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.

 

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Boats of the Highly Levered Seas

There used to be a time when the financing options for a shipowner where simple: seed capital was levered with a ship mortgage from a bank, and the loan was paid off based on an agreed-upon principal repayment profile from the operating profit. The terms of the shipping loans from banks were very similar and often the only differentiating factors for shipping loans were a few quantitative factors, principal among them the so-called spread, the difference over Libor for the cost of the debt.

Obviously, for any rational borrower, the lender with the lowest cost (interest rate) would get the business. When all things were equal, it was easy to note the sole differentiating factor, and push for the lowest number. Borrowers (shipowners) did not really have to create an “indifference curve”, their optimal set of choices. The leverage was in the 60-70% of FMV, the terms and covenants comparable, and thus the choices were limited. The “product” was one-dimensional and business was earned on the lowest spread.

Now that we live in times where by necessity there have been more types of capital than seed capital and traditional debt, such as alternative capital, mezz, senior and junior debt, etc, there is a greater opportunity to see the choices of preference for the shipowners.

There are funds that provide senior lending at only 500 basis points (5%) over Libor, but they do so at rather conservative terms, such as by lending in the 50-60% range of the FMV in today’s depressed asset pricing market environment. We would think that such financing is both cost competitive (in absolute terms) and also acts as prudent financial gearing for an owner to maximize returns and stay flexible when market conditions turn bad.

On the other hand, there are funds that provide close to 80% leverage, or even more, but at much higher cost, typically in the 8-12% range plus expectations of profit sharing, etc. The financial gearing is almost as sizeable as in the go-go days of the stratospheric market of a decade ago, but such levels of financial gearing add a lot to the costs of running profitably a vessel, and also multiplies the risk that when markets turn bad, the whole financial structure will not stand for more after the first few waves of the crisis reach the beach.

The options outlined above are as distinct as they can get, and although there are a few shades of gray between these two opposites, borrowers (shipowners) seem to gravitate to either of these polar opposites in terms of debt financing. And, watching shipowners make choices in the present market offers some insights on he direction of the market, the utility curves of the shipowners, their willingness to pay at various ranges of the curve, their risk appetite or risk aversion, and the inflection points thereof.

Even after the debacle of the last decade and the massive decade and rather fair prospects looking forward for shipping, there is a clear trend whereby shipowners prefer the high leverage, high cost (and high risk) option set over the low leverage, low cost (and low risk) alternative. There are many more shipowners who would rather borrow 80% of the value of a ship at 8% (spread) interest than shipowners who would borrow 55% at 5% (spread) interest. Credit funds and lenders in the former category are much more active than lenders in the latter camp.

Stephen, the Roaring Lion. Image credit: Karatzas Images

Apparently, shipowners (borrowers) seem to think that this is a time for “risk on” investments and thus higher financial gearing (at higher cost) makes sense. Asset prices, in the dry bulk market especially, are up by 30-50% on average in the last eighteen months, and thus, allegedly a high stakes strategy has paid off. Improving world economies and trade, and a historically low newbuilding orderbook add more fuel to the argument. But, playing the proverbial devil’s advocate, adjusted for risk, is a 50% asset appreciation investment justified on an 8% cost of debt?

In general, over the last decade, cost of capital (mostly debt) is going up in shipping. Interest rates have gone up, especially when they are expressed in terms of spreads. And, leverage overall has come down in shipping in the last decade. Likely, when shipowners (borrowers) are slowly adjusting their financing cost expectations, they seem to focus more on (and prefer) higher gearing at the trade of cost. In a theoretical binary choice of “give me more leverage or give me lower cost”, they are for the former, hands down. It may be that it takes a lot of time for habits to die?

High leverage at high cost has its risk, as mentioned. Already there are several transactions in the market where borrowers have already run into trouble and they desperately look to refinance high-priced transactions based on this structure. There are ships that have been arrested or are very close to arrest, ships financed with high leverage at high cost. And this is at a time when 2017 and 2018 freight rates are dreamboats of the 2015 and 2016 monster freight markets. Thus, in a relatively decent freight market, these high leverage preferences do not seem to always work out very well. We are afraid that after the debacle of private equity investments in 2011/2014 going sour in a major way and resulting in massive write-downs, the industry is setting itself up for another round of misguided investments powered by institutional money.

