Germany: HSH Nordbank Capital Injection, 2009

State-owned HSH Nordbank reported a EUR 2.8 billion loss in 2008, mainly from large loan loss provisions and write-downs. The Federal Financial Services Authority (BaFin) informed HSH on April 29, 2009, that it would close the bank if the owners, the governments of Hamburg and Schleswig-Holstein, did not achieve the 8% total capital ratio requirement. HSH’s bankruptcy would have been expensive for the states, since approximately EUR 36 billion of the bank’s current liabilities were covered by the states under two unlimited guarantees, in line with their ownership of the bank when it was formed through a merger in 2003. In addition, HSH’s failure would have had serious economic effects on the Northern Germany regional economy as a result of job losses and credit supply constraints arising from its failure (Schleswig-Holstein Parliament 2009a; 2009b).

The two states created a plan to ensure that the bank would meet its regulatory minimum while minimizing the budgetary impact, which required a capital injection of EUR 3 billion and an asset guarantee of EUR 10 billion. The asset guarantee limited the bank’s losses on those assets and reduced the amount of capital the bank had to use to fund them.

The finance minister of Schleswig-Holstein said that Flowers, a US private equity firm, was considering a limited participation in the capital injection (Reuters 2009a). However, Flowers and the other minority owners of HSH Nordbank ultimately did not participate in the capital injection (EC 2009c).

The EC, Germany, and minority shareholders disagreed on the validity of certain assumptions used during the valuation of HSH Nordbank’s recapitalization. The EC stated in its preliminary opinion that the valuation of the bank was too optimistic and did not take into account several important factors, such as the need to restructure the bank’s business, the market for its shipping and commercial business, and the bank’s S&P rating downgrade from A to BBB . The EC stated that if the shares were properly valued, the minority shareholders would have been completely diluted. In response to this, Germany and the minority shareholders pointed out that the extent of the share dilution depended on parameters chosen during a valuation of the bank conducted by PricewaterhouseCoopers (PwC). Germany and the minority shareholders stated that the PwC valuation was in line with the accepted valuation standards and the assumptions that the bank would regain its S&P A rating in 2013, the risk shield would be implemented, and markets would normalize in 2011. In its final State Aid decision, the EC held its view that these assumptions were too optimistic (EC 2011b).

Furthermore, the minority shareholders pointed out that the EC had not considered the capital provided by the minority shareholders in the months preceding the government capital injection. However, the EC stated that the capital provided by the minority shareholders in 2008 was a result of investment decisions and not a contribution to burden sharing in the context of the aid provided through the government capital injection. The minority shareholders also argued that the valuation of the bank should not be considered as State Aid since it was taken during the shareholders’ meeting; however, the EC disagreed with this since the majority shareholders were the state governments, which acted in their function as public bodies (EC 2011b).

The EC also expressed doubts regarding the compatibility of the risk shield with the impaired asset communication (IAC), since a small portion (less than 7%) of the shielded portfolio was considered impaired under the IAC. The EC particularly questioned the impaired nature of the portfolio, since more than 50% of the bank’s total assets were included under the risk shield, which was unusually high. The EC also questioned the valuation of the structured credit part of the portfolio and claimed that the bank relied on assumptions pertaining to the rate used to discount cash flows and the treatment of correlation between assets included in the portfolio, which were not compatible with the IAC. The EC retained external advisers and experts from the European Central Bank to conduct an asset valuation based on the current market value and the assets’ real economic value based on their underlying cash flows. Germany, however, argued that the IAC should not be applicable in this case since the risk shield was designed and pre-notified before the publication of the IAC. However, the EC disagreed with this view since the risk shield was adopted after the IAC was published (EC 2009c).

When the EC gave its final approval for the State Aid, it imposed an additional remuneration for the risk shield in the form of EUR 500 million in shares and an additional annual premium of 3.85% on the guaranteed amount. This was done to ensure compliance of the risk shield with EU State Aid rules and that minority shareholders bear a fair share of the restructuring costs (EC 2011a). The EC stated that the additional remuneration would provide for adequate burden sharing and mitigate the flaws arising from the PwC valuation by sufficiently diluting the minority shareholders’ stakes. The EC also stipulated that if HSH’s common equity ratio declines below the minimum common equity ratio (10%) owing to the additional guarantee premium of 3.85%, the Anstalt would waive part of the guarantee fee to ensure HSH’s common equity ratio remains above the minimum common equity ratio, in return for the provision of a debtor warrant (EC 2011b).

