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Scope: NordLB needs to find new investors to off-load toxic shipping loans

Capital-strapped regional German bank Norddeutsche Landesbank Girozentrale, or NordLB, needs an equity injection before selling over half of its nonperforming shipping loans, according to Scope Ratings.

NordLB, majority-owned by the state of Lower Saxony, has been exploring options for a capital raise since early 2018 as loan loss provisions on its large shipping portfolio spiked and dealt a heavy blow to its profitability and core equity position.

One of the main options under consideration is a minority stake sale to a private investor. A final decision on the deal has become more urgent as NordLB has moved closer to offloading a chunk of its toxic debt.

NPL sale could hit regulatory capital

The bank is said to be in advanced talks with U.S. private equity fund Cerberus Capital Management LP to sell two shipping NPL portfolios worth €3.9 billion and €2.5 billion respectively. This would help NordLB achieve its target to reduce its total shipping exposure to below €5 billion by the end of 2019, from €10.8 billion as of Sept. 30, 2018, Scope Ratings credit analysts said in a Jan. 4 research note.

Almost 60% of the group's shipping exposure consists of NPLs, amounting to €7.3 billion as of Sept. 30, 2018. Therefore a reduction is essential for the continuation of NordLB's operations in the future. But given their quality, the bank would likely have to sell the loans at a substantial discount and will incur a loss it would not be able to cover by its existing provisions, Scope said.

NordLB's shipping NPLs are equal to 83% of the group's combined common equity Tier 1 capital and loan loss provisions, which amount to €5.59 billion and €3.16 billion, respectively, the agency has estimated.

"For example, if the entire shipping NPLs were to be sold at an average price of 40 cents or less, NordLB would lose well over €1 billion," Dierk Brandenburg, executive director in Scope's bank rating team, wrote in the note.

A loss of this size would exceed NordLB's pre-provision operating income for 2018, and although it would be partly offset by a decline in risk-weighted assets, it still would eat into the bank's regulatory capital, Brandenburg said.

Furthermore, NordLB needs enough capital to cover its already-announced restructuring costs. In the first nine months of 2018, the group spent €122 million on its restructuring and reorganization, nearly twice as much as the €67 million spent in the same period a year earlier.

Given how much the sale of the toxic shipping loans would weaken the group's capital position, it is no surprise that regulators are pushing for an equity raise before the release of NordLB's full-year financial report, Scope said. NordLB is set to publish its final 2018 figures in April.

In early January, the ECB put pressure on the German Savings Banks Association, DSGV, to find a solution for NordLB as soon as possible given its dire capital situation. NordLB was among the worst performers in the European Banking Authority's 2018 stress tests.

The EBA tested 48 European banks and the results showed that NordLB's CET1 ratio would drop to 7.07% by 2020 if there were a downturn. This was the third-lowest level in the overall sample and the lowest among German banks.

Windup cannot be ruled out

As the sale of the shipping NPLs is dependent on a capital injection, this is most likely to come from a private investor, according to Scope.

The total capital needs of NordLB have been estimated at €3 billion to €5 billion and private equity funds, among which Cerberus and Centerbridge Partners LP reportedly number, are considering paying €3 billion to €4 billion for a minority stake.

NordLB bank and its owners, also including regional savings banks associations under DSGV's control, wanted to make a final decision on the capital raise by the end of 2018. However, they decided to prolong talks with potential investors as they review other options as well.

Private investment in NordLB is not the preferred option for the state-owned bank, which was also negotiating with fellow regional bank Landesbank Hessen-Thüringen Girozentrale for a while. A merger with another state-owned bank would be a better option for NordLB as it would keep it in the public sector deposit guarantee scheme. After Helaba backed out of the acquisition talks in late December 2018, the only two options left for NordLB are a stake sale to a private investor or a windup, according to Scope.

Although a 49% stake sale to a fund such as Cerberus looks to be the most likely scenario, a windup cannot be ruled out as well as there is very little time left to find an alternative solution, according to the rating agency.

Under a windup scenario, NordLB's owners risk losing their entire €5.7 billion investment in the bank, and DSGV's deposit guarantee scheme may be tapped if losses exceeded the equity base, Scope added.

Regional savings bank associations own 35.3% of NordLB, while the state of Lower Saxony holds a 59.13% stake.