Shipping is a unique industry with its high volatility and risk at an operational level as this can be counted by the spot freight market (in the last eighteen months, BDI has been up by a factor of 5 but down 40% in the last month or so). Financial gearing over operational gearing can easily get out of hand.

But again, how fortunes have been made… or…

Stitt, the Quiescent Lion. 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.

Disruption Has Come to Shipping

agw/wp/ucae/wog.

Only if I had a penny every time I had to spell out these terms to a financier dealing with commercial terms for the delivery of a vessel. It sounds almost like gibberish, but for those in the knowing, these are very clear terms and have saved many a shipowner or charterer from undue legal headaches. (For more shipping abbreviations, please see our S&P blog here!) These abbreviations are standard language and stand for All Going Well / Weather Permitting / Unforeseen Circumstances All Exempted / With Out Guarantee. They are the remnant of past reality, when Telex was the primary way of communicating commercial information in a time sensitive manner, and, text transmitted was charged by the number of the charterers consisting it. Really.

This was a time when people had to economize with their words due to technical and accordingly economic considerations. Had to be succinct since additional characters cost money; then, the telefax replaced the telex and transmitting was charged by the page, and eventually email has become the prominent way of transmitting information, which effective is free (besides a nominal monthly fixed cost for the connection). For those nostalgic of telex, Twitter had set a limit of 140 characters (now 280), but this was for other than economical considerations. And, the 280-character limit, Twitter does not stop someone for blabbing all they want; again for free.

The Internet has been changing the way the shipping industry is functioning. For starters, business has become much more transparent and efficient, and so far has affected the economics of auxiliary services such as ship-brokerage, charter brokerage, supplies and victualing, etc It has also affected documentation and certification for statutory and regulatory inspections, maintenance, communications, cargo and commercial documents, etc And, in the next phase of technology, the actual operations, management and trading of the ships are coming into focus.

When the Internet was “invented” in the 1990s and for the “dot com” mania, technology was still a novelty; too bulky and still very expensive in terms of computers and computer code, and, quite frankly, shipping was not the ideal industry for B2B (business-to-business) applications to start with. Two decades onwards, the cost of technology has come dramatically down, there are many app developers knowledgeable with new platforms, and more importantly, there has been a universal push to employ technology for both substituting for routine business and mainly “dig data” for making informed decisions. In the last decade, technology has had only an evolutionary impact on the shipping industry; however, looking forward, the impact can become revolutionary, or as they say, “disruptive”, in the sense it can disrupt existing industries from doing business “as always have been done”. Disruptive technologies effective force established industries to do business on a new set of economics and market drivers: physically hailing a taxi but now booking car service via an app (known standards of safety, security, timing, pricing, service, etc, with possibly automated cars in the future) is one of the most simplistic ways for one to understand “disruption”.

The impact of technology so far has been subdued and only limited to certain, well defined areas such as automation, digitization, etc It has just been complimentary to the industry by providing efficiencies and cutting costs, sometimes at the expense of shifting business models for a few complimentary service industries. However, looking forward, it seems we are almost of the cusp of major paradigm shifts that can change the market. For instance, brokerage – whether S&P and chartering – could be completely substituted by online platforms. What would stop a charterer from posting their business online and then get to choose the best bidder (ship) at the optimal price? What would stop a shipowner from posting their ship online for sale once the decision is made to divest of the asset? All these are commoditized products (cargoes, routes, ships, etc) and once a platform attracts critical mass, the market becomes much more efficient. And, execution of contract on an online platform, is just a formality.

