2018 was Indeed a Forgettable Year for Shipping. Is There More to It?

So far in 2018, the shipping freight markets have been proven uninspiring; current freight indices produced by the Baltic Exchange, the Shanghai Shipping Exchange and other data providers are comparable to year-old levels, give or take some “normal”volatility; and, it’s well known that shipping is capable of much more than “normal”volatility.

Product tankers specifically, and tankers in general, seem to be the disappointment of the year in terms of freight – but still, as of late, crude tankers have managed a fair recovery on the back of OPEC strong production performance and changing trade patterns for crude oil. The dry bulk market have mostly been having a respectable year with profitable cashflows, with the exception of a recent dive in the capesize freight market. The containership market had been fair in the early part of the year, especially for feeder and feedermax tonnage, although, recently. only trans-Pacific freight rates seem robust as shippers are trying to front-load their cargoes to the USA in expectation of heightened tariffs in the new year.And, the offshore market, after several years of tranquility reflecting an almost dead market, in 2018 has shown signs of hope as offshore drilling projects(very) selectively having been coming back to line.

The following chart from the Baltic Exchange, to which we are a member, depicts the BalticExchange freight indices for the drybulk market (BDI), and separately for the capesize market (BCI), its most important and also most volatile component;  also, the Baltic Exchange freight indices for crude(BDTI) and clean tankers (BCTI) are shown in the same graph. In order to provide more perspective, the graph incorporates both 2017 and 2018 y-t-d, showing that 2018 has been marginally better than the year before, at least for drybulk and tankers, seasonal volatility notwithstanding.

Likewise for the containership market with the Shanghai Containerized Freight Index (SCFI):

All in all, on average, freight rates for most shipping assets were hovering around cash breakeven levels for most of 2018. Operating profits have been uninspiring, mostly, for the profitable sectors, while operating losses were too small to trigger fresh bankruptcies in unprofitable sectors.  Most of the shipping bankruptcies in 2018 were of “legacy assets” emanating – hard to believe – from the go-go days of the last decade. A couple more of shipping bankruptcies in 2018 were triggered from other factors such as accounting fraud– including one in the fishing industry to which we have acted as LiquidationTrustee by order of the High Court of the Republic of the Marshall Islands.

In a post from almost a year ago, we had argued that an uninspiring shipping market in 2018was the best thing the industry could have hoped for. Not that we objected to outsized profits in the shipping industry, or wished ill for those that had a “long position” in shipping. We just thought that there were too many ships on the water for the cargoes available to be shipped, and, also, we did not see a great deal of growth for those cargoes. Our position for a forgettable year, truth be told, also incorporated some wishful thinking, that an uninspiring market would prevent the players in the market from fresh excesses, such as fresh waves of newbuilding vessels, more and cheaper capital in the industry, and so forth. We are pleased that our “prediction” for a forgettable market has been proven true, and we apologize for the betrayed dreams and hopes for a much stronger recovery for the shipping industry in 2018.

A forgettable year in 2018, as a “downer” as it has been for the shipping industry, it also has, at the very least, led to a) the slowest pace of newbuilding orders in almost every asset class, b) a low outstanding orderbook for many types of vessels, and the lowest for some in recent memory, c) few new capital coming to the market to ignite d) speculation and speculative transactions. There seems to be some “normalcy”in the market and a return to the basics, of supply and demand and the following of the trade and cargoes.

As shipping freight markets are concerned, probably 2019 will not be much different than 2018. But again, there are many “drivers” and “catalysts” that can make for an exciting year in shipping in the new year in other areas than shipping.

And, holding our second shipping conference in Athens on January 24th, 2019, we will aim to deliver, once again, profound insight from the Captains of the industry, literally and metaphorically, for the things to come in the near future!

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A Wishful Port Called Consolidation

The maritime industry has been facing headwinds for almost a decade now: chronic tonnage oversupply, intermittent demand growth, new trading patterns, heightened level of regulations, new technologies and vessel designs, and more recently, the prospect of a global trade war.  It’s not easy being a shipowner, if ever it was.

Besides the obvious “academic” solutions of self-discipline when it comes to newbuilding appetite and accelerated schedule of ship demolitions, little can be done strategically to alleviate the industry’s woes.

