Shipping industry’s “Neither a borrower nor a lender be”

2016 for the most part has been a difficult year for every sector in the shipping industry: weak rates for dry bulk, containerships, offshore and even tanker vessels exacerbated the financial distress for many owners and their lenders. Recently however the market has shown signs of hope, here and there, with freight rate and asset price improvements, but in general, the greatest hope of all has been that the worst days in shipping, likely, are behind us.

Great name for a bank by the water, but regrettably no shipping loans offered. Image credit: Karatzas Images

One driver in shipping that has not shown any signs of promise are shipping banks in terms of expanding their book in the industry. The market collapse since 2008 has been especially hard for the shipping banks which first saw their clients (shipowners) facing a weak freight market and rendering them unable to sustain the original ship mortgage payments, and then, a precipitous decline in the value of the assets (ships pledged as collateral for the ship mortgages) killed any motivation to keep making payment on underwater assets. Most shipping banks are in an expressed course of departing from shipping and actively have been selling their existing shipping loans for the last several years. The news of certain shipping banks turning their backs to the industry is challenging, but the more disheartening prospect has been that shipping banks still dedicated to shipping have not been able to adapt their models for the current market developments; probably because of the fact that they have to act within strict regulatory and auditing guidelines, shipping banks still active in shipping have been maintaining an almost religious focus on a handful of clients who seem to ‘check all the boxes’, while the vast majority of the market remains un-serviced.

As we had mentioned in the past, the funding gap left in the wake of shipping banks has provided opportunities for institutional investors to enter the ship lending market. Whether these funds are categorized as credit funds or lending funds or alternative capital funds or even disguised as leasing funds on occasion, effectively they are providing capital to the industry in the form of debt, as supposed to equity, and effectively in a sense are substituting for the role of a bank as a lender. On the surface of it, shipping is a capital intensive industry and someone, sooner or later, would had to step in to fill the gap left by the banks.

Credit funds, being institutional investors, have by default higher cost of capital than the funding cost of a bank (read customer deposits), and therefore one would expect that obtaining debt from a fund would have to be at a higher cost. And, indeed, debt financing from a fund typically starts in the low double-digits, all in, even for relatively conservative projects. In a sense, it’s unfortunate that credit funds cannot adjust downwards (below their threshold) the cost of debt of a project depending on risk, since their investors (LPs) have been assured of a certain minimum return, typically in the high single digits after expenses and fees. As expensive the cost of debt financing from credit funds as it may sound, one has to compare it not to what shipowners were accustomed to (and possibly spoiled by indulging shipping banks) a few years ago of a couple of hundred basis points (bps) above Libor (L), but to the real risk of the industry overall and the intricacies of the transaction in particular. If risk can accurately be described by variance and volatility, what risk a rational investor would assign to the dry bulk market when the BDI has varied between almost 13,000 and 300 points in a decade, or when the BDI has varied between 300 and 1,300 points in timeframe shorter of a calendar year?

In need of capital… ‘Ships in a Harbor’, ca 1873, Oil on canvas, Claude Monet; Denman Waldo Ross Collection (1906); Boston Museum of Fine Arts. Image credit: Karatzas Images

As expensive the cost of debt from a credit fund as it may sound, it’s still a relatively low return given that institutional investors typically aim at returns in excess of 20% by taking (mostly market) risk. In a sense, it begs the question why institutional investors would bother with debt investments in shipping. Probably, there are several answers to that: many private equity funds entered shipping aggressively in the last few years and their equity investments have shown a misunderstood industry and its risks; debt investments, on the other hand, either by the same institutional investors or funds who were browsing the industry, is a more measured undertaking of risk, in an industry notoriously volatile. Further, the state of the shipping industry has been so bad that shipowners these days casually consent to high debt financing given the alternative, or lack thereof. Thus, market conditions have pushed shipowners to modify their financing cost expectations and move from bank-related debt financing and closer to fund-related debt financing. And, last but not least, let’s not forget that we are living in an usually low interest rate environment where investors are starved for yield and returns from credit investments in shipping can be acceptable given the interest rate environment.

Depending on how one counts this, more than $5 billion have been committed to credit funds and platforms by institutional investors in the last three years. The mandate of some of these platforms includes investments in shipping loans in the secondary market (not just originations); and, discouragingly enough, some of these credit funds are not completely realistic in their expectations, so we hold doubts on whether their capital can be deployed (still, we cannot get over a really nice ad in the Financial Times a few years ago for a fund having just raised $1 billion to invest in distress, including shipping; they managed to deploy exactly zero dollars in the shipping industry so far, and their in-house shipping guru departed for balmier seas). And coincidentally, $5 billion is still a minuscule amount of money for the debt needs of the shipping industry given that the market of shipping loans stood at more than $700 billion at the top of the market a few years ago. Credit funds will not be able to fill the gap left behind by the banks, but again, that’s not their main mandate or concern.

Can credit funds be considered a strategic partner to the shipping industry? Probably a hard question to answer given that credit funds are still driven by institutional investors who are industry agnostic and tend to gravitate to industries / sectors / geographies in distress, and will not be able to accommodate shipping over the long term. But, for time being and for as long as credit funds are active in shipping, their relatively high cost of capital and their more conservative approach (than equity funds of recent or shipping banks of the last decade), one can be assured that shipping asset prices or newbuilding ordering will not get out of hand, as it has happened twice in the past decade. Credit funds may not be suitable for establishing ‘ceilings’ in the shipping industry but mostly to provide ‘floors’ and holding the market from dropping lower.


