HSH Nordbank AG

FINANCIAL INSTITUTIONS
HSH Nordbank AG
ISSUER IN-DEPTH
22 March 2016
FAQ: Restructuring Benefits Profitability and Risk Profile, But
also Raises Medium Term Uncertainty
RATINGS
HSH Nordbank AG
Baseline Credit
Assessment
b3
Senior Unsecured Debt
Baa3, developing
LT Bank Deposits
Baa3, developing
Counterparty Risk
Assessment
Baa3(cr)/Prime-3(cr)
Subordinated Debt
B2
Short-Term Ratings
Prime-3
KEY METRICS:
HSH Nordbank AG
Q3
2015
Total Assets (EUR billion)
Problem Loans / Gross
Loans
TCE / Risk Weighted
Assets (1)
Net Income / Tangible
Assets
2014 2013
104.9 104.8 104.7
-- 22.8% 23.1%
10.6%
9.5% 9.6%
0.0%
0.3% -0.6%
Market Funds / TBA (2)
43.4% 45.7% 48.6%
Liquid Assets / TBA (2)
19.8% 25.2% 23.5%
(1) TCE = Tangible Common Equity,
(2) TBA = Tangible Banking Assets
Source: Moody’s Banking Financial Metrics, adjusted
Contacts
Katharina Barten
49-69-70730-765
Sr Vice President
[email protected]
Alexander Hendricks,
49-69-70730-779
CFA
Associate Managing
Director - Banking
[email protected]
Carola Schuler
49-69-70730-766
Managing Director Banking
[email protected]
Even though last year's state aid deal has started to stabilise troubled HSH Nordbank AG
(HSH), Germany's largest ship lender must continue a path of fundamental transformation.
This will take several years, causing sustained uncertainty for investors.
HSH faces a number of transactions in 2016, which are largely positive and support its
recovery: Large non-performing loan sales will change its asset risk profile for the better, and
a substantial reduction in the premiums HSH must pay in compensation for state aid will lift
a burden from the bank’s weak income statement.
HSH reaffirmed this week what it had already said last October: that its state aid proceedings
had been concluded with the European Commission’s (EC) commitment to formally approve
the reinstatement of a second-loss asset guarantee of €10 billion, up from €7 billion. The EC's
formal approval is expected sometime during the second quarter of this year. The €10 billion
guarantee was initially provided in 2009 by the bank's public-sector owners, i.e., the federal
state of Schleswig-Holstein (unrated) and the city state of Hamburg (unrated).
The planned transactions raise a number of questions, some of which cannot be fully
answered at this stage. Delaying the publication of the 2015 results until 9 June 2016 extends
the current period of uncertainty as key aspects of HSH's solvency, in particular relating to
the remaining headroom under the €10 billion guarantee, will only then become available.
Meanwhile, we expect that the adverse developments in the shipping sector we've seen since
the original announcement last autumn will further complicate the planned restructuring
measures. In this report we try to answer key investor questions about how the planned
transactions will be structured and what impact they will have on HSH's financial position
based on what we know so far, and we will also attempt to provide some likely scenarios.
In addition, we touch on the key challenges awaiting the bank over the next couple of years.
HSH’s mandatory privatisation within 24 months from the date when the EC publishes its
formal approval is clearly the most significant condition of the EC’s state aid approval. The
required change of ownership implies an extended period of uncertainty, not only because a
failure of the bank’s sale would result in its wind-down, according to the EC's decision. Even
the bank’s successful sale may not be free of challenges, considering that HSH may then lose
its membership in the institutional protection scheme (IPS) of Sparkassen-Finanzgruppe (SGroup, Aa2 stable, a2)1 which is designed to support banks with a public-sector mandate and
public ownership.
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
What are the key financial implications of the EC’s decision?
The EC’s state aid approval came with a basket of structural adjustments to the previously agreed compensation measures. These
adjustments will strengthen HSH’s profitability and asset risk profile.
