Saturday, December 29, 2012

Greece’s national fate in view of the mounting Italian challenge to present Eurozone system

I have long maintained that Greece is so chronically dependent on the EU that its fate in the Eurozone will be determined by events in the larger periphery Eurozone members, particularly Italy and Spain.  Italian elections in two months’ time may prove a significant catalyst.  The Italian PDL under Silvio Berlusconi appears to have thrown the gauntlet to the Eurozone establishment, withdrawing their support from the Monti government and provoking the resignation of Mario Monti with early elections.

Berlusconi is openly attacking German mercantilism and threatening to leave the Eurozone.  Monti is forming an alliance with the centrist parties with tacit support from the Italian socialists favoring continuity of austerity. The outcome of these elections will be crucial.

Franklin Allen of the Wharton school at Penn has long maintained that leaving the Eurozone albeit temporarily with a national currency and devaluation is a faster road back to economic growth that the present hair-shirt forced deflation programs of the European Union. He foresees the risk of a populist politician in Europe, who effectively pulls the plug on Eurozone and leaves the system.

This situation seems to be brewing presently in Italy not only with Silvio Berlusconi but also two other major Eurosceptic political groups: the 5-star movement of Beppe Grillo and the Legha Nord. Historically, Italy was instrumental in the break-up of the 19th century Latin Union.

Unlike the smaller Eurozone members under TROIKA programs like Greece, Spain and Italy as larger countries with more leverage have resisted this type of work out program as degrading to their national sovereignty. They also have considerably more debtor leverage with the core EZ countries.  An Italian Eurozone exit and debt repudiation would leave the EZ core countries in serious financial problems.  The French have already suffered a minor downgrade.  Germany - a country with two major debt defaults over the last 100 years - is not necessary invulnerable.

Spain is presently in limbo for months now, trying to resist entering the Draghi-proposed OMT funding trying to survive with ad hoc austerity measures in mounting social and regional turmoil. The Brussels elite effectively created a putsch in Italy installing Mario Monti to lead a technocrat government. This was at the same time that they deposed the Papandreou government in Greece leading to present coalition government under Antonis Samaras, totally submissive to austerity policies and forced integration.

Monti was not unaware of the risks of austerity by the Greek example. He was instrumental with his compatriot Draghi in the creation of the ECB OMT program that has stabilized financial markets for the time being, despite many question marks concerning viability and never actually tested in practice. The Monti program entailed massive tax increases and Italy has fallen into a deflationary tailspin that is causing havoc and mass discontent.

Italy unlike Greece is an industrial country with a productive goods and service economy. There are significant economic interests open to challenge German mercantilism in the Eurozone system and its persistent policies to promote trade surpluses at the same time punishing the deficit countries with hair-shirt austerity programs. There is a rising Italian anti-European Union sentiment in reaction to the hardship from the imposed austerity conditions and movement to exit the Eurozone system. The Greeks by contrast are terrified of losing the EU transfer money and bailout loans, so they are willing to suffer like former Soviet satellite states to remain in the Eurozone.

Silvio Berlusconi, a self-made business man, is the antithesis of a European politician. The European (and Greek) political class is largely an idle rich, who have made politics their sole career or former labor union leaders. Antonis Samaras, the present Greek PM, like most key European politicians never held a normal job in his life. Indeed, he married into a wealthy family to subsidize his political career just as his socialist coalition cohort, Vangelis Venizelos.

In Europe there is a firewall that keeps people from the working world outside of key political positions. Democratic representation of the productive classes is scant, indeed virtually non-existent in Greece for example. It is rather disconcerting that European politicians – bereft of any practical work experience - engage in top-down economic central planning programs without any real skin in the game in terms of their own economic livelihood related to the success or failure of their policies, affecting millions of their hapless citizens.  For all the moral hazard issues in business transactions, the European Union with its enormous and non-transparent lobbies is one of the most dangerous examples of excess and lack of restraint from concentration of power.

