08/23/2016 - HSH Nordbank

FINANCIAL INSTITUTIONS
CREDIT OPINION
23 August 2016
HSH Nordbank AG
Semiannual update
Update
Summary Rating Rationale
We assign Baa3/P-3 senior unsecured debt and deposit ratings and B2 senior subordinated
debt ratings to HSH Nordbank AG (HSH). We further assign a b3 baseline credit assessment
(BCA), a b1 adjusted BCA and Baa3(cr)/Prime-3(cr) Counterparty Risk (CR) Assessments. For
the ratings of various deeply subordinated instrument, see details at the back of this report.
RATINGS
HSH Nordbank AG
Domicile
Hamburg, Germany
Long Term Debt
Baa3
Type
Senior Unsecured - Fgn
Curr
Outlook
Developing
Long Term Deposit
Baa3
Type
LT Bank Deposits - Fgn
Curr
Outlook
Developing
Please see the ratings section at the end of this report
for more information. The ratings and outlook shown
reflect information as of the publication date.
The long-term ratings reflect (1) HSH's BCA of b3; (2) a high probability of the bank receiving
affiliate support from Sparkassen-Finanzgruppe (corporate family rating Aa2 stable, BCA a2)
which lifts the adjusted BCA by two notches to b1; (3) the result of our advanced Loss Given
Failure (LGF) analysis, which takes into account the severity of loss faced by the different
liability classes in resolution and provides three notches of uplift from the b1 adjusted
BCA for HSH's senior debt and deposit ratings; and (4) our moderate government support
assumptions, equivalent to one notch of rating uplift.
HSH's b3 BCA reflects the bank's weak financial profile, in particular its very poor asset
quality, limited capital resources in the context of its high-risk asset profile and the
considerable opacity of its future performance. The latter results from HSH's ongoing balance
sheet overhaul. In addition, the European Commission's (EC) requirement that HSH must be
privatised by 28 February 2018, in compensation for state aid received, creates uncertainty
because a failure to privatise the bank would trigger its unwinding.
Analyst Contacts
Katharina Barten
49-69-70730-765
Sr Vice President
[email protected]
Exhibit 1
Scorecard Ratios of HSH Nordbank AG
Alexander Hendricks,
49-69-70730-779
CFA
Associate Managing
Director - Banking
[email protected]
Carola Schuler
49-69-70730-766
Managing Director Banking
[email protected]
Note: TCE = Tangible Common Equity, TBA = Tangible Banking Assets
Source: Moody's Investors Service
MOODY'S INVESTORS SERVICE
FINANCIAL INSTITUTIONS
Credit Strengths
»
HSH's agreement with the European Commission has helped stabilise its credit profile, and capital buffers are still intact for now
»
HSH's high stock of non-performing loans (NPL) will decrease as the bank sells underperforming asset portfolios
»
Senior creditors and depositors benefit from considerable volume of subordinated debt in a resolution scenario
Credit Challenges
»
Risks to capital remain considerable as the shipping sector crisis persists and the regulator intends to change the way the utilisation
of the asset guaranty is calibrated
»
Asset risk pressures are high, and even after the envisaged portfolio sales, HSH's NPL ratios will still be high compared with peers
»
Business model adjustments will continue over the next six to eight quarters, and major efforts will be necessary to mitigate
earnings pressure and reduce costs
»
The opacity of the bank's future in the context of its required sale by February 2018 could increasingly weight on investor
confidence with adverse implications on HSH's ability to access the debt capital markets
Rating Outlook
»
The developing outlook on the debt and deposit ratings reflects the high degree of uncertainty stemming from prospective changes
of the bank's financial profile and liability structure. We see a high likelihood for changes of both the BCA and the result of our
advanced LGF analysis.
Factors that Could Lead to an Upgrade
»
An upgrade of HSH's Baa3/Prime-3 debt and deposit ratings would be subject to (1) an upgrade of HSH's b3 BCA, whereby the
BCA upgrade would have to be sufficient to more than offset any adverse effects on these ratings from our advanced LGF analysis;
and/or (2) an explicit commitment from Sparkassen-Finanzgruppe which could result in additional rating uplift for affiliate support.