© 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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WWIID?

The dry bulk market has been in the doldrums for so long now that talks for a market recovery resemble the biblical story of Lazarus’ resurrection. Probably the news are not deadly bad but again shipping is known to be a very moody industry. On the other end of the spectrum, tankers and containerships are performing fairly well, and definitely they are working miracles as far as the dry bulk market is concerned. No wonder that that there is plenty of confusion and head scratching of what is happening in shipping, and most importantly, how shipping will develop from here.

In a way, we are in unchartered seas; in unchartered seas given shipping banks are leaving the industry en masse, in unchartered territory given that the primary driver of the industry (China) is changing course, in unchartered territory given the excess shipbuilding capacity available, in unchartered territory given the low interest rates and boatloads of money looking for industries to be rolled over.

Whatever the course of the shipping industry in the immediate and intermediate term, one factor will keep having a meaningful impact on the industry, and that factor has been fairly unpredictable: the institutional investors and their interests in shipping. In the last five years, institutional investors have committed to the shipping industry more than $30 billion, whether as private equity or through the public markets, whether in equity or debt. Given the state of the market and information publicly available, it’s safe to say that almost all of the investments in shipping by institutional investors are presently underwater, at least – and thankfully – metaphorically so far. Of course, this is based on the presumption of marked-to-market valuation and immediate liquidation, which may not be the case for those with staying timing and financial capacity to carry the position.

In trying to project how the dry bulk industry and the other market sectors will develop, one cannot create a fair opinion without taking into consideration the future action and reaction of institutional investors. This is not only about the famous Keynesian beauty contest, but also the logic and analysis of the investors that are holding money losing positions and how they will react but also institutional investors that may be tempted to enter the shipping industry given the present state of weak freight rates.

What Would Institutional Investors Do?

Hog Sty Bay_CaymansThe game plan two years ago was for institutional investors to buy ships and otherwise ‘go long shipping’, under the prevailing assumption that the shipping markets were on the crest of a structural recovery; in a matter of a few short years, either the vessels would had been sold at higher prices with the investors walking away from the smaller sized projects at a profit, while for sizeable investments, there have been plans for IPOs and floating the business for a much larger paycheck (for the institutional investors but also the management team as well.) Given the state of the market, unfolding positions of two-years-ago at a profit is not doable, and as far as the hopes for accessing the capital markets, let’s forget about it, at least for now; even for the tanker market where freight rates are respectable, there is little conviction that this may be the early stages of a long term bull market. How institutional investors will react it’s important since they are holding more than $30 billion in shipping investments (investments that were deployed in the last five years); and institutional investors control obscene amounts of money, thus how they could deploy them in shipping could affect the market at large, and the lives of shipowners and shipping banks.

What would be the possible scenarios of institutional investors in shipping?

Doubling down on their shipping investments in order to average down their cost basis; doubling down could be in the form of ordering more newbuildings at lower prices, which could be detrimental to the market. One clear example of such strategy has been WL Ross ordering of a few more Suezmax tankers to add to the Diamond S fleet at a lower cost. If the original plane mandated acquisition of secondhand tonnage, then doubling down could mean buying more ships in the secondary market, which likely is a good scenario for shipping; no additional tonnage is added to the world fleet while shipping asset prices are getting supported (more buyers for ships, high demand.) Doubling down means determination, patience and willingness to put more chips on the table, and it’s the path that makes most sense if there is a strong recovery. The ideal scenario would be for the institutional investors to keep adding more ships to their positions from the secondary market; on the other hand, given the low interest rate environment, low commodity pricing environment and excess shipping capacity, doubling down can easily extend to a new wave of newbuilding orders, a scenario least appealing to shipping in both the short and the long term.

Pirate_CaymansCutting their losses and exiting their positions, at least selectively; it’s not the easiest decision to make and having to realize losses on investments, but on the other hand, when a fund has no specific mandate to be in shipping, the investment is relatively small, and besides the economics of the investment there are additional issues to be considered, then selling sooner and at a loss may be a palatable approach. There have been rumors that several JVs between institutional investors and vessel managers are on a rocky ground and there have been barely contained divergent managerial views, so to speak. Committing more funding to a project already on shaky ground is almost as throwing good money after bad money. There have been sales of shipping assets prematurely and at sizeable loss, such as the sale of newbuildings capesize vessel by Scorpio Bulk in an effort to avoid dilutive equity offerings. Ill-timed sales in a bad market result into losses, result into setting a lower asset market, result into setting an even more depressing market mood, and definitely show the least degree of commitment to the industry or the market, and much more resemble trading and playing the market: sometimes one is right, sometimes one is wrong, just hope to convince your investors that the batting average is favorable over the long term. Untimely sales of shipping assets can definitely have the potential to drive the market lower, much lower than now, and could bring upon the possibility of ‘fire sales’, a wishful scenario much dreamt but rarely materialized in shipping since 2008.

