Moral Hazard and Hanjin Shipping

Not a week has passed since we posted an article on the Maritime Executive’s website about moral hazard in shipping, and the shipping world got a big-proportions, real-life case study of the risks in the industry. We argued that when shipowners are over their heads in debt and with little promise of ever recovering any equity, there is precious little they care about financing, operations, trade, safety and even the environment.

Hanjin Shipping, based in South Korea and world’s seventh biggest containership company, filed for protection in S. Korean courts in late August, and subsequently started filing for protection in several jurisdictions worldwide, including in the United States federal bankruptcy court (filing for Chapter 15 restructuring in Newark, NJ). As of the end of second quarter this year in June, the company had outstanding obligations close to US$ 5.5 billion, approximately US$ 900 million of which due by the end of 2017. There were approximately US$ 700 million in equity on the balance sheet. Hanjin stands as the manager of appr. 142 vessels, 98 of which are containerships and 44 are tankers and bulkers. Only one-fourth of Hanjin’s fleet is self-owned, 38 of them owned and the rest chartered in from leasing companies and other financially-minded shipowners. The ownership mix of the tonnage indicates more of a light-asset, trading company rather an asset-heavy, ship-owning balance sheet. The current value of the owned fleet stands at appr. US$ 1.7 billion.

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Shipping crossing a bridge… Image Credit: Karatzas Images

Many details are still too opaque and covered by bilateral non-disclosure agreements, but where several of the counterparties have been publicly listed companies, one can draw certain conclusions: Hanjin had chartered in two 2010-built capsize vessels from publicly listed Navios Maritime Partners (ticker: NNA) MV ‘Navios Luz’ and MV ‘Navios Buena Ventura’ at a daily rate of US$ 29,356 pd each; the average spot capesize market was barely $6,000 pd during the last year, and presuming that Hanjin was trading the vessels on the spot market, they were losing $23,000 every single day for the last year ; of each of the two vessels. That is $16 mil down the drain for the two vessels in just the last year alone; each of the vessels had more than four years of employment remaining with the shipowner, and presuming that the spot capesize market would remain at present levels, Hanjin would had to suffer another $90 mil in losses for just these two vessels. Eight containerships chartered in from Danaos (ticker: DAC) had charter payment obligations of appr. $565 million. Similarly, three neo-panamax containerships from Seaspan (ticker: SSW) had outstanding charter obligations of close to US$ 370 million. These charter obligations add up to close to US$ 900 million, and under present market conditions, reasonable estimates would be for losses of more than US$ 500 million. And these are the calculations based on publicly available information for only thirteen of the 100+ vessels chartered-in, with only three counterparties. There are un-accounted obligations for more than eighty vessels that have been chartered in from other owners.

$23,000 losses every single day in the last year for each of the two capes chartered from Navios. Talk about destruction of value!

What options such a ‘shipowner’ like Hanjin (effectively a structured house of cards) does have under the circumstances? As one would suspect, very few. There is little in matter of equity, there is little in matter of collateral, there is lots of debt, and mostly, most of the debt is in relatively unsecured position since it’s in the form of charter obligations for the vessels that have been contracted on charter arrangements.

Playing the devil’ advocate and ask surreal but economically oriented questions: How much vested interest the shipowner has in the assets and the business? Precious little, at this stage. What are the odds that they will recover any equity? Probably better than hitting the jackpot in a national lottery, which we all know is not a fair proposition. What would any rational economic being would do? Briefly, either ask for the mercy of their creditors, or, having little to lose, just stop paying the creditors and pass the buck to the other side. What we called moral hazard in the previous posting.

Hanjin had been rumored (along with their co-patriot Hyundai Merchant Marine (HMM)) to be facing financial problems and was an accident waiting to happen. HMM, being slicker, and faster, and part of a big chaebol (traditional corporate conglomerate structure in S. Korea, strongly affiliated with family management style and running businesses deemed strategically important to the State, in exchange of the State’s preferential treatment), managed in August to find their way out of their financial ‘pickle’. When Hanjin tried to secure the consent and more financing from their lenders (mostly Korean banks and the state-owned Korean Development Bank), there was little empathy. This would make perfect sense, as their lenders were in relatively preferred senior position, and any new financing would be considered either ‘throwing good money after bad money’ or diluting their position and getting lower on the seniority scale of claimants. It would make economic sense to refuse any new financing and let the un-secured creditors (that is the shipowners of the hundred vessels on charter to Hanjin, like Navios, Diana, Seaspan) accept a less demanding solution. Again, Hanjin and their prime financiers decided to drop the moral hazard bomb to the parties with a lower legal claim, the shipowners of the vessels.

