported lower cash flows from our residential operations. The overall results from our U.S. operations reflect lower operating margins, a decrease in impairment charges, and we believe we have started to see the bottoming of the residential markets in the U.S. The Canadian operations experienced stable margins but lower sales. Our Brazil operations experienced strong sales and launches during the quarter, and advanced construction on a number of projects resulting in increased revenues which are recorded on a percentage-of-completion basis.

 

     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

   June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
    June 30
2009
     June 30
2008
    June 30
2009
     June 30
2008
 

Residential properties

                          

Canada

   $ 468    $ 478       $ 468       $ 478      $ 13       $ 35        

Brazil

     2,735      1,878        1,232         735        44         28        

Australia

     420      486        420         486        1                

United States

     1,108      978        982         821        (3      13        

Impairment charge – U.S. operations

                                     (4      (27 )                    
     4,731      3,820        3,102         2,520        51         49      $ 51       $ 49   

Subsidiary borrowings/interest expense1

            (1,688      (1,727 )               (5      (3 )   

Cash taxes

                                  (3      (1

Co-investor interests

                    (681      (622                      (15      (3
     $ 4,731    $ 3,820      $ 733       $ 171      $ 51       $ 49      $ 28       $ 42   

1     Portion of interest expensed through cost of sales

                 

 

     22        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Total assets, which include property assets as well as housing inventory, cash and cash equivalents and other working capital balances, increased since 2008 reflecting expansion within our Brazil operations and investment in our U.S. operations. Subsidiary borrowings, which were unchanged during the period, consist primarily of construction financings which are repaid with the proceeds received from sales of building lots, single-family houses and condominiums, and are generally renewed on a rolling basis as new construction commences.

The net operating cash flows attributable to each of these business units, reflecting the 50% interest of Brookfield Properties shareholders in our Canadian operations, are presented in the following table. Taking these interests into consideration, the decline in the net contribution from our Canadian operations was partially offset by the increased contribution from our Brazilian operations.

 

FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS)    2009      2008      Variance  

Canada 1

   $ 7       $ 18       $ (11 )   

Brazil

     20         8         12   

Australia

     (3              (3

United States

     (2      (1      (1
     22         25         (3

Add back: minority interests of Brookfield Properties in Canadian operations

     6         17         (11
     $ 28       $ 42       $ (14
  1

Net of 50% interest held by minority shareholders of Brookfield Properties

Canada

We continue to benefit, albeit at a slower pace, from our strong market position and low-cost land bank, particularly in Alberta where we hold a 23% market share in Calgary. We share approximately 50% of the cash flows (and the changes therein) with the minority shareholders of Brookfield Properties. Net of these minority interests, our Canadian operations contributed $7 million of operating cash flow during the second quarter of 2009, compared to $18 million in the second quarter of 2008. The decrease in cash flows is due primarily to lower home sales, which declined from 162 units in 2008 to 121 units in 2009. Operating margins were 19% in the second quarter of 2009 compared to 27% in the second quarter of 2008.

Brazil

During the second quarter of 2009, we achieved launches totalling R$588 million (2008 – R$713 million) of sales value, representing a decrease of 18% over the same period last year. Our Brazilian operations contributed total and net operating cash flow of $44 million and $20 million, respectively. The 2009 quarter included a gain on the sale of a tower from an office project that was developed in Brasilia’s Federal District. The gain on the sale totalled $13 million, of which our share was $7 million. Contracted sales totalled R$569 million (2008 – R$320 million), an increase of 78% over the second quarter of 2008. These contracted sales will generate revenues to be recorded in current and future periods as units are constructed.

Australia

The carrying values of Australian projects reflect our acquisition of this business in 2007 and therefore already include much of the expected development profits. Accordingly, margins are expected to be low in the first few years of ownership.

United States

Our U.S. operations incurred $2 million of cash outflows after interest, taxes, impairment charges and non-controlling interests during the second quarter of 2009, compared to $1 million of cash outflows during the second quarter of 2008. Our share of impairment charges taken to reduce the carrying value of land and option positions totalled $2 million versus $10 million in the second quarter of 2008. The gross margin from housing sales was approximately 8% during the second quarter of 2009, compared with 12% last year. We closed on 169 units during the quarter (2008 – 216 units) at an average selling price of $486,000 (2008 – $548,000). The sales backlog at the end of the quarter was 310 units compared to 287 units in the second quarter of 2008.

In April 2009, we invested $248 million in our U.S. operations through the purchase of convertible preferred shares, increasing our interest to 82% on a fully diluted basis. The proceeds of the share issue were used to repay loans, including amounts we had previously advanced to the company.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         23    


Under Development

Properties under development include both active development projects as well as properties that we are redeveloping to enhance their value. We are also developing a number of hydroelectric generating plants and retail properties which are included under “Renewable Power Generation” and “Commercial Properties – Retail”, respectively.

In the second quarter of 2009, we recorded $7 million of cash flow from these operations, compared to $nil in the same period of 2008. Development costs, including interest, are typically capitalized to the carrying values and any income is applied to reduce these carrying values, although income is recognized periodically, for example, on dispositions.

 

     Invested Capital  
     Total     Net  
(MILLIONS)    June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
 

Commercial properties

            

North America

            

– Bay Adelaide office tower, Toronto

   $ 596    $ 510       $ 596       $ 510   

– 1225 Connecticut Ave., Washington D.C.

     154      151        154         151   

– Reston Crescent, Washington D.C.

     73      70        73         70   

– Bankers Court, Calgary

     50      40        50         40   

– 77k Street, Washington D.C.

