Financial distress in the shipping sector
January 2012 | TALKINGPOINT | BANKRUPTCY & RESTRUCTURING
financierworldwide.com
FW moderates a discussion on financial distress in the shipping sector between Randee Day at Day and Partners, LLC, Harry Theochari at Norton Rose Group and Nils Kuhlwein von Rathenow at Roland Berger Strategy Consultants GmbH.
FW: What key industry trends have you seen in the shipping sector over the last 12-18 months? Has there been a noticeable increase in insolvencies and liquidations among shipping companies?
Day: Since the 2008 financial crisis, the sector has seen both freight rates and values for vessels decline, as it tried to absorb the huge number of new ships ordered during the ‘boom’ period of 2006-08. The moderate pick up in 2010 in oil demand growth and an increase in the seaborne coal trade, steadied the market briefly, but in the later part of 2010 it became evident that volume increases were not sufficient to offset the supply/demand imbalance in tonnage, and rates continued to decline. In 2011, as the global economy recovery stalled, we saw a reversal in seaborne volume in both the dry and wet sectors. With the persistent delivery of new ships coming into the market, freight rates have fallen precipitously as capacity utilisation for oil tankers dropped to 78 percent and 81 percent for dry bulk vessels. Over the past 12 months, all shipping companies have experienced a significant drop in EBITDA which has resulted in many companies breaching both liquidity and LTV covenants with their lending institutions. A large number of ship-owners have already approached their banks two or three times for relief, but the ‘amend and extend’ business strategy of the banks has accomplished nothing more than forcing owners to drain their cash reserves. With spot rates in several sectors barely covering operating costs, some of the larger shipping companies have filed for bankruptcy, including Korea Lines and General Maritime.
Theochari: This period has seen the availability of bank lending to the shipping industry, and indeed the number of banks that are still active in shipping, decline dramatically. In view of the fact that bank lending accounts for the great majority of finance that is made available to the shipping industry, this has had a profound effect on many shipping companies during this very difficult period of economic crisis. There has been a noticeable increase in insolvencies among shipping companies but certainly not as great as many commentators had envisaged. The primary reason for this has been the very good sense that most banks and ship finance institutions have shown when dealing with problem loans. Obvious high profile insolvencies include Omega Navigation and Genmar. However, there have also been some successful restructurings such as Danaos.
Von Kuhlwein: One has to acknowledge that the ‘shipping sector’ is not a homogeneous industry. It has to be split into segments according to cargo and vessel types, and also according to different parts of the value chain. Markets differ heavily between the different segments – container, dry bulk, wet bulk, project bulk, and other segments. We have seen a substantial time lag between the segments. Wet bulk went into a trough, while container bulk rates already recovered again in 2010. In 2011 container bulk suffered again heavily. The economic situation of a specific corporate is heavily determined by whether the company is ship-owning only, or whether it is an operator. The container shipping segment is a growing segment due to ongoing containerisation and globalisation, with demand growing in the long-run. It is a heavily cyclical business currently influenced by a high number of deliveries of new large-size vessels ordered before 2008-2009. It is a highly competitive market, with high exit-barriers and a high degree of fragmentation. It is a market driven by asset-intensiveness. It is a highly commoditised market with low switching costs, standardised offerings, and transparent and comparable factor costs. Insolvencies and liquidations, with scarce exceptions, were seen at ship-owner companies and one-ship companies.
FW: Could you explain the economic and operational challenges causing financial distress for companies within the industry?
Theochari: The shipping industry has found itself having to weather a global financial crisis at the same time as the supply of ships exceeds, in some cases greatly, the demand for ships. This has led to a huge decline in freight rates for just about every type of ship. The most noticeable is probably the Capesize market where rates of $200,000 per day were not unusual during 2008, which have fallen to as low as $10,000 per day, although there has been some recovery to approximately $30,000 per day. The VLCC market and small chemical tanker sector have also been very badly hit. I would hate to contemplate the consequences for the shipping industry had China not experienced its recent phenomenal rate of economic growth. To a large extent, it is China and Chinese demand for ships that is keeping many sectors of the market going. The only exception is the LNG market where, due largely to the recent natural disaster in Japan, there has been a global increase in demand for gas as many sovereign states consider the viability and safety of nuclear energy more carefully.