As ships and cargoes getting connected, “Internet of Things” (IoT) can help with more efficient transport and optimizing the supply chain (translating to lower shrinkage, pilferage, spoilage, etc and of course lower financing trade costs). IoT can help from preventive maintenance onboard ships to minimizing to cost of repairs, but mainly can lead to automation of shipping and effectively to man-less ships. If airplanes with human cargo can be trusted on auto-pilots for most of the flight, it’s hard to see what would stop ships from navigating the seas on their own. And, one step further, “big data” and artificial intelligence can allow for predictive analysis of business trends and expected cargo movements. Probably, all these sound like a sci-fi scenarios with a remote hope of application. Instead of a counter-argument, one has to pay attention to a modern automobile and try to draw similarities to shipping. If a highly regulated and fragmented industry (automakers) with a much higher degree of human interaction can see their way to driver-less cars, it would not be too hard for ships to follow. Naval engineering remained a “bulk” and material-heavy discipline for the last several decades, just like cars used to be at Detroit’s glory days; however, a shift to more intellectual power is seems to be coming.

Ships are very expensive assets and often industry players prefer to stick with what it’s known and proven rather than take un-necessary risks; it’s an applaudable approach, but again, there is a paradigm shift when one has to jump into the future. Imaging being the last shipowner who built the last clipper ship only to see the steam engine cannibalizing the market. Change will come irrespective of the hesitancy by shipowners because other industries and companies from other industries will force their way on shipping. It is estimated that one-fifth of the containerized cargo moves on account of Walmart. While Walmart has taken a more cavalier approach to transport, Amazon has been much more aggressive and technology savvy. While at earlier stages, Amazon was completely dependent on UPS and FedEx for their shipments, now they building their own fleet of cargo planes and vehicles and hiring people for deliveries, just a step before deliveries with drones. It’s only a matter of time before Amazon will start shaking the containerized shipping industry. Would one think that other bulk commodity owners such as Vale, etc will not play the game?

Disrupted long time ago… 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.

 

For the Shipping Industry, a Matter of Interest and Indebtedness

Ever since shipping banks (and banks in other industries) have been curtailing their lending to shipowners (and for other banks outside shipping to small and middle-market companies), there has been a big funding gap, a market need, that has to be filled for the economy to grow. Many credit funds or alternative capital funds have popped in shipping that lend money for those who look for financing to buy or refinance ships. On a broader scale, many brand-name private equity funds have been setting up credit funds in order to serve the market need of lack of debt financing in numerous industries; with more regulation for banks (among other things), un-regulated lenders step in to serve the market.

There are substantial differences in the way a bank evaluates a loan in shipping than a credit funds approaches the market; although effectively they both look to undertake credit risk (they both lend money), there are always more types of risk entangled around credit: asset risk, operational risk, counterparty risk, etc No doubt that credit funds, as non-regulated lenders typically, have much more flexibility of the structures and the terms of the loans they can underwrite. For starters, credit funds can also take a little or a lot of residual asset risk (balloon payments, etc), market risk (profit sharing, etc), asset risk (finance older vessels, etc), that is, they can think outside the “credit risk” box and provide commercially more flexible structures (of course, at a higher cost of capital.) Also, since credit funds are not regulated, when there is a default of a loan, there is no reporting to a regulatory body which would have consequences on ratios and strategy; a credit fund would have the precious luxury to convert late payments to equity or accept payment-in-kind (PIK) or impose a higher profit sharing scheme and eventually take over the asset, if things really go bad. To be sure, a default for a loan is a painful experience for all those involved, for the shipowner / borrower of course, and also for the financier / creditor, whether the creditor is a regulated bank or a credit fund as practically no-one wishes for such an outcome of default (unless the lender is really a niche vulture fund specializing on feeding on carcasses and liquidation, but honestly, this is the exception than the rule.)

The typical credit fund these days would charge approximately 8% interest for a first preferred ship mortgage; for some, this is expressed as annual interest in absolute terms, but for others, it’s the spread over Libor (L+800 bps), meaning that the borrower also undertakes interest rate risk (at a time when the Fed and other central banks shifting to a tightening mode.) The amount of leverage is dependable, but most likely it populates in the 60-70% range, inlying that still a respectable percentage of equity is required; of course, more equity means that the shipowner has to be selective with their projects and also that the credit risk for the creditor goes down as the percentage of equity goes up. Although some credit funds can accept a bullet payment of the principal (under certain circumstances), a certain level of amortization is required for most cases. And, there are the usual assignment of earnings, minimum value clause, minimum liquidity clause, negative covenant clauses, and also pledge of shares, undated signed director resignations, and, more frequently these days, demands for a personal or corporate guarantee. All in all, the loan terms these days seem to be the extreme opposite of the easy credit days of a decade ago of name lending and loans agreed on a handshake.

