Sailing the Seas Depends on the Helmsman

Once upon a time, there was an independent shipowner with, let’s say, ten modern product tankers. Three of their tankers were mortgaged with a major European bank, a very well-known name and with proven past commitment to the shipping industry. And, the shipowner themselves, have been in the shipping business for more than a couple of decades and enjoying a solid reputation in the shipping community and with charterers. These, being legacy shipping loans, their terms were highly competitive in this market despite some success of the bank to tighten the loan terms since the market collapse a few years ago. Actually, the terms of these loans were exceptional, by today’s standards, as the spread was just 300 basis points. And, of course, the shipowner had watched these loans like the apple of their eye, and they were current with interest payments and principal repayments and the loans were comfortably meeting the loan-to-value (LTV) covenants.

Eighteen months ago, the shipowner got a note from their mortgage bank that since they (the bank) were exiting the shipping industry, the shipowner was given notice to make arrangements to pay back the loans (there was a small discount offered) or the bank would had to take matters in their own hands. Since these were performing loans, the mortgage bank could sell the loans at close to par, likely to a credit fund or an institutional investor, or possibly even to another bank if there were still banks out there buying shipping loans – not a likely cozy prospect under any circumstances.

It took a few months for the shipowner to recover from the first shock, having a brand-name bank giving them notice on performing loans. And, it only got worse from there. The shipowner’s shock got greater as soon as they started “shopping” the market for new financing: few shipping banks had interest in new clients or business or the capacity to finance a three-vessel package. While approaching institutional investors, the strategy was modified to squeeze the mortgage bank for a hefty discount of the loans, but with the institutional investors sharing (a great deal of) the economics of the transaction and not just to provide new loans. Almost a year passed since the mortgage bank had given notice and the shipowner could not find a new “deal” good enough. But again, having to replace shipping loans priced at L+300 bps in today’s market, one feels like they have been punched in the stomach.

And, while the shipowner was taking their sweet time to find the perfect financing they thought they deserved, the product tanker freight market started deteriorating: first freight rates dipped and then halved, and, as one would expect, secondary market product tanker sales started taking place at lower price levels. While the shipowner had a few million in cash in the bank, dry-dockings and other expenses started chipping away on the balances. And, the lower asset prices triggered LTV defaults now, giving much more leeway to the bank to sell the vessels themselves, and not just the loans – an even worse prospect for the shipowner.

And, lower freight rates and lower asset prices were making financing the original loans more difficult: cash flows now would only support lower financing, and institutional investors lost appetite since any discount now had less value in a weakening market.

All being told, the shipowner managed to finance just two of the vessels at today’s prevailing conditions (lower leverage, tighter covenants and cost in excess of L+600 bps.) And, the third vessel was let go and was sold (at a small loss) since no financing could be found within the parameters of a weak freight market and limited “sweat equity” from the shipowner.

This is a real story (unfortunately) and no names or other details can be divulged; but, such details do not matter really. If there are lessons to be learned is that first, in this market, shipping finance is the “determining factor” of the shipping industry, the independent shipowners. Shipping finance is the new battlefield where shipowners will be called to fight; if they cannot sort out their shipping finance game in the new market, they will be driven out of business – as simple as that. Second, in this difficult market, it’s not only “bad shipowners” who have problems; if your bank is not committed to shipping or you or they are having higher priorities unrelated to shipping, that’s the weakest link in the business, even if the loans are good and performing. Third, it pays to be pro-active in this market and tie loose ends as soon as possible; looking for the perfect financing at the expense of time, one can lose much more than a few hundred basis points – not arguing that two hundred basis points are not worth fighting for, but again, this is not a time when banks and lenders can bend much, if at all. And, lastly, independent shipowners had become a substantial part of the industry based on their shipping and operational expertise and efficiencies and not on their financial expertise (shipping banks were lending in the past liberally and just on the basics of how to extend credit); the present market is much more sophisticated than that and hiring competent shipping advisors may very well be warranted; trying to avoid paying an advisory fee can cost one whole ships.

“Sailing the Seas Depends on the Helmsman” was a revolutionary, patriotic song for Mao Zedong’s Red Guards in the 1960’s and 1970’s exemplifying the Chairman’s leadership skills, metaphorically speaking. For an independent shipowner these days, sailing the seas depends on the helmsman navigating the new reality of the shipping finance markets.