On October 17, 2008, Germany created the SoFFin to support German financial institutions through guarantees, recapitalizations, and asset purchases (Simon 2020). In November, SoFFin agreed to guarantee up to EUR 30 billion in new debt issued by HSH Nordbank (German Government 2008, sec. 6). The debt guarantee was conditional on the bank raising its Tier 1 capital ratio to 8%^FNOn December 12, 2008, after HSH Nordbank received the debt guarantee from SoFFin, the European Commission gave SoFFin approval to require a Tier 1 capital ratio of 7% instead of 8% for debt guarantees. However, since HSH Nordbank received its guarantee earlier in November 2008, SoFFin continued to require a Tier 1 capital ratio of 8% for the HSH Nordbank debt guarantee.  from 7.4% by February 2009. HSH was allowed to access up to EUR 10 billion of this guarantee before it raised its Tier 1 capital ratio (Handelsblatt 2008). The total amount guaranteed under this facility peaked at EUR 24 billion (FMSA 2019). The guarantee facility expired on July 23, 2012 (FMSA 2023).

Asset Guarantee (Risk Shield)

Along with the capital injection, the states of Hamburg and Schleswig-Holstein announced a EUR 10 billion asset guarantee, which they called a risk shield (Schleswig-Holstein Parliament 2009a; Schleswig-Holstein Parliament 2009b). The asset guarantee protected HSH from losses arising out of a portfolio of EUR 172 billion in assets. By transferring risk to the authorities, the guarantee also lowered the bank’s risk-weighted assets, improving its capital ratios. Under the terms of the asset guarantee, HSH covered the first EUR 3.2 billion in losses on the shielded portfolio, the Anstalt covered losses above EUR 3.2 billion and less than EUR 13.2 billion, and HSH covered any losses above EUR 13.2 billion. The asset guarantee was administered by the Anstalt, with the states bearing the guarantee equally, while the minority shareholders did not provide funding for it. HSH could cancel the asset guarantee at any time, but until December 31, 2013, the cancellation was limited. According to the contract on the provision of the asset guarantee, HSH initially paid an annual premium of 4 percent on the guarantee. However, following an EC decision in September 2011, the asset guarantee contract was amended and HSH Nordbank was required to pay an additional annual premium of 3.85% on the guaranteed amount assessed retroactively from April 1, 2009, and on a pro rata basis for parts of the financial year (EC 2011b). The EC also required HSH to make an additional EUR 500 million payment to the Anstalt. Through 2011, HSH canceled EUR 3 billion of the guarantee to reduce the bank’s fee payments, and BaFin indicated that it would not object to the termination (EC 2018).

However, following the shipping crisis in the second and third quarters of 2012, HSH’s capital ratios deteriorated. The EC approved the provisional restoration of the guarantee back up to EUR 10 billion in 2013 (EC 2013; Magnusson 2012). In May 2016, the EC gave its final approval for restoring the guarantee to EUR 10 billion under the condition that the bank had to be privatized by February 2018 or wound down (EC 2018).

By 2018, the bank had recorded substantial credit losses on the shielded portfolio and had fully drawn down the EUR 10 billion guaranteed from the Anstalt; the states of Hamburg and Schleswig-Holstein financed those payments to the bank through bonds issued by the Anstalt and later transferred to the state budgets (Hamburg Tax Authority 2021).

On February 24, 2009, the governments of Hamburg and Schleswig-Holstein negotiated a treaty to provide financial assistance to HSH Nordbank in the form of a EUR 3 billion capital injection and a EUR 10 billion asset guarantee (BBC 2009). The parliament of Hamburg approved this measure on April 1, 2009, and the parliament of Schleswig-Holstein approved the aid on April 3, 2009.

On April 30, 2009, Germany notified the EC regarding the State Aid measures, and on May 29, 2009, the EC approved them temporarily for financial stability reasons and announced that it would examine the asset guarantee (EC 2009a). An EC report from October 22, 2009, stated that after examining the information submitted by the German authorities, the EC had doubts regarding the compatibility of these measures with the common market and had decided to open an investigation into the aid under article 88(2) of the EC Treaty (EC 2009b). In November and December 2009, the German authorities, HSH, and the minority shareholders expressed their views regarding the valuation of the State Aid to the EC (EC 2011b). On September 20, 2011, the EC approved the capital injection and asset guarantee, conditional on the bank’s commitment to reduce its balance sheet by 61% and the payment of higher remuneration for the State Aid (EC 2011a).

The Anstalt was established as a joint legal institution under Hamburg public law to administer the capital injection and provide the asset guarantee. The states of Hamburg and Schleswig-Holstein each held a 50% share of the Anstalt’s assets (Schleswig-Holstein Parliament 2009a, 33).