     46      44        46         44   

– Other

          19                19   

Australasia

            

– City Square, Perth

     152      94        152         94   

– Claremont, Perth

     117      86        117         86   

– Deloitte Centre, Auckland

     106      72        106         72   

– Southern Cross West, Melbourne

     86      65        86         65   

– Macquarie Bank, Sydney

          230                230   

– Sydney Water, Sydney

          104                104   

– Other

          75                75   

United Kingdom

            

– Castle House, London

     124      60        124         60   

– Other

     37      42        37         42   

Brazil

            

– Faria Lima, São Paulo

     36      30        36         30   

– Parque Cidade, Brasila

     24      20        24         20   

– Other

     198      258        198         258   

Borrowings

                 (991      (1,228 )   
     $ 1,799    $ 1,970      $ 808       $ 742   

Current development initiatives in North America are focused on the construction of a 1.2 million square foot premier office property on the Bay Adelaide Centre site located in Toronto’s downtown financial district, representing a book value of $596 million as at June 30, 2009 (December 31, 2008 – $510 million), and properties in Washington, D.C. The Bay Adelaide Centre is 73% pre-leased and the first tenants are scheduled to move in during the third quarter of 2009. We are also continuing the redevelopment of a 269,000 square foot property in Washington D.C.

We have 1.9 million square feet of commercial property space under development in Australia. Current developments include four properties in Melbourne, Auckland and Perth, all of which are substantially pre-leased to tenants such as Australia Post and Deloitte, with a collective book value of $461 million. Our Macquarie Tower development and four other developments aggregating $575 million of book value, which are mostly 100% leased, were completed and transferred into commercial operations during the first six months of 2009. We have also commenced the construction of City Square, a 930,000 square foot premier office property in Perth, which is 82% leased to BHP Billiton, representing invested capital at the end of the second quarter of $152 million (December 31, 2008 – $94 million).

In the United Kingdom, we own a proportionate share of approximately 7.9 million square feet of commercial space development density at Canary Wharf in London, the carrying value of which is included in our investment in Canary Wharf (in Commercial Properties). Currently 1.3 million square feet is under active development, and substantially pre-leased.

 

     24        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Property-specific financing includes debt secured by Bay Adelaide Centre in North America as well as debt associated with developments in Australia and the United Kingdom, and declined with the transfer of debt secured by the Australia properties completed during the quarter.

Held for Development

We acquire land and long-term rights on land, seek entitlements to construct, and then either sell the development once it has been improved or build the project ourselves. We do not typically record ongoing cash flow in respect of properties held for development and the associated development costs are capitalized until this event occurs, at which time any disposition gain or loss is recognized.

 

     Invested Capital  
     Total     Net  
(MILLIONS)    June 30
2009
   Dec. 31
2008
    June 30
2009
     Dec. 31
2008
 

Commercial office properties

            

Ninth Avenue, New York

   $ 278    $ 269       $ 278       $ 269   

Other North America

     128      122        128         122   

Australia

     404      310        404         310   

Residential lots

            

North America

     768      718        768         718   

Brazil

     289      352        289         352   

Australia

     313      353        313         353   

Rural development lands

            

Brazil

     169      136        169         136   

Borrowings / working capital

                 (782      (567 )   
     $ 2,349    $ 2,260      $ 1,567       $ 1,693   

Commercial Office Properties

We own well-positioned land on Ninth Avenue between 31st Street and 33rd Street in New York City which is entitled for 5.4 million square feet of commercial office space. We will commence construction of this property once the necessary pre-leasing has occurred, similar to our strategy with other commercial developments. We also own development sites in our other core markets including North American and Australian locations.

Residential Lots

Residential development properties include land, both owned and optioned, which is in the process of being developed for sale as residential lots, but not expected to enter the homebuilding process for more than three years. We utilize options to control lots for future years in our higher land cost markets in order to reduce risk. We hold options on approximately 11,000 lots located predominantly in California and Virginia. We hold 14,976 acres of development land in Alberta and approximately 13,000 residential lots, homes and condominium units in our markets in Australia and New Zealand. We also hold development land in Brazil which can accommodate up to 73 million square feet of residential development and represent a total sales value of $7.4 billion.

Rural Development Lands

We own approximately 372,000 acres of prime agricultural development land in the Brazilian States of São Paulo, Minas Gerais, Mato Grosso do Sul and Mato Grosso. These properties are being used for agricultural purposes, including the harvest of sugar cane for the production of ethanol, which is used largely as a gasoline substitute. We also hold 33,200 acres of potentially higher and better use land adjacent to our Western North American timberlands, included within our Timberlands segment, which we intend to convert into residential and other purpose land over time.

Construction Activities

The following table summarizes the operating results from our construction operations, which fluctuate based on the timing of project completion:

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         25    


     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

   June 30
2009
   Dec. 31
2008
    June 30
2009
   Dec. 31
2008
    June 30
2009
   June 30
2008
    June 30
2009
   June 30
2008
 

Australia

   $ 2    $ 1              $ 1    $ 6         

Middle East

     24      49               8      27        

United Kingdom

     83      74                       3      6                  
     109      124      $ 109    $ 124         12      39      $ 12    $ 39    

Working capital and other

     1,325      1,175        575      421                              
     $ 1,434    $ 1,299      $ 684    $ 545      $ 12    $ 39      $ 12    $ 39   

We conduct third-party construction activities in Australia, Brazil, U.K. and the Middle East (Dubai, Abu Dhabi and Qatar). Our construction activities are focused on large scale construction of real estate and infrastructure assets.

The revenue work book totalled $4.1 billion at the end of the second quarter (December 31, 2008 – $3.5 billion) and represented three years of scheduled activity.

We measure our construction workbook in terms of the total revenue to be received over the life of a project for both internal and external work (i.e. gross) and total revenue remaining to be earned on external work (i.e. net). During the quarter, we were awarded two new projects in the Middle East with revenue backlog of $340 million and six new projects in Australia with a revenue backlog of $680 million.

