35 Danmarks Nationalbank's Costs of Supporting Ship Finance Peter Jayaswal, Financial Markets INTRODUCTION AND SUMMARY Over the years, Danmarks Nationalbank has provided support for various industries, reflecting a broader historical perception of Danmarks Nationalbank's role than is the case now. In addition, faith in the effect of direct support for the business community used to be more pronounced. Among other things, interest-subsidy schemes for ship finance have been extensive. This chapter estimates the costs to Danmarks Nationalbank of these schemes. In 960-6 Danmarks Nationalbank participated in the establishment of Danish Ship Finance (DSF), and from 964 to 995 Danmarks Nationalbank acquired DSF's bonds on special terms, typically at a price above the market price. This mainly applied until 986, when the nature of the schemes changed. The exact costs related to the schemes are difficult to calculate since they are not stated in Danmarks Nationalbank's accounts for all the years. A precise calculation requires historical information about prices and volumes; information which typically does not exist any longer. It is, however, possible to provide a good estimate of the costs on the basis of accounting data, as well as historical interest rates and lending volumes. Against this background, Danmarks Nationalbank's costs of acquiring Ship Finance bonds at par in the period 964-95 can be estimated to be in the range of kr. 2 billion. In 2003 prices this corresponds to kr. 33 billion. More specifically, it was the period up to 986 that involved high costs to Danmarks Nationalbank. Since Danmarks Nationalbank's profit after allocations accrues to the central government, the latter's revenue diminished correspondingly. In addition to the costs of acquiring the bonds at par, there are also costs related to premature redemptions under the index-linked scheme. This presentation and the calculations are based on annual reports from Danish Ship Finance and Danmarks Nationalbank in the period 96-2000, as well as Dansk pengehistorie (Danish monetary history), volume 4, by Richard Mikkelsen, 993.
36 The loans can be redeemed at par, and Danmarks Nationalbank must deliver the underlying bonds. A rough estimate of these costs so far is kr. 0.6 billion. Danmarks Nationalbank's costs of supporting ship finance by no means indicate the full extent of the support, and no attempt has been made to calculate the socio-economic impact of the schemes. However, it can be concluded that in spite of the various support schemes a number of shipyards have closed down, and the significance of the shipbuilding industry to the Danish economy has diminished considerably. This trend has also been observed in other European countries. DANMARKS NATIONALBANK'S INVOLVEMENT IN THE ESTABLISHMENT OF DANISH SHIP FINANCE The idea of a mortgage-credit system for ships emerged in the early 20th century following the development of the mortgage-credit system during the preceding century. After several vain attempts, the idea was finally realised in 959-60. Danmarks Nationalbank had an interest in this initiative since it wished to discontinue remortgaging arrangements in relation to ship finance, i.e. arrangements whereby banks were able to remortgage ships at Danmarks Nationalbank. In 960 this option ceased to exist and Danmarks Nationalbank reintroduced bond loans. This gave the banks a liquidity problem, which could be solved by establishing a bond-issuing institution. Naturally, the shipowners also had an interest in this initiative. Furthermore, the central government wanted an institution for financing ships with a view to the effect on employment and the foreign-exchange conditions. The interested groups agreed to set up a ship-finance fund, and on 6 June 96 Danish Ship Finance (DSF) was established as an independent institution by Danmarks Nationalbank, among others. DSF provided loans against collateral in the ship and financed the loans via bonds with a nominal yield of 6 per cent. The loans were granted on ordinary market terms, i.e. if the market interest rate was higher than the nominal yield on the bonds, the borrower suffered a capital loss and thus had to pay a higher yield to maturity than 6 per cent. The financial foundation was a guarantee capital of kr. 40 million, of which Danmarks Nationalbank provided kr. 0 million. The guarantee capital was subsequently augmented as a result of increasing lending activities, and today it amounts to kr. 300 million, cf. Table.