Clearly, the European political elite seem to be betting the house for economic recovery in 2013 with every Eurozone politician from the all-powerful Wolfgang Schäuble down to humble and subservient Antonis Samaras, seeing the crisis over by the second semester and the Eurozone back to economic growth.

What is difficult to reconcile is how this is going to happen with the doubling up of heavy taxation that will inevitably increase fiscal drag. The debt overhang is not being serviced because of increased tax revenue from new economic activity, but rather governments are closing their primary deficits by taking a larger chunk out the GDP in increased taxes. Will this concept of hopefully borrowing ‘cheaper’ in spite of massive debt overhang In Eurozone periphery countries address the issue of deep recessions and shrinking GDP at alarming rates?

The issue of debt restructuring down to credible levels (below 90% GDP) in the Eurozone periphery countries or the matter of the trade balance surpluses in the core countries is still very much politically taboo in Europe, making this a mounting challenge from Italy a very interesting political development. Certainly if Italy gets into an open dispute with the European Union on German trade balance abuses and the merits of aggressive deflationary front-loaded austerity measures on deficit members leading to ultimate withdrawal from the Eurozone, Greece is ill-prepared to face the consequences.

On the positive side, the Italians may force the Germans into a corner where they are constrained to give up their export privileges and forced to close their trade balances, creating a more equitable system. This would benefit smaller Eurozone periphery countries like Greece if they all remain in a new reformed system with Germans at bay. As noted above, there are many issues that would have to be addressed for this to be workable. Generally, European experience has shown that regions like the Italian mezzogiorno living on transfer money from richer areas are not happy places and tend to remain laggards, which is not at all encouraging for Greece even under this favorable scenario.

More likely in my view is that the Eurozone becomes smaller and more coherent in terms of Mundell optimum conditions. How Greece would fare locked into the Eurozone system in a perennial hair shirt with major countries like Italy leaving and devaluing their currency is a big question mark. Historical practice has been that those countries first out and in devaluation are the ones who gain the most economic benefit.

My view is that Greece really needs an entirely new developmental model that follows the pattern of Far East emerging market countries or even better, neighboring Israel. Israel and Greece have parallels in terms of a large diaspora and the concept of the national homeland. Israel has been extremely successful in harnessing the energy of its diaspora and its people for viable economic growth. Greece has been a disaster in this regard. To the contrary, the country has become a Mecca for unskilled immigrant non-Greeks. Presently there is over 50% Greek youth employment. 61% of Greek youth are looking to emigrate according to latest polls. Greek economist Yanis Varoufakis warns that Greece could evolve into another Kosovo.

Israel, only two thirds the size of Greece, exports twice as much goods and services with much higher added value. It is also successfully engaged in energy development with its off-shore gas fields in operation. Greece is mired in dysfunctional European Union infrastructure projects that have created a bloated construction industry. The lion share of private investment has been rent-seeking real estate projects. The Eurozone entry has removed any concern to earn foreign exchange by gaining new markets abroad to export goods and services.

Greece needs its own currency that follows the US Dollar (which was the Greek policy of the 1960’s and early 1970’s) and a viable developmental model to promote its shipping franchise, regional exports and encourage invisible inflows from its large Greek diaspora. This would not be possible without further deep haircuts, reducing its public debt to 90% GDP or below and with IMF credits to finance the transition and advise structural reforms on a bilateral basis. 

Above all Greece must guard its national shipping franchise and promote ancillary industries as well as off-shore energy and tighter political integration with Cyprus as a regional economic hub. It could remain in the European Union (albeit an external free trade agreement following the example of Switzerland might be preferable) to benefit from the customs union.

Unfortunately, present Eurozone and Greek policy seems to be moving in the opposite direction with mounting pressure to abolish the free off-shore status of Greek shipping and impose taxation, further eroding any competitive advantages.  Greece gambled its entire future on EU integration, having no coherent national development policy. Further, most of its public debt is currently in the hands of the EU with Germany the largest creditor so that any negotiation is a highly political subject where the EU and particularly Germany currently have total hegemony over Greece.   