Technically, the original compensation measures, i.e. those relating to the EC’s first approval of the guarantee dating back to 2011,
remain intact. However, by splitting various cost items and attributing portions of the future burden to a new holding company owned
by HSH’s public sector owners (that will hold the equity of HSH), the EC has effectively agreed to shift part of the burden from the
bank to its owners.
The agreement has several financial implications, particularly for the bank’s asset risk profile, profitability and funding structure. The key
implications in brief:
1. Cost relief: HSH will have to pay a reduced annual base premium of 2.2%, instead of 4.0%, to be paid on the amount not utilised
under the €10 billion guarantee, rather than on the full guarantee amount. The costs will fall to roughly €100 million from €400
million for the second-loss guarantee. HSH will also no longer pay various other guarantee fees.
2. Asset quality improvements: The agreed €8.2 billion asset sales will materially reduce HSH’s non-performing loans (NPLs).
Leaving aside any changes in classified assets since September 2015, NPLs would reduce to €6.9 billion from €15.1 billion, pushing
down the NPL ratio to 13% from the latest reported 23%. According to HSH's latest press release, €5.0 billion NPLs will initially
be transferred out into an entity held by HSH’s majority owners, and up to €3.2 billion is targeted to be sold on the market; (the
bank had previously reported it will transfer €6.2 billion to its owners and sell €2.0 billion on the market). We do not expect the
NPL ratio to reduce that much, however, considering recent adverse developments in the shipping sector.
3. Higher utilisation of risk shield: Because the transfer of assets from HSH to the states of Hamburg and Schleswig-Holstein will
be executed at updated market values, which we expect to be significantly below latest reported book values, the utilisation of the
€10 billion guarantee will materially increase. Due to the higher utilisation of the guarantee and the resulting absorption of capital
resources, we take the view that the asset quality improvement will have no positive effect on the bank's overall solvency.
4. Funding structure benefits: Through divesting €8.2 billion in NPLs later in 2016, HSH will achieve a better matched maturity
profile. The €3.2 billion NPLs to be sold will no longer require funding, and we expect HSH’s majority owners to arrange, after
a transitional period, alternative funding for the €5.0 billion NPLs they will purchase, with material benefits for HSH’s funding
structure.
What type of impaired loans does HSH intend to sell?
In its investor presentation of the group’s September 2015 results, HSH said that it will focus on US dollar denominated ship finance
loans when selecting guaranteed impaired assets for the planned portfolio sales. By selecting US dollar denominated loans, HSH will
not only reduce credit risk, but also sizeable market risk attached to its large US dollar exposure.
However, selling €3.2 billion of a single underperforming asset class in the market may have undesired implications. If this portfolio
exclusively comprises impaired ship finance loans, the transaction would risk to have a negative market impact. Such a large volume of
ship finance NPLs may exert pressure on the price of underperforming ship finance loans or even the valuation of the loan collateral,
i.e., of maritime vessels. This is not in HSH’s interest as it could have a negative impact on the valuation of collateral for portfolios
that will remain on its books. HSH may therefore select this portfolio carefully and include other assets in order to avoid such market
implications.
To what extent will structural changes show in HSH’s 2015 financial accounts?
HSH will have selected and earmarked the asset portfolios that it seeks to either sell or offload in preparation of its 2015 accounts.
Although HSH will probably close the transaction only in H2 2016, the bank must, according to IFRS rules, show in its 2015 accounts
the volume of loans that represent non-current assets held for sale.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
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FINANCIAL INSTITUTIONS
The required change in categorisation makes a material difference as to how risk provisions are calculated. The level of risk provisioning
for loans intended to be held on the balance sheet (i.e., not held for sale) is based on an estimate of future cash flows, whereby the
bank may take into consideration its view of the future recovery of current market values of collateral over a long time-horizon, and/or
its future success in carefully working-out underperforming loans. In contrast, risk provisioning for assets held for sale must reflect their
fair market value, for which short-term supply and demand are the dominating considerations when valuing loan assets.
