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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Shipping’s Best Hope of Forgettable Years

By all accounts, 2017 was a forgettable year for shipping – which it may be the best characterization the industry could possibly have at present. Recent memorable years in shipping have not been very uplifting. Probably many people in the industry are still struggling to forget 2016 and its 296 BDI and 161 Capesize readings in March of that year, the lowest ever readings by the Baltic Exchange.

2017 was rather good for dry bulk (pleasantly great if one opts to compare it to an abysmal 2016) while tankers, containerships and offshore were mildly disappointing markets. Shipping segments are not often in sync with each other and segment gyrations are to be expected. Although the fundamentals driving each segment differ nominally, there have been a few common underlying trends across segments at present: the outstanding orderbook has been low in each and every segment, actually the lowest in recent memory. Tonnage demand keeps increasing on the strength of global economic growth. Tonnage supply keeps growing but at lower levels, so much so that tonnage demand hesitantly exceeds tonnage supply growth in certain markets. And, lack of shipping finance negatively affects all segments of the industry, further curtailing the possibility for an exorbitant wave of newbuildings. When one examines shipping closely, as a pure tonnage supply and demand equilibrium, 2018 and the near future seem rather promising.

However, shipping is an industry known to get people by surprise and looking forward there are reasons for a market participant to be concerned. Several factors, complimentary to the industry, are cause for concern; probably not as bad as to make the proverbial list “what keep’s you awake at night” but again, not an era of assured smooth sailing.

The shipping finance market has been dysfunctional for the last few years, but at present, the dislocation in the market is reaching unprecedented levels. As traditional shipping banks keep leaving the industry and institutional investors have lost any interest in private equity investments and some public market investments as well, the cost of capital keeps increasing steadily. It’s not unheard of for independent shipowners to be borrowing at 8% spread for first preferred ship mortgages with tight covenants and terms these days. For a capital intensive industry, the high cost of capital is an accident waiting to happen for shipowners and financiers alike. Also, lack of debt financing is shifting the market, even forcing smaller players to shut down and slowly driving a consolidation wave. Probably too soon to notice any immediate effect in 2018, but watching the Greek and German markets over the last few years, one can note the trend forming.

Many hopeful shipping business plans and corporate presentations pride on the industry’s low outstanding orderbook. It’s absolutely marvelous that shipowners have shown self-discipline in the last few years and abstained from speculative orders; however, the counter-argument is that shipbuilders are immediately ready for new orders and can deliver new ships as soon as within nine months. Low outstanding orderbook implies plenty of spare shipbuilding capacity. And, while there has been talk about inconsequential Chinese shipbuilders getting weeded out in the last couple of years, the truth of the matter is that shipbuilding capacity is highly elastic and all those now defunct shipbuilders would be entering again the market the minute that hot new orders start arriving. It’s a good thing that institutional investors and shipowners have lost interest in “speculative” newbuilding orders, but a strong freight market could likely incite many new orders that can start flooding the market very soon and thwarting a full market recovery. Barring an exogenous stimulus such as export credit incentives or materially lower newbuilding contract prices, a “forgettable” and un-inspiring freight market may be the safest way of navigating these narrow shoals.

While when talking about shipping the focus is on freight rates and asset prices, one cannot neglect the regulatory and operational nature of the business. The ballast water treatment management plants (BWMS) have already been costing the industry additional capital, and new emissions regulations are fast afoot. New regulations are costing the industry billions of dollars when the industry can poorly afford them, and one would expect even tighter standards going forward. Higher standards for vessel performance, tighter standards for safety and security, likely soon IT security to make ships relatively secure from hacking and ransomware, and all these, before one takes into consideration technological obsolescence factors: if for instance natural gas bunkering is the way of the future, what would happen to today’s modern world fleet? We do not want to be the Cassandras and the pessimists of the business, but one has to think about the long future very hard when ordering vessels that have twenty-five years of design life.