Since the early days of the present decade, the concept of consolidation has been mentioned as a solution with the best hope for mitigating the industry’s problems. Conceptually, fewer and bigger owners could better sustain the weak times of the industry by sharing overhead and expenses across larger fleets, by having higher fleet efficiencies, and by affording more competitive access to capital; a market dominated by fewer owners can also employ strategic efficiencies whereby fewer players would be more disciplined at ordering newbuldings and also providing a united front against the demands of charterers.

Notable names of the shipping and the finance worlds have been advocating for industry consolidation for some time now, most conspicuously then-private-equity-shipping-investor and now Commerce Secretary Wilbur Ross. Proponents of consolidation have drawn their conclusions mostly from other industries than shipping, such as the steel industry in the case of Wilbur Ross; and, there is a strong body of academic research and case studies taught at business schools supporting the case of consolidation. On the surface, consolidation has saved the steel industry from chronic losses (although ironically part of the current trade war discussion is driven by the consolidated state of the steel industry having cost thousands of jobs). Likewise, the airline industry, via consolidation (and also chronic waves of bankruptcies), have reached now a point of high utilization and profitability, as any weary traveler can attest to these days.

No doubt there are economic benefits for the players in a market that has undergone consolidation; on the other hand, we think that certain markets and industries are more prone to consolidation than others, for many reasons.

Let’s follow the empirical approach to see what has happened so far in this maritime field:

Wall Street and institutional investors are big proponents for consolidation in the shipping industry. Image credit: Karatzas Images

In the tanker market, after Frontline’s failed effort to acquire DHT, the got critical mass to defend itself by buying the BW VLCC fleet, catalyzing, in turn, Euronav’s acquisition of Gener8 Maritime (itself the product of merger of General Maritime and Navig8 Crude Tankers). There is little merger activity in the rest of the crude tanker market, with the exception of Teekay folding two “daughter” publicly-listed companies into one, and also  acquiring the Principal Maritime crude tanker fleet. In the product tanker market, Scorpio Tankers acquired Navig8 Product Tankers in 2017, while recently BW took a bow with publicly listed Hafnia Tankers. If there is a lesson to be learned from merger activity in the tanker industry is that these are a handful of transactions among already sizeable players who are publicly listed and/or driven by institutional investors or financially-oriented managers behind them. The typical, average tanker owner has been least affected, or bothered, at least so far. However one slices the tanker market, there are almost 15,000 tankers of all sizes with a few thousand shipowner groups worldwide; if all these tankers and owners were to be consolidated into groups of big companies, investment bankers in shipping would be among the richest people on this planet.

In the dry bulk market, Star Bulk, publicly listed and driven by institutional investors, have been growing the size of their fleet by acquiring Augustea, Songa Bulk, and Ocean Bulk in the past. Golden Ocean acquired the Quintana capesize-focused fleet, and potentially the acquisition of the CarVal Investors dry bulk fleet by Good Bulk can be considered a case of consolidation; there are a few more meaningful transactions with privately held companies (most the Angelicoussis and Zodiac groups) acquiring massively, and surgically, shipping assets in the secondary market.  There is no doubt that there has been much more S&P activity in the dry bulk, but nothing to qualify as consolidation. The dry bulk market is often described as the textbook case of perfect competition, and as such, it makes little sense to buy (and retire) dry bulk shipping companies – the companies have little to offer in excess of  the stripped assets. Again, zooming out on the sector, consolidation so far seems to be with mostly sizeable companies, publicly listed, often driven by institutional investors, and almost always payment taking place – at least partially – in shares. There is still a very ‘long tail’ of small shipowners in the sector. And, there are more than 12,000 dry bulk vessels and several thousand shipowners active in the market; once again, investment bankers in shipping should be voted happiest people on earth if consolidation was ever to take hold in this market segment.