Ahead of the transactions, HSH will 1) select the portfolio it intends to sell from its pool of guaranteed non-performing assets; 2) make
additional provisions for these loans to reflect their fair market value; and 3) charge the total additional provisions to the €10 billion
asset guarantee. The latter will increase the guarantee utilisation and reduce the headroom under the risk shield left to cover future
risk provisions. The impact on the income statement will be modest: To mirror the higher claim under the guarantee, HSH will book a
compensatory amount to the income statement, which will broadly offset the extra provisions on reclassified loans.
We understand that these items will be largely or even fully included in the bank’s 2015 accounts, whilst the changes in NPL volumes
and respective ratios will be reflected in HSH’s financials only after the transactions have been executed.
Why did HSH delay the publication of its 2015 financials and what are the implications?
As HSH said first on 3 March and then on 21 March, it will not publish its 2015 annual accounts until 9 June 2016, i.e. two and a
half months after the originally targeted date of 24 March. According to the bank, the delay is required because it had to address
questions on how to account for the planned restructuring measures within the scope of the EC’s state aid approval. Meanwhile, HSH
has resolved those questions affecting its balance sheet, including the valuation of the portfolio to be transferred to Hamburg and
Schleswig-Holstein. Changes to the earlier structure of planned portfolio sales include that HSH will initially transfer only €5.0 billion to
its owners, less than the originally earmarked €6.2 billion, and sell to the market a higher amount of up to €3.2 billion NPLs, instead of
€2.0 billion.
Although HSH did not provide any further details, we expect that the complex accounting of the planned asset sales is further
complicated by the continued decline in key indicators for the shipping sector since the bank's October 2015 announcement, including
significant changes year-to-date. The Baltic Dry Index, a measure of bulker vessel freight rates, lost some 30% between early January
and the end of February 2016, although it then recovered some ground during March to date. In container shipping, which represents
HSH’s highest exposure concentration, freight rates remained at historical lows throughout January and February, after a steep decline
in Q4 2015. Such market movements after the financial year-end date matter because material changes may trigger adjustments
during the so-called “adjustment period”, i.e., until the financials are eventually published.
Our forecasts for the shipping sector are mostly negative. Even though the tanker segment continues to perform strongly, we expect
the supply-demand gap for the industry overall to exceed 2% in 2016, and possibly into 2017, as large new vessel deliveries coincide
with subdued demand for dry bulk and container ships.2 To the extent recent developments and current forecasts are materially weaker
than assumed by HSH for the purpose of setting fair market values, these may prompt adjustments to the 2015 accounts.
It is too early to assess any particular implications of such adjustments. However, if HSH’s ship finance loan valuations required
further downward adjustments, these will necessitate higher provisions on the respective loans and a higher utilisation of the €10
billion guarantee. If HSH targets to achieve a pre-agreed utilisation amount of the guarantee, the bank may alternatively change
underperforming assets in the portfolios earmarked for sale for less risky ones. Whilst a sale of a lower amount of NPLs would imply
that the targeted 13% NPL ratio cannot be met, we expect that the bank will in any case struggle to achieve this ratio because ongoing
recoveries in portfolios unrelated to shipping may slow down and be insufficient to offset sustained deterioration of ship finance assets
during 2016.
In its 21 March statement HSH did not explain why it may transfer a lower NPL volume to its owners than originally planned, and then
sell a higher amount to the market instead. As the pricing of this transfer will be set by the EC, we believe that this may have been
changed at the bank's request. This could indicate that the EC's valuation of the portfolio that will be transferred to HSH's owners is a
conservative one, possibly in order to make sure that this transfer does not constitute renewed state aid.