»
An upgrade of the BCA will depend on HSH's smooth execution of the envisaged transactions and additionally be subject to
stronger and more predictable profits and improving asset quality combined with prospects of a recovery in the shipping sector.
Furthermore, the bank would need to maintain stable solvency metrics and continued access to debt capital markets.
Factors that Could Lead to a Downgrade
»
A downgrade of HSH's debt and deposit ratings could result from (1) a downgrade of the BCA; and/or (2) indications of weakening
commitment from Sparkassen-Finanzgruppe to supporting HSH; and/or (3) changes in HSH's liability structure which may result in
fewer notches of uplift incorporated in the bank's ratings as result of our LGF analysis. The LGF result for HSH's senior debt remains
vulnerable to diminishing volumes of subordinated instruments relative to total banking assets.
»
We may consider downgrading the BCA if the envisaged measures prove insufficient to properly stabilise the bank, in particular if
(1) HSH's access to debt capital markets for long-term unsecured funding is not sustained; or (2) HSH's prospective capital metrics
prove to be insufficient in Moody's forecasts under an adverse scenario. The latter could be triggered not only by capital erosion
due to persistent asset risk, but also if the ECB changes the way it calibrates risk-weighted assets and/or utilisation of HSH's €10
billion asset guaranty in a way that current capital buffers are materially diminished.
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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HSH Nordbank AG: Semiannual update
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MOODY'S INVESTORS SERVICE
Key Indicators
Exhibit 2
HSH Nordbank AG (Consolidated Financials) [1]
Total Assets (EUR billion)
Total Assets (USD billion)
Tangible Common Equity (EUR billion)
Tangible Common Equity (USD billion)
Problem Loans / Gross Loans (%)
Tangible Common Equity / Risk Weighted Assets (%)
Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%)
Net Interest Margin (%)
PPI / Average RWA (%)
Net Income / Tangible Assets (%)
Cost / Income Ratio (%)
Market Funds / Tangible Banking Assets (%)
Liquid Banking Assets / Tangible Banking Assets (%)
Gross loans / Due to customers (%)
3-162
12-152
12-142
12-133
12-123
Avg.
92.8
105.8
4.3
4.9
11.7
0.7
0.5
-0.2
84.0
40.3
15.9
122.2
93.4
101.4
4.5
4.8
20.1
11.9
206.7
1.0
2.2
0.2
57.4
39.8
25.3
126.9
104.8
126.8
3.7
4.5
22.8
9.5
264.7
0.5
-0.5
0.3
118.6
45.7
25.1
156.0
104.7
144.2
3.6
5.0
23.1
10.2
223.6
0.8
1.0
-0.6
71.4
48.6
23.5
168.4
123.2
162.4
4.3
5.7
18.5
7.1
191.2
1.1
1.2
0.0
63.0
54.8
20.6
195.0
-6.84
-10.24
-0.24
-3.74
21.15
11.06
221.55
0.85
0.76
0.05
78.95
45.85
22.15
153.75
[1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [3] Basel II; IFRS [4] Compound Annual Growth Rate based
on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - fully-loaded or transitional phase-in & IFRS reporting periods have been used for
average calculation
Source: Moody's Financial Metrics
Detailed Rating Considerations
Restructuring measures, as agreed with the European Commission, reduce downside risks
With the conclusion of the state aid proceedings earlier this year, HSH has obtained the European Commission's (EC) formal approval
for the reinstatement of a second-loss asset guaranty of €10 billion, representing a €3 billion raise of the previous ceiling. The guaranty
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).
As part of the agreement, HSH needs to execute various agreed compensation measures along with portfolio sales that are beneficial
for the bank's asset risk profile; however, these transactions will cost HSH valuable loss absorption capacity under the €10 billion
guaranty and therefore weigh on HSH's overall capitalisation. The agreed measures include the following material transactions:
»
In June 2016, HSH transferred €5.0 billion in non-performing ship finance loans to a special purpose vehicle owned by the stakeholding federal states for a purchase price of €2.4 billion. To the extent that risk provisions on the portfolio taken in prior periods
remained below the €2.6 billion loss on this transaction, these were charged against the €10 billion asset guaranty in Q4 2015,
resulting in diminished room for future losses.