The following table summarizes the gross and net workbook in our largest markets at the end of the second quarter of 2009 and end of last year:

 

     Gross     Net  
(MILLIONS)    June 30
2009
   Dec. 31
2008
    June 30
2009
   Dec. 31
2008
 

Australia

   $ 2,370    $ 2,254       $ 1,508    $ 1,084    

Middle East

     1,848      1,828        1,848      1,828   

United Kingdom

     823      727        697      615   
     $ 5,041    $ 4,809      $ 4,053    $ 3,527   

Underlying Value

The underlying value of our development assets after deducting borrowings and minority interests was $3.3 billion as at December 31, 2008, roughly equal to the net book value of our invested capital.

The valuation of residential development lots, which are considered inventory for these purposes, reflects the lower of the existing carrying value and their expected net realizable value. Net realizable value is determined as the value at the anticipated time of sale less costs to complete, typically discounted at a rate of 12%-15%. Many of our land holdings, particularly those located in Alberta, were acquired many years ago. Accordingly, while we believe the fair value of these lands significantly exceeds existing carrying value, the carrying value for IFRS purposes is required to be set at the lower amount.

Values attributable to commercial office property developments reflect the estimated value at completion less the remaining capital expenditures, all discounted to the current period using discount rates of 7%-9%.

Specialty Funds

We conduct restructuring, real estate finance and bridge lending activities. Although our primary focus throughout the broader organization is property, power and infrastructure assets, our mandates within our bridge lending and restructuring funds also include related and other industries which have tangible assets and visible cash flows, particularly where we have expertise as a result of previous investment experience.

Specialty investment funds generated net operating cash flow of $15 million during the second quarter of 2009 compared with $32 million of investment income and $39 million of security valuation gains in 2008. We have significantly reduced the level of capital deployed through our bridge lending following maturities of prior loans.

 

     26        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


     Invested Capital     Operating Cash Flow  
     Total     Net     Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

   June 30
2009
   Dec. 31
2008
    June 30
2009
   Dec. 31
2008
    June 30
2009
   June
2008
    June 30
2009
   June 30
2008
 

Restructuring

   $ 1,622    $ 1,625       $ 429    $ 384       $    38    $      30       $      3    $      7    

Real estate finance

     2,053      2,045        308      298      18    33      4    8   

Bridge lending

     282      269        196      188      10    19      8    17   
   $ 3,957      3,939        933      870      66    82      15    32   

Securities valuation gain

                                    39         39   
     $ 3,957    $ 3,939      $ 933    $ 870      $    66    $    121      $    15    $    71   

Underlying value

          $ 4,023             $ 903                         

Restructuring

We operate two restructuring funds. Our first fund, Tricap Restructuring Fund (“Tricap I”) completed its investment period in 2007 and we continue to manage and harvest the remaining invested capital of $267 million. Tricap Partners II (“Tricap II”), which now has C$1 billion of committed capital, has deployed substantially all of its available commitments.

Our two most significant investments in Tricap I are Western Forest Products Inc. (“Western Forest Products”), a western Canadian lumber producer, and Concert Industries Ltd., a leading producer of air-laid woven fabric with operations in Quebec and Germany. Investments in Tricap II include Longview Manufacturing, which is a U.S.-based container board and pulp company and Maax Bath Inc., a Canadian-based producer of bathroom fixtures. Tricap II also holds several investments in the oil and gas sector.

Most of our investments are in companies that operate in cyclical industries with viable long-term operating plans but which suffered from unviable capital structures at the time of our initial involvement. This combination typically gives rise to attractive restructuring opportunities. Our focus continues to be on restoring the financial health of the businesses and strengthening their capitalization to ensure that they can execute their long-term business plans, at which time we will typically sell our investment. As a result, we expect that the majority of our returns will come in the form of disposition gains because cash flows during the restructuring period are often below normalized levels.

Real Estate Finance

We operate three real estate finance funds with total committed capital of approximately $1.9 billion, of which our share is approximately $380 million. Our first fund, the $600 million Brookfield Real Estate Finance Partners (BREF I) completed its investment period in 2007. The commitments for our second fund (BREF II) totalled over $700 million. We had $308 million of capital invested in these operations at the end of June 30, 2009, compared to $298 million at the beginning of the year.

The BREF portfolios continue to perform in line with expectations notwithstanding difficult credit markets, and realized credit losses to date have been minimal. These activities contributed $4 million of net operating cash flow, compared to $8 million during the second quarter of 2008.

Bridge Lending

We operate three bridge lending funds. The total loans advanced on behalf of our partners and ourselves was $687 million at quarter end.

The net capital invested by us in bridge loans declined to $196 million from an average of $472 million in the second quarter of 2008 due to collections and our adoption of a more cautious approach to new loan commitments. Accordingly, net operating cash flows declined from $17 million in the second quarter of 2008 to $8 million in the second quarter of 2009. In addition, the 2008 quarter reflects net gains of $39 million.

Our portfolio at quarter end was comprised of 10 loans, and our largest single exposure at that date was $71 million. Our share of the portfolio at quarter end has an average term of 13 months excluding extension privileges, and generates an average yield of 15%.

Underlying Value

The net asset value of our specialty fund operations was $0.9 billion as at December 31, 2008 for the purposes of preparing our pro-forma IFRS balance sheet. The values are based on publicly available share prices where available as well as comparable valuations and internal calculations.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         27    


Investments

We own a small number of investments which will be sold once value has been maximized, integrated into our core operations or used to seed new funds. Although not core to our broader strategy, we expect to continue to make new investments of this nature and dispose of more mature assets.