How Greece in this position is to avoid becoming another Kosovo -an impoverished and ethnically divided protectorate - is a big question.  Greece is far from the enviable position of other European countries like the UK or Norway, who can debate the merits of joining or leaving the EU.   A financially and politically weakened EU and downgraded Germany from an Italian EZ exit might well prove a salvation in the long run for Greece.

Wednesday, November 14, 2012

Structural changes in the crude oil tanker sector: failure of companies to adapt may prove fatal!

The crude oil tanker sector faces the double whammy of excess capacity from overinvestment as well as structural changes in trade flows.  It is not a growth industry.  Developed economies have proved successful in rolling back consumption and diversifying in alternative fuel sources.  Marginal demand growth to fill the slack depends on emerging market economies.  The degree of hard landing in China and future level of growth rates in emerging market economies thereafter is very critical in the short and medium term.   Those tanker companies heavily dependent on traditional crude oil transport – VLCC’s, Suezmax and Aframax – without other revenue sources are severely exposed.  Those with high bank leverage are in severe distress.

Spot market tanker rates can be very volatile. These vessels are dependent on one cargo only: crude oil. Demand is driven by inventory levels; futures pricing, oil production levels and underlying oil import needs. Oil production is in part manipulated by the oil producer cartel OPEC and particularly Saudi Arabia as a swing producer, so productions levels play a key role in available cargo volume for transport. Politics plays a big role with the Iran oil sanctions. Speculation plays a role depending on the future pricing curve whenever it is favorable to buy and store the physical commodity in chartered tonnage for sale at a later date, taking this out of the transport market, leaving less tonnage available for lifting cargos to destination.

As the US has been the greatest consumer of crude oil in cargo volume, the VLCC trades were developed as the most economical means per unit cost to transport crude oil to the Houston area for refining from the Middle East. With the China and emerging market boom of the last decade, there was a deluge of new refinery projects in the Middle East, China and India.

Middle East producers wanted to develop a more value-added economy, investing their profits from oil sales into refineries to produce products at source for export. This led to great optimism in the product and chemical tanker sector that jumped the gun in over investment in these sectors. Since the 2008 global financial crisis, some of these projects have been cancelled, some delayed and some progressed and are on stream. Demand was less than expected for the ship owners.

One of the most novel projects from the Middle East was the Motiva refinery. This is a 50-50 Shell and Aramco joint investment of three new refineries in the US Gulf region. It is the reverse concept of the Middle East refinery projects. They transport crude to the US and refine there. This has been a boon to the product tankers trades in US Jones Act cabotage trade; albeit due project delays and a refinery closure due an accident, it has been slow to come on stream.

Conversely, there have been some overwhelmingly negative structural changes that threaten crude oil trade to the US, namely:

• Technological evolution in the production of tight oil and shale gass, allowing more US domestic energy production, together with the Keystone pipeline project facilitating Canadian oil imports. Whilst this is another potential boost to US Jones Act shipping for distribution of products, it is one of the main contributing factors this year to a dreadful international tanker market.

• Expected increased domestic use of energy resources in the Arabian Gulf, making less crude oil available for export. This is developing on several fronts. First, there is the political front with the Iran oil embargo. Second, there was a drastic reduction of Saudi oil exports during the summer where the oil was diverted to domestic use for electricity production. Finally, the above-mentioned refinery project now coming on stream to produce clean products and chemicals for export. After the GFC, about a third of the projects were cancelled and another third in delay, but the last third is now coming on stream and exporting. This means production at source and less crude oil for export.

The rise of gas shipping as a new growth area is also impacting negatively on crude oil transport. The LNG market is dominated by cargo operators and normally done on long period contracts. Historically, returns have been less than desired and tonnage ordering has overshot the market, but the Japanese tsunami provided the catalyst to rekindle this market to profitable rates with attractive returns to investors. The vessels are much more complex to build than crude oil tankers and capital costs are significantly higher, providing serious entry barriers. The limited number of yards that can turn out such specialized vessels has created a two-year window of opportunity for nice run on rates with existing tonnage in relatively short supply.