Von Kuhlwein: All segments are currently facing a high supply-demand surplus, which is, in some markets, up to 40 percent. This will presumably last through to 2014. It is mainly driven by the high number of large-size vessels delivered to the market in 2011 and 2012, which still results from the high number of new vessel orders pre-crisis, fuelled by prospects at that time of ongoing market growth and cheap access to capital. The surplus in container markets also comes from new frontiers in vessel sizes, growing from 8000 TEU to 13,000 TEU, and 18,000 TEU. Currently, some players are thinking about the next generation of vessels beyond the 20,000 TEU barrier. With those vessels coming to the markets, freight rates eroded, also due to the effect, that those vessels pushed down rates for the next smaller ones, while bunker prices picked-up after the crisis 2010, resulting in high pressure on profits for ship operating companies.
Day: The biggest economic challenge facing the industry is the present financial crisis in Europe and its affect on the availability of credit for this capital intensive sector. A huge percentage of the new building book, which was deferred over the past two years, is yet to be delivered. Owners are struggling to find the funds required to pay the shipyard upon delivery. The banks know that the vessel’s value upon delivery will be ‘impaired’ against their loan and are reluctant to make the final payments. Most of the traditional shipping banks are based in the Eurozone and several are experiencing balance sheet issues of their own, which has increased their cost of funding. Recently, some of these banks have been unwilling to finance the purchase of second-hand vessels, which is creating a stalled sale and purchase market. Additionally, these same banks are witnessing significant erosion in the collateral value of their security and are pushing owners to sell vessels that they believe will be further impaired . This has and will continue to put tremendous pressure on second hand values. The biggest operational challenge is managing the rising price of bunker fuel and keeping trade creditors current.
FW: Are shipping companies pursuing refinancing and restructuring solutions to resolve their current problems? How much success are they having on this front?
Von Kuhlwein: Many ship-owning companies currently face a fundamentally worsened economic outlook as lay-ups increase and their charter rates are decreasing. Whether they are entering, or have yet to enter, restructurings or refinancing depends on the time limit of current charters and agreements negotiated with financers during 2008 and 2010. It is to be assumed that the number of restructurings at ship-owner companies will increase again in 2012. For the ship operators, it depends on whether they sufficiently restructured back in 2009-2010. Some of the large operators still sailed very successfully in 2011; others failed to do their homework and face tremendous profitability issues.
Day: Under pressure from banks, shipping operators have used liquid reserves to pay down debt, simply to preserve loan-to-value covenant compliance. Both the banks and owners must have seen that they were operating at a cash loss and eventually, by running down their liquidity, the company was exposing itself to issues with its unsecured creditors. Both the banks and owners should have pushed out the loan amortisation schedules last year and anticipated that many companies would be lucky to cover operating costs, G&A and interest expense. Most of the deals that were done in 2010 or early 2011 have not been sufficient as debt restructuring is not enough. The only way many of these companies will survive, whether in or out of bankruptcy, will be if new capital comes into the business. This could be in the form of DIP financing or strategic and/or opportunistic investors injecting funds in order to take control of the enterprise. One of the bigger names in the business, Frontline, appears to have crafted its own reorganisation with the company’s founder and lead shareholder, John Fredriksen, injecting $500m to save his company. Very few owners today have such flexibility and sizable resources.
Theochari: There are an enormous number of shipping companies in financial difficulty, not least those listed on the New York capital markets. Largely due to the common sense approach that banks and financial institutions have been taking during the present crisis, there have been a great number of reschedulings, restructurings and refinancings. One of these was the largest restructuring ever of a listed shipping company, Danaos Corporation, in a $3.5bn restructuring involving $500m of new money and many millions in new share warrants.
FW: What sources of financing are available to shipping companies in the current market? How would you characterise the appetite among traditional banks, private equity funds, sovereign wealth funds, etc., to contribute capital to this particular sector?
