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That Sinking Feeling

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Are German banks headed for the scrapheap too?
  • Why it matters

    Why it matters

    The European Central Bank will soon take responsibility for German banks and is stress testing them to assess vulnerabilities. Huge loans to struggling shipping firms put many at risk.

  • Facts

    Facts

    • Three banks, HSH Nordbank, Nord LB and Commerzbank, are sitting on €50 billion of ship financing.
    • Ships built today are selling for 30 percent less than those built before the 2008 financial crisis.
    • German taxpayers will be liable if the banks default on their debts.
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    Audio

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At the beginning of this year, the weather in Australia was so bad that very little coal could be loaded onto ships for export. A few weeks later, the crisis in Ukraine almost brought shipments through Crimea to a standstill. And while China remains a strong importer, it isn’t importing as much iron ore and crude oil as expected.

All of this is bad news, especially for Oliver Faak. But as head of the ship finance business for Nord LB, a state-backed bank in Hannover, northern Germany, Mr. Faak is used to bad news. The shipping sector has been in crisis for more than six years, with a number of ships generating so little revenue that their owners can’t even pay the interest on their loans.

This is unlikely to change in the foreseeable future. Nord LB expects the market to remain weak until the end of 2015, followed by a slight recovery at best.

Banks have held on to their shipping sector loans for years, betting on a recovery in the market. That strategy could now take its toll. The European Central Bank is due to take over supervision of Germany’s largest banks from the national regulator later this year, and in order to identify overstretched banks, it has undertaken a round of stress tests.

As part of this, the ECB is taking an especially critical view of shipping sector loans. Banks found to have vulnerabilities in the sector are at serious risk of failing the tests, putting their survival in jeopardy. The test results are due to be released later this month.

Banks have held on to their shipping sector loans for years, betting on a recovery in the market.

The banks have sold off loans in recent months and significantly increased their provisions for risk. Nevertheless, Nord LB, HSH Nordbank and Commerzbank, Germany’s second-largest lender, are still sitting on loans with a combined value of almost €50 billion ($63 billion).

A self-assessment by Commerzbank shows how dramatic the situation is. About half of its loans, roughly €6.4 billion worth, involve borrowers already in default or on the verge of default.

In the case of the two northern state-owned banks, the ratio of lending to the size of the institution is dangerously high. German regulators have been concerned about these banks for some time, and even the International Monetary Fund has warned of further write-offs.

The banks have managed to avoid such write-offs until now. They assess the value of their loans mainly on the basis of forecasted future ship revenues, using data from specialized brokers. But because everything is interconnected in shipping, models are incredibly complex, and guesswork is necessary. Every political crisis destroys these models.

Unsurprisingly, the ECB isn’t very enthusiastic about this approach. It shocked the banks with the idea of appraising ships according to the current selling price and not the presumed proceeds from the sale of their cargos. There is enormous fluctuation in the market prices of ships, but they are significantly lower than that assumed in the banks’ calculations.

The shipping industry has experienced an unprecedented decline in prices for freighters. Shipyards worldwide have not reduced their output of new ships, even though demand has dropped considerably. New ships are now selling for 30 percent less than before the 2008 crisis.

In the case of Nord LB and HSH Nordbank, the ratio of lending to the size of the institution is dangerously high.

Technical breakthroughs in the construction of container ships are exacerbating the price slump. For decades, freighters remained largely unchanged, with fuel consumption not seen as a significant variable. That has changed fundamentally. To reduce transport costs, new ships are larger and considerably more fuel-efficient. But it is older, less efficient ships that German banks have tended to finance.

After some initial disagreements, the ECB and the banks agreed to a compromise under which the ECB would reduce the ships’ estimated values by a set amount. More talks between regulators and banks were underway last week. But even the ECB’s modified approach could be detrimental to the banks.

They share part of the blame. In the years before 2008, they believed that global trade would continue to grow forever. Because they expected most of that trade to take place on ships, they issued loans with almost no limitations and ignored all rules of caution. They were also encouraged by the fact that there had been virtually no defaults for decades.

 

ships2_dpa
Giant, efficient container ships now rule the waves. Source: DPA

 

As a result, the lenders often required less than 30 percent in equity capital, and if a ship owner was short on funds they were willing to provide the necessary financing. It wasn’t a very profitable business, with margins sometimes lower than one percent.

HSH Nordbank was especially generous. In 2008, the state-owned bank was planning its IPO and was painting itself as the “world’s largest ship financier.” The bank has defended the title, but today it is seen as a serious blemish.

For months, the financial world has been awash with doom and gloom scenarios involving HSH Nordbank. If the bank fails the ECB stress test, its owners, the states of Hamburg and Schleswig-Holstein, will probably have to use taxpayer money to bail it out. But because they have already bailed out the bank before, the European Union competition commissioner in Brussels could order its liquidation.

“Our goal is to ensure that the ships earn enough money during ongoing operations to pay the interest and installments.”

Claus Ganter, Banker, HSH Nordbank

HSH bankers intend to show that their situation is serious but not hopeless. They do a lot to help out borrowers, they say, for example, deferring loans and lending cash to allow companies to modernize their fleets. “Working together with the owners, our goal is to ensure that the ships earn enough money during ongoing operations to pay the interest and installments,” says HSH banker Claus Ganter.

In practice, this means owners have to inject their own capital. This is difficult if the companies’ backers are private fund investors, as they are usually not interested. In fact, several have already filed suits against the banks.

Despite this, HSH has reduced its shipping sector lending by €10 billion since 2010, mostly by not replacing loans that were paid off with new loans. The bank plans to finance new ships to the tune of €1.4 billion this year.

Because of low market prices, banks have long been hesitant to sell shipping assets. Commerzbank now takes a different approach. It discontinued new lending for ships in mid-2012, and since then it has focused on accelerated liquidation. Only recently, the bank sold nine container ships.

The burdens of the past limit the banks’ leeway, often leaving ship owners with only one other option. Although the average life of a ship is at least 25 years, many significantly younger ships are now making their last journey – to the ship breaking yards on the beaches of India and China. The raw materials extracted when the ships are dismantled fetch €2-8 million. It isn’t much, but it’s better than nothing.

 

This article first appeared in the business magazine WirtschaftsWoche. To contact the author: cornelius.welp@wiwo.de

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