The Anstalt was authorized to:

• Acquire and dispose of shares in HSH
• Assume guarantees of up to EUR 10 billion
• Take loans up to EUR 3 billion to purchase shares in HSH
• Take additional loans up to EUR 500 million, if HSH uses the guarantees
• Take additional loans up to EUR 1 million to commence business activities (Schleswig-Holstein Parliament 2009a)

The Anstalt therefore had the power to issue bonds for the capital injection and asset guarantee. The Anstalt had an institutional support assembly consisting of two members appointed by the tax department of Hamburg and two members appointed by Schleswig-Holstein’s Minister of Finance. The institutional support assembly appointed two managing directors responsible for running the Anstalt and reporting to the institutional support assembly regarding business operations regularly.

PwC helped establish the price at which the Anstalt purchased shares of HSH.

The Anstalt had to provide quarterly reports regarding its business activities to subcommittees of the parliaments of Hamburg and Schleswig-Holstein. The supervisors had the right to inspect the Anstalt’s operations, documents, annual financial statements, economic management, and management reports (Schleswig-Holstein Parliament 2009a).

When the states of Hamburg and Schleswig-Holstein announced the capital injection, the mayor of Hamburg called it a solid sustainable result that would save an important financier of industrial sectors in the region. In the announcement, Schleswig-Holstein's minister-president called it a difficult decision and said he would not rule out SoFFin’s participation in future aid (BBC 2009).

On May 29, 2009, the EC issued a press release outlining the aid’s temporary authorization for reasons of financial stability, and on October 23, 2009, the EC also announced it had opened an in-depth investigation into the aid package under the EC Treaty State Aid rules, which was standard procedure given the size of the interventions (EC 2009b). On September 20, 2011, the EC gave its final approval for the capital injection, conditional on restructuring the bank, after it concluded the in-depth investigation (EC 2011a).

The EC also initially noted that HSH and the German authorities did not provide sufficient ex ante transparency and disclosure to the EC regarding the risk shield, in line with the Impaired Assets Communication (EC 2009c). However, the EC stated in its 2011 decision on the aid that it was satisfied with the revised disclosure Germany had provided (EC 2011b).

The year before the recapitalization, in July 2008, the bank had raised EUR 962 million in mandatory convertible silent capital from the minority shareholders, including EUR 300 million from Flowers. Although the EC approved the deal in May 2009, it said at the time that the owners who did not participate in the recapitalization benefited disproportionately, since they were not completely diluted (EC 2009c). The EC deliberated on the State Aid for two years, as described in Key Design Decision No. 1, Purpose, before it gave the final approval for the State Aid on September 20, 2011. In its final State Aid decision, the EC required HSH to pay an additional EUR 500 million in shares to the Anstalt for the provision of the asset guarantee used to reduce HSH’s risk-weighted assets (RWA) (EC 2011a). Following the final State Aid decision, the bank’s minority shareholders appealed for an annulment of the State Aid decision in the EU General Court. However, the General Court dismissed the appeal since the EC decision created proper burden sharing (Werner 2016).

The institution was not required to bail-in any debt or equity holders because of the capital injection. The EC prohibited HSH from paying any dividends at least until January 1, 2015, and between 2015-2016, dividends could not exceed 50% of the bank’s annual surplus to ensure State Aid was kept to a minimum.

Until December 31, 2014, the EC also prohibited HSH from making any payments to profit-related equity instruments, including hybrid financial instruments and profit participation certificates. The EC also required that these hybrid instruments participate in any business losses as long as they are not carried forward from previous years (EC 2011b).

On April 29, 2009, BaFin informed HSH that it would close HSH pursuant to paragraph 47 of the German Banking Act if the owners did not recapitalize the bank to the 8% total capital ratio requirement set under Section 2(6) of the Solvency Regulation, of which at least 4% had to be core capital (EC 2009c).

To increase the core capital ratio, the Anstalt acquired core Tier 1 capital and provided the asset guarantee. The asset guarantee, by reducing the bank’s exposure to credit risk, allowed the bank to lower its estimated RWA, thereby raising its risk-weighted capital ratios. The act authorizing the rescue measures stated that from a fiscal point of view, using a combination of the capital injection and asset guarantee was budget friendly (Schleswig-Holstein Parliament 2009a, 19).

HSH’s core capital ratio was 2.2 percentage points below the international standard for minimum core capital ratio of 7% after taking the net loss of EUR 2.8 billion for the 2008 financial year.