Although a few short years ago shipowners would never had conceded to a first preferred ship mortgage with an interest rate above 4-5% or other funky terms, these days there are few options, and thus the reason that 8% has become the prevailing cost of the debt for ship mortgages. Different types, different norms, as said before.

For a theoretical example of a five-year modern panamax bulker valued at $22 mil and 65% leverage and five year term, at 8% annual interest, the daily interest payment alone is appr. $3,000 per diem; presuming that there is a requirement for the principal to be amortized by 50% over the term of the facility, then another $4,000 pd had to be added to the financing payments. Based on a back-of-the-envelope assumption of $6,500 pd vessel daily operating expenses, the cash expenses for operating such a ship range from $9,500 – $13,500 pd; just as a reminder, only in the last eight months panamax freight rates sustainably moved above $10,000 pd, meaning that many borrowers, at best, they were breaking even in the last eighteen months. Of course, there is the hope for higher asset prices and higher freight rates, but, as they say, hope does not make for a good business plan. This model of 8% cost of debt financing would never work with modern, expensive ships (as the interest payment would become exorbitant in today’s freight market), while older tonnage (to the extent that a credit fund can be enticed enough to consider it) has more favorable economics.

There are a few corollaries to the prevailing market practices that need come elaboration:

  1. the cost of debt financing has moved to such high levels that it’s barely economically feasible to undertake new projects or buy ships for the smaller, independent shipowner
  2. borrowers undertake severe interest rate risk at a time when interest rates are moving higher (unlike a shipping bank with its interest rate swap desk that offered a full package, credit funds do not offer such service, and the borrower has to search a dis-incentivized market for this product for effectively project finance and small amounts)
  3. there is a lot of risk for both the borrower and the creditor under such scenario of high interest rates, and it will not take much for many of these financing projects to be underwater, so to speak
  4. as several more tight covenants have been added to these types of loans, in the event of defaults, it can be really ugly; if the overall market turns south (an unlikely scenario for now, but as we have learned, in shipping even unlikely scenarios are probable), there will be a massive cascading problem (credit funds will not be as cavalier as shipping banks with arresting ships, but then how they would be operating them or sell them in a declining market?)
  5. with so many credit funds having been set up for shipping, potentially there could be the possibility of them having to compete and lowering their standards in order to gain business; we are well aware of at least one credit fund that between April and October 2016 made a complete U-turn on their credit underwriting as they could not get one deal done.
  6. as cost of debt financing is too high, many financial sources keep looking entering the market which likely would undermine the credit fund market; we are working with a Chinese-originating fund providing first preferred ship mortgages at 5% interest for 50-60% leverage and very normalized covenants.
  7. disappointedly, for credit funds being private equity funds and well versed in structured finance, their proposed structures are extremely monolithic and inflexible, which will cost them a lot over the long term; being unregulated and flexible, only imagination could limit structures where they could make big returns if they were willing to be flexible and exchange some credit risk for some market risk and some asset risk and some residual risk and some counterparty risk and some… All credit funds have been pigeon-holed into credit, they compete heads-one with every other credit fund, and the only reason they do business now is that shipping is desperate for capital; this market could easily move away. But again, most of these credit funds have been run by former shipping bankers with some trying to exonerate themselves for the shipping bank mistakes of the last decade…

For now for sure, shipping debt is an interest-ing market to watch…

For some, a foggy market… One World Trade Center in Downtown Manhattan. 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.

Is the Dry Bulk Tramp Shipping Industry at an Inflection Point?