Just like consolidation in shipping, the bigger, the better… or, the sky is the limit! Image credit: Karatzas Images

Onto a shipping sector with a more disciplined structure, the containership liner market, it would appear that consolidation has offered a proven solution to this market over time; from almost thirty liner companies in existence in the early 1990’s, the number now stands at fourteen (14), a clear trend of consolidation over the last two decades. Again, there does  seem to be the same consolidation pattern of this market segment: most of these companies were big companies to begin with, often publicly listed or owned / managed by sophisticated investors in a market segment with relatively high barriers to enter; nothing new here. Looking onto smaller regional market players, the market has been much more fragmented, and allegedly ripe of consolidation. Some of these regional players are publicly listed or some of them run by investors and financiers, but it’s hard to discern a consolidation pattern on the surface. Probably the transactions that stand out in this sector are those of KG owners that are driven by shipping banks to consolidate, most notably MPC Container Ships, the Zeaborn and the Claus-Peter Offen groups that have keep absorbing smaller players such as Cido (containers), E.R. Schiffhart, Rickmers Linie, Ahrenkiel, Conti, etc (some of these transactions involved also MPP vessels).  And, there has been the absorption of many more smaller KG houses and vessels that popped up in the last decade jus because of the exuberance of the KG market in Germany. What all these stories of consolidation have in common, in our opinion, is that most of these target companies had their financial base completely wiped out, the management teams had no ‘skin in the game’ but mostly, German shipping bank have effectively forced ‘shotgun marriages’ (read consolidation) in this market. Otherwise, left to its own devices, it’s questionable how much consolidation would had taken place in this segment.

Despite the obvious benefits in the shipping market by a less fragmented ownership distribution, with fewer and more stable players, it’s still a very long way, in our opinion, for the industry to really get to appreciate consolidation. It’s been vividly implied in the discussion above that each segment in the shipping industry is driven by slightly different factors, but it’s abundantly clear that consolidation so far has been driven by a confluence of financial owners (this includes shipping banks) building up on the critical mass of already sizeable companies and where egos can be forced aside by the prospects of economic benefits and payouts, often in the form of paper (shares).

For the several thousands of shipowners worldwide, especially when they are the founders of shipping companies or have some sort of competitive advantage (captive cargo, access to terminals, etc), consolidation would be a tall order. Consolidation favors bigger players, but still smaller players can be shaping the market for longer than hoped for.

Darwinism in known to work, but it takes a notoriously long time; economies of scale make for more efficient shipping companies, but again, this takes time. In Darwinism, let’s not forget, some species become extinct. Probably for some shipowners, unless extinction becomes their only choice, consolidation will be getting little attention. The financial markets and shipping finance can impose their will on shipping forcefully, but likely consolidation in the shipping industry cannot be material in the near future, at least for commodity shipping.


Article originally appeared in Lloyd’s List on September 7, 2018 under the heading “Consolidation Players Go Hungry“.


© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

Karatzas Marine and Slide2Open to Host 2nd Shipping Finance Conference in Athens on January 24th, 2019

Building upon the successful inaugural conference held in February 2018 at the Intercontinental Hotel in Athens, Greece, Karatzas Marine Advisors & Co and Slide2Open are thrilled to announce that next year’s conference will be held on January 24, 2019. Save the date!

An expanded agenda on shipping finance, new environmental regulations, innovation and disruption, but also analysis of international trade and geo-politics, and an alignment of  speakers and thought leaders of the highest caliber in their fields, are guaranteed to render this conference a “must attend” event.

For more information, please feel free to contact us by email at:   info[at] bmkaratzas[dot]com or at info[at]Slide2open[dot]net or make sure to follow our blog for regular updates, or follow the conference website at Slide2Open Shipping Finance 2019!

© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

The Maritime Industry Hopes for Silver Lining as Talks of Tariffs Escalate

Talk of possible trade wars has kept executives in a wide range of industries at the edge of their seats; this is even more true for people in the maritime industry, which  afterall is the hauling provider on a global scale. Trade wars imply lower trade volumes, which would be a monumental concern to the shipping industry.

