First International

Slater on Money

- April 2012 -

The Great Shipping Recession continues

2012 will arguably be the 5th year of the Great Shipping Recession and many are asking
“How long is this going to continue?” and “What can we do to prevent it from getting worse?”

I would add to these questions one more important one,
 “What needs to be done to re-balance the industry and return it to profitability?”

The published results of QI 2012 that have been delivered, alongside the final results for the year 2011, show a continuing pattern of serious cash flow problems and little or no signs of any recovery in the markets.

Meanwhile a lot of restructuring has taken place in both the public and private companies and the Chapter 11 bankruptcies have had mixed results.

The common problem for almost all the public shipping companies and presumably for most of the private ones, is the levels of debt they have taken on to finance both newbuildings ordered and second-hand ships bought in the boom years prior to 2008.

Shipping banks were lavish in their lending even as the capital costs of ships rose to
unprecedented levels and the collateral requirements of charter cover were completely ignored or deferred until the ships delivered.

The spot markets that existed at the time the newbuilding contracts were signed may have been profitable for older existing ships but would not have paid for the newbuildings.  By implication therefore the banks were assuming that markets would continue to strengthen and thereby fund the expensive new buildings.

Even as markets slowed going into 2008 the banks seemed oblivious to the huge forthcoming supply of un-chartered new ships in both the dry and wet bulk markets, and the huge extra capacity delivering into the container sector.

Amazingly banks continued to finance further orders of new ships through the rest of the decade with minimal equity from the owners and few if any charters.

2011 was a bellwether year where banks faced rapidly diminishing shipping company balance sheets and cash flows, and their own changing regulations governing risk assets, Basel III.

The inevitable result of this is no new lending to shipping companies with non-performing loans, no further waivers of covenant breaches, and foreclosures and ship arrests as banks work to recover what they can from the debacle they helped to create.

It is becoming increasingly clear that any meaningful or lasting recovery of freight rates in the near term, prior to 2015, is unlikely.  This will mean that companies with large debt leveraged against the values of ships prior to 2009 will certainly be unable to meet any capital repayments and struggle to pay interest.

In short, the dominating issue of today and going forward is insolvency, or the fact that revenues will not be sufficient to cover expenses.

Faced with this fact many companies have sought to restructure their debt, but are now finding banks unwilling or unable to do this.  Instead banks are looking at forcing the sale of ships, taking the proceeds and holding the equity responsible for any shortfall.

This approach is being publicly played out in the US Bankruptcy Courts with mixed results.

Chapter 11 is a US bankruptcy legal tool, designed to enable debtors and creditors to reach agreement on restructuring and validate it through the courts.

It requires plans for restructuring to be submitted and argued in the courts and negotiated there, even if the end result is liquidation of the assets and termination of the shipping company’s activities.

A number of Chapter 11 cases have emerged in the past year and some have been resolved while others remain in limbo.

Having closely followed several of these cases in recent years I have come to the conclusion that shipping companies should only use the US Chapter 11 system if they have spent time and money preparing a restructuring plan and have it presented in court by lawyers who have a well established shipping practice in the expectation that their creditors will also use experienced maritime lawyers.

After all, in most cases, the shipping companies and their bankers have entered into loan agreements, assignments of charter income and mortgages on the ships, most of which have been drawn up under non-American laws.

To try and use Chapter 11 to disrupt or even invalidate this security, using lawyers with little or no maritime experience is a futile and expensive exercise.

To use Chapter 11 to approve and validate a reconstruction plan that protects debtors and creditors and possibly create a viable new operating entity is the essence of the law.

Unfortunately, as I will explain in a subsequent article, we are destined to see many more shipping companies fail over the next few years.  From past experience the ships will continue to trade, under new ownership and the capacity surplus will be with us for years to come.

Financing of new ships will be increasingly difficult and the arrival of Private Equity as a primary source of capital is no solution. The investment returns they expect and their tight control of management and cash flows will not work in the shipping industry.  After all they are only the managers of other people’s money and shipping will not dance to their quick-step tunes.

Shipping undoubtedly needs a lot of new equity capital but it is difficult to see where it will come from. As shipbuilding prices decline one might hope to see a reduction in capacity, but instead we are seeing aggressive marketing of new designs claiming operating and fuel efficiencies which are hard to reconcile. Some of these new ships have recently been ordered by private equity firms, but once again without any charter cover.

Inevitably we will see the major charterers in the oil markets locking up new ships of their own design on long-term charters with quality owners which will keep the spot markets depressed and cause operating problems for the older less economic ships.

In the dry markets the reduced demand for minerals into China and the development of new mineral sources will have a continuing adverse effect on the capesizes which are already vulnerable to the VLOCs coming into the Brazilian market. The smaller handysize ship markets are hugely over-tonnaged and the rates needed to fund the expensive new ships that are already delivered will be difficult to find.

LNG is now fashionable again with some 70 new ships on order, but LNGs are long lasting ships and one must wonder if all of these new ships will find employment.

The container sector continues to barrel on with its largest orderbook in slot terms and ever increasing ship sizes. With little or no scrapping and the lowest average age of just over 8 years the fleet is growing while world trade in its cargoes continues to decline.

The Great Shipping Recession is set to continue for several years.

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