»
HSH plans to sell an additional non-performing loan portfolio worth €3.2 billion over the next 12 months, whereby any losses that
exceed risk provisions already taken will also be charged against the €10 billion guaranty. Through these additional NPL sales, HSH
expects to reduce its total NPLs by 50%, based on the €16.3 billion NPLs reported as of December 2015.
The key benefit is a reduction in NPLs, and therefore a reduction in tail risk relating to the relevant non-performing exposures that
could result from further quality deterioration and/or a strengthening USD/EUR rate. However, the NPL transfer had to be done on
harsh terms and at the cost of a material reduction of the headroom under the €10 billion guaranty. HSH's owners had agreed with
the EC a portfolio transfer of up to €6.2 billion and a sale to the market of €2.0 billion. However, HSH considered the imposed terms
for the asset transfer unfavorable, taking the view that the 52% discount is overly conservative, requiring a disproportionate use of
the guaranty. HSH therefore transferred only €5.0 billion to its owners in order to maintain the upside of (but also the risk associated
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FINANCIAL INSTITUTIONS
with) selling a higher volume of NPLs to the market. The terms for the asset transfers were based on asset valuations provided by
independent experts.
HSH's mandatory privatisation implies uncertainty
The state aid approval comes at the price of HSH's mandatory privatisation by 28 February 2018, and this requirement implies
uncertainty as to the bank's long-term viability. The EC demands this to be achieved through an “aid-free, positive price offer”, while
the €10 billion asset guarantee will be maintained as part of the transaction. The EC maintains the right of assessing HSH's viability
as an independent bank once a bidder has been identified. The mandatory privatisation implies an extended period of uncertainty for
investors, because, according to the EC's decision, a failure of the sale would result in the wind-down of the bank.
We consider the risk that HSH cannot be successfully privatisated to be high, because the bank's high-risk profile will only be partially
addressed by the implementation of restructuring measures. However, the bank's unwinding is not necessarily the highest-risk scenario
for investors, even though it would imply sustained elevated risks for subordinated creditors. The incentives to orchestrate and support
a coordinated unwinding which protects senior creditors from incurring losses are high for several stakeholders, in particular for
Sparkassen Finanzgruppe. Considerable amounts of HSH's debt are held by savings banks and their clients.
NPL divestments in 2016-17 will relieve HSH's very poor asset quality, but NPL ratios will remain high compared with peers
The transfer and planned sale of €8.2 billion in NPLs will bring relief to HSH's asset quality. The transactions will halve HSH's large
€16.3 billion NPL volume which, as per December 2015, translated into an NPL ratio of 26% (2014: €15.3 billion or 23%; as reported by
the bank). The lower expected 15% NPL ratio, however, will still represent one of the highest ratios in the German banking sector.
Even after the planned NPL sale, HSH's risk profile will remain constrained by (1) its lending focus on cyclical sectors; (2) singleborrower concentrations, which result from the bank's large asset-based finance activities; (3) market risk from the largely US-dollardenominated ship-finance assets; and (4) the potential for further credit losses from its loans to the shipping sector.
HSH reported a €23.9 billion ship finance exposure as of December 2015, which represents a key vulnerability in the prolonged
negative environment for global shipping. The bank is engaged in all important areas of the sector, with container shipping dominating
the portfolio. HSH also has a large €18.2 billion exposure to commercial real estate. However, credit risk associated with HSH's higherrisk assets is to a large degree mitigated by the €10 billion risk shield, especially because 93% of total problem assets fall under this
asset guaranty as of December 2015. The risk shield covered 42% of HSH's total exposure as of December 2015, comprising the bulk
of assets relating to its weaker legacy portfolios, including 78% of the total ship finance book. To reflect this substantial transfer of risk,
we have adjusted the Asset Risk score upwards to ba3.
