Germany-Based HSH Nordbank AG Rated 'BBB/A-2'; Outlook Stable; Assigned 'BBB+/A-2' Resolution Counterparty Ratings

  • Following the successful privatization, HSH Nordbank can now execute its multiyear transformation to a more sustainable and efficient mid-size corporate lender, supported by a clean balance sheet and large liquidity buffer.
  • HSH Nordbank's sizable buffer of subordinated debt would likely help to protect senior unsecured creditors if the bank failed and was subject to a bail-in resolution action.
  • We are assigning HSH Nordbank our 'BBB/A-2' issuer credit ratings and 'BBB+/A-2' resolution counterparty ratings.
  • The stable outlook reflects our view that the privatization and ensuing transformation enables HSH Nordbank's management to build on its solid capitalization and current good asset quality, and that results will materialize only over the coming two to three years.
FRANKFURT (S&P Global Ratings) Dec. 6, 2018--S&P Global Ratings said today 
that it had assigned its 'BBB/A-2' long- and short-term issuer credit ratings 
to Germany-based HSH Nordbank AG (HSH). The outlook is stable. 

We also assigned our 'BBB+/A-2' long- and short-term resolution counterparty 
ratings (RCRs) to HSH.

HSH is a German midsize corporate bank, previously under public ownership, 
that was recently sold to a consortium led by private equity firms Cerberus 
and JC Flowers. 

Over the past few years, HSH has materially deleveraged, as required under the 
terms of the EC state aid approval in 2011 after the bank's rescue by its 
public owners during the financial crisis. Following the privatization and 
sale of its non-core, nonperforming portfolio, HSH's loan exposure is now 
predominantly to German clients. While the bank is now in a position to focus 
on exploiting new business opportunities, also in international markets, we 
expect HSH will remain a niche player in European corporate banking, therefore 
enjoying less diversification and business stability than larger and more 
established peers. 

Following the sale of its non-core, nonperforming portfolio, HSH has a healthy 
balance sheet, with a strong pro forma risk-adjusted capital (RAC) ratio of 
12.4% as of year-end 2017. Although the RAC ratio could decline by about 1% 
over the coming two years as loan growth picks up, our projection of about 
11.5% at year-end 2020 would remain comfortably above the 10% threshold for 
strong capitalization. However, we note that the bank's weak profitability 
limits the capacity of earnings to buffer potential losses. For 2020, we 
project a return on equity of about 1.9% and an earnings buffer of 9 basis 
points (bps), well below the 30-50 bps we see among German peers such as 
Commerzbank or Deutsche Pfandbriefbank. 

Additionally, despite a nonperforming loan level of less than 2%, we note the 
bank's focus on German commercial real estate and corporate business in more 
volatile sectors like shipping, energy, and infrastructure. In our view, this 
exposes HSH to more pronounced credit cycles than its better-diversified 
peers. Furthermore, we understand that HSH will expand its business beyond 
Germany to countries where it has not conducted business in recent years. 

We believe that the quality of HSH's new lending will only be proven over the 
economic cycle. Going forward, key rating considerations will be based on the 
relative pace of credit growth, impacts on sector diversification, and the 
quality of the loan book, as we still consider that underwriting standards 
could weaken in the pursuit of new business. However, in our view, the close 
oversight by BdB (the Association of German Banks), especially over the 
multiyear transition period, will restrain HSH from increasing its risk 
appetite or deviate from its business plan. We expect HSH to comply with all 
agreed terms to ensure the targeted senior membership in the private deposit 
protection scheme from 2021 onwards.

Overall, and despite current favorable funding and liquidity metrics, we still 
see HSH as having a more confidence-sensitive, less deposit-rich funding 
profile than its German peers'. In June 2018, HSH's stable funding ratio stood 
at 105% and its broad liquid assets to short-term wholesale funding at 1.7x. 
In our view, HSH will need to re-establish its funding franchise after several 
years of intense deleveraging and limited long-term funding issuances. 
Furthermore, management will need to deliver on the agreed way of transferring 
from public sector deposit insurance to private. 