As punishingly brutal as the shipping industry can be in bad times, it’s fulfillingly rewarding in good times. Who can forget the days from a decade ago when capesize bulkers were earning $250,000 per diem and the ships themselves were changing hands in excess of $150 million? We are a long way from those good old days but memories of and even hopes for prompt arrival of great times keep many a shipowner persevering in this business. It’s known that sweet memories and often hopes have on occasion been used to spruce up many “investment theses” in investment presentations.

The dry bulk tramp trade – whereby ships do not sail on a fixed schedule or published ports of call – has long been considered a textbook case of perfect competition in economics with its low barriers to entry and exit, minimal government and regulatory interference and taxation, an international market of price-takers for an un-differentiated product where no individual player – whether shipowner or charterer – has controlling influence on the market.

In such an individualistic market environment, fortunes have been made – and occasionally lost – when independent shipowners took timely risks and positioned their companies favorably on the dramatic upswing of the business cycle. Now that the dry bulk market is closer to the bottom than the peak of the cycle, there are calls to take risks for a market upswing.

Probably the timing is opportune for buying bulkers in expectations of an upswing in the market but one has to consider whether the dry bulk tramp market still is a market adhering to the rules of a perfectly competitive market. The last decade has seen many fundamental changes in the market that one has to wonder whether the old playbook is still working.

The greatest barrier to entry the shipping industry has been capital, given that this is a capital intensive industry. However, in past times shipping banks were providing generous financing in terms of financial gearing (leverage) and covenants, and even there have been cases of “name lending” and financing agreed on a handshake. Now that shipping banks have been departing the industry, and with the capital markets veering away from project finance and commodity shipping, private equity and other institutional investors have been depended upon to provide capital to shipping but at a much higher cost of capital, tighter terms and covenants and often for a share of the economics. The barriers to entry in terms of accessing capital have definitely been affecting the industry in an adverse way, in this respect.

In reference to government interference and regulation, for vessels having open registries (flags of convenience), the burden is still low in comparison to other onshore industries, but one can see the writing on the wall of higher regulation (and higher costs.) Emissions and the quality of bunker fuel have been making headline news in the last year resulting in both a higher financial component to the business and also technological and regulatory risk. Likewise for ballast water treatment plans, past the official deadlines, technology and approvals only now are getting sorted out. Likely, there will be higher risks for safety and security and ensuring that ships and the seaways supply chain are supported by hack-free systems (ransomware NotPetya have cost Maersk a few hundred million in losses in their last quarterly report, while the possibility of “hacked” ships became a prominent scenario in a recent wave of collisions involving US Navy ships in the Pacific.) And, while offshore registered vessels are taxed on the so-called “tonnage tax” system, many revenue-challenged jurisdictions and taxpayers have been taking a second look on the substantial differential in taxation in reference to domestically registered shipping companies and the potential loss of revenue. Taxation is a risk routinely mentioned in the prospectuses of all publicly listed companies in the US-capital markets and that the current favorable treatment by the IRS cannot always considered to be “a sure thing”. Thus, in an increasingly burdensome era of regulations (environment, safety, security, etc) and taxation, another of the legs of perfect competition seems challenged.

In theory, the “product” that dry bulk shipping companies “sell” is a “commodity” and “interchangeable” as all dry bulk shipping companies offer the service of transporting cargoes in bulk over the sea; as simple as that. And, although there are many charterers who only care for the basic good of cheap transport, an ever increasing number of quality charterers demand more than the “basic” service of transport: they demand quality ships and proper management systems and real time reporting and accountability, and also solid shipowners and managers free of financial risk of default. Thus, the “product” of the tramp dry bulk shipping slowly becomes less commoditized and more of a “service” whereby now ships and shipowners are not exactly interchangeable. Quality ships run by quality managers are preferred by charterers, but they still earn market price; and, in order to be profitable at market prices, critical mass of a fleet is required in order to access capital and also spread the overhead among a larger number of vessels. Thus, another tenet of the perfect competition model that dry bulk is a “commodity” good is slowly challenged.