Risks to capital remain considerable
HSH's capital ratios remain intact for now. Its transitional Common Equity Tier 1 (CET1) ratio under the Capital Requirements
Regulation/Fourth Capital Requirements Directive was 12.0% as of March 2016 (December 2015: 12.3%). HSH's capitalisation
additionally benefitted from some headroom under the guaranty which, as of December, was utilised with €8.1 billion, leaving room
for an additional €1.9 billion in risk provisions that the bank can yet charge against the guaranty. The €8.1 billion utilisation already
included the entire additional risk provisions HSH needed to take on the €5.0 billion NPL portfolio in preparation for its transfer at a
price of €2.4 billion.
We consider the risks to HSH's capitalisation to be considerable, for several reasons:
4
»
The persistent shipping crisis will likely drive adverse rating migration, additional provisioning needs and defaults in HSH's ship
finance portfolio. This may exert upward pressure on risk-weighted assets (RWA), and to the extent provisions are required for
guaranteed assets, they will reduce the modest remaining headroom under the guaranty.
»
HSH runs considerable market risk; in particular a rising USD/EUR rate could drive RWAs up, for which the guaranty does not offer
protection.
»
The planned sale of €3.2 billion NPLs could also reduce headroom under the guaranty if these assets can only be sold below their
March 2016 book value.
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HSH Nordbank AG: Semiannual update
MOODY'S INVESTORS SERVICE
»
FINANCIAL INSTITUTIONS
Full utilisation of the €10 billion asset guaranty would cease to secure the standard 20% risk weight for the third tranche of the
guaranteed portfolio (that is, the volume in excess of €13.2 billion) which, as of December 2015, amounted to €28.2 billion.
In addition, the ECB's planned change of RWA recalibration under the risk shield pose a regulatory risk to capital. Higher risk weights
applied to assets under the asset guaranty could diminish or even fully erode the remaining €1.7 billion headroom, as calculated from
a regulatory perspective, under the asset guaranty later in 2016. We consider the ECB's move as credit negative because, with a more
conservative treatment, the ECB would effectively gain earlier intervention rights, but will not necessarily achieve an improvement in
HSH's economic situation. The adverse market conditions and timing are both critical drawbacks to HSH's scope to adjust to such a
change. HSH cannot pay dividends in any case, and will also not service coupons on its Tier 1 instruments until 2020, leaving limited
flexibility to respond.
That said, we believe HSH still has some scope for RWA reduction measures. To reflect the risks stated above, we adjust HSH's Capital
score downward to b1.
Despite a reduction in the cost of support, core profitability will remain weak
Under the new compensation structure, HSH will eventually pay a total of roughly €100 million per annum in guaranty fees instead of
the previous €400 million (plus three other types of fees) for the second-loss guaranty. The amount is lower because the reduced fee
of 2.2% (instead of 4.0%) will only be paid on the amount not utilised (after settled losses) under the €10 billion guaranty. This relief
will happen gradually during 2016-18. This part of the agreement is an important positive factor, because the earlier fee structure had
proved too costly and therefore unsustainable. However, to ensure that this part of the restructuring is state-aid neutral, HSH had to
pay a €210 million one-off compensation to its (newly set up) holding company, which HSH accounted for in 2015.
Notwithstanding the relief, we expect HSH's weak profits to remain under pressure and volatile. Gains and losses on financial
instruments and valuation effects from USD/EUR basis swaps, albeit reduced since the €5.0 billion portfolio transfer, remain substantial
relative to HSH's earnings power. In addition, HSH will continue to face major headwinds in its effort to improve efficiency and riskadjusted returns. While the reduction of the asset base that is subject to unwinding will offer some cost relief, we expect that revenues
will continue to fall given the reducing scope of the bank's operations.
HSH's weak underlying profitability is illustrated by the poor result for the first quarter 2016, for which HSH reported a €44 million
net loss (Q1 2015: €206 million profit). Although a part of the decline was due to one-off profits in Q1 2015, the loss was strongly
driven by lower net interest income (-43%) and net fee income (-34%) which, despite one-off gains on asset sales, resulted in a 20%
decline in revenues. The 11% cost reduction year-on-year could only partly offset the topline pressures, resulting in a high 84% cost-toincome ratio (based on our own calculation method). That said, HSH expects positive results for H1 2016 as well as the financial year,
supported by new business generation and additional streamlining and cost reduction efforts. To balance these factors we assign a b1
Profitability score.