The net operating cash flow generated by our investments in the second quarter of 2009 was $56 million, compared to $51 million generated in the second quarter of 2008. During the quarter we exchanged our remaining Norbord Inc. (“Norbord”) exchangeable debentures into 10 million common shares of Norbord realizing a gain of $65 million based on the original issuance price of C$12.75 per share. We exchanged the first half of the debentures in the second quarter of 2008 resulting in a similar cash flow gain in that period.

 

     Invested Capital      Operating Cash Flow  
     Total     Net      Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

  

June 30

2009

   

Dec. 31

2008

   

June 30

2009

   

Dec. 31

2008

    

June 30

2009

   

June 30

2008

   

June 30

2009

   

June 30

2008

 

Industrial - forest products

   $ 1,523      $ 1,568      $ 455      $ 390       $ 69      $ 57      $ 62      $ 55   

Infrastructure

     73        70        73        70         2        1        2        1   

Insurance operations

     1,044        1,428        53        157         2        (3 )              3   

Other operations

     276        193        94        40         1        4        (9     (2

Property

     73        75        68        47         (3            1        (6

Net Investment

   $ 2,989         $ 3,334         $ 743         $ 704       $ 71         $ 59      $ 56         $ 51   

Underlying value

           $ 3,549              $ 701                                    

Capital invested in our insurance operations declined due to the completion of the sale of a U.S. specialty property and casualty business for proceeds of $130 million in the first quarter. We invested $120 million in Norbord during the first quarter to complete the second stage of rights offering following the first closing in December 2008. Our fully diluted interest in Norbord is now 79%. We have continued to record our share of Norbord’s results as equity accounted income for the purposes of this MD&A consistent with prior treatment. We recorded operating losses from our interests in pulp and paper operations, including Fraser Papers Inc.

Underlying Value

The underlying values are determined by market values, actuarial valuations and internal calculations, and totalled $0.7 billion at December 31,2008, similar to our carrying value.

Cash and Financial Assets

We hold a substantial amount of financial assets, cash and equivalents that are available to fund operating activities and investment initiatives.

 

    Invested Capital     Operating Cash Flow  
    Total     Net     Total     Net  

AS AT AND FOR THE THREE MONTHS ENDED

(MILLIONS)

 

June 30

2009

 

Dec. 31

2008

   

June 30

2009

   

Dec. 31

2008

   

June 30

2009

 

June 30

2008

   

June 30

2009

   

June 30

2008

 

Financial assets

                     

Government bonds

  $ 197   $ 177       $ 197      $ 177             

Corporate bonds

    152     123        152        123             

Fixed income

    9     10        9        10             

High-yield bonds

    60     88        60        88             

Preferred shares

    33     25        33        25             

Common shares

    182     230        182        230             

Loans receivable

    60     317        60        317                                 

Total financial assets

    693     970        693        970       $ 50   $ 36      $ 50      $ 36   

Cash and cash equivalents

    536     290        536        290                       

Deposits and other liabilities

               (387     (187                   (5     (6 )   
    $ 1,229   $ 1,260      $ 842      $ 1,073      $ 50   $ 36       $ 45      $ 30   

Underlying value

        $ 1,260              $ 1,073                                 

Cash and financial asset balances were $1.2 billion at the end of the second quarter of 2009 compared to $1.3 billion at the end of 2008 on a total basis, and net of deposits and other liabilities were $0.8 billion versus $1.1 billion. The decline in net invested capital represents capital deployed into our core operating platforms to reduce leverage and invest in growth initiatives as well

 

     28        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


as a decline in value of certain positions. Net invested capital includes liabilities such as broker deposits and a small number of borrowed securities that have been sold short. Loans receivable at year-end included advances to Brookfield Homes, of which $203 million were repaid out of proceeds of an equity offering underwritten by us and which closed in April 2009.

In addition to the carrying values of financial assets, we hold protection against widening credit spreads through credit default swaps with a total notional value of $1.3 billion (December 31, 2008 – $2.5 billion). We have reduced our holdings of credit default swaps in response to improvements in market sentiment.

ASSET MANAGEMENT ACTIVITIES

The following table summarizes asset management income on a “total” basis, which includes income in respect of our own capital invested in funds, as well as the income earned solely from third-party clients. In our financial statements, the portion of the income that is earned in respect of our own capital is eliminated in determining our financial results in accordance with GAAP but at the same time the statements include 100% of the operating costs that we incur in managing these funds. To address this distortion, we present both “total” income, which includes the income earned in respect of the capital we have invested in these funds, as well as “third-party” income, which is the income earned from our clients because we believe the operating margins are more accurate if they are based on 100% of both the expenses and the associated income. We also present the “total” results with and without property services activities due to the different operating margin profiles of these businesses.

 

     Total 1     
     Excluding Property Services    Including Property Services    Third Party

FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS)

     2009        2008        2009        2008        2009        2008  

Asset management

                     

Base management fees

       $ 39          $ 43          $ 39          $ 43          $ 28          $ 33  

Performance returns

     1        4        1        4        1        1  

Transaction fees

     6        2        6        2        6        —  

Investment banking

     4        3        4        3        4        3  

Property services

     —        —        89        76        84        76  
     50        52        139        128          $ 123          $ 113  

Direct operating costs

     (25)       (23)       (102)       (85)       
         $ 25          $ 29          $ 37          $ 43        

1      Includes fees on Brookfield invested capital

                 

Asset Management Income

Asset management income is dependent on the amount of capital managed by us on behalf of our clients (base management fees) and our investment performance (performance returns). Base management fees typically reflect a fixed percentage of assets or capital, including committed but uninvested capital and therefore vary based on the level of such assets or capital. Performance returns include contractual arrangements whereby we are entitled to a variable amount based on the relationship between actual investment returns and a predetermined benchmark, as well as carried interests whereby we participate in investment returns through an ownership interest in the assets being managed.