At the end of the day, dry bulk shipowners in the tramp trade are “price takers” and will take what the market pays as there is little pricing power; again, a perfect competition characteristic. However, the case of just buying cheap ships and wait for the market to recovery will not necessarily hold true in this new market environment. One has to wonder whether the tramp dry bulk market, as a precursor to other asset classes – is slowly approaching an inflection point where “value added” services would be a differentiating factor.

“Hope is a good thing, maybe the best of things, and no good thing ever dies”, as the quote goes, but one may has to start thinking that just hope alone of a market recovery similar to recoveries in previous business cycles may not be the case.


Article was originally was published on The Maritime Executive under the title “Is The Dry Bulk Tramp Market at an Inflection Point?” on December 1st, 2017.


Dry bulk vessel about to go under a bridge. 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.

Sailing Winds on Wall Street

Shipping is an industry full of surprises. And, volatility. While until February this year the surprise mainly had been about the really terrible state of the freight market, the last few months have shown a tendency for the market to surprise on the positive side. Freight rates for the dry bulk market have moved to cash-flow positive levels in the last few months and tanker freight rates have been fair despite some relative weakness.

It’s a long way from saying that the market has recovered, no doubt. Many shipowners still remain in financial distress and several of the options available to shipping banks can only have adversarial impact on shipowners. But again, when shipping has been in a miserable stage for the last eight years, there are no overnight cures – short of a major macro or geopolitical event.

Besides freight rates, the overall mood for the market seems to be improving; we do not mean only shipowners, who by nature are always an optimistic bunch and they seem pre-conditioned to be looking to buy more ships – always. The capital market seem to have gotten a sense of euphoria too after the presidential elections in the US, whether on a sense of a perceived catalyst of definitely a new approach to governing or on the hopes of an infrastructure investment spree. The fact that capital markets didn’t melt after the results of the Italian elections last week is a further sign of pervasive optimism.

And, we are glad to see that market optimism getting tangible for shipping companies, especially for publicly listed companies. After several years of a bone-dry draught for IPOs and secondary offerings, the last month, just in time for the holidays, brought several successful fund raisings. Most recently, Seanergy of Greece (ticker: SHIP) raised $15 mil in a secondary offering and Safe Bulkers still of Greece (ticker: SB) raised $14 million the week prior; both companies are active in the dry bulk market and intend to finance vessel acquisitions with the proceeds. A couple of weeks ago, Costamare of Greece (ticker: CMRE) raised $72 mil in the containership markets and Höegh LNG of Norway (ticker HMLP) raised $106 mil in the LNG tanker market. A month ago, Saverys in Belgium raised $100 mil in the US for a blank check (SPAC) to acquire dry bulk vessels via their Hunter Maritime Acquisition Corp (ticker: HUNTU) investment vehicle.

The amounts involved are a small fraction of the golden days of the capital markets for shipping companies a decade ago; however, until recently it has been a very quiet market in the capital markets for IPOs and secondary offerings for all types of companies. However, this is a positive development under any light seen. All the offerings mentioned above took some serious effort and / or a serious management team and sponsor behind the companies to raise the money; and still, some of the raisings took place at a discount to the market. Thus, not all news is as rosy and sunny as they appear. However, again, we want to take the view that a successful raising today for shipping is a major accomplishment irrespective of the circumstances. These are five successful attempts for different amounts of money and circumstances and in three different industry segments, two of which (dry bulk and containerships) were left for dead four months ago. It shows in our opinion the resilience of the capital markets and the investor appetite for shipping overall. To that extent, we tend to take the view that the news is just fantastic!

Hopefully the momentum will continue and there will be more offerings in the new year. And, hopefully, any fund raisings will be utilized to build solid shipping companies or strengthen balance sheets of shipping companies and the capital markets will not serve as a fodder for speculative newbuilding orders as it happened a couple of years ago, a course of action that has been detrimental for both the instigators and innocent bystanders whereby the freight market crashed under the burden of huge tonnage oversupply. Hopefully there is a lesson to be learned here.

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Smooth seas… Image credit: Karatzas Images.