Playing for time, may be the third viable scenario, in the present market, as long as one has the time and the money. Just last week, Star Bulk had another ‘follow on’ to raise additional equity and meet their financial and capital requirements; almost 50% of the offering was subscribed by the company’s three anchor investors; it’s worth noting that the offering took place at approx. $3.2 /share, while shares were trading above $8 a few months ago and the company went public with a double-digit sticker price. Putting more money into the venture whether from the original or additional shareholders seems to be least obtrusive to the shipping markets, as it does not interfere with tonnage supply and demand dynamics and has limited impact on asset pricing. On the other hand, not many institutional investors have deep enough pockets (when asset allocation has to be taken into consideration), the timing or the commitments of the management of the JV.

All in all, institutional investors hold substantial positions in shipping, with allegedly additional appetite for shipping investments; in a market environment that has gotten many players by surprise and patently too unruly to play by the original game plan, these institutional investors can easily move the market in terms of tonnage supply and demand, move the market in terms of asset pricing, and can easily set the tone for the market for the next business cycle, whenever such arrives.

To think otherwise, that the impact of institutional investors on shipping is behind us, and one ought to focus on pure market dynamics, it seems to likely be a miscalculation.

A good question then to be sorted soon is: ‘What Would the Institutional Investors Do?’


© 2012-2015 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.

Doubling Down as an Exit Strategy?

The present state of the dry bulk market has caught many people in shipping by surprise; the wave of the orderbook getting delivered in 2015 onwards was expected, but several macro factors – and primarily China’s slowdown – were not properly factored in; as a result, dry bulk rates are close to thirty-year lows. Other sectors in shipping such as tankers and containerships – although markedly with cash flow positive numbers – have not been doing exceptionally well either. And now, with the collapse of the price of oil, the offshore industry is also under the watchful eye of creditors and value-oriented investors.

The weak state of the market definitely has ripple effects in every aspect of the maritime universe from shipowners with quickly diminishing cash reserves, to the deteriorating condition of shipping loans and their impact on the shipping banks and their capital ratios, to the collapsing prices for scrap metal and ships. One thought that has been in the mind of shipping people is the behavior of the institutional investors having entered shipping between 2010 and early 2014, when the markets were at higher levels – primarily in terms of asset prices. Most of these investments in hindsight turned out to be poorly timed and investors ended up catching a ‘falling knife.’ Hindsight is perfect, as they say, but most of the concern is with future action and reaction in reference to the underwater investments.

MV SEAGO PIRAEUS 2

Panamax Containership MV ‘Seago Piraeus’ calling the Port of Piraeus Image source: Karatzas Photographie Maritime

Private equity funds and institutional investors were never expected to be long partners and capital providers in shipping, just opportunistic investors exploiting the crisis and benefiting along with their strategic and limited partners from the recovery phase of the cycle. Thus, an exit strategy was expected sooner or later, and some people were concerned from the possible waves of said exit strategy. The most likely scenario of an exit strategy would have been an IPO whereby companies, businesses and ships could be sold at a profit to retail investors and hedge funds – constrained by mandates to invest small amounts or in liquid investments – but still aiming at an ever growing shipping market. The present state of the market with fairly weak asset prices is definitely not conducive to IPOs in an industry where shipping companies are valued at NAV of their long-term assets (ships) instead at a premium to that for management expertise or multiple of cash flows. One can easily realize that the damage done by ‘falling knives’ has cut too much into pricing that even in the tanker sector – where freight rates are strong enough to be suitable for an IPO, shipowners cannot dare go for an IPO; asset prices are well below the cost basis.
Typically, institutional investors have approximately five to seven years as an investment horizon, implying that for investments taking place in 2010, the window is not fully open any more.  Based on anecdotal evidence during our travels, whether from envy or misinformation, some shipowners are expecting that institutional investors will be forced to sell their ships to meet such deadlines, thus creating ripples in the market and also a buying opportunity; such an outcome is not likely to happen, at least not any time soon; there is still time for the funds to play for time and also deadlines to liquidate a fund and return proceeds to investors are not set in stone as there are provisions for extensions; and of course, unfavorable positions could be rolled over in future funds and  be given even more time to wait out the cycle and hopefully come to fruition.

There may be an alternative scenario on how institutional investors could react to the present unfavorable shipping market conditions and also better position themselves for an IPO – the dream exit strategy. Commodity prices for iron ore, coal, copper, etc. and also prices for oil and petroleum products, etc are at cycle lows whether it has been caused by excess investment and capacity (i.e. iron ore, oil, etc) or diminishing demand primarily from China. The corollary of this is that prices for newbuilding contracts can now be more favorable; the direct material cost is at least 10% lower than this time last year, all being equal, and thus the shipbuilders have room to lower prices. Also, most of the outstanding orderbook is maturing by the end of 2016, less than eighteen months away. It’s a scary thought, but the shipbuilders may decide to get aggressive later this year in attracting new orders and building their backlog once again. Given that commodity prices have been declining, many shipbuilders may decide to pass the savings to the buyers of newbuildings rather than go for thicker margins.  Besides lower newbuilding prices, likely ‘new and improved’ vessel designs may be developed by the end of the year, higher fuel efficiency, higher cargo capacity, bigger…better… why not a new ‘eco eco design’ to completely kill vessels of fifteen years of age and make hell the trading life of new, just ‘eco design’ vessels?