37 GUARANTEE CAPITAL OF DANISH SHIP FINANCE Table Kr. million Of original guarantee capital Increased by kr. 80 million in 965 Increased by kr. 60 million in 969 Increased by kr. 90 million in 975 Increased by kr. 30 million in 978 Danmarks Nationalbank.. 0 30 42 63 63 Banks... 20 50 70 05 35 Shipowners... 4 6 26 39 39 Shipyards... 4 8 33 49.5 49.5 Insurance companies... 2 6 9 3.5 3.5 Total... 40 20 80 270 300 Source: Danish Ship Finance. INTEREST-SUBSIDY SCHEME FOR SHIP FINANCING The increasing interest rates in the 960s pushed up the yield to maturity on loans from DSF to 8-9 per cent. This led to pressure to mitigate these effects since interest subsidies and government guarantees for shipbuilding were prevalent in other countries. In the autumn of 963 new bond loans were introduced at the initiative of the central government. The nominal yield was still 6 per cent, but the banks purchased the bonds at par value. In return, the banks were able to pledge the bonds at the same low yield to Danmarks Nationalbank, which thus bore the costs. The financing scheme was available for domestic and foreign orders for Danish shipyards. In the autumn of 965 the scheme was changed so that Danmarks Nationalbank acquired the bonds at par. From July 970 the bonds were listed on the Copenhagen Stock Exchange and resold by Danmarks Nationalbank at market price. The scheme became the key element in ship financing and the lending rules were adjusted on an ongoing basis to reflect the terms and conditions for ship financing agreed within the OECD and the EC in respect of minimum interest rate, loan-to-value ratio and redemption period. Consequently the loans were also known as OECD loans. The home-market scheme In 977 several shipbuilding countries introduced particularly favourable conditions for financing newbuilding for domestic shipowners by domestic shipyards. This made it difficult for Danish shipyards to attract orders from foreign shipowners. Consequently, in the autumn of 977, a One reason why interest subsidies, not e.g. direct government subsidies, became the key element may be the rising level of interest rates in Denmark compared to abroad in the period up to the early 980s. This was also the case for other sectors, e.g. support for industry, agriculture and fisheries via the so-called K loans from 977, giving the sectors an opportunity to raise low-yield foreign loans that were hedged against the exchange-rate risk. Support schemes for various sectors were generally seen in many countries.
38 home-market scheme was introduced. This was an extended credit scheme for Danish shipowners who chose Danish or other EC shipyards for their newbuilding. Under the home-market scheme, Danish shipowners were able to obtain 0-year loans covering up to 80 per cent of the newbuilding price at the OECD's minimum interest rate for ship financing, at that time 8 per cent. This implied a bond yield of 7.5 per cent and an administration and risk fee of 0.5 per cent to DSF. Newbuilding by foreign shipowners at Danish shipyards could be financed via 7-year loans covering up to 70 per cent of the newbuilding price, also at a yield of 8 per cent including the administration and risk fee. Under both lending schemes, Danmarks Nationalbank continued to acquire the bonds at par. DSF also provided loans for other financing requirements, e.g. newbuilding by Danish shipowners at shipyards outside the EC, but the bonds were sold on market terms. This lending activity was insignificant, and practically all bonds issued by DSF were comprised by the above schemes, under which Danmarks Nationalbank acquired the bonds at par value. In the subsequent years the schemes were regularly adjusted in order to comply with international provisions and accommodate further demands for support. Towards the end of 978 it thus became possible to extend the maturity of loans under the home-market scheme to 4 years with deferred amortisation for the first four years. Both these conditions were subsequently changed again. The shipyard package As a consequence of a sustained low order intake for Danish shipyards, a number of supplementary support schemes were introduced in 986, known as the shipyard package. Danish Ship Finance was enabled to issue index-linked bonds for financing index-linked loans, with a ceiling on the indexation premium payable by the borrower. The borrower was given the option of a coupon of 2.5 or 4 per cent and would pay a maximum yield of 5.5 per cent after indexation. Any indexation premium exceeding 3 and.5 per cent, respectively, would be payable by the central government. The bonds were exempt from real-interest-rate tax, and Danmarks Nationalbank acquired the bonds at par, as was the case with the nominal bonds. The administration and risk fee contributed to the consolidation of DSF and meant that Danmarks Nationalbank's loss was greater than the difference between the OECD's minimum interest rate for ship financing and the market interest rate. The contribution was betweeen 25 and 50 basis points for loans granted in the period 963-84. In March 984 it was lifted for new loans, and the coupon rate on the bonds became equal to the OECD's minimum interest rate for ship financing.