Day: Several of the largest global shipping banks, such as DVB Bank and Norway’s DNB, have publicly confirmed that the Eurozone financial crisis has resulted in a credit squeeze that will continue to restrict finance for second hand tonnage. Forced liquidation in cases such as Saga Tankers resulted in the price for a 10 year old VLCC falling 30 percent since last July. This plunge in values has also affected the dry sector, with the price of a five year old Capesize vessel falling 28 percent. Some of the larger shipping banks, such as Lloyds and RBS, have been trying to sell portions of their loan portfolios, but few buyers have emerged. Private equity firms have been discouraged by the interest rates on many of these portfolios – averaging 125 basis points over LIBOR – which they find surprisingly low for an industry with such high volatility and risk.
Theochari: There are very few deals in the market at all. Those that are in progress, or are being contemplated, are invariably backed with some form of either export credit finance – from, for example, China EXIM Bank, Korea EXIM Bank, Finvera and Hermes – and increasingly by private equity. Recent major private equity investments include those by the famous investor Wilbur Ross, with his investment in Diamond S; Fortress with their investment in Seacastle; and also the very large investments made by Oak Tree Capital in General Maritime and Beluga, as well as the interest being shown in shipping by the major investment house, The Carlyle Group.
Von Kuhlwein: Before the crisis the German banking sector was the largest ship financer in the world, with an exposure of more than €120bn face-value. With EU regulations on state-aid forcing the German banking sector to fundamentally wind-down its exposure in the shipping industry, those banks and especially the public banking sector will stay away, or will only very selectively finance shipping in the future. We have seen increasing interest from institutional capital, be it private equity, sovereign wealth funds, and others, in various levels of the industry. Also the German KG – the financing model of splitting the equity portion over retail investors – is heavily breaking away, and the industry desperately needs new financing models and sources. One such source is Chinese banks, which are increasingly filling the gap by offering financing against placing orders to shipyards.
FW: What steps can shipping companies take to raise additional capital or attract investment? Is it crucial, for example, to reduce operational costs and increasing efficiencies wherever possible?
Theochari: Any investment in shipping at the present time is likely to be a hugely speculative one. Asset values in the shipping market are at their lowest level for at least the last six to eight years, and as a consequence, these assets can seem attractive to investors. However, the huge imbalance in demand and supply means that investors generally have to take as educated a guess as possible as to where particular markets are likely to be in the next few years. Offshore and drilling vessels are very attractive at present as there is a widely held belief that oil prices are never likely to fall to any great extent. Large container vessels are also still being ordered as there is a belief that the economies of scale that these bring will be very important for the increasingly vital Asia and Europe routes. That said, every company needs to make every effort to keep its costs to an absolute minimum, and to be as efficient as possible if they are to attract any type of financing or investment.
Von Kuhlwein: It is of paramount importance for operators to secure access to financing, to be able to invest at the right time, into the right vessel type, to have the right number and size of vessels on the trades, to manage networks more efficiently than competitors, and to unleash profit improvements along the entire P&L. Different strategies exist on the side of diversification and investments along the value chain. Some players are invested in very profitable port operations; others follow different strategies on direct access to freight. Obviously, the charter strategy also matters for instance, owned versus chartered capacity. Also, trade strategies can be decisive, as some trades are highly profitable, while others might be eroded. Those points are the main differentiators for operators and thus may be decisive for attracting capital, besides factors of ‘housekeeping’ such as transparency, accountability and credibility.
Day: In the traditional shipping sub-sectors, such as dry bulk and tankers, very little can be done on the cost side. Rising bunkers prices have impacted every operator and global crew wages, and insurance costs remain high. Additionally, every time a company goes to its bank or banks for a waiver or amendment, they are being charged a fee for doing the deal in addition to having their interest margin increased. Now the banks are insisting that many owners hire professional restructuring firms to help them vet revenue assumptions and craft recapitalisation plans, adding more pressure on expenses. With the huge fall in share prices over the past 18 months of all public shipping companies, raising capital, either debt or equity, is virtually impossible in the present environment; owners are therefore looking to sources of mezzanine or private equity capital. Any new money investing into the company’s capital structure is likely to result in significant dilution for existing investors and in many cases, a total change of control.
FW: What is the outlook for the shipping sector in 2012 and beyond? What developments do you expect to shape the industry going forward?