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The good times left behind… Image Credit: Karatzas Images

Hanjin Shipping is the seventh containership company in the world but with only appr. 3% market, thus, belonging in the lower tier of containership companies as compared to behemoths like Moeller Maersk, Cosco, MSC and CMA CGM. A default by Hanjin cannot be expected to have a major domino effect on the overall shipping or containership world markets. The majority of Hanjin’s lenders were Korean banks, including the Korean Development Bank (KDB), and the Korean banking system (and the Korean taxpayer, if so required) can absorb the losses without posing a systemic risk to the Korean economy, at least at this stage. Hanjin had been a major carrier for LG electronics, but again, even Hanjin’s demise could not be detrimental to LG and the Korean electronics and manufacturing industries; not to mention, since HMM’s successful restructuring in the summer, now there has been an alternative, an alternative based in Korea itself (subsequent reports state the LG has already been shifting their shipment contracts to HMM). Thus, once the situation was ‘ring fenced’ and a fall-out was determined to be contained, Hanjin and its main creditors stopped paying to the lower standing creditors (other shipowners with charter-in tonnage). An example of moral hazard in all its glory.

Hanjin has filed for restructuring (and not for liquidation) expecting to find a way to save the company as a going concern over the long term. However, owners of vessels on charter to Hanjin, companies like Danaos, Seaspan, Navios and many other smaller, private owners, stand to lose the most. In an oversupplied market of low freight rates, it will be difficult to withdraw their vessels from Hanjin and seek equally profitable charter rates elsewhere in the present market; likely, they will have to accept lower and extended rates that Hanjin will offer them, and possibly some equity upside if and when the company recovers. Otherwise, the shipowners will have to seek legal remedies which are costly and time consuming, and always risky on whether there will be a chance to ever collect. After all, the events of last week have shown that Hanjin is not a systemically important company to the Korean economy, there is little the Korean constituents that can lose, there is little left for Hanjin’s management and shareholders to lose. Heads I win, tail you lose.

A case of moral hazard of the highest caliber.


A better edited version of this article was originally published on The Maritime Executive website on September 6th, 2016 under the title ‘Moral Hazard Case Study: Hanjin Shipping’.  This article builds on our essay on the dangers of the moral hazard in a weak freight market posted in early September in this post, when market participants were left with few options and little to lose, so much so that they care little for the outcome or the interests other constituents of the shipping industry.


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

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

The chronically weak freight market and moral hazard

Low freight rates have been a concern for a great number of reasons and to a wide range of market participants: low freight rates entail weak cash flows for the shipowners who cannot perform on their loans and causing problems for the shipping lenders; investors in shipping having experienced poor returns on their investments contemplating asset sales and leading even lower asset prices; shipbuilders facing a great deal of slippage and defaults on existing newbuilding orders while demand for additional orders has vaporized; charterers and cargo owners have to be very careful that vessels chartered even in the spot market not only are seaworthy and commercially competitive, but also the shipowner is current with their financial obligations and there is no risk of seeing the vessel delayed or arrested and the cargo onboard not delivered on time; likewise, vendors to the shipping industry have to be experts with managing credit risk and keep their clients on a short leash (further curtailing market activity and their own business).

All the concerns mentioned above emanate from a single cause, a low freight market that radiates and affects every dimension of the shipping market. Despite the recent bounce in the dry bulk market, freight rates are still very low and at barely operating break-even levels. The freight markets have been too low and for too long, and shipowners, still in business, have had to dip deeply into their cash reserves or seen their equity overly diluted. There is little more aside in terms of cash reserves, funding from investors and financiers outside the industry, or for that matter, of patience.

Based on recent transactions and experience, now another concern has to be added to the long list springing from a weak freight market: moral hazard. Moral hazard in this case can be defined as the behavior where an owner is so much disengaged from reality as to act carelessly in reference to the asset and the parties with an interest in the asset. The most obvious example is when the owner’ economic interest in the asset is so minuscule that there is precious little to care about the asset.