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HSH Nordbank AG: FAQ: Restructuring Benefits Profitability and Risk Profile, But also Raises Medium Term Uncertainty
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
How will HSH’s capitalisation and loss absorption capacity be affected by the assets sales?
The impact on HSH's capitalisation from the asset sales is hard to ascertain at this juncture because a lot of detail will only be disclosed
in the 2015 statement and over the course of 2016. Charging additional provisions on assets earmarked for sale in 2016 against the
€10 billion guarantee will reduce the remaining headroom of the guarantee. In this context, HSH's indication that the headroom will
expand to roughly €4.5 billion after the portfolio sales from €4.3 billion as of September 2015 looks peculiar, in particular in light of the
recent developments. This €4.5 billion headroom can be calculated based on the reported future annual costs of €100 million being
equal to 2.2% on the unutilised amount of the guarantee (see the pro-forma calculation in exhibit 1).
We consider that this 'pro-forma' scenario is unlikely, mainly for two reasons: First, we concede that more headroom could principally
be explained by the bank's expectations that it could offset loan recoveries under the guarantee, which would prompt a release of
risk provisions on assets that will not be sold. However, we expect the difference in book values and fair market values for impaired
ship finance loans to be substantial, and consider a fully offsetting effect from recoveries to be very unlikely. Secondly, with HSH's
announcement that it will need to delay reporting its 2015 financials until early June, we believe that the bank will need to fall back
on a bigger chunk of the guarantee for the €8.2 billion NPL sales than was estimated back in October 2015, which would result in an
unutilised amount less than €4.5 billion.
In this context we note that HSH did not offer an exact definition of the unutilised amount that will be the basis for future fees. Given
the complexity of differing economic and regulatory perspectives of the guarantee utilisation, further clarity is needed. Moreover,
HSH has not given any indication of the regulatory utilisation of the €10 billion guarantee post NPL-sales, and therefore it remains to
be seen whether the bank's overall solvency will benefit or suffer. The regulatory buffer afforded by the guarantee -- only 11% of the
guarantee as of September -- will remain important for assessing HSH’s capitalisation.
HSH will only be able to disclose the exact implications on its capital position after the planned balance sheet clean-up. As HSH
intends to sell €1.2 billion more in NPLs than it originally said in October, deviations from the target ratio appear more likely.
Exhibit 1
Stressed shipping markets will likely weigh on the free capacity under the €10 billion guarantee in 2016
Structure and utilisation of the guarantee before and after accounting for the asset sales
Note: Amounts in EUR billion. The lower “pro-forma” utilisation of €5.5 billion that was originally (i.e., last October) expected to be achieved after the planned portfolio sales is calculated
based on the reported €100 million future fee p.a. (2.2% on the unutilised amount). The regulatory utilisation, at €8.9 billion (89%) as of September 2015, cannot be calculated or reliably
forecast.
Source: HSH Nordbank, investor presentation on the bank’s September 2015 results; Moody’s calculations.
HSH also said in its 21 March press release that, once the transactions are closed, it expects a Common Equity Tier1 (CET1) ratio above
12.0%. This ratio is the result an amendment to the compensation package, whereby HSH’s “claw-back” buffer must be released and
the amount transferred to capital, which will simplify its capital structure. This buffer refers to fees paid in the past, which the bank
could claim back to preserve its Common Equity Tier1 (CET1) ratio at a minimum of 10%. As of September 2015, this claw-back buffer
was 2.7 percentage points and effectively raised the reported 10.1% CET1 ratio to 12.8%. As of December 2015, HSH will no longer
have this buffer available, but instead report a higher CET1 ratio. Economically, this is neutral, and the bank's expectation of a CET1
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22 March 2016
HSH Nordbank AG: FAQ: Restructuring Benefits Profitability and Risk Profile, But also Raises Medium Term Uncertainty
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
ratio above 12.0% after the portfolio sales therefore does not constitute any real improvement. HSH's estimate of a CET1 ratio “above
12.0%” indicates that it will probably not reach the 12.8% like-for-like ratio it reported for September.