The New York Stock Exchange. Image credit: Karatzas Images

Intuitively, trade wars are bad for the shipping industry; tariffs and higher barriers to trade result in lower trading volumes that lead to lower demand for ships, and that, in turn, results in lower freight rates. However, nothing is as simple anymore in today’s world: higher tariffs can also lead to disruption of established supply chains, which, in the short term at least, can mean longer and less efficient paths between manufacturers and buyers, which could mean a lengthier than normal supply chain.  Talks of dismantling NAFTA, for instance, has led Mexican importers of grains to substitute imports from the U.S. with imports from other countries, primarily from countries in South America. U.S. grains to Mexico are mostly shipped from the ports of Texas and Louisiana to Veracruz in Mexico in a week’s long sailing voyage; however, Mexican imports from South America take twice as long to transport, and, all being equal, this shipping trade has been beneficial for the (international) shipowners.

Trying to assess the impact of possible trade wars on the maritime industry and try to plot an optimal strategy are in the minds of small and large shipowners alike worldwide. If a shipping company, for instance, was planning for an expensive fleet renewal, the potential of trade wars likely to be a cause to chart a new course of action. Who wants to be investing in expensive new ships when the prospects are less than rosy?

There are many permutations of possible scenarios of international trade wars as there are many variables; mostly, however, there are many theories and lines of thinking, as well as egos involved, and also grave political implications to consider, or ignore that could affect potential outcomes. On one extreme, there is the scenario for maximum tariffs on an international scale that could lead to a complete collapse of trade; at least for now, the probability for such a catastrophic scenario seems slim, thankfully. Focusing on the more likely scenario of small to moderate tariffs but where logic and economic sense would still drive decisions for the most part, it seems to be a more probable scenario.

A consideration to ponder is that the U.S. strategy so far seems targeted on imposing tariffs mostly on finished-products imported to the country, and such tariffs seem to be encompassing many industries and also being most disruptive to the supply chains; for example imports from China often have been sub-assembled in other countries and the supply chain in these countries is impacted too. China, Canada and Mexico so far seem to apply a more surgical approach by placing tariffs on mostly raw materials and commodities that concentrated political impact and relatively small collateral damage to the supply chain.

International trade bridging the seas… Image credit: Karatzas Images

Under a probable scenario of moderate tariffs and under the current modus operandi, different segments of the shipping industry will experience a varying degree of disruption.  The containership industry likely to experience a direct negative impact as import containers are mostly filled with consumer and other end products. Head-haul trade routes from China, whether to the West Coast or via the Panama Canal to the East Coast of the U.S. seem to stand at bull’s eye, but the impact  will percolate to other trade to Europe and other smaller traders localized trades. Earlier in the summer, there has been a noticeable increase of input volumes in U.S. ports and strong export data have been reported out of China; this positive impact has mostly been attributed to seasonality, as some of the peak season volumes were moved forward to dodge the first round of tariffs imposed in early July. The heightened trade due to timing considerations is expected to taper off and eventually volumes to tick downwards. Liner containership companies with their modern, huge boxships, especially those with focus on the China to North America trade, stand to be impacted most.  Localized containership markets that feed on the main trading routes had been the bright spot of the long-challenged containership market in the last couple of years, but now there are signs that smaller feeder containerships are getting off-hire at an alarmingly high rate.  It seems that pro-actively charterers opt to stop renewing charters in anticipation of reduced need for trade.

One of the great surprises in the energy world in the last decade has been the success of the shale oil production in the U.S. that potentially can make the country a net exporter for oil. Energy seemed to be getting a free pass from tariffs, but with escalating threats, now it seems to be fair game as well.  China and Far East are the biggest consumers of oil these days, and slowly the success of the shale oil in the U.S. was forming into a new trade of exporting crude oil from Corpus Christi in Texas to China via supertankers (VLCCs); this potentially could had been a game-changer trade for the crude oil tanker market given the large ton-mile numbers involved and also given the overall disruption in the trading patterns for VLCCs. This trade now seems in jeopardy, although just earlier in the week it was announced that Trafigura was still considering building a deep sea oil export terminal in Texas; but again, just this week, Chinese stated-controlled Unipec was suspending oil imports from the U.S., rattling the crude tanker market. To the extent that long term contracts will be honored or competitive pricing for U.S. shale oil can be obtained, there is a scenario of petroleum product tankers benefiting from the trade as well, whereby refineries will be focusing more on export trades. The U.S. natural gas LNG trade could also be adversely impacted by tariffs, and this is most unfortunate as the LNG tanker market desperate needs some hope in chronically oversupplied market; in addition, U.S. LNG export infrastructure is still being built up, and talks of tariffs possibly will stall some of these much-hoped-for projects.