MT AEGEAN VIII_7

Bunkering Tanker MT ‘Aegean VIII’ in the Port of Piraeus. Image source: Karatzas Photographie Maritime

One may get tempted to question whether such line of thinking makes sense at all, when the freight market is at a thirty-year low (for the dry bulk vessels, at least,) the outstanding orderbook overall is more than 20% of the world fleet, and the majority of the vessels on the water at present are newer than five years old. It’s a fair prayer to have that buyers and investors will show restrain and self-discipline and will not follow up with a new wave of newbuildings trying to undercut the competition and double-down on their investments.  But as previously mentioned, shipowners are their own worst enemies and ‘shipping is not a team sport’, thus self-discipline is in the eye (or judgment) of the beholder, and each potential investor can decide their own course.  Furthermore, legendary investor Warren Buffett is happy to see share prices of stocks he owns to go down as that gives him the opportunity to buy whole companies at a lower cost; if doubling down is good enough for Mr Buffett, why then not good enough for the garden variety institutional investor with shipping interests?  And as an exhibit, another legendary investor, Wilbur Ross, ordered a series of Suezmaxes at $70 million per vessel in 2010; in the fall of 2014, it has been reported that his funds have sponsored the newbuilding contracts of four additional Suezmax tankers at $60 million apiece, bringing his overall cost basis to $67 million per vessel overall. If they were a good investment at $70 mil apiece, then they make an even better investment at $60 mil apiece.

It’s hard to predict how the present owners and institutional investors will react to the weak shipping market; there are many variables that can change fast, including the freight market itself. On the other hand, there are too many contributing factors that favor a new wave of newbuilding contracts and going for a ‘doubling down’ strategy: low commodity prices that drive lower newbuilding costs, comparatively low interest rates that make newbuildings a fair game, excess shipbuilding capacity and a diminishing orderbook by the end of this year – plenty of money to be invested, whether in shipping or other industries, whether by funds with shipping exposure or funds still looking for optimal timing to get invested in shipping…whether the freight market moves up or down, it will stimulate more orders, too.

Possibly doubling down may provide the best way out… sometimes one has to wonder…or wander…


Article was originally published on the Maritime Executive website, under the ‘Blogs’ section, where Karatzas Marine Advisors & Co. are regular contributors.


© 2012-2015 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.

Shipping, Private Equity and the Theory of Agency

The involvement of the private equity in the shipping industry has consumed plenty of ink and has rekindled not too little of a hope for an industry in distress; since the collapse of shipping market in 2008, private equity investors (and by extension, institutional investors wholesale-ly) have been accorded a portrait ranging from guardian angels and saviors of the industry to the “locusts” purveying industries in distress. A lot second-guessing can be excused when markets are dislocated and survival takes precedence over form or order. However, seven years after the instigation of the crisis and more than $30 billion in investments in shipping, people have been trying to take stock of what they had, what happened and what they should had. The fact that seven years after the instigation of the shipping market’s collapse still major shipping industry indices are flirting with all time lows does not make attempted assessments about the industry any easier.

MV PRINCE JOE 10

MV ‘Prince Joe’ in Piraeus – Your typical princely ‘Joe’, today in Piraeus, tomorrow on Wall Street… Image credit: Karatzas Photographie Maritime

As a matter of fact, the precipitous drop of the market and the establishment of thirty-year lows for indices like the Dry Baltic Index (BDI) have brought the concern of industry stock-taking to the pages of the mainstream business press. Most prominently, recently the Financial Times run an opinion article on shipping and the involvement of the private equity in shipping, and what it may have gone so awry; after all, the best and the brightest of the industry have poured their greyest of their gray power into alleviating the troubles of the industry. So far, the foray of institutional investors into shipping has not gone as modeled (at least up until now), and the aftershocks of such involvement are widely expected to make waves in an industry used to be dealing with physical waves.

Blame has been laid on the shortcomings of the agency theory as managers may try to put their own interests ahead of those of their principals and investors. The agency theory has been offered as a management or administration class in business schools, but actually applies nicely in the shipping industry, and actually twice. Corporate officers and corporate managers are running the shipping company on behalf of the investors – who are not involved with day-to-day operations, and in their absence, corporate managers may make decisions that have the managers’ best interests at heart instead of the shareholders. The potential conflict is clear.

In a model often adopted in shipping, the vessel management of the company’s fleet is often outsourced to a vessel management company often affiliated with the corporate officers or at least the ‘sponsor’ of the company when the shipping company was IPO-ed. Many shipowners – both operating and financial shipowners – outsource their vessel management to third parties, for many reasons – including benefitting from economies of scale, etc, and there is nothing inherent wrong with outsourcing; however, when the vessel management company is affiliated with the company’s management, and the earnings of the steady, market-neutral cash flows of the vessel management are unilaterally benefiting private the corporate management, then there may be a concern. It’s apparent that the potential for conflict arises twice when the agency theory is applied to shipping.

Now that several publicly listed shipping companies have become ‘penny stocks’, not mentioning several restructurings and bankruptcies and many investments by institutional investors gone sour, the conflicts of interest get front and center attention. It took a shipping cycle of a lifetime to burst in 2008 and a dip to 30-year low for the Baltic Dry Index (BDI) for concerns to be raised, as such in the article in the Financial Times.