How do we expect HSH to perform in 2016 and how will the funding profile evolve?
HSH said it expects a “positive result” for the full year 2015. Considering the substantial cost relief that the new compensation package
affords, as well as the envisaged higher utilisation of the guarantee, we expect two developments for 2016:
»
HSH will be able to post stronger results in 2016, underpinned by the envisaged €300 million in annual cost relief. However,
depending on how the new 2.2% fee has to be calculated and accounted for, the respective cost relief may materialise only after
the NPL transactions are closed. Parts of the respective cost relief may therefore be delayed until the second half of 2016 (or even
later).
»
HSH’s earnings stability will somewhat improve after the asset sales, partly because compensation under the guarantee will better
match write-downs on newly impaired or deteriorated guaranteed assets as several guarantee fees will fall away and no longer
be deducted from the compensatory amount. In addition, guarantee-related effects which caused major profit volatility in recent
years, will wane because the portfolio covered by the guarantee will shrink.
The portfolio sales in H2 2016 will add several percentage points to HSH’s liquidity coverage ratio (LCR) and net stable funding ratio
(NSFR). This is particularly important for the NSFR, which we expect to have weakened in Q4 2015 due to approximately €10 billion in
debt maturities, relating to liabilities that still fell under the statutory guarantee (grandfathering) of the bank’s public sector owners. A
weak NSFR in the near term, for instance between 80-90%, would still be commensurate with HSH’s b3 baseline credit assessment,
although it would not be sustainable for the bank. However, we expect the NPL sales to partially restore the NSFR in the course of
2016.
As restoring the NSFR through new long-term debt issuances would likely to be very costly, we consider the funding structure benefit
to be an “windfall” credit-positive factor of the planned NPL clean-up exercise. However, more efforts will likely be required to achieve
a NSFR of 100%. We consider mending HSH’s funding profile to be vital for putting the bank in a more resilient position for periods
when it may face limited market access owing to volatile global markets, any further set-backs in the shipping industry and/or varying
levels of confidence in the success of its privatisation in 2018.
What will be the key challenges in 2018, the year when HSH must be privatised?
The uncertainty of a successful privatisation
We cannot forecast at this stage whether HSH’s privatisation will be successful. There is considerable opacity to HSH’s future
performance, prospects for the shipping sector are dim, markets are highly volatile and investor appetite for bank equity highly
uncertain. Even if HSH demonstrates that it can fully exploit all upside potential in the areas of profitability and risk management, the
outcome of the privatisation is likely to remain uncertain until a serious strategic investor bids for the bank or an initial public offering
(IPO) proves successful.
The unabated shipping sector crisis
We expect that a successful privatisation will happen only if HSH’s risk profile and capital show substantial improvement, and if the
expectations for the shipping sector change towards a sustainable recovery. However, as for now there is no respite from the shipping
crisis, and we caution that 2016-17 may see a renewed worsening as major new capacities in the container and tanker segments will
enter the shipping market.
The potential for and opacity of an unwinding scenario
Failure to privatise HSH would imply that the bank needs to be closed down and unwound. In that scenario, we expect a negative
impact on HSH’s profits, owing to the continued loss of economies of scale and revenue potential. That said, HSH may well have
sufficient capital reserves as and when such consequences must be faced, to see the bank through several years of unwinding. By
implication, creditors will not immediately be at risk of suffering losses. Importantly, any un-utilised amounts under the €10 billion
asset guarantee would remain available to shield creditors from losses. In an unwinding scenario, we expect that a broader set of (stateaid-neutral) options will be available, and carefully applied, to more efficiently use all capital and equivalent resources.