Increased LNG production as a long-term secular trend means also downstream enhanced prospects for LPG shipping. Together with the offshore sector, these are presently the major growth sectors in the tanker markets.

Conversely, the crude oil tanker market – except for sudden brief demand spikes in refinery restocking – does not seem to offer good long term growth prospects in the face of these secular trends. A number of established tanker operators like BW Shipping have been shedding VLCC tonnage.  BW like Teekay Shipping and major private owners like Angelicoussis in Greece, foreseeing these secular treds  have diversified themselves in timely fashion into other more attractive areas like LNG shipping and offshore, positioning their businesses with profits from these new growth areas that shelter them from the current losses on their tanker tonnage.

Some like TeeKay Shipping have sought to develop a franchise in tanker trades demanding special expertise, namely shuttle tankers offloading directly from oil rigs. These vessels have special mooring fixtures and are equipped with dynamic positioning technology. They require specially trained crews. An extension of this offshore business is the FSO and FPSO business with floating oil storage and production facilities, another current growth area in shipping.

Companies who have been slow to adapt to these developments are generally in deep trouble. General Maritime (GMR), for example, just recently got out of Chapter 11. Peter Georgiopoulos appears to have ignored totally all of these developments. His company was probably the weakest of the large listed tanker operators in terms sound commercial management. Perhaps he was distracted by his ventures into dry cargo. Now he has lost control of his tanker business and is fighting to save Genco and Baltic in the current severe bulk carrier markets correction. What Oaktree gained in taking over General Maritime remains to be seen. Presumably they were attracted by a cyclical asset play because the enterprise value of their acquisition is quite low compared to peer tanker operators.  Oaktree now seems to be ready to do a startup asset play in dry cargo with Petros Pappas of Oceanbulk.  At least this venture promises to have a lower entry and transactions costs than Genmar....

Overseas Shipping Group (OSG) was too little and too late in these structural market developments and left with heavy crude oil spot exposure. It appears to be heading to Chapter 11. Whereas their peer colleague Peter Georgiopoulos by contract proved timely and diligent bringing in Oaktree to support his company, OSG management also appears to be failing with senior lenders in prompt action in debt restructuring. Hopefully, OSG management ultimately will prove adequate to the circumstances.  I have always felt that their age and career path has made it very difficult for them to adapt to crisis management. The OSG Board made a good decision to appoint outside advisers.

In these cases, it is not only the over indebtedness of the companies, but also the failure of the business model that put these shipping groups in their present predicament. Conversely, the successful operators like TeeKay Shipping have outperformed peer tanker operators because they adapted in timely fashion their business model to anticipate structural market changes and have much better business models.

The Leucadia buyout of Jefferies and departure of Hamish Norton to a job in the Greek shipping industry marks a tsunami of change in the investment banking industry for shipping

There have been profound changes in capital markets for shipping since the Global Financial Crisis of 2008. The market for shipping IPO’s has been severely limited.  Follow-up share issues from solid shipping names can only be placed with discounts to entice investors to enter into the business at levels that they feel comfortable.  A much larger portion of shipping issues now goes to retail investor, giving the large bulge-bracket investment banks with substantial retail capacity considerable competitive edge in placements.  As a result, boutique shipping investment banks like Jefferies and Dahlman Rose have become marginalized in the new market conditions, leading to dramatic changes in both organizations.

After the GFC shock, the shipping industry waxed and waned but never fully recovered from the drop in cargo volume and lower freight rate levels. Initially in 2009 there was a sort of Zarnowitz-style bounce in freight rates that provided a good feeling. Over time, conditions in the bulk shipping markets deteriorated. Cargo demand could no longer keep up with the order book overhang of new tonnage. More recently incremental demand in emerging markets has begun to dry up, leading to significantly bleaker conditions this year for both dry bulk and tankers as well as a new dip in the containership market. Only gas shipping and offshore sectors have healthy demand.