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Neo-panamax containership MV ‘Hanjin Namu’ entering the Port of Piraeus in better days. Image credit: Karatzas Images

There has been moral hazard in reference to financing and outstanding shipping loans. When the principal amount of the ship mortgage is materially higher than the present value of the vessel (and any hope of market recovery thereof), the shipowner has little incentive to make any effort to fulfill their obligations according to the loan agreement. There is very little hope that they will ever see their money back and thus little incentive to behave. Several owners we know had been making good, more or less, on their loans for the last couple of years in the hope of a market recovery. Two years later, having thrown good money after bad money, and reaching the bottom of their cash reserve piles, now they are barely inclined to keep performing. There have been cases of shipowners who have stopped paying interest and principal of their loans despite having the financial capacity to do so. They are better off with shipping loans in default than with performing loans. First, they reserve capital, which they can deploy to new clean-slate shipping investments and let the legacy transactions sink. Second, for loans in default, shipping banks seem keener to grand concessions to shipowners with non-performing loans while they seem to uphold ‘good’ shipowners at a much higher standard. Thus, it pays to be bad. Thirdly, there had been traditionally an unspoken law in shipping that for a borrower defaulting to a shipping bank, effectively they were ostracized for life by the ship banking community, thus a very high incentive to behave: not to borrow more than one could afford, and, even when things turned sour, to make every effort to see the lender to recover as much as possible of the principal outstanding. Now with several executives at shipping banks being corporate officers with little knowledge of or affection for shipping or with a great deal of shipping banks actively exiting shipping, there is no longer the self-watching ship banking community to ensure proper borrower behavior and thus, plenty of room for moral hazard. Sort of, ‘what they can do to me?’

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Image credit: Karatzas Images

There has been moral hazard in reference to the maintenance of the vessels as well. When the freight market is low, economizing by cutting on expenses is required to make do with less and ensure survival in a challenging market. First goes the ‘fat’ and then ‘discretionary spending’ (spare parts onboard the vessel is the classic case) and then laying off people ashore, and then keeping vessel maintenance only to the extent that the classification society requires in order to renew the certificates. Talking to inspectors boarding vessels on behalf of charterers, the technical quality of the vessels has become a concern; and, this concern is highly troubling for tankers and for oil companies given the level of liability in the event of an accident involving pollution. Talking to inspectors boarding vessels on behalf of the port state control (such as the US Coast Guard), there is real concern about vessels that have been under-maintained. Talking to inspectors boarding vessels on behalf of buyers of ships in the secondary market, there is lots of concern about vessels that have been neglected for too long. With the freight market too weak for too long and with many vessels afloat ‘depending on the kindness of strangers’, there is little incentive to do anything above the absolutely minimum required in terms of maintenance.

There has been moral hazard in reference to seafarers and the environment as well. There have been several stories recently in the trade press about seafarers getting abandoned, gone unpaid for months and malnourished, and even stories of vessels arrested due to outstanding crew wages. And, in a market place where the shipowner does not care much about the asset or the lender or the crew, it’s hard to envision how or why they would care much about anything else, such as the environment or adhering to sound navigational practices. Such is the risk of moral hazard.

There is no doubt that we are living through unique times in shipping; the present shipping crisis has been much more monstrous than others in the past. Examples of moral hazard is a known consequence of rapidly shifting economic structures and defaults (think of moral hazard in the subprime real estate in the US a few years ago). However, given that there is low expectation of a market recovery in the near future, issues arising from moral hazard will only get more complicated and perilous. After all, moral hazard in shipping can affect trade, human lives and the environment. When contemplating actions in shipping at present, one has to be cognizant of addressing alignment of interests and dissipation of moral hazard.

There is an anecdote of Shipowner A confiding to their friend, Shipowner B, that Shipping Bank X arrested four of their vessels. ‘Oh dear,’ replies Shipowner B, ‘I am so sorry to hear. And now, who is your best banking relationship?’ he asks, to which, Shipowner A dryly replies with relief: ‘I think I already told you, Bank X’!

As funny as the joke is, a market cannot function on such a basis.


The above article was originally published on The Maritime Executive website on August 30th, 2016, under the title: “Shipping’s Moral Hazard”. We are thankful to the Editors of The Maritime Executive for hosting our article.


bmti-1An abbreviated version of the article suitable for the weekly market report was published on September 2, 2016 by BMTI in Germany, under the title: “Concerns About Moral Hazard in the Shipping Industry”. We are thankful to our friends at BMTI (a well respected dry bulk market data provider, with special focus on smaller tonnages and MPP vessels, and the short sea market) for hosting our article. For more info on BMTI and their services please click on the image of their homepage to the right!


© 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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