Another lesson to be learned too, hopefully, by the recent developments is that the capital markets, especially the US capital markets, are deep and substantial and can be depended upon for shipowners to keep raising money; as long as they have solid management teams and transparent corporate governance and decent business plans. All the companies mentioned above successfully check almost all of these points. Taking a broader historical view of the capital markets and shipping, there has been a wide and diverse populace of shipping companies that opportunistically went public in the last decade and now a few of them ended as penny-stocks or and others soon will be delisted. One cannot blame the market for some of these companies falling into hard times, but there is plenty of blame to go around seeing the management of these companies aggrandizing for themselves by exorbitant executive compensation packages, usurious vessel management agreements and plain old-fashioned self-dealing. Hopefully the present success of shipping companies raising money will be a painful reminder to some of the ailing companies that greed is not always good as it can kill the goose that lays the golden eggs.

We long have taken the position – and have advised our firm’s clients accordingly, that shipping finance is facing structural changes; the old model of committing to lending in shipping based on a hand-shake is extinct. Raising money from shipping banks is and will be getting tougher and more expensive. Capital will be coming to shipping in different ways (capital markets, etc) whereby only few owners will be able to benefit from. The work for shipowners adjusting to the new market circumstances is not done yet.

As we said earlier, we are a long way from a market recovery.


Disclaimer: Karatzas Marine Advisors & Co. has advised or otherwise has been involved with some of the market transactions referenced above. This article is strictly intended for information purposes.


The article was originally appeared on the Maritime Executive under the title “Setting Sail (Again) on Wall Street on December 13, 2016.


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Where the winds are strong… Image credit: Karatzas Images

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.

Shipping is Sailing Against Trade Winds, and Other Protectionist Concerns

With the dry bulk freight market limited to bouncing along the bottom for now, most of the resources – when not afforded for ships to (figuratively) stay afloat – are devoted at buying dry bulk vessels at cheap prices in the secondary market. It seems that everyone is convinced that asset prices at present offer a unique investment opportunity not to be passed up. After all, freight market weaknesses come and go, but markets of cheap ships do not present themselves often.

The weakness of the shipping markets is mostly attributable to tonnage oversupply, whereby there are just too many vessels chasing few cargoes. In general, demand for vessels – that is trade and cargoes to be transported – is only un-inspiring at present. The main concern is that there are many more ships than cargoes, but trade is still existent, just not robust enough to employ all available vessels. Too many vessels were built because of too much speculative investment in shipping, and also because of too much available liquidity and that, at a very low cost.

Most potential buyers of ships believe that there will be tonnage equilibrium as soon as older vessels and less efficient vessels find their way to the scrapheap. Thus, effectively, it’s a matter of timing and awaiting for the immutable laws of nature to work their unique rejuvenation of the markets by way of aging. After all, it often has worked out just like this in previous business cycles in shipping. It’s true, newbuilding orders have diminished in the last year while scrapping has been as strong as it has been in the last seven years; thus, tonnage supply is coming down, and that’s easy to verify in most cases.

Demand for shipping is a much more convoluted analysis since there are too many commodities and cargoes and trading patterns, and permutations thereof, to analyze. Then, one has also to take into calculation macroeconomic factors, political events, possibly technological developments, changing consumption patterns, trade barriers, etc, and all of them, to varying degrees of seriousness, affect demand for shipping. Quite frankly, often analyzing demand for cargoes (and shipping) in detail resembles the so-called the Butterfly Effect model.

Trying to view demand for shipping from 10,000 feet, one has to identify the long-term trends and ideally be on the ‘right side’ of those trends. As a rule of thumb, growth for international trade is twice as much as economic growth (GDP), as commodities, raw materials and finished products have to pass international borders often to reach the end consumer as the economies grow. Further, growth for international trade declines much faster than economic growth in decelerating economies, while growth for international trade increases much faster when economies grow. It’s intuitive, as, when an economy is slowing down, need for trade comes down fast, while as an economy starts growing again, there is fast demand for trade for products to be brought together and reach the end consumer. The fact that the IMF and OECD keep revising downwards world economic growth has not escaped the shipping markets that have been trading at almost all time lows.