Further, while the vessels themselves can be the subject to higher standards and technological obsolesce, how about the cargoes and the underlying trading trends themselves? The cost of producing solar and wind energy has been dropping precipitously and jeopardizing the importance of coal, and possibly crude oil, as the world’s primary energy sources. Electric cars have slowly been passing the “novelty” phase of new products and becoming mainstream that would further impact the energy transport market. And, as shale oil and natural gas keeps improving lowering its production cost, likely to be less need for transport. Probably an isolated example, but the current polar wave of freezing weather in North America barely registered on the crude tanker market; there was a time when crude tanker rates were shooting skywards as charterers were scrambling to import more oil to the US to cover increased energy demand every time there was a cold front in North America. Energy trends take a long time to materialize, but on the other hand, one cannot dismiss that a new baseline that’s forming for the immediate and distant future.

We do not want to be pessimists and do not want to be the ones who are pointing to a half-empty glass. 2017 has been a respectable year, and, with a bit of good luck, 2018 would be equally fair. After many years of persistent fireworks in the industry, some “forgettable” years would be a welcome change. But just like navigating in unchartered waters, one has to keep paying attention to the dangers lurking in the ambient environment and under the surface of the sea.

A Happy New Year to all, especially the seafarers in the middle of the ocean an away from their families!

Happy Shipping and Happy New Year! Virginia Beach, VA. Image credit: Karatzas Images


An edited version of this article first appeared on Splash 24/7 on January 3rd, 2018, under the heading “A forgettable year is our best option”.


© 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.

Looking for Treasure Fleets in China

In a very interesting recent transaction in the dry bulk market, Sea Traders of Greece has acquired at auction in China eight modern dry bulk vessels, three kamsarmaxes and five supramaxes, for approximately US$ 68 mil in total, or at approximately $8 mil per vessel – wholesale price – for vessels with slightly lower five-year average age. The vessels were:

Sisterships MV “LAN HAI ZHAO YANG”, MV “LAN HAI XU RI” and MV “LAN HAI YANG GUANG” (79,600 DWT/Built 2011 at Wujiazui Shipyard), each with RMB 60 mil. (ca. US$9.4 mil) reserve price; sisterships MV “LAN HAI YING XIN”, MV “LAN HAI LIAN HE”, MV “LAN HAI QIAN JIN” (57,000 DWT/Built 2011 at Yangfang Shipyard – Cranes 4/30 tons), each with RMB 55 mil (ca. US$8.6 mil) reserve price; and third set of sisterships MV “LAN HAI YANG FAN” and MV “LAN HAI DONG FENG” (57,000 DWT/Built 2010 at Yangfan Shipyard – GEARLESS), each with RMB 45 mil (ca. US$ 7.0 mil) reserve price.

The transaction is interesting on several levels: first, the price itself is eye-catching, as even in today’s depressed dry bulk market with asset prices in free fall, these vessels were priced at 60% below market, as the Baltic Exchange lists 5yr old panamaxes at $17.34 mil and 5yr old supramaxes at $15.35 mil. The vessels were sold through auction via the Guangzhou Shipping Exchange, and there was exactly one bidder who offered at exactly the reserve price.

MV HARLEQUIN 11

Chinese-built bulker steaming upstream… (Image Credit: Karatzas Photographie Maritime)

The buyer was Sea Traders of Greece, the lesser known dry bulk arm of George Procopiou (mostly known through Dynacom in the tanker markets and Dynagas in the LNG tanker business). The principals at Sea Traders are known for gutsy market calls, and this transaction fits their investment profile; dry bulk is completely out of favor at present, and the purchase price is significantly at discount to the market; more interestingly, the purchase price is approximately twice the scrap price of the vessels, not a bad benchmark, especially given that each of the vessels on average has twenty years remaining design life. The ‘bet’ is fairly asymmetric in favor of the buyer, paying 2x scrap to buy ships with 20yrs life remaining.