Wholesale funding dependence coupled with significant US dollar funding requirements implies confidence sensitivity
Funding risks continue to represent a constraint for HSH's ratings. The bank's predominantly asset-based lending model requires
substantial amounts of long-term funding, with a large portion in US dollars, in order to match the asset profile. HSH reported in its Q1
2016 report that it intermittently suspended its issuing activities and recorded deposit outflows when it reported the postponement of
the publication of its 2015 financials in early March, highlighting the bank's vulnerability to negative news flow.
However, we expect improvements during 2016, partly because HSH's portfolio divestments will result in a better matched maturity
profile. The €5.0 billion NPLs transferred out in June may only require short-term funding as the federal states, as the new owners
of these assets, will likely have alternative funding sources. The €3.2 billion NPLs to be sold on the market will also no longer require
funding. Barring major market shocks, HSH will be able to maintain a liquidity coverage ratio (LCR) above 100%. Its LCR was a
satisfactory 121% at the end of March 2016.
HSH's access to long-term senior unsecured funding markets is unlikely to improve to a level that is comparable with its German peers
given the required privatisation by the end of February 2018. HSH's funding risks are partly mitigated by its access to the deposit base
of the German savings banks which fund 30%-40% of HSH's annual long-term funding activities. HSH also relies strongly on assetbased funding through secured loans and covered bonds.
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FINANCIAL INSTITUTIONS
HSH's ratings are supported by its 'Strong' Macro Profile
Our assessment of HSH's international exposure mix results in a `Strong' Macro Profile, somewhat below the `Very Strong -` Macro
score for Germany. Although German banks benefit from operating in an environment with very high economic, institutional and
government financial strength and very low susceptibility to event risk, HSH's Macro Profile strongly reflects the bank's foreign assets
and its large exposure to the global shipping sector, resulting in a Macro Profile weaker than that of many other German banks. HSH
benefits from Germany's strong funding conditions and strong domestic deposit base. However, operating conditions for the German
banking system are constrained by high fragmentation in an over-saturated market, low fee income generation and intensifying
competition for domestic business.
Low business diversification and the complexity of HSH's capital structure constrain the bank's BCA
We apply two qualitative adjustments to the calculated b1 Financial Profile Score. In consideration of the bank's very high business
concentrations, and the resulting low diversification of its assets, revenues and profits, we apply a negative adjustment by one notch.
We apply a second negative adjustment by one notch to capture the considerable complexity of the bank's capital structure in the
context of the €10 billion asset guaranty, and the resulting limitations to forecasting regulatory capital ratios.
Notching Considerations
Affiliate Support
HSH benefits from cross-sector support from Sparkassen-Finanzgruppe, reducing the probability of default as such support would be
available to stabilise a distressed member bank and not just compensate for losses in resolution.
We continue to consider the readiness of the sector to support its members to be high, which results in two notches of rating uplift to
HSH's debt and deposit ratings.
Loss Given Failure
In our advanced LGF analysis, we consider the risks faced by the different debt and deposit classes across the liability structure in
resolution. We assume residual tangible common equity of 3% and losses post-failure of 8% of tangible banking assets, a 25% run-off
in “junior” wholesale deposits and a 5% run-off in preferred deposits. These ratios are in line with our standard assumptions. We base
our calculation on the assumption that deposits are preferred to most senior unsecured debt instruments, in line with the new German
insolvency legislation that will effectively subordinate senior bonds and notes to deposits in resolution from January 2017.
Our LGF analysis indicates an extremely low loss-given-failure for deposits and senior unsecured debt, leading to a three-notch uplift,
respectively, above the b1 Adjusted BCA.
Our LGF analysis indicates a high loss-given-failure for senior subordinated debt, leading us to position these instruments at B2, one
notch below the b1 adjusted BCA.