We do not apply any ratings uplift to our assessment of HSH's stand-alone 
credit profile (SACP) for government support. We consider the prospect of 
extraordinary government support for German banks to be uncertain, following 
the full implementation of the EU Bank Recovery and Resolution Directive, 
including bail-in powers, in January 2015. 

However, we note that while HSH appears less systemically important than 
larger and more complex German peers. Moreover, it is a sizable institution 
that is subject to direct supervision by the ECB and oversight by the Single 
Resolution Board. We therefore assume that. in the event of failure, it might 
be targeted for a bail-in led resolution. The bank's material buffer of 
subordinated instruments, which provide material protection to senior 
unsecured creditors, would facilitate a recapitalization. We calculate that 
HSH's additional-loss absorbing capacity (ALAC) was about 29% of S&P Global 
Ratings' risk-weighted assets (RWA) at year-end 2017, far beyond our 8% 
threshold for a two-notch uplift. This incorporates the statutory 
subordination of plain vanilla senior unsecured instruments under the German 
law change on Jan. 1, 2017. While the ALAC buffer will likely reduce over the 
coming two years, we expect it to remain well above the 8% threshold. 

The one-notch negative adjustment to the issuer credit rating reflects our 
holistic view on the risks in HSH's multi-year transition. It also 
incorporates the bank's currently depressed profitability, which is low even 
relative to German peers. 

The 'BBB+/A-2' RCR reflects our RCR jurisdiction assessment on Germany, and 
our review of its relevance for HSH. We consider that there is an effective 
resolution regime in Germany and that HSH would be covered by the group's 
single point-of-entry resolution strategy if it were to reach a point of 
nonviability. An RCR is a forward-looking opinion of the relative default risk 
of certain senior liabilities that may be protected from default through an 
effective bail-in resolution process for the issuing financial institution. 

The stable outlook on HSH reflects our view that the successful privatization 
should enable the bank to continue its transformation, leading to a more 
sustainable and predictable performance over the next two years. We anticipate 
that HSH will maintain its strong financial profile, supporting its 
confidence-sensitive transformation over the coming years. Indeed, HSH's 
future profitability and internal capital generation hinge on its ability to 
attract lower cost funding and expand its client franchise.

We could lower the ratings on HSH if it fails to stabilize its franchise and 
to cut costs, or if it encounters troubles in meeting the membership terms of 
the protection scheme. In addition, we could consider a downgrade if we 
observe a deterioration in asset quality and significantly increasing risk 
appetite, materializing in rapid loan growth or higher credit losses than 
currently anticipated. Notably, aggressive growth of RWAs that runs ahead of 
earnings retention could risk a reduction in the risk-adjusted capital ratio 
to less than 10%. 

If these negative indicators appear, we would expect to reflect them in the 
SACP. A downward revision of the SACP would lead us to lower our issue credit 
ratings on any rated hybrid instruments. Whether we also lowered the issuer 
credit rating would depend also on our broader analysis of HSH versus 
similarly rated peers. 

Although unlikely within the two-year outlook horizon, we could consider an 
upgrade if HSH, under its new ownership, builds a track record of substantial 
improvements in revenue generation, cost structure, and risk-adjusted 
profitability. An upgrade would likely hinge on the bank's progress on 
delivering its business plan and remaining compliant with the protection 
scheme's covenants. We look in particular for a cautious approach to growth, 
and the maintenance of solid capitalization, together giving us continued 
confidence regarding the bank's exposure to credit losses and its ability to 
absorb them through capital and, to an increasing extent, earnings. However, 
an upgrade would also depend on HSH establishing a sustainable funding 
franchise, including creating further diversification in funding sources and 
an increase in the average duration of wholesale funding.