The truth of the matter is that it’s unfortunate that conflicts of interest let the managers on occasion get the better end of the deal; it’s part of the human nature that such things happen, and the managerial science has been at work on how best to optimize corporate governance, motivate sufficiently the managers but not at the undue expense of the shareholders. However, this is not the first time that managerial abuse may have taken place, and shipping is not the only industry having such ‘privilege’. Just recently in the news, former CEO of Tyco International Dennis Kozlowski was looking for absolution for the managerial excesses of ice sculptures decorating corporate events in Sardinia of an era past (hopefully).

Lighthouse Point Judith 6

Lighthouse ‘Point Judith’ in Rhode Island; image credit: Karatzas Photographie Maritime

The truth of the matter also is that in reference to managerial excesses in shipping – and mostly when it comes to vessel management – the news about the abuses are often pre-announced and occasionally never exaggerated at all. One only has to peruse the filings and the prospectuses of shipping companies – mandatory information for publicly listed companies – to see that in many cases, there have been a garden variety of excesses and conflicts, including exorbitant vessel management fees. There is no digging, begging, suing, etc to get access to such information; it’s in black and white, publicly filed, and available on any computer with internet access. It only takes a few phone calls to market experts and other vessel management companies to get a sense of the going market rate for vessel management fees, which coincidentally is less than $500 per diem; however, on average for most publicly listed shipping companies, the shareholders are paying more than twice as much to affiliated companies to have their vessels managed; There are actually publicly listed companies that they have proposed as high as $1,800 per diem vessel management fees. Why? Why anyone would accept such without qualifying the service or attempt to negotiate better pricing or shop the market? And of course, vessel management fees is only one form of conflicts and managerial abuse; there are commissions for the sale & purchase of vessels managed, for the chartering and the commercial management of the vessels, for ordering the vessels at the shipbuilders, for supervising the construction, for … for… Back-of-the-envelope calculations for last year’s darling of shipping companies on Wall Street is that the management of the company has earned close to $100 million in fees alone, risk free and captive proceeds effectively for doing their job; and this is before executive compensation and other benefits. And a few years ago, executive compensation for another certain shipping company amounted to $75 million out of $125 million operating profit in the course of a few years. Again, such information has been filed publicly and it is not news, or it should not be news.

We can talk about the excesses of the shipping markets, but as in many things in life, there is the overarching principle of caveat emptor, buyer be aware; pertinent information is made publicly available, and let the investors make their own decision, and let them be prepared to take certain risks, let them benefit or suffer from the consequences. And, shipping is a very volatile industry with lots of inherent risk and meaningful chance of one losing their investment. Heightened management fees and other conflicts have exacerbated the results of the crisis but cannot be blamed for the crisis. And, placing the blame solely on the management teams doesn’t advance the debate about better corporate governance. After all, these prospectuses are primarily filed and intended for institutional investors who are well educated and experienced and compensated to invest money professionally; they should have done their due diligence, they should have checked the market, they should have ‘kicked the tires’ as they say, or in shipping, possibly they should have boarded a vessel or two. The truth of the matter is that sometimes investors are blinded, motivated by deal pressure and the need to deploy their money under management and start earning their own fees, they sometimes think monolithically and chase the same story, and unfortunately, very often, minimizing their due diligence to a box to be checked, and not a real in-depth search of the real events, causes and relationships. Unfortunately, we have seen it too many times in our business life, including most memorably once getting a call from Sydney, Australia from a firm where a US-institutional investor had outsourced their due diligence ‘box’ – the heavily Aussie-accented gent was calling to ask about a Greek shipowner; when the reply was ‘Well, they are not exactly Angelicoussis’, the follow-up question was ‘What’s Angelicoussis?’

Putting the blame solely on managerial abuses and conflicts of interest on the management and sponsors of shipping companies reminds of the joke where a prostitute, failing to collect the earnings after rendering certain services, yells ‘Rape!’ When professional fund and asset managers depend solely on screens and models to make their decisions and fail or turn a blind eye to conflicts in pursue of a quick return to be booked in this quarter, and follow a trend because everybody else is doing it (‘eco design’ newbuildings come to mind), it’s a disingenuous service to the shipping industry and a disingenuous service to the shareholders on behalf of whom institutional investors are acting. When short-termism and herd mentality guides investment decision-making, when due diligence is a box to be ticked, one has to wonder whether shipping will get to see better days soon… or more respectable days…


 

© 2012-2015 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.

Private Equity’s Black Ship

Since the beginning of the shipping crisis, it seems fewer topics have drawn more attention than private equity (PE) funds interested to invest in shipping. When capital markets and shipping banks were frozen while freight rates and shipping asset prices were in a precipitous fall, lots of hope was placed into the institutional investors as both equity providers to provide financing for new projects and also white knights for restructuring legacy deals.

Fast forward a few years later, and the topic of private equity funds still draws lots of attention, mostly heated attention, for the deals they have done and mostly the deals they have not done. There is lots of blame that PE funds are behind the recent wave of newbuildings and therefore for the continuing market malaise and fairly anemic prospects of a market recovery. Also, there is subdued optimism that there will be better days to get PE funds still interested in shipping, disappointment that the best days of PE investing in shipping are behind us, and outright happiness that PE funds got their investments wrong, and that they will be the next wave of players in shipping who will be realizing big losses (after the shipowners buying ships in 2007 and banks lending 120% of peak phase of cycle).