Base Management Fees

Base management fees in the second quarter of 2009 consist of $28 million (2008 – $33 million) earned from third-party clients and $11 million (2008 – $10 million) from the capital that we have invested in existing funds. The decrease in third-party fees was due primarily to the decline in value of fixed income and equity portfolios under management relative to the 2008 quarter. As at June 30, 2009, annualized base management fees on existing funds and assets under management totalled $165 million (December 31, 2008 – $170 million), of which $125 million (December 31, 2008 – $130 million) relates to client capital. The decrease reflects lower levels of invested capital in respect of bridge lending activities following the collection of advances and return of capital to our clients. Annualized base management fees are an important measure of the expected contribution from these activities to our overall results and represent a stable source of cash flow that we believe adds considerable value to our business.

The following table presents the base management fees earned in respect of each of our operating platforms together with the associated capital commitments:

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         29    


     Base Management Fees    Capital Commitments
     Total    Third Party    Total    Third Party

AS AT AND FOR THE THREE

MONTHS ENDED (MILLIONS )

  

June 30 

2009 

  

June 30 

2008 

  

June 30 

2009 

  

June 30 

2008 

  

June 30 

2009 

  

Dec. 31 

2008 

  

June 30 

2009 

  

Dec. 31 

2008 

Commercial properties

       $    $    $    $    $ 4,575     $ 4,591     $ 2,927     $ 2,869 

Infrastructure

                         4,487       3,818       2,798       2,736 

Development properties

                         825       818       492       388 

Specialty funds

          11                 3,742       4,411       2,622       3,118 

Other

                         84       84       63       63 
     29       29       19       20       13,713       13,722       8,902       9,174 

Public securities

     10       14            13       18,822       18,040       18,822       18,040 
         $ 39     $ 43     $ 28     $ 33     $     32,535     $     31,762     $     27,724     $     27,214 

Other Fees and Services Income

Transaction Fees

Transaction fees include investment fees and other income earned in respect of financing and M&A activities related to managed entities and include commitment fees, work fees and exit fees.

Investment Banking Fees

Our investment banking services are provided by teams located in Canada and Brazil and contributed $4 million of fees during the second quarter of 2009 (2008 – $3 million). The group advised on transactions totalling $1 billion in value during the quarter.

Property Services Income

Property services fees include property and facilities management, leasing and project management and a range of real estate services which form a natural extension of our global property operating platforms.

 

     Total    Third Party
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS)    2009      2008      2009      2008  

Property services revenues

   $ 89       $ 76      $ 84       $ 76  

Direct operating costs

     (77      (62)       (77      (62) 
     $ 12       $ 14      $ 7       $ 14  

Assets Under Management

The following table summarizes total assets under management and net invested capital as at June 30, 2009 and December 31,2008:

 

    

Total Assets Under    

Management    

  

Brookfield’s Net    

Invested Capital    

   Third-Party Commitments 
(MILLIONS)    June 30
2009
   Dec. 31 
2008 
   June 30
2009
   Dec. 31 
2008 
   June 30
2009
   Dec. 31 
2008 

Unlisted funds and specialty issuers

                     

Commercial properties

   $ 12,458    $ 11,960     $ 1,388    $ 1,290     $ 2,927    $ 2,869 

Infrastructure

     6,461      6,201       726      696       2,798      2,736 

Development properties

     2,396      2,273       324      366       492      388 

Specialty funds

     4,744      4,817       933      870       2,622      3,118 

Other

     129      140       21      21       63      63 
     26,188      25,391       3,392      3,243       8,902      9,174 

Public securities mandates

     18,956      18,161       20      20       18,822      18,040 

Total fee bearing assets/capital

     45,144      43,552       3,412      3,263       27,724      27,214 

Directly held

                     

Operating assets

     32,970      31,525       9,202      8,215            — 

Other assets

     4,025      3,620       3,638      3,620            — 
     $ 82,139    $ 78,697     $ 16,252    $ 15,098     $ 27,724    $ 27,214 

Total assets under management increased by $3.4 billion during the year, or 4.4% primarily due to the revaluation of non-U.S denominated assets and the increase in the market value of our public securities portfolios.

 

     30        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Unlisted Funds and Specialty Issuers

This segment includes the unlisted funds and specialty listed issuers through which we own and manage a number of property, power, infrastructure and specialized investment strategies on behalf of our clients and ourselves. The funds are listed in more detail on page 58 and elsewhere in this MD&A.

Third-party capital commitments to these funds decreased in the year by $272 million. The return of capital to investors from more mature funds was partially offset by new capital commitments.

Public Securities

We manage fixed income and equity securities with a particular focus on distressed real estate and infrastructure. The following table summarizes assets under management within these operations. We typically do not invest our own capital in these strategies as the assets under management are securities as opposed to physical assets.

 

    

Total Assets Under    

Management    

   Third-Party Commitments
(MILLIONS)    June 30
2009
   Dec. 31 
2008 
   June 30
2009
   Dec. 31 
2008 

Public securities

             

Fixed income

   $     15,870    $     15,199     $ 15,736    $ 15,078 

Equity

     3,086      2,962       3,086      2,962 
     $ 18,956    $ 18,161     $ 18,822    $ 18,040 

Equity securities and fixed income under management increased in market value during the quarter. In addition, we secured $890 million of new advisory mandates during the quarter offset by $715 million of redemptions.

Directly Held

Operating and other assets and the associated net invested capital increased by $1.9 billion and $1.0 billion, respectively, in the quarter compared to the year ended December 31,2008 mostly due to currency revaluations.