A long shadow over one of world’s most important shipping cluster. 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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Credit is due to Shipping Finance

The freight market has been disappointing recently, for dry bulk, tankers and containerships, while asset prices too have been on a softening trend, especially for tankers. As one would expect, traditionally the freight market gets most of the attention in shipping, for signs of strength with the hope that asset prices would be lifted too; however, we are of the opinion that shipping finance may be the key for successfully navigating the shipping markets going forward.

Having traveled extensively recently and having closed several S&P and structured, financial transactions, we can only be more convinced by the day that shipping finance is where the real battlefield lays for shipping nowadays. Access to finance, whether based on own funds or access to financing from third parties, is what sets shipowners apart in terms of survival and growth.

Shipping banks are done with traditional shipping and first preferred ship mortgages. Yes, we have seen a couple of occasions where European banks are still lending at 300 bps spread over Libor, but they are so selective and have such a limited capacity that effectively such lending activity only confirms the fact that shipping banks are not active for most practical purposes. Thus, cheap debt financing is no more.

Shipping credit funds have made lots of noise in the last year, and we estimate that they have deployed close to a billion dollars in the last eighteen months; still, they are too afar from financing the average shipowners, notwithstanding the temptation in this desperate market for debt financing. Credit funds typically look for 8% minimum yield before any fees, equity kickers and other incentives, which limits their applicability to only second hand vessels that are priced at a multiple of the collateral’s scrap value; financing the acquisition of a resale capesize vessel with excess $30 mil acquisition price and paying 8% yield, one may as well try their luck in Las Vegas and try to have a good time while they are at it. Thus, credit funds can have parodical application.

Private equity funds having made ill-timed “bets” in 2011-2014 in shipping (and we consciously use the term “bets”), now they stand licking their wounds and trying to devise ways to cut their losses short. Never mind grandiose plans for IPOs, market consolidation and bringing turn-around expertise and making a commitment to the industry; we have been the busiest we have seen with advisory, market intelligence, valuation, industry expertise services for disputes, arbitration and litigation between shipowners and financial investors. So much for hopes that private equity could feel the funding gap left in the wake of shipping banks leaving the industry.

True, there are still shipowners with deep pockets who have kept buying vessels well into 2017, despite the asset price bounce compared to all time lows in 2016 for the dry bulk market; however, there are few shipowners that indeed still have deep pockets. German owners may feel sick that they lose ships to other markets and especially to the Greek market, and this can be true to an extent, but on the other hand, few shipowners have been buying and can keep buying on a sustainable basis; most shipowners with ‘seed money’ are almost maxed out and looking for third-party money if they were to keep buying.

Shipping finance is really the battleground for modern shipping these days, the industry’s ‘soft underbelly’. While one can keep projecting on tonnage demand growth and developing trade patterns, shipping finance will be the field that will make or break shipowners. Shipping finance is getting to be ever more challenging and there is no realistically any reason that the picture will get brighter in the future. Yes, for few publicly listed shipping companies with critical mass, real business plans and solid corporate governance, capital markets can still be the way to go. But for most of the independent shipowners and several of the penny-stock listed shipping companies, shipping finance would be the critical link in their survival and / or success.

Based on reports from a recent shipping conference in New York – which purposefully we did not attend, we have seen that “M&A” and “consolidation” were the buzzwords of the day. But again, in a market that is as dead in activity as a coffin floating after the sinking of the „Pequod” in Moby Dick, whether for IPOs, etc (even a SPAC sponsored by the blue blood Saverys’ shipping family has failed) or follow-ons, hopes for “M&A” and “consolidation” have to do. And, statements that shipping and commercial banks ought to be considering shipping again, given that the industry is “low volatility”, humored us for reminding us the proposed “Hamburg Formula” for vessel valuations  of almost ten years ago where the shipping industry was suggested to be an industry of low volatility and risk and the suggested cost of capital was a whole of 50 basis points over the T-bill, then.

Solving the shipping finance riddle is really a critical point for most of the shipowners to address going forward, the direction of the freight and asset pricing markets.


This article first appeared on Splash 24/7 on June 23rd, 2017, under the title “Credit is due to Shipping Finance”.


Manhattan, New York City: An ever more critical place for shipping finance. 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.

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.

Shipping Finance Elements and Concepts

Following Presentations on Shipping Financing have been found on the internet. They are reproduced here as a matter of convenience for readers interested in the subject of how ships have been financed under different structures and different business models, at present and over time.

