Tuesday, March 17, 2009
Add shipping exposure to European banks’ woes
As if European banks didn’t already have enough to worry about, S&P warned on Monday that rapidly deteriorating shipping markets will put yet more pressure on their ratings.
According to the report by Harm Semder and Andreas Kindahl (emphasis FT Alphaville’s):
Rapidly deteriorating conditions in the shipping sector are squeezing the ratings on European banks exposed to the shipping industry. Many shipping companies are struggling following a sharp downturn in global trade and challenging funding conditions. We expect these difficulties to result in a material increase in banks’ loan loss provisions. We see pressure on banks coming from an increasing number of loan defaults, rapidly deteriorating shipping company credit quality, and weaker recovery expectations due to falling asset values. In addition, we believe banks’ capital ratios may decline as deteriorating creditworthiness feeds through internal rating models and increases the relative risk-weighting under Basel II.
European banks are especially exposed to drybulk and container shipping, the fundamentals of which are “particularly weak.”
The S&P analysts highlighted seven banks with significant shipping exposures - DnB NO, DVB, KfW IPEX-Bank, NIBC, HSH Nordbank, Norddeutsche Landesbank Girozentrale and Nordea.
Still, while S&P expects the downturn in shipping to be prolonged and the asset class to be one of the more troubling for banks over the medium term,
… the effect on European banks [should be] modest due to their moderate portfolio exposure to the shipping industry.
As long as you take modest to mean more than a bit stressful, since:
In our view, banks’ shipping portfolios are likely to suffer from widespread deterioration, because no shipping company appears insulated from the current fallout from the financial and shipping markets. Owners and operators alike will see their revenues pressured by falling demand and subsequently lower freight rates, some segments more dramatically than others. Consequently, we expect the performance and credit quality of shipping companies, and, consequently, banks’ segmental results, to significantly weaken in the coming quarters.
S&P also warns that banks’ risk managers may underestimate their prospective losses due to shipping exposure:
We believe that banks’ internal credit scores of their shipping company clients may significantly migrate downwards in 2009 as a consequence of a near-term increase in default risk in the shipping sector. As the deterioration in shipping industry conditions has been rapid and extreme, we believe that the downward movement of these internal scores could be sudden and sharp (to the extent that these scores do not reflect current conditions). Sharp downward migrations may accelerate banks’ loan loss provisions, raise levels of risk weighted assets, and put additional pressure on capital ratios.
Banks may also have been overly optimistic in their estimates of collateral values:
While banks may have generally refrained from using recent peak pricing for second-hand and newbuilt vessels when determining collateral values, we believe that fluctuating second-hand ship prices over the past 10 years in all segments suggest potential recovery risk when assessing loss given default estimates.
In line with these banks’ optimism, loan provisioning against shipping portfolios has been less than aggressive - until the third quarter of 2008, these provisions were at historic lows.
A sudden ratcheting upwards of the risk profile of these portfolios, which is what S&P expects, could mean a quadrupling in demand for regulatory capital under Basel II - quite a significant increase, particularly in these strained times.
Banks aside, S&P provides some interesting commentary and data on the state of shipping:
We expect other shipping segments, including the tanker segment, to face challenging near-term market conditions as industry fundamentals deteriorate. Oil tanker demand is likely to fall as a result of cutbacks in OPEC production and a high pace of newbuilding deliveries which will pressure tanker freight rates through 2009. Similarly, offshore shipping freight rates are likely to weaken as a result of lower oil prices, which are expected to curtail oil exploration. Vehicle carriers have been impacted by weak new car sales globally, and the cruise industry is likely to be affected by a reduction in discretionary consumer spending.
Market imbalances are in our view aggravated by the large newbuilding orderbook across most segments. These vessels will be delivered during difficult market conditions with most having been ordered at high prices. All shipping sectors will likely be affected by the high prices paid for newbuildings in recent years. By our reckoning, these vessels will, on average, have to earn high freight rates to cover their purchase price and operating costs. With freight rates now very low in some segments, vessel operators look likely to incur substantial losses. Consequently, we expect that the downturn for shipping will be severe and prolonged. We expect some relief on supply-side pressure, however, to come from widespread newbuilding cancellations or deferrals, and subsequent bankruptcies at weaker shipyards or cancellation of new ‘greenfield’ shipyard projects, primarily in China. We believe this is most likely to affect deliveries in 2011 and 2012.
As adapted from FT Alphaville
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