39 The index-linked financing transferred most of the subsidisation costs from Danmarks Nationalbank to the central government. The nature of the subsidies changed from capital losses for Danmarks Nationalbank and thus indirect losses for the central government via lower profit allocations to lower tax revenue, as well as unknown indexation costs for the central government during the term of the loan. The home-market scheme continued, but its significance diminished and it ceased to exist at the end of 988 since practically all lending took place under the index-linked scheme. In 986, DSF was also empowered to offer loans in certain currencies determined by Danmarks Nationalbank on the same interest and amortisation terms as the loans in kroner. This scheme was known as the forward scheme. Transition to direct government subsidies and the swap scheme In 993 the existing subsidies for ship financing were replaced by direct government subsidies equivalent to the level permitted within the EU. The subsidies comprised a disbursement of up to 9 per cent of the contract sum and were payable as a lump sum on delivery of the ship or distributed over the maturity of the loan. Originally the scheme applied to contracts concluded in 993 and 994, but it did not cease until the end of 2000. The introduction of the direct government subsidy scheme led to the termination of the index-linked scheme, which had involved unknown future commitments for the central government and had also lost its subsidy value owing to the significant fall in interest rates in 993. The last disbursements under the index-linked scheme were made in 995. Since shipowners' revenues are often in dollars, there was demand for dollar-denominated loans. In connection with the index-linked scheme the shipowners' favourable loans were to a large extent "resold" to financial institutions. The subsidy was thus capitalised and the ship could be remortgaged in dollars. In order to enable DSF to offer loans in dollars, Danmarks Nationalbank committed itself to acquiring the bonds at market price with a view to resale in the market, and in addition it would, for a limited period, contribute to DSF's lending in dollars by concluding foreignexchange swaps. DSF was thus able to finance dollar-denominated loans by issuing krone-denominated bonds without incurring any exchangerate risk. The yield in dollars was set at the CIRR interest rate. The com- The CIRR interest rate is an OECD interest rate determined for one month at a time on the basis of the preceding month's average interest rate on government securities plus percentage point. It applies with half a month's delay. The CIRR interest rate is published for three maturities: 0-5 years, 5-8½ years or more. The CIRR interest rate to be applied is determined by the maturity of the loan.
40 mitment was temporary and applied to contracts concluded in 993 and 994 with delivery of the ship within three years. This scheme is known as the swap scheme. As planned, the commitment ceased for contracts concluded after 994, and since then Danmarks Nationalbank has not been involved in support for ship financing. However, premature redemption is still an option, cf. below, and the last commitment vis-à-vis DSF expires in 202 at the latest. DANMARKS NATIONALBANK'S COSTS OF ACQUIRING THE BONDS AT PAR A common feature of the subsidy schemes for ship financing has been Danmarks Nationalbank's acquisition of the bonds at par. This has entailed capital losses for Danmarks Nationalbank since the market interest rate has been higher than DSF's lending rate, cf. Chart. After 986 the spread between the two became less relevant as an expression of the costs to Danmarks Nationalbank since practically all bonds issued were index-linked bonds, the market price of which was typically closer to par than that of nominal bonds. THE BOND YIELD AND THE MARKET INTEREST RATE Chart Per cent 22 20 8 6 4 2 0 8 6 4 963 965 967 969 97 973 975 977 979 98 983 985 987 989 99 Danish Ship Finance's bond yield Long-term yield to maturity Note: The Chart shows the bond's coupon rate since this is the yield which affects Danmarks Nationalbank's costs in connection with the scheme. Typically, the borrower's yield was 25-50 basis points higher as a result of administration and risk fees to Danish Ship Finance. This contribution was removed in March 984 in respect of new loans, and subsequently the bond's coupon rate was equal to the OECD's minimum interest rate for ship financing. Source: Danish Ship Finance, Statistics Denmark and own calculations.
4 DISBURSED LOANS IN BOND SERIES COMPRISED BY SUBSIDY SCHEME Chart 2 Kr. billion (2003 prices) 2 0 8 6 4 2 0 964 965 966 967 968 969 970 97 972 973 974 975 976 977 978 979 980 98 982 983 984 985 986 987 988 989 990 Source: Danish Ship Finance and own calculations. In March 984 a commission fee to Danmarks Nationalbank was introduced, comprising 5 per cent of the nominal bond value for the bonds acquired by Danmarks Nationalbank. This reduced Danmarks Nationalbank's costs. The commission was borne by DSF. In 990 the acquisition commission was, however, suspended. One of the reasons was that DSF had become tax liable. The acquisition commission was reintroduced in 992 in order to finance a postponement of the phasing-out of the index-linked scheme. The commission was 5 per cent of the nominal bond value for the indexlinked bonds acquired by Danmarks Nationalbank, applicable to the years 993-95. However, the commission for each of these years must not exceed kr. 00 million and should be kept within DSF's profit for the individual year. In addition to the spread between the market rate and the lending rate, Danmarks Nationalbank's costs on acquisition of the bonds at par also reflected the lending volume. Loans disbursed under the subsidy scheme reached a considerable volume, cf. Chart 2. Quantification of the costs of acquiring the bonds The costs related to Danmarks Nationalbank's acquisition of Ship Finance bonds at par in the period 974-95 appear from Danmarks Nationalbank's annual reports. In these statements, the acquisition commission received during some of these years was offset.