Trust-preferred securities and silent participations (Stille Einlagen) are rated Ca(hyb). These ratings relate to the entities HSH N
Funding I, HSH N Funding II, RESPARCS Funding I Limited Partnership, and RESPARCS Funding II Limited Partnership, and are based
on our expected-loss calculation. The Ca(hyb) ratings reflects (1) principal write-downs to 52.4% of the nominal amounts in 2015;
(2) the requirement for HSH to abstain from servicing its hybrid instruments until the bank is privatised, which we understand allows
resumption of coupon payments in 2020 for 2019 at the earliest. The latter implies a delay compared with previous year's guidance for
the resumption of coupons. We note that there is no clarity yet as to what extent HSH may write back amounts written-down during
the next few years.
Government Support
Although German banks operate in an environment of materially weakened prospects for financial assistance from the government,
we maintain one notch of rating uplift in our senior unsecured debt and deposit ratings for members of the Sparkassen-Finanzgruppe,
reflecting our assumptions of a moderate support probability. Our government support assumptions reflect the large size and high
systemic relevance of Sparkassen-Finanzgruppe.
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MOODY'S INVESTORS SERVICE
About Moody's Bank Scorecard
Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in
conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecard
may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong
divergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down to
reflect conditions specific to each rated entity.
Rating Methodology and Scorecard Factors
Exhibit 3
HSH Nordbank AG
Macro Factors
Weighted Macro Profile
Strong
100%
Financial Profile
Factor
Historic Macro
Ratio Adjusted
Score
Credit
Trend
Assigned Score
Key driver #1
Solvency
Asset Risk
Problem Loans / Gross Loans
22.0%
caa1
↑
ba3
Capital
TCE / RWA
11.7%
baa2
←→
b1
Capital fungibility
Profitability
Net Income / Tangible Assets
-0.2%
caa1
↑
b1
Expected trend
Combined Solvency Score
Liquidity
Funding Structure
Market Funds / Tangible Banking Assets
b1
39.8%
ba3
←→
Liquid Resources
Liquid Banking Assets / Tangible Banking Assets
25.3%
baa1
←→
Combined Liquidity Score
Financial Profile
Business Diversification
Opacity and Complexity
Corporate Behavior
Total Qualitative Adjustments
Sovereign or Affiliate constraint:
Scorecard Calculated BCA range
Assigned BCA
Affiliate Support notching
Adjusted BCA
Instrument Class
Counterparty Risk Assessment
Deposits
Senior unsecured bank debt
Dated subordinated bank debt
3
3
3
-1
ba3
Market
funding quality
Access to capital
ba2
Asset encumbrance
ba3
b1
-1
-1
0
-2
Aaa
b2-caa1
b3
2
b1
Additional Preliminary Rating
Assessment
notching
0
0
0
0
Collateral and
Sector concentration
provisioning coverage
b1
ba1
Loss Given
Failure notching
Key driver #2
ba1 (cr)
ba1
ba1
b2
Government
Local Currency rating Foreign
Support notching
Currency
rating
1
Baa3 (cr)
-Baa3
1
Baa3
1
Baa3
Baa3
-0
B2
Source: Moody's Financial Metrics
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MOODY'S INVESTORS SERVICE
Ratings
Exhibit 4
Category
HSH NORDBANK AG
Outlook
Bank Deposits
Baseline Credit Assessment
Adjusted Baseline Credit Assessment
Counterparty Risk Assessment
Issuer Rating
Senior Unsecured
Subordinate -Dom Curr
ST Issuer Rating
Other Short Term -Dom Curr
Moody's Rating
Developing
Baa3/P-3
b3
b1
Baa3(cr)/P-3(cr)
Baa3
Baa3
B2
P-3
(P)P-3
HSH N FUNDING I
BACKED Pref. Stock Non-cumulative
Ca (hyb)
HSH N FUNDING II
Jr Subordinate
Ca
Source: Moody's Investors Service
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FINANCIAL INSTITUTIONS
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REPORT NUMBER 1034076
9
23 August 2016
HSH Nordbank AG: Semiannual update
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
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10
23 August 2016
CLIENT SERVICES
Mark C Jenkinson
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HSH Nordbank AG: Semiannual update