Norddeutsche Landesbank Girozentrale's (NORD/LB) strategy to reduce its shipping exposures by EUR4bn-6bn over the next three years makes sense, but will likely encounter high execution risks, says Fitch Ratings.
Planned disposals, representing up to one-third of the bank's total shipping exposures, are large, but the shipping markets are not yet showing signs of sustainable recovery and there is a risk that disposal markets could become overcrowded.
Currently, a number of lenders are attempting to sell ships, including HSH Nordbank AG, which plans to sell up to EUR3.2bn of ships over the next two years.
In our view, ship financing, which represents around 10% of NORD/LB's credit volumes, continues to pose the most significant source of risk for the bank. Over one-third of the shipping portfolio is non-performing, and the vast majority of the bank's impairment charges relate to the shipping portfolio.
Cutting its exposure to the shipping sector represents an important step in trying to address asset quality weakness at NORD/LB. The bank is not exiting the ship financing market and will continue to lend selectively to the sector.
Impaired shipping exposures are not fully reserved. But the expected loss shortfall against the shipping portfolio, which we estimate reached around EUR650m at end-March 2016, is already deducted from the bank's 12.6% phased-in common equity tier capital ratio.
In our opinion, NORD/LB's capitalisation is still sufficiently robust to absorb a reasonable level of unexpected losses arising from planned disposals.
However, additional ships could become non-performing if charter rates fall further. Exchange rate movements could also push up reported levels of non-performing shipping loans. The loans are denominated in US dollars, and euro depreciation against the US dollar forces up the reported loan values when these are converted into euros.
We expect loan loss provisions to remain high in the next few quarters. On 18 May, the bank announced a 1Q16 EUR84m consolidated net loss and issued a profit warning for the year. Further deterioration in the shipping markets led to more provision requirements, and management says this trend is likely to continue.
We affirmed NORD/LB's Long-term Issuer Default Rating of 'A-'/Stable on 12 May. The bank's 'bb+' Viability Rating (VR) incorporates our expectation that the shipping portfolio will continue to weigh on asset quality and earnings.
If the bank fails to make disposals in line with its plan and this results in a higher-than-expected level of losses, the VR could come under pressure. Alternatively, if management successfully executes its plan, this could provide some uplift to the VR.