The dry bulk market seems to be least impacted from talks of tariffs as the trade concerns mostly commodities and raw material used in the first steps of industrial production. For now, these trades seem safe, and, in the case of the grain trade to Mexico mentioned earlier, and grain trade worldwide, this would be a downright positive development for the shipping industry. Tariffs on Chinese steel will eventually catch up with China’s imports of coal and ores from Australia and Brazil and could negatively affect big-sized dry bulk vessels (capesize and Newcastlemax vessels).

The shipping industry is impacted by a wide range of factors, and the impact of tariffs is not isolated or easily quantifiable, and definitely at this stage, still much is unknown on how tariffs will be applied in terms of products, levels, reciprocity or exemptions, etc; on the other hand, no doubt some shipowners will find talk of trade wars a convenient excuse to blame for the industry’s and even their own companies’ structural problems.

Shipowners internationally have maintained a sanguine approach to talks of tariffs and trade wars. To a certain extent, this is understandable as the shipping industry has proven to do better at times of conflict, high uncertainty and interrupted trading patterns. On the other hand, continuous talk of trade wars can sap investment and trade sentiment, and trading volumes, that cannot be good for shipping. Or, anyone else.


© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

There is no Alpha (α) in Shipping

Companies, seen as going concerns, are usually valued as a multiple of their earnings or cash flows (selectively), reflecting that a buyer of a company will be generating profits in the years to come based on the business’ assets, contracts, reputation, management, corporate competitive advantage, etc Based on the nature of the business and market conditions, the preferred multiple can differ or modified to accommodate unique circumstances. Of course, there are exemptions to the rule. For instance, who could forget the dotcom years when internet startups where valued on “eyeballs” rather than actual cash flows, reflecting hope and ambition that the distant future will be rosiest?

And, then, there are ship-owning companies – on the other spectrum of company valuations. Shipping companies are asset-heavy entities since they own the vessels, expensive capital assets with long economic lives. The prospect is that these capital assets will be utilized to generate cash flows and earnings – and, logically, shipping companies ought to be valued of some multiple of cash flows or earnings rather than just the assets. Valuing a refinery company, for instance, at the cost of their plant value most likely would imply a liquidation or a fire-sale scenario and not a going concern.

For those paying attention to publicly listed shipping companies, the valuation metric is the so-called “NAV”, that is the Net Asset Value – that is, the current value of the fleet less outstanding debt (mortgages) plus cash in the bank or other tangible assets. That’s how publicly listed companies are valued, as the value of the “steel” (ships) with little immediate consideration for earnings. In general, shipping companies are valued at or below NAV – effectively, if one were to liquidate the business would end up with the same or more hard cash in their bank account. Philosophically speaking, being dead (liquidated) has a higher price than being alive (going concern); this does not exactly sound very inspiring…

Perusing a current research report from a major investment bank one sees that the mean stock price of shipping equities stands at 0.97x of NAV and the median at 0.87x; with the exception of two companies that have long term contracts for their fleets (MPLs in the LNG space) that trade above NAV, more or less, any other shipping company trades at a discount to NAV; even the mighty Maersk with its hundred-plus year old name, gloried history, global reach and household name “doesn’t get no respect” – below NAV valuation, too; one tanker company actually at the time of this writing trades at 0.60x of NAV, meaning that if the stock price per share represents $10 worth of shipping assets, the price of the share stands at only $6. Ouch!

Shipping freight rates fluctuate over time and shipping asset values move accordingly with some time lapse and a varying degree of correlation. And, it’s well known that, unlike other assets that only depreciate, shipping assets do also appreciate in price. In a hot freight market, ships get more valuable despite their age. Low NAVs follow weak freight markets and usually indicate the prospects of freight rates are anemic in the near future, which is the current state of the market.