The vessels came to the market as a result of the 2013-collapse of Guangdong Lanhai Shipping Co. of China, and were offered twice for sale by the China Construction Bank at auction last year, each time with a botched outcome; typically, the calisthenics involved bidding at Chinese auctions is a tad too much for the liking of most foreign bidders, including bureaucracy and terms, delays and postponements, ‘hurry up and wait’ developments, conflicting information and a daisy-chain of brokers from Shanghai to New York who pretend to have the ‘inside’ and access to the owners / procedure / process. This time the sale took place through the Guangzhou Shipping Exchange, an ambitious Chinese effort in shipping to shift the center of gravity in shipping to their region.

It’s interesting that no financial buyers, especially from the US, bid for the vessels. There are more distressed funds with interest in investing in shipping than we care to count, and all complain that there are no distressed deals in shipping; if this transaction at 60% below market and at 2x scrap for five-year-old ships does not qualify as distress, then, what does? Is that the dry bulk market at present is so much out of favor and many funds lost shiploads of money in shipping that no-one wants to hear about the sector any more? If this is the case, and market participants are prepared to ‘throw in the towel’, then this is actually great news since in most cases signifies the bottom of the market. Was it that no financial buyers appreciated the ‘distressed’ nature of the transaction because some say that funds really do not know much about pricing in shipping and appreciating ‘full price’ from ‘value’ or ‘distress’? Was it that many funds in the past bought cheap Chinese ships because they were just ‘cheap’ (cheap in price, cheap in quality) and they ended up spending a fortune to bring them to quality standards and that those vessels would never get to appreciate in price given their lousy pedigree?

MV ATLANTIC OASIS 5@

Crane me up! (Image Credit: Karatzas Photographie Maritime)

It’s interesting to note that these vessels in this transaction are not of the sexiest, shipshape-ly structures ever to float on the water: they were built by universally unknown ‘greenfield’ shipyards that built these vessels for their own account (more or less) with no independent third-part supervision (more of less). The vessels are China Class, which does not offer the highest degree of comfort to some buyers. Besides their un-impressive pedigree, the vessels were at warm lay-up for more than a year now, and idling vessels, even with crew onboard, ‘aren’t getting any prettier’ with time: marine life keeps accumulating below the waterline and rust from sea-water keeps chipping above the waterline (vessels were under arrest for a distressed owner, and one has to think with how much enthusiasm the crew was looking after the vessel). Also, the last set of sisterships, are gearless supramaxes, a rather limited asset class with limited trading capabilities. All in all, in terms of pedigree, reputation and quality, the vessels, despite their modern vintage, were not exuberantly impressive, and for the buyers, it will require some investment and operating shipping expertise and TLC to make ships out of them.

Again, for a gutsy operating shipowner the transaction makes sense: buying ships dirty cheap when the market is completely out of favor; It will take some time and investment to upgrade the vessels, but on an un-levered basis, they are expected to be cash flow positive in their trading lives with such low cost basis; in such respect, this is a ‘neutral carry’ position, and if/when the dry bulk market pops in five years, if we say, these vessels would have delivered a double digit return. If the market goes to hell, as everybody expects now, the absolutely worst case scenario is that the buyer has lost $3 mil per vessel: the downside is limited, the upside can ride the market to the top, the probability is higher that the market will be higher rather than lower in five years, and thus, a fairly favorable ‘asymmetric bet’.

There has been the additional reputational benefit for the buyers acquiring eight vessels en bloc at a Chinese auction for US$68 mil; not many transactions of this nature take place and not many buyers have successfully done that. Given that this is an auction sale that requires immediate full payment, there are no many shipowners in the present dry bulk market who can afford US$68 mil auction acquisitions, in an abysmally low dry bulk freight market. At a time when rumors fly on which shipowner is next in line filing for protection, this transaction has certain reputational cache. Again, the rumors for dry bulk companies possibly preparing to file for protection encompasses very well respected and big names, almost as big and good as the buyers of similar ships.

At a time when dry bulk freight rates dial up losses and the pain in the market, there are interesting transactions here and there; there is always money to be made in those ships, but watching who was ‘waving the flag’ and who was not, always informative. As the recently departed Yogi Bera once said: “You can observe a lot by watching”.


© 2013-2015 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.