Companies suddenly faced a dramatically different banking climate. The shipping industry, being labor and capital intensive, has relatively low investment returns over time except for cyclical booms. It is has always been dependent on low cost shipping finance to provide necessary leverage for expansion and adequate investment returns. Bank spreads rose to unprecedented levels only sustainable due the very low LIBOR cost of funding.  Even that depended what cost the particular bank could raise its funding. No longer were there banks looking for new customers. Companies become restricted to their existing banks. Credit conditions hardened with far more restrictive loan conditions. Credit generally was hard to find.

Investors lost a great deal of money holding shipping stocks. Many of the new issues in the boom times prior 2008 were startups with little intrinsic enterprise value. They were asset plays on a shipping provider business model. They tried to generate high investor returns with large block vessel acquisition deals that were leveraged with bank finance. As asset values began to shrink and cash flow tightened in weaker freight market conditions, many listed shipping companies began to face covenant violations and required additional capital.

Among the exposed companies was DryShips, who very early in the game recapitalized successfully with repeated ‘at the market’ share offerings to retail investors, which resulted in severe share dilution. This marked a shift from the initial placements with hedge funds and institutional investors taking large blocks of shares. Only a large investment bank of the bulge-bracket nature with a large retail operation could do this kind of placement, raising large amounts of money from feeding day traders and others in small amounts over time.

The IPO window closed with the GFC was briefly opened when General Maritime (GMR) jumped in to raise capital for its Metrostar block tanker acquisition deal. Genmar was not in the greatest health at the time, having bruised itself with a bond issue at higher pricing than anticipated when the bond investors discovered covenant issues with senior secured bank lenders. At the time of the IPO despite a minority of the wary, institutional investors bought the deal and Genmar received a rapid placement without suffering any share discount. Unfortunately, the deal proved poison for investors, who suffered severe losses with the subsequent financial difficulties of the company. Chapter 11 wiped out the unsecured Genmar bond holders in a sizeable cram down.

I believe that the Genmar debacle marked a major change in market perception of the risks in investing in shipping shares. The bond of trust between investors and Peter Georgiopoulos could never be the quite the same again.  This appears to have changed dramatically risk perception. The IPO window closed again. Follow-on issues and rare IPO's were only possible for a select number of shipping companies. For new money - even top shipping names - investors were now demanding substantial discounts for entry prices. Despite very soft rates in the US corporate bond markets, shipping bond issues continue to carry substantial premium.

This new climate proved lethal for Dahlman Rose, leading to major shareholder changes and senior executive departures like David Frischkorn to Global Hunter. Hamish Norton was initially successful in holding on at Jefferies longer than his Dahlman peeor.  Hamish had come to Jefferies prior the GFC from a very timely and prescient move from Bear Stearns shortly before the meltdown there. His assistant Nicky Stillman left Jefferies for Clarksons last year. Market conditions, however, severely restricted potential to build a book of business in the shipping space. Jefferies tried to get restructuring business, but the Omega (ONAV) account was small and precarious with limited options.

Jefferies is now selling itself to Leucadia. Perhaps this influenced Hamish’s decision to leave the firm. Jefferies actually outperformed its larger investment bank peers since the GFC, but wanted bigger capitalization under the umbrella of a larger financial group. Leukadia is their biggest shareholder and its unused tax benefits will shelter Jefferies profits.

Hamish is one of the most capable and conscientious investment bankers in the shipping space with solid rainmaker reputation.  When he leaves banking to go to a private shipping industry position with Petros Pappas in a dry cargo joint venture start up with Oaktree, this is a statement in itself of the dire situation in the investment banking industry regarding shipping issues. Of course, who could ever imagine likewise an established blue chip tanker operator like OSG teetering on Chapter 11 proceedings with shell-shocked CEO and former banker Morten Arntzen at the helm!  Times are difficult indeed in the shipping sector.
Shipping is a cyclical industry so there is always hope for a recovery and reversion to boom psychology, but after several years of repeatedly pushing forward market recovery dates because improvement never came, people are less sure of recovery time than before.  No one knows what 2013 will bring.