Theoretically, from an investment point of view, there is an arbitrage opportunity and money to be made between undervalued shipping equities (buy the stock or sell the ships when NAV is low) or sell shares when stock trading above NAV; and there has been just a case of the management team of two affiliated publicly listed shipping companies that have presented to the investment community an arbitrageur model of making money in shipping, buying back their own stock when below NAV or selling their ships when overvalued. Unfortunately such an investment strategy has not played well in real life in this case; many reasons, in our opinion, that the arbitrageur model has not panned out well, but let’s say that real life in the shipping industry is more challenging than an investment proposal often assumes.

The paradox, and a disheartening fact, in our opinion, remains that shipping companies are valued according to the value of their hard assets. There is zip premium for brand name (or “franchise”) value, for intellectual property, for charters and other contracts in place, for intangibles, and, regrettably for management expertise. And, if one adheres literally to the valuation definition, a below NAV valuation implies that the company’s management team not only does not add value to the firm, but, in a sense, is a liability to the firm. One gets the firm cheaper than one can buy the assets. Ouch!

From an investment point of view, one could argue that shipping management teams offer little alpha (α) – the premium return over the market return. Their expertise, knowledge, efforts and hard work mean precious little when it comes to adding value; the shipping equity stocks move along the beta (β) of the market, without adding any value. Ouch, again! Unless, there are concerns with the agency theory

Shipping company management teams most obviously generate value by timing vessel acquisitions and disposals, mainly by buying ships when they are cheap or undervalued. Effectively, it’s a focus on market beta (β) and market timing versus capturing alpha (α) by building and running a superior business. And, by focusing on beta – instead of alpha – there is a re-emphasis of a trading model at the expense of an operating business model, one to focus on generating profits from running the ships and not trading the ships themselves.

Some have argued that the public markets with their short-termism, regulatory constraints and poor valuation metrics are not the ideal source of capital for the shipping companies. Irrespective of whether such criticism is valid, the shipping industry is ripe for a shipping company management team that will be able to provide a superior business model and convince the investors to value shipping companies on metrics that go beyond the value of the “steel”.


And, just for the record, Basil M Karatzas, Founder and CEO of Karatzas Marine Advisors & Co., is an Accredited Senior Appraiser (ASA) for Machinery & Equipment by the American Society of Appraisers.


Love the “steel”, hate the shipping stock! Image credit: Karatzas Images


© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

 

Where Money in the Maritime Industry Will Come From?

Ships are expensive assets, even small pleasure boat owners know. A small handysize bulker of 32,000 dwt has cost no less than $20 mil as a newbuilding even during weak markets; on the other hand of the spectrum, crude oil supertankers (VLCCs) currently cost appr. $85 mil brand-new, while LNG tankers cost almost twice as much.

Being a successful shipowner, therefore, requires access to capital, as plentiful and as at low cost as possible. Even flamboyantly rich shipowners do not have enough money to own outright their fleets (in most cases), and they have to depend on financial “leverage” and financial partnerships.

Banks traditionally had been providing most of the financing in the maritime industry; throughout business cycles, banks could be depended upon to provide 50-80% leverage, usually in the form of a first preferred ship mortgage – just like a bank would provide a mortgage loan for a residential property, with the asset as collateral. There have been dedicated banks to shipping (typically Scandinavian, British and German due to maritime history) and several more banks were transient in the industry when times were good. And, while easiness of financing varied depending on the phase of the business cycle, it was always available, as long as the shipowner had an impeccable record honoring previous commitments to the banks.

A decade after the Lehman Brothers collapse, banks are heavily regulated (although there is talk of late of loosening banking regulations, at least on one side of the pond), and ship mortgages and asset-backed financing are not the preferred line of business any more. In addition, many banks with shipping exposure are actively still selling shipping loans, trying to cut their exposure to the industry to nil. And, for many shipping banks with big losses from their shipping portfolios, it’s hard to convince senior management and shareholders on the appeal of the shipping industry these days anew; in some corners, shipping and maritime have become dirty words.

Besides small lending on a very selective basis by a handful of small banks for ship mortgages, so small that almost does not matter, traditional lending by the banks is a dead business. There is much more activity in terms of corporate lending to shipowners with big balance sheets and consolidated financials, and with long term and “bankable” charter employment, but there are relatively few such shipowners. The majority of the shipowners are smaller companies, trading their vessels in the spot market, and taking preponderous exposure to the vicissitude of the freight markets.