42 In 963 no loans had yet been disbursed under the subsidy scheme. For the period 964 to 973 no statements of the costs are available. However, they can be approximated by applying the difference between the nominal yield on the bonds and the market interest rate, the duration and the disbursed amounts in the bond series in the year in question. The introduction of the minimum coupon rate via the Capital Gains Act in 986 led to a change in the 965 agreement on Danmarks Nationalbank's acquisition of nominal Ship Finance bonds at par. It was agreed that DSF could issue bonds meeting the current minimum-coupon-rate requirement for exemption from capital-gains tax. If the minimum coupon rate exceeded DSF's lending rate, Danmarks Nationalbank paid the difference to DSF on an ongoing basis. The costs were debited in the profit and loss account in connection with the acquisition of the bonds and are included in the calculation of the capital losses. 2 Table 2 shows Danmarks Nationalbank's capital loss on acquisition of Ship Finance bonds at par in relation to the market price. Until the mid-980s the capital losses on acquisition of the bonds were considerable and increasing. This was partly due to the volume of loan disbursements, partly to the fact that the high market interest rate relative to the lending rate resulted in significant capital losses on the individual loan disbursements. From 984 to 989 the capital losses were reduced by the acquisition commission, which was also the case in 993 and 995. 988 saw revenue of kr. 393 million compared with expenditure of kr. 89 million in the preceding year. This was to some extent related to the acquisition commission, but above all to the fact that after the introduction of the shipyard package in 986 practically all bonds issued were index-linked. Like the nominal bonds, the index-linked bonds were acquired at par, but whereas the acquisition of the nominal bonds entailed a capital loss, the price of some of the index-linked bonds was above par and a capital gain was thus achieved. The higher prices for index-linked bonds were a consequence of the exemption from real-interest tax. In 989 Danmarks Nationalbank also made a profit on acquisitions of index-linked bonds, but 990 saw expenditure again, mainly as a result 2 For an elaboration of the calculation method, see the Appendix. In practice this meant that DSF issued 9-per-cent bonds with a debtor yield of 8 per cent since these were the minimum coupon rate and DSF's lending rate, respectively, at that time. The capital loss to Danmarks Nationalbank was thus lower since the capital loss on a "black-stamped" 8-per-cent bond in relation to the market interest rate would have been greater than for a "blue-stamped" 9-percent bond in relation to the market interest rate. The current interest payments from Danmarks Nationalbank to DSF were thus offset by lower capital losses. A bond complying with the minimum-coupon-rate requirement is referred to as "blue-stamped" and is exempt from capital-gains tax. Bonds not meeting the requirement are referred to as "blackstamped" and are not exempt from capital-gains tax.
43 DANMARKS NATIONALBANK'S CAPITAL LOSSES ON ACQUISITION OF BONDS AT PAR Table 2 Kr. million Actual prices 2003 prices 964... 2 8 965... 20 65 966... 78 600 967... 43 306 968... 66 434 969... 29 825 970... 85,09 97... 263,490 972... 300,595 973... 342,66 974... 32,34 975... 295,36 976... 599 2,6 977... 776 2,467 978... 63,77 979... 49,294 980... 658,544 98...,43 2,967 982... 2,246 4,283 983...,50 2,693 984... 752,262 985... 362 580 986... 7 264 987... 89 28 988... -393-559 989... -483-656 990... 584 772 99... 32 403 992... 463 586 993... -24-30 994... -3-4 995... -4-4 Total... 2,267 32,686 Note: In the years when Danmarks Nationalbank received acquisition commission, this has been offset against the capital loss. From 987 onwards, Danmarks Nationalbank's current interest contribution to Danish Ship Finance has been included in the expenditure. Source: For the period 964-73, the calculations are own approximations. The period 974-95 has been sourced from Danmarks Nationalbank's annual reports for the period. of a significant increase in the yield on index-linked bonds so that prices dropped sharply from above to below par. In addition, the acquisition commission was suspended in 990. Subsequently expenditure fluctuated a little in line with the volume of loan disbursements and the price of index-linked bonds. Overall, Danmarks Nationalbank's expenditure on acquisition of Ship Finance bonds was almost kr. 2.3 billion in the period 964-95, equivalent to kr. 33 billion in 2003 prices. The expenditure mainly relates to the years until 986, cf. Chart 3.