FINANCING AND OPERATING COSTS

Interest

Interest costs include interest on corporate borrowings, certain subsidiary borrowings, property-specific borrowings and capital securities as set out in the following table:

 

     Total     Net
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS )    2009    2008    Variance       2009    2008    Variance 

Corporate borrowings

   $ 35    $ 41    $ (6 )     $ 35    $ 41    $ (6) 

Subsidiary borrowings

     83      122      (39 )       22      20      2  

Property-specific borrowings

     312      289      23                  —  

Capital securities

     22      23      (1 )       22      23      (1) 
     $     452    $     475    $ (23 )     $ 79    $ 84    $ (5) 

1      Relates to financial obligations that are guaranteed by the Corporation or issued by direct corporate subsidiaries

Total interest costs declined in the quarter by $23 million or 5% compared with the second quarter of 2008 due to lower debt levels, the impact of lower interest rates on floating rate debt and the impact of lower exchange rates on non-U.S. borrowings. Net interest costs were relatively unchanged as the borrowings are largely fixed rate.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         31    


Average borrowing costs for the second quarter of 2009 and 2008 are as follows:

 

     2009    2008
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS )   

Average

Outstanding

  

Interest

Expense

  

Average 

Rate 

  

Average

Outstanding

  

Interest

Expense

  

Average 

Rate 

Corporate borrowings

       $ 2,267    $ 35    6%         $ 2,412    $ 41    7% 

Subsidiary borrowings

     5,224      83    6%       8,345      122    6% 

Property-specific borrowings

     23,207      312    5%       22,005      289    5% 

Capital securities

     1,440      22    6%       1,606      23    6% 
         $ 32,138    $ 452    6%         $ 34,368    $ 475    6% 

Operating

Operating costs relate to our asset management and corporate activities, and for the second quarter of 2009 and 2008 were as follows:

 

     Total    Net
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS )    2009    2008    Variance     2009    2008    Variance 

Asset management

                   

Asset management activities

   $ 25    $ 23    $    $ 25    $ 23    $ 2  

Property services

     77      62      15       77      62      15  
     102      85      17       102      85      17  

Corporate and other costs

     64      63           52      56      (4) 
     $     166    $     148    $ 18     $     154    $     141    $ 13  

Operating costs include those of Brookfield Properties, and reflect the costs of our asset management activities as well as costs which are not directly attributable to specific business units. Property services expenses in the second quarter of 2009 increased due to the acquisition of a U.S. based relocation and brokerage services business in the fourth quarter of 2008 and an increase in the number of contracted service agreements.

Interests of Other Investors in Consolidated Operations

Co-investors’ interests in total operating cash flows decreased by $11 million during the quarter compared with the second quarter of 2008, as the increase in cash flows within commercial properties was more than offset by lower cash flows in our infrastructure operations investments.

Co-investor interests on a net basis are limited to the interests of minority shareholders in Brookfield Properties, which were relatively unchanged as improved commercial office results were offset by a lower contribution from the residential operations conducted by the company.

NET INCOME

Net income was $147 million in the second quarter of 2009, compared to $110 million in the same quarter in 2008.

The following table summarizes our consolidated statements of net income and the subsequent discussion pertains to items not discussed elsewhere in this analysis:

 

     Three Months Ended June 30      Six Months Ended June 30  
(MILLIONS)    2009      2008      2009      2008  

Revenues

   $ 2,978       $ 3,436      $ 5,629      $ 6,646  

Net operating income

     1,126         1,234        2,141        2,554  

Expenses

             

Interest

     (452      (475)       (867)       (1,002) 

Asset management and other operating costs

     (166      (148)       (325)       (313) 

Current income taxes

     (31      (21)       (42)       (38) 

Non-controlling interests in the foregoing

     (201      (212)       (358)       (380) 
     276         378        549        821  

Other items, net of non-controlling interests

     (129      (268)       (309)       (514) 

Net income

   $ 147       $ 110      $ 240      $ 307  

 

     32        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


Revenues

 

     Three Months Ended June 30     Six Months Ended June 30 
(MILLIONS)    2009    2008     2009    2008 

Asset management

   $ 123    $ 113     $ 228    $ 227 

Commercial properties

     719      725       1,391      1,463 

Power generation

     299      362       600      701 

Infrastructure

     107      149       210      298 

Development and other properties

     801      1,062       1,290      1,828 

Specialty funds

     450      584       883      1,126 

Investment income and other

     479      441       1,027      1,003 
     $ 2,978    $ 3,436     $ 5,629    $ 6,646 

Revenues declined from $3.4 billion in the second quarter of 2008 to $3.0 billion in the second quarter of 2009. The decrease reflects the impact of lower exchange rates on non-U.S. revenues as well as a lower level of activity in our construction businesses and lower volumes in our residential, insurance and timber operations. The impact of the lower volumes on operating cash flows is discussed within the review of Operating Platforms.

Net Operating Income

Net operating income includes the following items from our consolidated statements of income: fees earned; operating revenues less direct operating expenses; and investment and other income. These items are described for each business unit in Part 2 – Performance Review.

Other Items

Other items are summarized in the following table, and include items that are non-cash in nature or otherwise not considered by us to form part of our operations cash flow.

