Schleswig-Holstein is strapped for cash. And yet the state, a co-owner of struggling HSH Nordbank, has forked out funds for four new permanent positions in its HSH department at the state finance ministry in Kiel. “There is a lot of work to do, and we want to be less dependent on outside expertise,” said Finance Minister Monika Heinold, a Green Party member.
The new employees will be handed a thankless task. According to a requirement by the European Union, majority owners Schleswig-Holstein and Hamburg must sell or liquidate ailing HSH Nordbank by spring next year. The selling process began recently. Potential buyers must submit their non-binding bids by the end of March. But whether or not the sale succeeds, the consequences will be serious for everyone involved: The cash-strapped states, which could be stuck with €20 billion ($21.5 billion) in losses; the regional savings banks, which could be asked to pay up; and the private small investors, who have entrusted HSH with €7 billion in certificates.
Probably no other German bank has presented its owners with bigger problems in recent years than state-owned HSH, based in Kiel and Hamburg. The world’s largest provider of ship finance was once expected to fill the states’ coffers. Yet since the financial crisis, Kiel and Hamburg have felt more as if the bank were holding them hostage. Since 2008, there has been nothing but bad news. Management errors, coupled with an underdeveloped awareness of risk and lack of control, almost destroyed the bank. Only under chief executive Stefan Ermisch and his predecessor Constantin von Oesterreich did HSH finally enter calmer waters.
It was not the major owners’ decision to sell the bank in a period of low interest rates. After the bank had to increase its balance sheet guarantee because of its erroneous assessment of shipping markets, Brussels stepped in. The European Commission approved a second subsidy – under one condition: The bank be sold by the spring of 2018.
The owners are trying to stay optimistic. Ms. Heinold said the selling process, which is expected to be highly inconvenient in light of upcoming state elections in May, has been met with “gratifying resonance.” According to financial insiders, Anglo-Saxon investors are among the potential buyers, which number in the double digits. Strategic investors from China, which are usually ICBC and the Bank of China, are also reportedly on the list. On Friday, HSH chief Mr. Ermisch said there was “great interest” from China. NordLB, another German state-owned bank, is also a potential buyer.
But even if the privatization is successful, the states will be left with billions in losses. These days, the owners must feel like protagonists in a Greek tragedy. No matter which path they choose, the outcome will be disastrous for taxpayers.
“We were more or less drunk on the idea that HSH Nordbank would always be making tremendous profits.”
It’s like choosing between the devil and the deep blue sea. Ironically, HSH was viewed as an industry poster child in the last decade. Formed in 2003 from the merger of the state-owned banks of Schleswig-Holstein and Hamburg, it was profitable and paid generous dividends to shareholders. “At the time, we were all more or less drunk on the idea that HSH Nordbank would always be making tremendous profits,” said Heide Simonis, the former Social Democratic state premier of Schleswig-Holstein, and chair of the bank’s supervisory board until 2005.
But disaster ensued. Before the guarantor liability, which guaranteed the bank favorable refinancing, expired in 2005, HSH filled itself with liquidity – money that needed to be invested. This prompted the bank to pump up its volume of ship loans to more than €30 billion. Lacking real customers, HSH also entered the credit substitution business in a big way. The business involved securities that were based on securitization of problematic U.S. mortgage loans. These two bad strategic decisions were to have dire consequences.
In 2008, the bank increasingly became caught up in the turmoil of the international financial crisis. Large write-offs on the toxic U.S. securities piled up, leading to an annual loss of €2.8 billion. In 2009, the owners were forced to rescue the bank with a €3 billion infusion of capital and a €10 billion balance-sheet guarantee. The European Commission approved the aid, but with conditions.
The balance-sheet guarantee acted like a securitization, ensuring less capital was required to support the shielded balance sheet total. Then-CEO Dirk Jens Nonnenmacher, a mathematics professor, likened it to “catastrophic insurance for losses.” The owners only had to carry the losses if the bank lost €3.2 billion or more.
This disastrous prospect, which many had considered impossible, became a reality because the expected recovery of the ship markets never arrived. Fewer and fewer ship owners could service their debts, let alone pay them off. Provisions for impaired loans ballooned – so much so that Mr. Ermisch announced that the complete guarantee would be withdrawn in the current year. This means the states are now confronted with losses of €10 billion. But it won’t stay that way.
Under the agreement with Brussels, the bank can sell €6.2 billion in non-performing ship loans to its owners. “I’m afraid that’s ultimately worth almost nothing,” said Tobias Koch, fiscal policy spokesman for the center-right Christian Democratic Union (CDU) in the state parliament. In that case, the states’ debts would increase by more than €3 billion. This is because the owners are required to borrow new money for about half of the portfolio, while the other half is paid for by the guarantee. Another billion is added to this because the bank has only paid off two-thirds of the capital injection financed by the states with a loan.
And it may get worse, because the European Commission has decreed that HSH Nordbank must fetch a positive selling price. This is far from self-evident, because HSH consists of a flourishing core bank and a restructuring unit with problematic loans, and both are listed on the balance sheet. “The purchase price for the core bank would have to be higher than what the buyer needs as a dowry for the restructuring unit,” CDU fiscal expert Mr. Koch said. If this fails, HSH Nordbank will be scheduled for liquidation.
“In an emergency, we will walk around the organization with a collection bag, so that NordLB can acquire HSH Nordbank.”
The owners are combing forces and deploying an army of consultants to prevent this from happening. Citibank is serving as the states’ privatization consultant, Bain & Company is the strategic consultant, and Linklater is providing legal advice.
Brussels pushed for liquidation once before, with WestLB, which was also caught up in the maelstrom of the financial crisis. The Düsseldorf state-owned bank is now history. A liquidation scenario à la WestLB would lead to more costs for the HSH owners. This is because of the guarantor liability, which states that the guarantors, including savings banks, are ultimately liable for claims against the bank. Bank issues worth €2.2 billion are currently still at stake.
If the HSH Nordbank chapter is brought to a close, “both Hamburg and Schleswig-Holstein could see their debts increase by €8 billion,” according to a prediction by Mr. Koch. This is about 80 percent of Schleswig-Holstein’s annual budget.
It is doubtful whether the savings banks could shoulder the €400 million in impending burdens from the guarantor liability. If not, the institutional guarantee system of the savings bank financial group would have to step up. It would already be on board, because HSH has sold certificates worth €7 billion to private customers through savings banks.
Given these dimensions, a regional savings bank president believes a liquidation is unlikely. “I assume that in an emergency, we will walk around the organization with a collection bag, so that NordLB can acquire HSH Nordbank,” said the group head. “In doing so, we preserve the reputation of our deposition insurance.” Politicians are not the only ones who want to close the HSH chapter as quickly as possible.