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HSH Nordbank AG: FAQ: Restructuring Benefits Profitability and Risk Profile, But also Raises Medium Term Uncertainty
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
Credit profile after a successful privatisation
A successful privatisation is also not without risk for creditors, chiefly for two reasons: First, the change of ownership could weigh on
investor confidence for unsecured long-dated debt which HSH’s business model will continue to require. Second, the S-Group may call
for a phase-out of HSH’s membership in its institutional protection scheme (IPS). As per the group’s statutes, any member bank’s exit
needs to be supported by a two-year period during which the IPS remains liable to providing support in case of need. This period may
not be sufficient to secure investor confidence, especially if HSH had to face setbacks post privatisation.
What will be the role of the institutional protection scheme of the S-Group?
Failure to privatise HSH in 2018 may also become a litmus test for S-Group's IPS. We do not expect HSH’s membership in S-Group’s
IPS to be at stake in a scenario where HSH’s current public sector ownership remains unchanged. As and when HSH requires either
liquidity or capital resources during its potential unwinding, the IPS’ governing body will have to make a decision, whereby any support
measures will be subject to a 75% majority vote of the IPS’s representatives. Our base scenario is that HSH will receive required
support from the group, although such a decision may not be taken easily, judging by major controversial debates and friction during
2015 over the question of Landesbank support.3
Our base scenario assumption that HSH will be supported takes into account that the withdrawal of support (through a no-vote)
would cause major collateral damage for the S-Group itself -- not least due to the impairment of the group’s IPS. The high probability
of support is illustrated by two notches of rating uplift for affiliate support we currently factor into HSH’s ratings.
In this context we do not rule out that, if HSH’s sale in the market were to fail, S-Group or its member institutions would emerge
as a bidder and would secure full control over HSH. The bank's 19 October 2015 ad-hoc announcement on the EC's commitment
to approve the state-aid proceedings stated that the sale will be effected in an open, competitive and transparent process, and that
other Landesbanks may also take part in the sale. We therefore conclude that S-Group would also not be barred from a bid, which we
consider more likely than one from any of the Landesbanks.
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HSH Nordbank AG: FAQ: Restructuring Benefits Profitability and Risk Profile, But also Raises Medium Term Uncertainty
FINANCIAL INSTITUTIONS
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Peer Group:
»
Bayerische Landesbank
»
Landesbank Baden-Wuerttemberg
»
Landesbank Hessen-Thueringen GZ
»
Norddeutsche Landesbank GZ
Moody's Related Research
Credit Opinion:
»
HSH Nordbank AG
Credit Focus:
»
HSH Nordbank AG: State aid deal is credit positive but privatisation plan prolongs uncertainty, October 2015 (1009116)
Issuer Comments:
»
European Commission's Approval of State Aid for HSH Is Credit Positive, October 2015 (185365)
»
HSH Nordbank Capital Buffers Deteriorate Amid US Dollar Strength, August 2015 (184032)
»
ECB Presses HSH Nordbank to Speed Up Its Divestment of Nonperforming Assets, a Credit Positive, July 2015 (183269)
Banking System Outlook:
»
Germany, October 2015 (1006359)
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this
report and that more recent reports may be available. All research may not be available to all clients.
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Endnotes
1 The ratings shown here are S-Group’s corporate family rating and its baseline credit assessment (BCA).
2 See our report „Weakness in Dry Bulk, Container Segments Drives Outlook Change to Negative”, March 2016.
3 See our report „Revised Institutional Protection Scheme Leaves Landesbank Ratings Intact For Now”, February 2016.
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REPORT NUMBER 1016574
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22 March 2016
HSH Nordbank AG: FAQ: Restructuring Benefits Profitability and Risk Profile, But also Raises Medium Term Uncertainty
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Maximilian Denkmann
Associate Analyst
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10
22 March 2016
CLIENT SERVICES
Gabriele Thesing
AVP-Research Writer
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HSH Nordbank AG: FAQ: Restructuring Benefits Profitability and Risk Profile, But also Raises Medium Term Uncertainty