The states of Hamburg and Schleswig-Holstein also intended to achieve a yearly dividend of 10%. Given that HSH’s business plan did not project sufficient profits for the period 2009-2012 to pay a 10% dividend on all ordinary shares, the issue price of the new ordinary shares purchased during the capital injection was discounted by 10% for the period 2009-2012 (EC 2011b). The present value of the 10% dividend payment for the period 2009-2012 amounted to EUR [650-800] million or EUR [3-6] per share. The price for the new shares was therefore fixed at EUR 19 per share (EUR [19-28] minus EUR [3-6]), and the Anstalt acquired just under 158 million new ordinary shares.

The Anstalt injected cash into the bank. The act authorizing the aid and establishing the Anstalt also gave the Anstalt the power to issue bonds to raise cash for the capital injection and asset guarantee (Schleswig-Holstein Parliament 2009a). The Anstalt’s liabilities arising from the bond issuance were guaranteed equally by the states of Hamburg and Schleswig-Holstein as partial debtors and by means of guarantees to the bondholders.

During the 2008 financial year, HSH reported a EUR 2.8 billion loss due to write-downs in its credit investment portfolio and its exposure to Icelandic banks and Lehman Brothers (Dow Jones Global 2009). In November 2008, SoFFin granted HSH a guarantee covering new debt issuances for up to EUR 30 billion to improve HSH’s liquidity after the bankruptcy of Lehman Brothers increased refinancing costs. On February 17, 2008, the bank’s management proposed that the bank’s capital should be increased by EUR 3 billion, and that a EUR 10 billion asset guarantee should be established by the bank’s owners (Dow Jones 2009a). On February 24, 2009, the states of Hamburg and Schleswig-Holstein announced they had signed a treaty to provide the requested aid. The parliaments of Hamburg and Schleswig-Holstein ratified the treaty on April 1 and April 3, 2009, respectively (Dow Jones 2009c; Reuters 2009b).

On April 30, 2009, Germany notified the EC regarding the State Aid measures, and on May 29, 2009, the EC approved them temporarily for reasons of financial stability. The capital increase of EUR 3 billion was completely paid in by June 2009 (HSH 2009). After considering the valuation of the capital injection carefully, the EC approved the capital injection permanently in September 2011.

The bank had begun restructuring before receiving capital. The bank’s managing board had announced a week before the state governments announced the capital injection that it planned to reduce the number of full-time employees by 1,100 over three years and dismantle its credit investment portfolio, international leveraged buyouts business, and US real estate business. The bank’s managing board also announced that the bank would withdraw operations from container financing, refinancing of leasing companies, conventional energies in Europe, and corporate business in Asia and Scandinavia (Dow Jones 2009a).

The act that authorized the capital injection and the EC decision approving it required that the bank undertake restructuring. The EC temporarily approved the aid in May 2009 and required the bank to submit a restructuring plan within three months. On September 1, 2009, the bank’s restructuring plan was submitted to the EC. The bank committed to reducing its balance sheet by 61% to shrink its funding needs and increase its long-term viability (EC 2011a).

In November 2008, HSH CEO Hans Berger resigned following the bank’s negative results that year (HSH 2011). In April 2009, the bank also dismissed a member of its management board, Frank Roth, and pressed criminal charges against him for leaking confidential strategy documents (HSH 2012).

In 2013, Hamburg public prosecutors charged the former members of HSH’s board of directors in relation to a transaction called Omega 55, which constituted an accounting fraud and caused a EUR 500 million loss at the bank (Reuters 2013). In June 2019, five former directors settled the charges by paying fines ranging from EUR 500,000 to EUR 1.5 million (Damyanova 2019).

The EC said it would consider cash remuneration exceeding EUR 500,000 to its bodies, employees, and essential agents inappropriate if HSH was unable to pay dividends (EC 2011b).

There was no regulatory relief to facilitate the injection.

At the earliest, the act authorizing the capital injection could be terminated by either Hamburg or Schleswig-Holstein by December 31, 2013, by giving a one-year notice. On October 19, 2015, the Minister-President of Schleswig Holstein, First Mayor of Hamburg, and European Commissioner in charge of competition reached an agreement to split HSH into a holding company and an operating subsidiary and privatize the operating subsidiary (EC 2015). An EC decision on May 2, 2016, required the states of Hamburg and Schleswig-Holstein to sell HSH by February 28, 2018, to allow HSH to return to viability without requiring further State Aid. On November 26, 2018, the European Commissioner in charge of competition announced that the sale of HSH to a consortium of private equity funds led by Flowers and Cerberus complied with the requirements set in the EC decision on aid-free privatization (EC 2018). On November 28, 2018, the consortium of private equity funds purchased HSH Nordbank for EUR 1 billion (Schleswig-Holstein Parliament 2018).