As a quick disclaimer, for those hoping that private equity (and by extension institutional investors, in general) were interested in investing in shipping to solve other people’s problems for the good of their souls or the general good of mankind, probably they were daydreaming. Typically, PE funds have a five to seven year horizon and high return hurdles and they are industry agnostic or indifferent, thus shipping was an attractive proposition to them given the state of the market. Funds are money machines, at least that’s the business plan, and they specialize at solving problems in industries or with companies, but at a very hefty cost. Thus, consideration should be given whether PE has so far approached shipping in a productive way for the many stakeholders involved.

M:Y RADIANT 7For the widely-circulated blame that PE funds are behind a tremendous part of the tremendous orderbook outstanding in this still trough phase of the cycle, it’s true that PEs have ordered many vessels directly (i.e. Wilbur Ross and Diamond S.’ suezmax tankers early in the crisis and recently more orders in the same sector in a different JV arrangement), in JV with certain shipowners (mostly private, bi-lateral deals), and many more were ordered by hedge funds investing in publicly traded companies (i.e. Scorpio Tankers and Scorpio Bulk are the blaring examples to name in this category). On the other hand, one has to mention that the tremendous outstanding orderbook has also been the handiwork of many independent shipowners, small and large, looking to exploit lower prices for newbuildings and mainly efficiencies of new designs. And, the strangest thing of all is that many orders have been placed in second- and third-tier shipbuilders in China, on speculation, and no financing in place beyond the downpayment requirement in the progress payment process. Thus, putting the blame for the newbuilding orderbook solely at the PEs door may be a bit presumptuous, and rather more introspection is required on why shipowners tend to be their worst enemies by flooding the market with more ships at bad times. It has been said by a pre-eminent shipping executive (of a company with a tremendous orderbook) during a shipping conference that ‘shipping is not a team sport’, but still there has to be a better explanation on this.

Since the beginning of the shipping crisis in 2008, it is estimated that more than $30 billion has been invested in shipping by institutional investors (although all these type of investors are summarily classified under ‘PE’ in most discussions today). Oaktree, Apollo and KKR have been the largest investors of all in shipping, with many more funds having done deals, and many many many more looking into doing deals in shipping. Although the Oakree-s of the world get most of the attention, it has to be noted that many of the PEs interested in having invested in shipping are small or very small and most of the transactions have remained well at the below $50 million equity investment mark. In most of the cases, the PE is providing almost all of the equity but takes the driver’s seat, with often the ‘shipping partner’ relegated to an employee or a very junior partner in the arrangement (although often the ‘shipping partners’ have been exaggerating their involvement, equity participation, sharing of upside potential, and compensation). Truth of the matter is that for many of these partnerships, it has taken a lot of time and effort (and legal fees, due diligence, etc) to agree on the partnership agreement and usually the ‘shipping partners’ had to give up the most to get the partnership agreed to. We suspect, in a sideways moving market, many of these ‘shipping partners’ have been experiencing ‘buyers’ remorse’, and, to a certain extent, are percolating the market with their disappointment inviting PEs to their companies, etc

While most of the investments by PE in shipping so far have been concentrated on equity investments, there seems to be an ever-growing trend of funds looking to provide credit to shipping, and in our practice with Karatzas Marine Advisors, we see an ever-growing trend of shipowners looking harder and harder to obtain debt financing, sometimes senior, but often junior, second lien, mezzanine, work capital, etc Probably it makes more sense to invest in ‘credit’ rather than ‘equity’ in a weak market at present with rather anemic prospects looking forward in shipping, but many of these PEs funds have built their models around industries in distress with little customization for the shipping industry and flexibility on structures or adjusting returns to fit the risk. Most of the funds are looking for at least 8% return for their LPs (Limited Partners), and thus for all projects they see, irrespective of risk, they are sending out term-sheets with at least such threshold or meaningfully higher for ‘deals with hair’. Ten-year old Japanese-built aframax tanker with $23 mil FMV and $10 mil loan (less than 50% LTV and loan just $2 mil in excess scrap value) and employed in major, well-reputed pool, seeking senior loan (first preferred ship mortgage) gets L+850 bps offer (and hefty origination fees), despite the low riskiness of the project. Four handysize bulkers built at 1998 seeking financing, they are offered advance 70% of current scrap pricing at 9%. 2004-built MR1 tanker freshly drydocked seeking 70% leverage while assigning solid two-year charter is offered 11% interest. These are typical projects that there would be no issue obtaining ‘normal’ financing in an average market; however, PEs looking to provide credit in shipping are looking for very high single digit returns, irrespective of risk. Often working on structures like these, shipowners / borrowers / vessel managers come to the conclusion that ‘PEs don’t get shipping’, where ‘one size fits all’ model is applied.

Shipping has not been recovering as many people’s ‘gut feeling’ said or ‘model’ projected. There still is pain in the market, and the prospects looking forward are not as rosy. It’s only natural for people to complain, to allocate blame, to feel envy for the parties having done deals or having second thoughts on deals already done. Private equity funds have been center stage for a long time, but often their website and brochure and their claim to flexibility on structures and access to the different sources of capital seems to be an illusion or in disconnect with reality. Whether for equity or credit, whether for low risk or higher risk projects, whether for new projects or legacy projects, whether dealing with shipping banks or shipowners, whether for tankers, dry bulk or containerships, some counterparties think that all funds have the same term sheet to send around.

Some think that such term-sheet may be for a ‘black sheep’ or for a ‘black ship’.

Some, even they may agree on that.