MV NEPTUNE THALASSA 13 BMK_5610 @There is debt (senior or first preferred ship mortgage, second lien, junior loans) and equity (owners’ equity or sweat equity, friends-and-family money) for the archetypal structure available to independent (individual) shipowner. Shipping banks over time had been the prime financiers of the shipping industry mostly in  the form of asset-backed financing (mortgage). There is leasing whether operating or financial leases, sale and leaseback, or uniquely structured Japanese Operating Leases (JOL), and financing earned via long-term charters (time charters and long-term bareboat demise charters). Independent shipowners have been dealing with shipping banks and often financed vessels via project finance, and when circumstances fertile, dealt with private equity as well. For owners who sought public equity and underwent an IPO process, the capital markets for equities and for bond (shipping bonds) have offered more alternatives. Shipping finance has been experiencing tectonic changes since 2008 and has moved from relatively self-explanatory terms of vessel valuations and Loan-to-Value (LTV) to terminology to accommodate Basel III with its Tier 1 Capital (CET1) to Risk-Weighted Assets (RAW) and the Capital Adequacy Ratio.

Copyright to the presentations and articles listed herebelow belongs to their perspective owners, and hereby duly acknowledged. Presentations have been found posted freely on the world wide web, and reproduced here as a matter of convenience.


Elements of Ship Finance
Zan Yang and Jian Chen
Department of management, Dalian Maritime University                                                  Last accessed on the internet on July 26, 2016.                              http://www.paper.edu.cn/scholar/downpaper/yangzan-2.html


Risk vs Return for Lenders and the Economics for Borrowers
by R. Philip Bailey, June 2015
Last accessed on the internet on July 26, 2016.

By Allan D. Reiss, Morgan Lewis & Bockius LLP, 2014

Last accessed on the internet on July 26, 2016.

Deloitte, 2011
Last accessed on the internet on July 26, 2016.

Irish Maritime Development Office, 2015
Last accessed on the internet on July 26, 2016.

Shipping Finance: A New Model for a New Market                                                  Citi, 2015                                                                                                                       Last accessed on the internet on July 26, 2016.                                    https://www.citibank.com/tts/trade_finance/financing/docs/citi_ss_v2.pdf


The Impact of the Basel III Capital Accord of Asset Finance
by Angelo L Rosa, 2012
Last accessed on the internet on July 26, 2016.

by Basil M Karatzas, 2010
Journal of Equipment Lease Finance
Last accessed on the internet on July 26, 2016.

Dissertation by Alex Orfanidis, 20014
Last accessed on the internet on July 26, 2016.

Ariff Kamarudin, 2012
Lehigh University
Last accessed on the internet on July 26, 2016.

© 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.

Consolidation and Shipping: A Cure for All?

Since the initial collapse of the shipping industry in the second half of 2008, many remedies have been proposed for a market recovery, ranging from pragmatic (slow steaming, etc) to utopic (accelerated demolitions for older tonnage, shipowner self-discipline and abstinence from newbuildings, etc). Depending on the point of view, remedies proposed included M&A, market consolidation, selective financing from banks and financiers, etc

The consolidation theme has been particularly in the news for the last several years, and now that five years into the crisis there is no clear light at the end of the tunnel, consolidation once again has been commanding the headlines. At a recent shipping conference in New York City, eminent institutional shipping investor Wilbur Ross once again re-iterated the need for market consolidation.

Consolidation definitely has its usefulness as any investment bank can attest to. An industry with a relatively low number of companies controlling a rather large market share can have a better control of the cost structure, quality, product differentiation and more importantly better pricing power than an industry that is fragmented and controlled by numerous small players. Shipping, especially the dry bulk market, has often been offered as an example of perfect competition with minimal barriers to entry, minimal regulatory and taxation concerns (at least until recently), an internationally open and competitive market; in other words, a industry as antipodean to consolidation as one can get.

Many ship-lending banks have repeatedly raised the point of market consolidation: supposing that as a lender one has a portfolio of several similar vessels in default with several borrowers, it makes sense to consolidate the borrowers (shipowners) simply from a cost basis benefit: instead of having to deal with several borrowers and explaining, negotiating, formalizing the same ‘procedure’ several times over, there will be just one discussion with one counterparty; such an approach not only saves time, overhead and bank resources, but sometimes putting several problems together to form one big problem, the big problem can have solutions not available to many smaller problems of the same kind – critical mass is an obvious benefit of consolidated owner versus the one- or two-vessel special projects.