 

     Total    Net 1
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS )    2009      2008      2009      2008      Variance  

Depreciation and amortization

   $ 300       $ 328      $ 174       $ 192       $ (18) 

Equity accounted results

             21                21         (21) 

Revaluation and other items

     73         46        66         70         (4) 

Future income taxes

     (97      (3)       (111      (15      (96) 

Non-controlling interests

     (147      (124)                       —  
     $ 129       $ 268      $ 129       $ 268       $ (139) 

1      Net of non-controlling and minority interests

              

Depreciation and Amortization

Depreciation and amortization for each principal operating segment is summarized in the following table:

 

     Total    Net 1
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS)    2009    2008     2009    2008    Variance  

Commercial properties

   $ 155    $ 168     $ 70    $ 71    $ (1) 

Power generation

     52      51       44      44      —  

Infrastructure

     20      36       10      24      (14) 

Development and other properties

     25      36       16      28      (12) 

Specialty funds and investments

     47      35       33      23      10  

Other

     1           1      2      (1) 
     $ 300    $ 328     $ 174    $ 192    $ (18) 

1      Net of non-controlling and minority interests

              

We recognize depletion expense in our timberlands operations on a volumetric basis and accordingly have a lower expense in 2009 because we reduced harvest levels in order to capture higher values in future periods. Certain intangible assets recognized in respect of acquisitions were fully amortized over the course of 2008 resulting in lower expense within the Development segment in 2009.

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         33    


Equity Accounted Results

We recorded net equity accounted losses of $21 million during the second quarter of 2008 from our investment in Norbord. We increased our interest in Norbord to 60% at the end of 2008 and to 75% during the first quarter of 2009. We have continued to account for Norbord on an equity accounted basis for the purposes of this analysis, consistent with prior treatment.

Revaluation and Other Items

Revaluation and other items are comprised of non-cash accounting adjustments that we are required to record under GAAP to reflect changes in the value of certain contractual arrangements whereas we are not permitted to revalue the corresponding assets or revenues to which these arrangements pertain. Changes in the value of these arrangements contributed a loss of $66 million to net income after taking into account non-controlling and minority interests, representing a $4 million positive variance over 2008, as illustrated in the following table:

 

     Total    Net 1  
FOR THE THREE MONTHS ENDED JUNE 30 (MILLIONS)    2009      2008      2009      2008      Variance    

Norbord exchangeable debentures

   $     68       $     48      $ 68       $ 48       $ 20   

Interest rate contracts

     (100      (42)       (97      (42      (55 )  

Power contracts

     4         42        9         55         (46 )  

Provisions for potential impairment

     83         —        72                 72   

Other

     18         (2)       14         9         5   
     $ 73       $ 46      $ 66       $ 70       $ (4 )  

1      Net of non-controlling and minority interests

              

We hold interest rate contracts to provide an economic hedge against the impact of possible higher interest rates on the value of our long-duration interest sensitive physical assets. The relevant interest rate curves changed between March 31, 2009 and June 30, 2009 by 87 basis points, which led to a $100 million increase in the net value of these contracts. A 10 basis point parallel increase in the 10-year interest rate curves results in a pre-tax gain of approximately $9.1 million.

In our power operations, we enter into long-term contracts to provide generation capacity, and are required to record changes in the market value of certain contracts through net income. We recorded a small gain on these contracts due to lower energy prices in the current quarter, whereas we recorded a much larger gain in the second quarter of 2008, during which prices experienced a larger decline. No losses have been realized to date in respect of these assets.

We have recorded provisions in respect of the potential impairment of certain residential development and real estate finance assets to reflect a decline in values and a change in intentions with respect to our ownership, although no losses have been realized to date in respect of these assets.

Future Income Taxes

We recorded a larger income tax benefit during the quarter due to the recognition of additional tax benefits that are available to reduce taxable income in future years.

 

     34        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


OUTLOOK

The current economic circumstances continue to be challenging, including increasing levels of unemployment, lower consumer and business confidence and spending, and uncertainty with respect to the longer term implications of government sponsored initiatives to restore the health of the global economy.

While we have not been immune to these factors, we attempt to organize our operations in a manner that provides an important measure of stability, consistent with our long-term business strategy. In particular, we believe that our focus on owning high quality assets, backing revenue streams with long-term contractual arrangements, match funding long life assets with long-term financings and maintaining a high level of liquidity has, and will continue to, benefit us during these volatile times.

Accordingly, while these events may constrain our ability to increase operating cash flows in the near term, we remain confident in our ability to achieve our long-term objectives. Furthermore, we believe we will have the opportunity to make investments during this period at very favourable prices that will create attractive shareholder value in the future.

We believe that our renewable power operations are well positioned to exceed our targets of long-term average generation in 2009 based on current storage levels if normal hydrology conditions prevail. The forecast for natural gas and electricity prices during the balance of 2009 and 2010 is lower than the spot prices we received in 2008, however, we have contracted pricing for approximately 80% of our generation over the next two years at favourable prices, which significantly mitigates the impact of lower spot electricity prices.

In our office property sector, leasing demand in most of our markets has tempered and increasing direct and sublease availabilities have increased, resulting in downward pressure on rents and economic fundamentals. Our occupancy levels, however, are at 95% across our portfolio and only 2% and 4% of the space within our portfolio is scheduled to come off lease during the balance of 2009 and 2010, respectively, of which a large portion is customarily renewed in the normal course. The high quality of our properties relative to others in our markets should enable us to attract new tenants if we are unsuccessful in extending leases with the existing tenants. Furthermore, we believe our in-place rents continue to be below market. Within our North American portfolio, our average expiring rates in 2009 are $23 per square foot compared with an estimated average market rate of $28 per square foot, representing a substantial discount. A general lack of development, especially in central business districts, has also created stability from a supply perspective. Nevertheless, a prolonged continuation of the current economic downturn could lead to tenant bankruptcies and lower market rents which could reduce our cash flows. Our strong tenant lease profile, low vacancies and rental rates that in most properties are substantially below current market rates give us a high level of confidence that we can achieve our operating targets in 2009.