While we all hope that there will be robust economic growth soon enough to save shipping, one has also to pay attention to the fact that international trade thrives when there is a receptive ground and open-minded trading partners. And, international trade, much glamorized by free-market economists, demonstrably has been exerting a positive outcome on our societies. But often, international trade has to get clearance by politicians, and from their voters. International trade agreements can formalize trading relationships among geographic regions or bloc of countries, and make trade easier to happen. While the World Trade Organization (WTO) is the large overreaching umbrella for trade worldwide, trade agreements can be negotiated at local levels by countries or group of countries. The EU started as a quasi-trade agreement and has evolved into a political union (its end results to be seen, however), while most readers in the US can recall NAFTA, the North American Free Trade Agreement, between Mexico, USA and Canada, and its eventful passing despite the ‘giant sucking sound’ warnings of jobs lost to the south borders of the NAFTA countries.

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Shipping keeps an eye on trade patterns

On a macro-level, one today has to notice a wave at the international level whereby voters have been turning much more ‘isolationistic, nationalistic and ethnocentristic’ and against (free?) movement of people and cargoes. For instance, just recently British voters opted for Brexit, which, while driven by desire against free movement of citizens within the EU, eventually will have to have implications on movement of goods, if and when Brexit gets to be implemented. Most definitely this is not a positive development for trade and for the shipping industry, especially given the fact that Great Britain has historically been a beacon for openness and trade, being an island nation with long tradition in and institutions for maritime and trade. Moving on to the Continental Europe, there have been reports that in the State of Bavaria in Germany there is very strong anti-trade sentiment against CETA, the Comprehensive Economic and Trade Agreement, between the 28-nation EU and Canada, finalized in 2014. And, in the USA, while the Obama administration has spared no efforts to fast track the Trans-Pacific Partnership (TPP), both presidential candidates – including his presumptive legacy preservationist Hillary Clinton – have come against the trade agreement. One cannot be sure of the outcome for these trade agreements, especially since they seem to be driven by voter angst against migrants from poor regions and/or possibly terrorist risk underlining, but the writing on the wall is clear that free trade is a ‘zero sum game’. Irrespective of one’s political or philosophical inclinations, trade and shipping will have to face some headwinds, at least in the short term.

Intra-region free trade agreements (FTA) such as ASEAN (Association of South-East Asian Nations), RCEP (Regional Comprehensive Economic Partnership), MERCOSUR and UNASUR in South America seem to be faring better, but these being localized agreements, their big impact on global trade (and shipping) is rather limited.

If there was ever any doubt on the beneficial impact of trade to shipping, in the following graph we present trade data from the WTO website, for total world exports and for exports from the USA and China starting in 1980 (in 2015 US$ value). China became formally member of the WTO at the end of 2001, and it’s apparent that trading values have increased for the world, USA and China since 2001. Of course, increased growth in trade since 2001 cannot totally be attributed to China’s ascension to WTO, but there is no doubt that China has been the primary driver. On the same graph, on the right scale in red, the annual averages for the Baltic dry bulk market (BIFFEX and BDI) are shown, and it’s clear that since 2001, the BDI had been trading – for most of the time – at a different plateau altogether.

Trade and BDI since 1980 (large)

‘One great wowing sound’ for shipping following China’s acceptance to WTO.

There is no dispute that shipping asset prices present great investment opportunities and that eventually enough ships will be scrapped to reach equilibrium with demand. On the other hand, the demand side of the equation has to be given proper consideration, in the light of present anti-trade sentiment in mostly the western world.

And, as a disclaimer, trade and trade agreements in this article are being viewed strictly from the point of view of a shipping man without imparting any political judgment or inclination, but bearing the strong belief that all trade is good for consumers and citizens and the society and culture, not to mention good for shipping, too.

Trade is not a zero sum game.


This article was first published on Splash24/7 under the title ‘Where’s the Growth in Trade?’ on August 8th, 2016. On August 14th, 2016, following A.P. Moeller’s quarterly report, Bloomberg published an article titled World’s Biggest Shipping Firm Warns Against U.S. Protectionism’.


© 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.

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