Times for most shipping sectors are very tough, by many standards, even if one takes a long-term historical perspective. The Baltic Dry Index (BDI), the proxy for the broader shipping industry in many ways, is almost 100% up in the last forty days – and still, dry bulk vessels barely achieve operating break-even rates on the spot market.
Dry bulk asset prices, despite the recent rejuvenation of the last two weeks, are very low; bulkers older than ten-year-old typically change hands at multiples of their scrap price. The dry bulk freight market has taken most of the blame, since what kind of buyer would like to buy a vessel – irrespective of attractive pricing – and start losing money from the minute they touch them when the closing and delivery of the vessel is in effect.
No doubt the weakness of the freight market deserves lots of the blame. But, anyone, who has been involved with vessel valuations and shipping investments, knows that vessel asset prices are also materially influenced by several more factors, availability of cheap capital being the primary driver among them.
Financing for shipping projects at present is typically rather very expensive. Most shipping banks have already left shipping and a few more have been divesting shipping loan portfolios as fast as practically possible. For the banks still active in shipping, very few and precious, they mostly stay away from soliciting new clients – since their existing clientele can absorb their curtailed availability of funds, and without having to undertake the always challenging KYC approval, etc. For new clients to be considered, they have to be “strategic”, with critical mass of fleet of vessels, sound prospects of business success, and sometimes, already recognizable names from the bank’s private wealth departments. Lending against dry bulk vessels is of no interest to the shipping banks now, tankers older than typically eight years of age are too old to lend against, crude tankers are too risky to touch, containerships need to have long term charters, and offshore is off a cliff for now. In short, for a shipping project to obtain new financing from a shipping bank these days, the ship will have to walk on the water, not just keep afloat!
Obtaining equity for shipping is no much easier, as most funds have lost billions and billions chasing a market recovery in 2013 that never came – or was run over by their exuberance optimism and newbuilding contracts, and now they stay away from the industry. Also, equity funds often invest pro-cyclically, when the market is in recovery, and thus the dry bulk’s negative cash flows are a serious deterrent. There are many funds (credit funds) that provide lending in the shipping industry, and they often charge 6-10% interest rates plus some degree of equity participation. And, the market is so constrained for debt financing, that we know several owners (and actually our firm has arranged such financing for a few more), where shipowners are borrowing at such high terms in order to be able to expand and exploit the present state of the market and the historically low asset prices.
The difficulty of obtaining financing for shipping projects has to do with many factors, some originating from the shipping industry but some not. The excesses of the shipping banks, for example, of the pre-Lehman credit boom still have not worked their way through the banking system. There is still an amazing amount of shipping loan portfolios that are priced close to original cost basis, allowing for little else for the banks but to play for time and hope for a market recovery. There are cases where the ‘non core’ bank is not allowed in any way to assist a potential, legitimate buyer of assets with the ‘core’ department of the same bank – forcing many times deals to be scrubbed or consummated at terms clearly inferior to what could had been achieved if the ‘core bank’ could be engaged; the legal limitations and other considerations for need of lack of coordination between ‘core’ and ‘non core’ are appreciated, but one may be tempted to say that regulators have been overshooting in order to compensate for their undershooting a decade ago.
Another interesting observation on misplaced actions by banks (shipping banks in our case) due to regulation is that at a time of low or even negative interest rate policies (NIRP) and still extensive quantitative easing (QE) by the European Central Bank (ECB), banks go for few, selected, concentrated credit risk, especially when such risk is perceived to be superior that would lead to no losses for the bank. As a result, banks (shipping banks) end up chasing a handful of accounts, whether super-major independent shipowners or top-tier corporates, at razor thin margins. Banks these days would rather lend US$ 1 billion at no more than 150 bps spread to an account they deem superior rather make originate several mortgages of US$ 20 mil each, to solid accounts that do not tick all the boxes, at spreads of 500 bps. For the sake of being optically correct and allegedly minimize the probability of originating a loss-making mortgage, banks concede to cut their margins to the bone and accept concentration on a handful of accounts, while 90% of the lending market remains virgin territory. It’s amazing that our office, in our capacity of advisors and private placement agents, habitually is fielding calls these days from American and European and Asian banks desperate for new projects, but always for deals where credit is superior and always at increments of hundred millions. No project finance, no small or medium owners, no private companies: oil companies, large corporates, stand-out clients of private wealth, substantial end users.
We cannot name names but one can peruse the list of serial buyers of modern tonnage, often tonnage unloaded by publicly listed companies and private equity investors, to get an idea who are the clients the banks (shipping banks) want these days as clients. Rumor has it that such names have billion dollar lines with banks at barely higher than 100 bps spread; a ridiculously thin margin and a ridiculously low cost of funding given that interest rates by central banks are at almost all times lows.
Banks seems to have been boxed not by a “liquidity” trap but by a “safety trap” where regulators and central banks demand high credit assets as collateral, pushing banks to do business for what it is considered safe and not necessarily economic (at a price); some say that present policies have even been contributing to stagnant growth overall. Taking a narrow-focused group on shipping, one may wonder whether the banks (shipping banks) are shooting themselves on the foot and whether they are laying the ground for the next bubble: banks prefer to lend US$ 400 mil to one lender for the purchase of ten modern cape vessels at excess 80% leverage and at 150 bps spread, while will not even contemplate doing forty (40) mortgages at 50% leverage at 500 bps spread for ten-year old bulkers priced at 3x scrap value. Over-concentration on one account and asset class and trade at historically low margins (that likely to hurt the banks when interest rates increase) are clearly preferable, in bank’s point of view today, to broader diversification at robust margins that offer better prospects in the long term but also support the shipping market (including the shipping banks themselves in the short term).
In our humble opinion, the shipping finance market is highly dislocated at present (offering many investment opportunities), but more crucially, it seems that the elements of the next crisis are already incipient in the waters.
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