My personal concern is the increasingly fragile situation in China and emerging market economies, which are the sole source of global incremental demand.  The European Union has been the worst performer with its macabre fascination with debt deflation.  The IMF has signalled repeated EU policy failurs especially in the EU Periphery as high risk to the global economy.  China has a very large and risky speculative position in commodities, having assumed unsustainable double digit forward growth rates that have slowed considerably with negative impact on shipping markets. 

Should commodities prices fall further, this could trigger another leg down in the shipping markets.  Softer iron ore, steel and scrap prices would lead to even lower vessel values.  With dwindling resources have such prolonged weak market conditions, many companies are ill-prepared for a further market leg downwards.  Bankers holding many of these lame duck companies alive fear sizeable losses on their loans.  Understandably, many are hoping for a floor in place from further decline in freight rates and ship values. 

There is the old saying that once you lose virginity, it is impossible to get it back again; but fortunately when good times appear investors tend to have short memories.

Greece as Iphigenia: the consequences of poor judgment in public policy decision-making in both Greece and the EU

After months of negotiation for the next bailout loan tranche, the plot thickens for Greece in downwards debt deflation and deep recession.  The much touted spring PSI+ loan restructuring now appears too little and too late with the IMF now arguing for OSI (official sector) participation, opening political drama in EU donor countries.  How to explain to their taxpayer- voters these losses from very unpopular bailout loans to Greece? The IMF is expressing deep concerns about deteriorating economic fundamentals in the EU as a major threat to the global economy.  The Greek economy continues with GDP sliding at 7% per annum and 25% unemployment with total GDP shrinkage from the outset of these EU bailout programs surpassing Great Depression levels.  The utopia of the single currency zone has become a nightmare for the Greek people as well as most the Eurozone Periphery.  

Greece is a European periphery country and traditionally a sea power with a larger merchant fleet. Shipping is a major offshore industry, which is as an important national franchise as the City financial services are to the UK. The Greek Diaspora lives in large numbers outside the European Union. The clientele of Greek merchant fleet is mainly emerging markets, all in the US Dollar zone. Neighboring countries like Turkey and Israel as well as the Arab world are outside of the EU. Fundamentally, Greece never met the Mundell criteria for optimal currency zone membership in the Eurozone.

For these reasons, it is very hard to understand why Greece chose to enter the Eurozone and did not take a more prudent stand following the Scandinavians like Norway, Sweden and Denmark, not to mention its traditional ally, the UK. Conversely neighboring Turkey, who at present is only part of the EU trade union without full EU membership and outside the Eurozone, achieved far superior GDP growth rates with a new class of entrepreneurs and burgeoning exports. The Greek economy was not able to keep up. Now Turkish GDP overshadows Greece in totally different league of successful emerging market countries, whereas Greece is locked in an economic zone of losers.

Why did not the business savvy Greek shipping community follow the example of their financial brethren in London City and see the dangers and risks of Eurozone membership, lobby against it to protect their economic interests and thus spare millions of Greek compatriots from the current pain and misery of rapidly declining living standards, business failures and massive unemployment?

Austerity fatigue is rampant in Greece with the third bout of austerity measures passing by a slim parliamentary majority of 153 votes and the New Democracy party dependent on the PASOK Socialists, who have less than 8% of the vote by latest polls.

The pattern over the last few years is Greece falling consistently behind targets with an ever deeper recession and then required to make additional austerity measures for the next tranche of EU bailout money to stay in the Eurozone. The tax code changes every few months as the government runs out of money. No one in Greece except its political class expects that they will ever see the end of new and harsher measure down the line. Accordingly, the Greek political elite has largely lost any credibility with the Greek electorate.