44 ACCUMULATED COSTS ON ACQUISITION OF BONDS AT PAR, STATED IN 2003 PRICES Chart 3 Kr. billion (2003 prices) 35 30 25 20 5 0 5 0 964 966 968 970 972 974 976 978 980 982 984 986 988 990 992 994 Source: Danmarks Nationalbank and own calculations. COSTS OF PREMATURE REDEMPTION UNDER THE INDEX-LINKED SCHEME On acquisition of the index-linked bonds, Danmarks Nationalbank made the commitment that they could be redeemed prematurely at par. In the event of premature redemption, Danmarks Nationalbank must deliver the underlying bonds. If it is not possible to deliver the bonds, a debenture may be created whereby Danmarks Nationalbank takes over the debtor's and the central government's obligations vis-à-vis the bond owners and covers the future payments on the bond. If, at a later time, it becomes advantageous to purchase the underlying bonds in the market, the debenture may be cancelled. It is very difficult to calculate the costs of premature redemption at par. On delivery of the bonds the cost corresponds to the difference between the market price and par value after indexation. For a debenture the cost is not known until the expiry of the loan since future indexation is unknown. Since 997 debtors have redeemed 50 loans with a total index-linked value of kr..5 billion. In 29 cases Danmarks Nationalbank has delivered the underlying bonds on redemption. The loss on these redemptions has been around kr. 60 million.
45 It has not been possible to calculate the cost of the other premature redemptions. Stated as if the underlying bonds had been delivered, expenditure is equivalent to kr. 0.6 billion. Premature redemptions and thus costs on the scheme may still occur. COSTS OF THE SWAP SCHEME Under the swap scheme, Danmarks Nationalbank acquired the bonds at market price. The yield was, however, pegged to the "delayed" CIRR interest rate in a period of increasing interest rates. In addition, the CIRR interest rate is an average of lower-risk interest rates on government securities plus percentage point. This may deviate from the market premium for the liquidity and credit risk on ship loans in relation to government loans. It is thus difficult to assess the scope of interest subsidies in relation to a market interest rate. The loans under the swap scheme may be redeemed prematurely, and Danmarks Nationalbank must deliver the underlying bonds or issue a debenture as under the index-linked scheme. On premature redemption Danmarks Nationalbank receives the present value of the loan in dollars calculated using the current CIRR interest rate. It has not been possible to calculate the costs of the swap scheme, but presumably they have been limited. Premature redemptions under the scheme are still possible. CONCLUSION Danmarks Nationalbank's costs of supporting ship finance, and thus indirectly the costs of the central government via lower profit allocations, by no means give a complete picture of the socio-economic gains and costs. In the autumn of 983 a report was published on the socio-economic impacts of the ship-finance support schemes. However, there was no clear conclusion as to the volume of support as regards the value added and employment. It could be seen that Danmarks Nationalbank's capital loss in 982 was 37 per cent of the output value. It can be concluded that in spite of the various support schemes a number of shipyards have closed down, and the significance of the shipbuilding industry to the Danish economy has diminished significantly. This trend has also been observed in other European countries. Dansk pengehistorie (Danish monetary history), volume 4, by Richard Mikkelsen, 993.
46 APPENDIX: ELABORATION ON CALCULATION OF CAPITAL LOSS For the period 964-73 no statements are available of Danmarks Nationalbank's costs of acquiring the bonds at par. However, they can be approximated using the difference between the bonds' nominal yield and the market interest rate, the duration and the amount disbursed in the bond series in the relevant year. The loans were originally issued as serial loans with underlying bullet bonds with different maturities. There are no statements of disbursed loans in the bond series by maturity. Instead the duration has been calculated by breaking down the total loan in the series into serial loans over a maturity corresponding to the applicable maturity for the year in which the loans were disbursed. The maturity of the loans fluctuated between 7 and 8 years, and the yield between 5.5 and 7.5 per cent in the period. Consequently a duration of between 3.5 and 4 years has been applied. In the period 964-73 Danmarks Nationalbank received no acquisition commission, and it was not possible to defer amortisation. This simplifies the calculation of the costs in this period. It is not possible to break down the loan amounts disbursed in the bond series by loans under and outside the subsidy scheme. The latter proportion was, however, insignificant. This can be seen from the annual reports from DSF and by comparing the disbursed loans in Chart 2 with bonds acquired at par as published in Danmarks Nationalbank's annual reports for the period 967-77. (The bond's coupon rate the market interest rate) x loan amounts disbursed x krone duration.