Within our infrastructure operations, we expect our transmission businesses to provide operating returns in 2009 consistent with those recorded in 2008, excluding non-recurring items. We expect our timber operations to continue to experience reduced demand and pricing due to weakness in the U.S. homebuilding sector. As a result, we have elected to reduce harvest levels in order to preserve value and increase exports to Asia, which we believe will enable us to achieve higher returns as markets recover. We expect harvest levels in Canada and the U.S. to be approximately 30% and 50% below 2008 levels, respectively.

Residential markets remain difficult in our core markets. The current supply/demand imbalance in North American markets has reduced operating margins and must be worked through before we experience margin improvements and volume growth. In the U.S. we have been successful in acquiring additional lots at distress prices while preserving value in our existing businesses. Most of the land holdings within our Canadian land operations were purchased in the mid-1990s or earlier and as a result have an embedded cost advantage today. This has led to favourable margins in this region and sales activity has appeared to increase recently. We expanded our Brazilian operations during 2008 which we expect will lead to an increased contribution from these markets during 2009 and beyond.

In our specialty funds operations we are focusing on deploying the capital from new funds, which should lead to long-term growth. In the short-term, we expect that the current difficulties in credit markets will lead to a greater number of opportunities for our restructuring operations, and more attractive pricing for our real estate finance group, although the same conditions will likely reduce opportunities to monetize investments and the opportunity to recognize disposition gains.

Within our asset management activities, our goal is to continue to expand our distribution capabilities, our client base and the amount of capital committed to us, which should, over time, increase the capital available to invest and lead to growth in asset management income. The current environment has made it more challenging to raise additional capital commitments from certain

 

    Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT         35    


institutions. However, there are a number of companies that, like us, believe that the current environment offers considerable opportunities and wish to commit capital alongside ours. While it is currently more difficult to earn performance income, we expect to record a stable contribution from base management fees in 2009.

The fluctuations in the value of the U.S. dollar against various currencies impacts the contribution from our operations that are denominated in these other currencies, notably the Canadian dollar, the Brazilian real and the Australian dollar in 2009. The recent strengthening of these currencies is generally beneficial to both our operating cash flows and equity values. Lower short term interest rates in most economies has a beneficial impact on our results, although this is limited because most of our financings are fixed rate in nature. Similarly, the long-term nature of our borrowing base and the relatively low proportion of annual debt maturities lessens the impact of higher credit spreads on new financings.

We have endeavoured to extend debt maturities on a proactive basis and reduce near-term financing requirements. Although we expect to renew or replace most of our existing financings at equivalent levels, we may reduce leverage in certain areas of our business. While we expect that any deleveraging will likely have a limited impact on our short term operating results, it would reduce the capital available for investment. We maintain a high level of liquidity as further discussed in Part 3 of this MD&A, and regularly replenish our liquidity through operating cash flow and asset monetizations.

Over the past eighteen months, the investment market has become less competitive and acquisition prices have declined due in large part to reduced availability of capital for many owners and investors. The access to liquidity from our own balance sheet as well as from our clients, financial partners and the capital markets continues to provide us with funds to invest in our own operations and in new opportunities. We believe the breadth of our operating platforms and our disciplined approach should enable us to invest this capital on a favourable basis for the balance of 2009 through 2011.

There are many factors that could impact our performance in 2009, both positively and negatively. We describe the material aspects of our business environment and risks in Part 5 of the MD&A contained in our 2008 Annual Report.

 

     36        Brookfield Asset Management    |    Q2 /2009 INTERIM REPORT     


PART 3 – CAPITALIZATION AND LIQUIDITY

The strength of our capital structure and the liquidity that we maintain enable us to achieve a low cost of capital for our shareholders and at the same time provide us with the flexibility to react quickly to potential investment opportunities and adverse changes in economic circumstances, such as we have witnessed over the past 18 months.

The following are the key elements of our capital strategy:

 

   

Match fund our long-life assets with long-duration mortgage financings with a diversified maturity schedule;

 

 

   

Provide recourse only with to the specific assets being financed, with limited cross collateralization or parental guarantees;

 

 

   

Limit financial leverage to investment grade levels based on anticipated performance throughout a business cycle;

 

 

   

Structure our affairs to facilitate access capital and liquidity at multiple levels of the organization; and

 

 

   

Maintain access to a broad range of financing markets.

 

LIQUIDITY

Core Liquidity

Our primary sources of liquidity, which we refer to as “core liquidity”, consist of our cash and financial assets, net of deposits and other associated liabilities, and undrawn committed credit facilities at the corporate level and at our principal operating platforms.

Our core liquidity at June 30, 2009 is approximately $3.1 billion, which includes core liquidity of $2.0 billion at the corporate level and $0.5 billion at our principal operating platforms and a further $0.6 billion in pending transactions. These include the monetization of 50% of Canadian renewable power assets which is expected to close in late August 2009. At March 31, 2009, we held $2.5 billion of core liquidity and $0.3 billion of expected proceeds from pending transactions.

During the quarter we generated $2.3 billion through financings and asset monetizations. Highlights included the issuance of $725 million of perpetual preferred shares and 5-year notes at the corporate level, the receipt of $220 million in proceeds from the sale of our Brazilian transmission interests and $600 million of property-specific and subsidiary level financings, including a C$370 million mortgage bond secured by one of our Calgary properties. Approximately $0.9 billion of the proceeds were used to refinance existing short-term maturities, and approximately $450 million was invested in our operations to acquire new assets or increase our ownership of existing businesses. Investments include $250 million invested in equity of affiliates at attractive values; $100 million used to pre-pay the December 2009 corporate maturity within our power operations; and $100 million was used to reduce the leverage of select property development assets.

We generate substantial liquidity within our operations on an ongoing basis through our operating cash flow, which typically exceeds $1.5 billion on an annual basis, as well