It has been estimated that shipping banks loan portfolios stood at close to $600 billion at the peak of the market in 2008, which is a very big funding gap to fill.

There has been a plethora of so-called credit funds entering the shipping finance market and aiming at filling the funding gap left behind by the shipping banks. Credit funds has been a new mania on the Wall Street, as such funds try to exploit the inability and inefficiency of the regulated banks to service small and mid-sized companies and companies that cannot “tick all the boxes” of a traditional lender. A recent article in the Financial Times states that between 2010 and now, credit funds based in North America doubled in capacity from app. $75 billion to more than $160 billion, so much so that “shadow banking” started being a concern. Credit funds active in shipping are usually funds dedicated to the industry and not part of multi-industry funds, and often are set up and managed by private equity funds and institutional investors with prior exposure to shipping. Fine print aside, credit funds usually charge at least 7% spread over Libor, with several of them well into double-digit territory. No-one expected credit funds to be as “cheap” as bank loans, but at 700 bps minimum margin, shipowners can barely claim that they have access to effective capital. After the honeymoon period of the first entrants to the market, credit funds cannot be the dependable source of capital the shipping industry requires, it seems.

Looking into equity, in the last decade, when the freight market was the best in a lifetime and equity markets were buoyant, there were several attempts of Initial Public Offerings (IPOs) by several shipping companies. Their track-record aside, public equity markets at present are looking for only large (billion-plus balance sheet, etc) and well established shipping companies with a “story”, hopefully a story of growth; for many of the smaller shipowners, the public equity (and debt) markets cannot be considered a source of capital, another dead-end for shipping financing.

Chinese leasing recently has been in the news as many Chinese lessors are looking into expanding aggressively in the international shipping market, and they have been active with sale-and-leaseback transactions. Although more bureaucratic than western financing, their overall terms are rather lenient – but again, for shipowners with sizeable fleets and consolidated financials.

Many industry experts have been contemplating what the source of capital will be for shipping. It’s really a very critical question to answer, and we think, it will affect the nature of the shipping industry in the years to come. Karatzas Marine Advisors & Co even held a shipping finance conference in Athens in early 2018 focused on just such question, and a follow up conference is already in the works for January 2019. Because of shipping finance (and also new regulations, etc), we believe that the shipping industry is at an inflection point where drastic changes are about to take place. Likely shipping in the next decade and the decades to come will be of a different nature, and that’s mainly because the nature of the shipping finance is a-changing. A great deal of shipowners will be materially affected by it, unless they start being pro-active right away.


© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

 

A Matter of Shipping Interest

Interest rates are on the rise. The Fed recently increased the so-called Fed Funds Rate by 0.25% and two more increases are boringly expected within 2018. There had been two increases in 2017 for a total of 0.50%, thus, in two calendar years, interest rates moved up by 1.25%. The Fed Funds Rate stands at 1.50% at the time of this writing, which is materially below the historic average. The 2yr Treasure Bill yields appr. 2.27% while 10yr Treasuries yield 2.80%, at the time of this writing.

In the short term, the US economy seems to be approaching full employment, and the risk of inflation (and higher interest rates) cannot be ignored. Of course, there are still many events, emanating both from the US and the international stage, that can affect economic growth, trade, employment, and the course of interest rates. Excluding a major shock to the system, it can be taken as a given that interest rates are on the rise for the foreseeable future.

Higher interest rates and higher interest cost can be good for regulated banks, but it can be detrimental to industries that depend on cheap financing to thrive. The shipping industry, we can all agree, is a capital intensive industry as it requires big investments upfront for the acquisition of shipping assets, and the cost of financing is crucial for the success of a shipowner.

Higher interest rates logically should be a negative development for the shipping industry: for higher cost of necessary leverage (ship mortgages) directly affects the bottom line – and, there are few shipowners who can do without leverage.

There have been few headlines in the shipping / maritime trade press about the higher interest rates. Not sure whether the news has been underestimated, or whether the shipping finance industry is so dislocated at present that rising interest rates are of little concern to the industry, but the subject has almost gone un-noticed.