Ship of Fools - An Old Story!

Ship of Fools – An Old Story!


© 2013-2014 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.

 

 

Shipping Bonds

In a historically very low interest environment, corporate borrowers of every sort and industrial flavor have been lining up to exploit such favorable conditions. At a time when the benchmark 10-year US Treasury notes yield about 2.5%, short duration sovereign bonds of industrialized nations are fairly close to zero, and the President of the European Central Bank (ECB) Mario Draghi contemplates lowering even further European interest rates in order to weaken a strong Euro, even companies like Apple, with about $150 billion in cash reserves and money being the last thing they need, are turning to borrowing in order to accommodate their corporate and financial needs.

It’s not only companies and sovereigns of stellar credit the only beneficiaries of low interest rates; with many funds in desperate need of achieving decent yields from their credit investments, borrowers of lower creditworthiness have seen an open window to access the markets.  Countries in the European periphery have benefited from such appetite with Spanish bonds yielding below 3% recently, whereas Greece, the enfant terrible of the EU, has been back to the capital markets with its bonds yielding close to 6%. Strong investor demand for bonds has been reaching as far away as into well ‘junk status’ corporate territory, with a glaring example of Numericable, a French telecoms firm, which recently issued bonds with yields as low as 4.5%; for the record, Moody’s rating for these bonds was ‘Ba3’, three notches into junk territory.

Better options in shipping finance these days...

Better options in shipping finance these days…

For shipping, a capital-intense industry at a junction where its traditional spigots of financing – that is shipping banks – are shut for all practical purposes, the strength of the bond markets and investors’ appetite for even low quality credit should be considered manna from heaven. In all fairness, it should be noted that shipping and bond markets have been having an awkward relationship when in the 1990’s more than $3 billion in junk bonds in shipping were issued and all but one (Ultrapetrol) of the issuers soon ended up in default. The volatility of freight rates makes it difficult to assure to investors always timely payment of the coupon, and when bonds are secured by the ships themselves, residual values can vary as widely as freight; as a result, bonds are not the natural way of seeking debt financing for mainstream shipping with commodity vessels fully exposed to market exposure. For shipping companies where vessels are employed under long term contracts, especially with bankable or energy companies, the prospects are more favorable due to earnings visibility, and from time to time, such companies have been accessing the bond markets; Seaspan, NYK Line, Navios Maritime Acquisition and Teekay LNG have been issuing bonds on such promises, while Jones Act and logistics companies can depend on the ‘service’ nature of their businesses to secure coupon payments: Hornbeck and Tidewater, Norwegian Cruise Line and Navios South American Logistics are examples of ‘shipping’ companies in niche market with regular runs to the bonds markets. Navios, originally on the strength of long term charters from Chinese end users on the VLCCs acquired from Univan, have been exploring bonds guaranteed by both the cash flows of the time charters and the residual values of the underlying fleet and in October 2013, Navios Maritime Acquisition issued $610 million bonds secured by first priority ship mortgages with B/B3 rating at a 8.125% coupon. The company issued $50 million additionally in March 2014 on identical terms with the October issuing.

For established companies in shipping, the bond markets seem to be more active of recent, with the Rickmers Group issuing a multi-currency $200 million bond in the European markets at competitive terms, and just last week, Rickmers Maritime Trust has issued in Singapore about $80 mil in bonds at 8.45% with 2017 maturity. State-owned shipbuilder China Shipbuilding Industry Corp has expressed their intent to raise about $1.1 billion in corporate bonds, which despite the ‘shaky’ ground of Chinese shipbuilding overall, their investment grade rating likely will assure for competitive pricing. In the US, even Scorpio Tankers with their spectacularly successful equity raisings could not resist the temptation of raising $50 mil in senior unsecured notes at 6.75% with 2020 maturity.

Money! Shiploads of it!

Money! Shiploads of it!

Interestingly, Ridgebury Crude Tankers, a relatively new US-based shipowner sponsored by the private equity fund Riverstone Holdings, issued recently in the Norwegian market $210 million in bonds secured by first priority mortgages on their modern Suezmax fleet. The vessels had approximately $300 million in fair market value so the LTV was close to 70%, and the coupon has been set at 7.625% with three-year maturity. The bonds were acquired entirely by US-based investors and there were heavily oversubscribed; actually, it has been rumored that just one institutional investor expressed interest in acquiring the whole transaction. Given that Ridgebury is relatively new company with their fleet employed in the spot market, traditional shipping banks were not keen to provide traditional debt financing, despite the firm’s substantial sponsor, and confirming the suspicion that ‘advertised’ shipping business by traditional shipping banks at 4% interest rates are really reserved for their few select clients. The bond has been trading well and the yield has moved lower, but traditional shipowners would consider that 7% interest for effectively first preferred mortgages to be exorbitantly high. It may be true in absolute terms, and especially to the terms shipowners got to receive during the boom years of the cycle, but one has to take into consideration that mortgages are amortizing while bondholders are looking to regular coupon payments and the return of the principal at bond maturity, in 2017 in this case, leaving the borrower with additional operating cash flows to be deployed in other ways rather than amortizing the principal borrowed and implicitly passing part of the residual risk to the bondholders.