Von Kuhlwein: For container operators it remains to be seen what impact the new G6 alliance will have on the markets, and whether consolidation will be kicked-off. On the side of the ship-owners, with consolidation already underway, small players will increasingly find it hard to get access to capital and therefore might not be able to finance new ships. Increasingly, some of them will be not able to offer competitive advantages and will have to pool their assets with larger players. Those large players are already increasingly offering their platforms for smaller ones to dock-on the operations. Also, larger players are opening their operations for alternative investors. Traditional ways of financing new vessels will hardly be sufficient and thus alternative financing models are required. As the fundamental drivers of the industry – worldwide GDP growth, dependency on raw-oil prices, vessel capacities, fragmentation and commoditisation – will not change and may even worsen in 2012, it is very likely that there is no fundamental relief to be expected for this year. The future development of the industry depends heavily on a change of these fundamentals, and the reaction of market players remains to be seen.
Day: 2012 will be as difficult or worse than 2011, as many companies will simply run out of money. Waivers and amendments on existing loan repayments will not be enough. We will see more charterer’s renegotiate the terms of commitments that they can no longer afford to pay and if owners do not agree or simply can’t accept the reduction, we will see more bankruptcies. With a challenging global economic recovery and a liquidity crisis within the Eurozone, there is little prospect in 2012 for a recovery in freight rates. Most industry experts do not expect the tanker sector to recover before the second half of 2013. I do not believe that shipping as we have known it will function in the same manner going forward. Small and medium size companies will either disappear or have to merge in order to attract scare capital and the future of vibrant publicly traded shipping market is doubtful. The value destruction in the market caps of most public shipping companies has been shocking but clearly underscores the volatility of risk capital and speculative nature of the sector. Large governments, such as China, that need access to commodities, will continue to expand their fleets to the detriment of the independent owner, therefore, I believe that we will see more consolidation and partnering between end-users and operators.
Theochari: In September of 2011, I suggested that there would be at least four listed US companies in Chapter 11 by the end of 2012. Two such companies – Omega Navigation and General Maritime – have already filed for Chapter 11. Bearing in mind the current cash position of many such US listed entities, I would be very surprised if my prediction was not exceeded. The great oversupply of vessels in most sectors is likely to keep the shipping market in the doldrums for at least the next 12 months and possibly longer. China has been the great driver for the shipping industry for more or less the last decade and, in my view, any recovery that we are likely to see will be driven by Chinese demand for raw materials and Chinese exports to Western nations.
Randee Day is president and CEO of Day and Partners, LLC. She has an extensive background in international trust and maritime law and has worked with clients on bankruptcies, foreign judgments and strategies for disposing of real estate and shipping assets in various international jurisdictions. Ms Day served as the Head of J.P. Morgan’s Marine Transportation and Finance department in New York, before founding Day & Partners Inc in 1985. She is an independent director of DHT Maritime, Inc., a director of TBS International Limited and serves as a director of Ocean Rig ASA. Ms Day can be contacted on +1 (203) 542 7234 or by email: randee@dayandpartners.com.
Harry Theochari is global head of transport at Norton Rose Group. He specialises in international shipping finance and he has been involved with the financing of second-hand and new building vessels, oil rigs, and other floating structures worldwide. He is regarded as a leading expert in the financing of LNG vessels. Mr Theochari and his team have been awarded the Legal Business Shipping Team of the Year Award, the Jane’s Transport Legal House of the Year and Transport Shipping Law Finance awards, and the Lloyd’s Shipping Economist Award for legal services relating to shipping and shipping finance. He can be contacted on +44 (0)20 7444 3648 or by email: harry.theochari@nortonrose.com.
Nils R. Kuhlwein von Rathenow is a partner at Roland Berger Strategy Consultants GmbH. He is the co-head of the firm’s Corporate Performance Competence Centre, he focuses on restructuring, profit improvement, and strategic reorientation projects. As a consultant, he has successfully restructured a variety of companies in all major industries across Europe. For years he has worked intensively in the maritime industry across the whole value chain. He is board vice chairman of the German Turnaround Management Association (TMA Deutschland). He can be contacted on +49 211 4389 2122 or by email: Nils_von_Kuhlwein@de.rolandberger.com.
© Financier Worldwide
THE PANELLISTS
Randee Day
Day and Partners, LLC
Harry Theochari
Norton Rose Group
Nils Kuhlwein von Rathenow
Roland Berger Strategy Consultants GmbH