Traditionally, debt financing in the shipping industry has been obtained from shipping banks in the form of first preferred ship mortgages, at LIBOR (the short-term interbank rate) plus the so-called spread, the lender’s profit margin. Interest rates obtained from shipping banks have varied over time depending on market conditions (interest rates, etc) and also the banks’ own appetite to expand their shipping lending business which has varied through business cycles. Although the loan from a shipping bank was “floating”, as the total interest rate varied with the changing-over-time LIBOR, the hedge desk from the same shipping bank would arrange – at the request of the client, of course – for an interest rate hedge / swap, so that the borrower could hedge, at the time of the loan inception, the interest rate risk. One has to note that the absolute interest rate was depending on two main factors, overall lending market conditions (LIBOR) and the banks’ appetite for shipping risk (spread), and these two variables were not necessarily in sync at all times. The other noteworthy observation is that a shipping bank was offering full service solution to the client, both the shipping loan and the hedge for the interest rate risk.

In the last several years, it’s widely known that shipping banks have been withdrawing from the shipping industry (anyone remembers the Royal Bank of Scotland (RBS) or even Lloyd’s TSB?), and credit funds have been moving into the shipping lending market. Given that institutional investors are behind such funds with higher return hurdles, the cost of borrowing from credit funds is much higher than that of the shipping banks. Still, credit funds express their interest rate offers in terms of LIBOR plus their spread over LIBOR, with usually the spread ranging in the 6-10% band. As a matter of comparison, traditionally shipping banks were (and, to the extent still active today, are) lending at 1-4% spread.

Reflecting… Image credit: Karatzas Images

No-one can blame the credit funds for being so expensive as their capital base is much different than that of a bank. [And, many would argue that shipping banks were mispricing risk and offering too cheap loans in the first place, but that’s a topic beyond the scope of this article, valid point nevertheless, in our opinion.] Also, no-one can blame credit funds that are not full service financial providers as they do not offer interest rate hedging, and shipowners / borrowers have to source it independently from banks, not an easy undertaking in today’s market when banks are disinterred in the shipping industry or in ad hoc clients and projects. The bottom line is that all ship mortgages and other debt financing instruments and transactions taken place via institutional investors are not hedged and most are fully floating and exposed to the rising interest rate environment. The cost is not inconsequential as 1% increase in interest rates reflects $27 per diem higher interest cost per each million borrowed; for a typical panamax bulker with a $10 mil mortgage from a credit fund, the 1.25% Fed rate bump in two years (included the expected twice in 2018) reflect $320 per diem additional daily financing cost, all being equal. For reference, the Baltic Exchange’s most recent report has BPI time-charter equivalent at $12,011 per diem (which incidentally is much higher than last year). $320 per diem incremental financing cost when the ship earns $12,011 per diem is not negligible, and this is still under an environment of well-behaving financial (and stock) markets presuming very rosy outcomes and being “priced to perfection”.

The shipping finance market is materially dislocated at present and the step-wise increases of interest rates by the Fed are a small problem to have in a much more challenging market. The concern however is that rising interest rates is a headache the market is ill prepared to deal with at present, and given that many borrowers (and lenders) are already stretched, there is minimal room for error. Anecdotally, we are aware of a couple of cases where shipowners trying to replace their 8% spread from credit funds with new financing, and not because they have expectations for lower interest rates.

It’s been a while since the shipping industry has been moving from one ring to a lower ring in what in business is called “vicious cycle”, when strategic errors keep compounding, further driving companies and the industry deeper into Dante’s Inferno.

Higher interest rates, in all likelihood, would push institutional investors and credit funds to increase their spreads as well, as now, in a new interest rate environment, their expected returns have to increase as well. Credit funds may theoretically opt to compete with each other on price (spread) in order to gain market share, or possibly decide to curtail their lending activities in shipping, neither option being a great outcome for the shipping industry.

Rising interest rates is not a laughing matter for the shipping industry, especially for the shipowners who went on the limb to borrow expensively in the hopes of out-running the business cycle. We would expect more news (and honestly more advisory work) from these developments.

Calm seas but not calm shipping… Image credit: Karatzas Images


© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.