Given the state of traditional lenders in shipping, the bond market likely will be an active venue for shipowners to access capital. As long as interest rates remain low and demand by investors for yield products in the 5-10% remains strong, at the trade-off of lower credit or collateral, there will be plenty of activity from established shipowners and also for relatively newcomers in their ongoing pursue of alternative financing. The days of 200-base-point spreads with high leverage are gone, and new times required fresh approaches, whether in the form of private equity investors for equity or bond investors for new lending in shipping.

 

© 2013-2014 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 Porthole of an Exit Window for Shipping Investments?

Momentum and, to a certain extent, freight rates and shipping asset prices have improved meaningfully since last year; while this time last year most vessels – including large vessels such as capesize bulkers and supertankers – were earning barely cash break-even freight, there have been a few windows of opportunity here and there since then.

After a rather prolonged weakness in the markets – that actually has tested some market players like shipowners, bankers, brokers, etc. – it was great just to see the freight market hitting $40,000 pd on occasion and the BDI topping the psychological level of 2,000 points at some point, actually tripling in less than a year. To the extent that the second-hand market for vessels is reliable, all shipping asset classes – across all vintages – have improved by 10%-40% in the last year, with older capesize vessels showing the strongest performance (admittedly, some of the ‘market’ sales of last year were textbook cases of ‘motivated’ selling.)

So much so momentum in shipping has improved since last year that the words Initial Public Offering (IPO) have come back to our vocabulary in shipping. While still ‘distress’, ‘restructuring’ and ‘bankruptcy’ are still part of daily life in shipping, it’s encouraging seeing that smaller shipping companies – even ones sponsored by smaller independent shipowners and ‘wet behind the ears’ – are lining up for the public equity markets; 2013 and the years before were ‘decent’ in terms of shipping IPOs offerings – given the circumstances, but absolutely all IPOs were focused on LPG, LNG, offshore, energy (rather than mainstream shipping) or had heavy-hitters as sponsors (Ardmore Shipping, a typical case) or both advantages (Navigator Gas with WL Ross as the sponsor in the LPG segment another typical example.) More than ten companies at present have filed or are actively exploring a public offering, at least half of them are smaller names, and one may be tempted to commend, with thin resumes or credentials.

Some of the IPO hopefuls are sponsored by big private equity (PE) funds that have entered the cycle relatively early and approaching the fund’s typical five-year investment horizon, and thus in need of exploring liquidity and gradual exit from their shipping investments; whether the PEs are reaching their investment horizons or not is irrelevant in a respect, as in any event, they have been eyeing for the exit and the public equity markets from the time of committing money in shipping. The smaller PE funds that have invested in shipping on a smaller scale or on a project basis – and thus not ‘IPO-able, have also been discreetly ‘shopping’ the market to sell their vessels in the second-hand market at today’s pricing or ideally at a small premium, and thus exit for a quick and decent return without having to stay around for long to see how the shipping markets eventually will play out. In short, sooner or later, smaller and larger private institutional investors will be looking for the exit, which is great; it’s called capitalism and an efficient market.

MV GENCO AUGUSTUS - 180,000 DWT Capesize Bulker built at Koyo Dock K.K. in 2007

MV GENCO AUGUSTUS – 180,000 DWT Capesize Dry Bulk vessel built at Koyo Dock K.K. in 2007

This past week, Genco Shipping & Trading Ltd announced that they will be filing for Chapter 11 bankruptcy, a pre-packaged restructuring arrangement that hopefully will save the company.

Notwithstanding the irony that bankruptcies and IPOs can so naturally co-exist in shipping, the fact that caught our attention is that in Genco’s financial disclosures, the company is expecting a 30% freight revenue drop between 2015 and 2016. There is no fleet break-down or additional clarification, but it seems that projections are based on the company’s fleet remaining constant (about 53 vessels, of which nine capes, nine panamax, seventeen supramax, six handymax and thirteen handysize vessels); as such, based on constant fleet, voyage revenue is projected to drop from $302 million in 2015 to about $215 million in 2016; parenthetically, on the other hand, operating expenses are projected to keep growing at 2% annually. The primary reason for the drop in the company’s freight revenue projections between 2015 and 2016 is that freight rate for dry bulk market will experience a meaningful market correction caused by tonnage oversupply. [By association and anecdotal evidence, the same belief holds true for the commodity tanker markets as well, just to a slightly lesser degree.]  Most of the ‘smart money’ expect that the market will fall based on the delivery wave of vessels presently on order that will start ‘hitting the market’ in late 2015 (and early 2016 as likely several deliveries will be pushed forward into the following year.)  The projections in Genco’s filing do not divulge any ‘state secrets’, but they do put forward formally, and rather eloquently, the expectation that any shipping recovery during the present cycle will likely be weak, with no ‘higher highs’ or great volatility; more importantly, Genco’s projections imply that the window of opportunity will be rather very short-lived.

If the window of opportunity is expected to be short-lived, then it will have to be utilized to its maximum potential by likely selling assets and lining up fast on the IPO queue to obtain a public listing. If so, likely the present pool of companies mentioned or considered for IPOs will have to be more numerous than it meets the eye; not bad for advisors and investment bankers, but it will be interesting seeing whether the public markets – and second-hand buyers – will be hungry enough and for a sustainable amount of time to absorb tonnage and shares from all these promising companies.

But again, that’s capitalism.

Ship of Fools - An Old Story!

Ship of Fools – An Old Story!

 

© 2013-2014 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.