Still with the ship-lenders’ point of view, a consolidated owner can not only save resources for the lender, but also can economize for their own benefit by spreading the cost of running the business over a bigger pond of vessel ownership. IT, accounting, admin services are the obvious candidates for cost savings, not to mention that savings can be obtained from suppliers and third party providers based on greater purchasing power. And such savings can be detrimental to survival in a market where many vessels are earning at or below operating break-even levels.

A consolidated industry with fewer shipowners also has benefits when dealing with charterers in terms of maximizing revenue and obtaining favorable terms in the charterparty. Larger shipowners can have better control of the market and provide a better orchestrated approach when chartering vessels instead of having to deal on fixture at a time, one vessel at a time, one port at a time, one day at a time. The benefits of a consolidated market can best seen in markets that have been ‘sort of consolidated’ based on their nature, such as the markets for large vessels like VLCCs and capes, and niche markets with few players like asphalt carriers, cement carriers, heavylift vessels, etc Typically in such consolidated segments, not only broad market trends are identifiable – just like in the commoditized shipping industry – but also the cargoes themselves can be identified and accounted for: i.e. Saudi Arabia’s crude oil production is known or very well expected (barring macro-, political events, etc) and since most of crude oil our of major exporting crude oil countries is on VLCCs (each holding two million barrels of oil), chartering VLCCs is a game of chasing specific cargoes at specific points in time; thus, an owner with fifty VLCCs under control can optimize the fleet position to access those cargoes versus a shipowner of one VLCC who has to be satisfied with what the market would bear each time their VLCC reaches a loading port in Saudi Arabia.

So far, so good. Consolidation then it seems makes great sense and it almost looks like panacea for an industry of distress.

There are more than six thousand and five hundred (6,500) handymax and handysize dry bulk vessels in the world, with more than one thousand (1,000) shipowning groups active in this segment worldwide. The top one hundred owners control only two thousand of these vessels (appr. twenty vessels per owner) or less than 30% of the world fleet, with an apparently very long tail of ownership. As much as consolidation may make sense, it’s impossible to ever get close to a consolidated market from a practical point of view in this market segment. Lots of these shipowners will fail to see any economic benefit from getting consolidated, amalgamated, merged, acquired or otherwise voluntarily get off of their present equilibrium; not to mention that most of the shipyards can build handymax / handysize vessels for anyone who can afford them (and sometimes cannot afford them), thus the market could not stay consolidated for long, even if forced into a consolidation due to poor present dynamics. Further, handymax / handysize vessels effectively can trade any type of dry bulk cargo in the world and can access all the ports of the world, thus there is an infinite number of cargo and port permutations. And, we have not talked yet about the charterers of these vessels, which is an equally impressive of long tail of charterers, with the common denominator among them their desire for the lowest transport cost for their cargoes, condition of the vessels, well-being of seafarers, regulatory environment be damned by a great deal of these charterers – the sorry state of the truth, politically correct or not [this statement is not an opinion or comment in any way, just a sharp-tongued observation]. In certain markets, consolidation seems it is not practically doable given the existing dynamics of the market and the prospects that such dynamics can change in the long run.

And for the markets where consolidation can be feasible, the argument’s prime mover is that larger fleets call for efficiencies, efficiencies ad infinitum according to certain presentations. We all know that life and business is not a straight line, and a fleet of forty uniform vessels is not twice as efficient as a fleet of twenty vessels which is not twice as efficient as the fleet of ten vessels, etc Clearly fleets of fewer than five vessels are completely inefficient, but where the marginal benefit of adding more vessels to a fleet stops being worthy the additional consolidation? We are not aware of any academic studies but empirical evidence from many markets concentrates around the number of thirty vessels. Some publicly listed companies want us to believe that fleets of one-hundred vessels are the most efficient, but we are not convinced that the magic number one hundred is the result of business amalgamation rather than a convincing coherent business strategy.

There are so much in savings from IT and admin to be derived and so many synergies and discounts to be obtained, that a lousy freight market can save. A shipping company in a consolidated market segment may have a higher probability of survival in a bad market, but the law of gravity is universal and when gravity exceeds buoyancy, the result is a downward movement.

Consolidating or not, the shipping industry has proven that it’s not always like other industries; what has worked in other industries is not always applicable to shipping, at least not for the broad ocean of vessel ownership in all markets and corners of the word.


© 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.

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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).

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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.