It was amusing in the parliamentary debate to see Alexis Tsipras of the leftist SYRIZA party citing IMF reports about Greek debt unsustainability and need for further public debt restructuring (OSI) - in front of Harvard Business School educated PM Antonis Samaras, stone-faced clinging to the confidence fairy of debt deflation, as the only remedy – something that American economists like NYU’s Nouriel Roubini, Princeton’s Paul Krugman or Wharton’s Franklin Allen sharply dispute. What an incredible role reversal!!!

Economics minister Ioannis Stournaras made straight face budget projections of GDP shrinkage of 4.5% in 2013 at the same time, talking about additional austerity measures for billions of Euro that he was unable to extract this year due falling tax revenues from a moribund Greek economy. Opposition leader Alexis Tsipras was probably more realistic in his projections of 7-8% GDP shrinking in 2013. Stournaras has been systematically wrong in his projections since 2010. He was part of the team who fudged Greece’s ill-fated entry into the Eurozone with EU collusion, yet Samaras rewarded him the Economics ministry portfolio, not a sign of great leadership or critical thinking!

Whilst the Greeks are in an increasingly difficult position to comply with EU demands with the severe carnage that the EU internal devaluation dogma has on their domestic economy, Northern European taxpayers are increasingly outraged by the Greek bailout and concerned about throwing good money after bad.

This was evidenced in the slow pace of negotiations between Greece and the European Union since the June 2012 elections and increasingly tough conditions set for Greek compliance to release the bailout money tranche. The IMF suggestion of an OSI restructuring poses a substantial political dilemma for northern European politicians. Understandably the Germans are avoiding the subject with upcoming parliamentary elections next year.

Clearly, there is increasing pressure to limit losses and cut Greece loose from the Eurozone, but the Greek political elite seem ill-prepared for such an eventuality. Ironically the only politician, who has dared to publically to raise the subject of a Plan B for Greece going back to a national currency as suggested by eminent people like Nouriel Roubini and Franklin Allen cited earlier, is Alekos Alavanos, former leader of SYRIZA.

Added to this is high drama of the Lagarde list. In 2010 Christine Lagarde, then financial minister of France, sent a list of 1991 names of Greek customers with bank accounts at HSBC's Geneva branch to the Greek government. This list traces offshore companies to their principals and word has it that it contains significant representation from the Greek shipping community – not only high profile Greek ship owners, but also middle level Greek management.

Shipping is an offshore industry and under law 89, shipping companies have no tax liability. Bonuses and salaries are commonly paid in US dollars. It is no secret that some circles German creditors have been pressing for abolition of the Greek shipping free zone. Greek politicians have done their best to avoid the subject but as economic and social conditions deteriorate in Greece and the EU increases its demands for more bailout money, anything could happen.

The Greek shipping community not only risks the Greek government confiscating a significant portion of private savings money in foreign currency accounts abroad for the ultimate benefit of foreign Greek creditors for debts and mismanagement that they played no part in creating; but even more sinister, the eventual abolition of their off-shore business zone status as part of the price extracted for Greece to remain in the Eurozone in these interminable and indeterminate bailout negotiations.

How many in Greece are now seriously considering that the price of remaining in the Eurozone is becoming intolerably high simply to perpetuate the whims of the Greek political elite, who have so mismanaged the country and have no alternative games plan?

Jettisoning the current failed and discredited Greek political leadership may well prove a more prudent sacrifice…. Returning to the Drachma may well prove a salvation from the current economic and social hell in the Eurozone.

Greece should denounce the Troika for wrecking its economy with five years of debt deflation that has created suffering and poverty for large parts of the population and bankrupted over 20% of the private sector, press hard for OSI debt restructuring as per IMF recommendations and ask to leave the Eurozone consensually with a bridge package for the transition instead of any more Ponzi bailout loans.

PS I am appending the impressions of Nouriel Roubini from his spring trip to Greece. I find very true what he says about the present psychology and unsustainability of the present course:

I attended a public debate on whether Greece should exit the EZ; three-quarters of those who attended were against that option. One caveat is that most of the attendees were middle class folks who work in the private sector, speak English, are europhiles and blame the government and public sector for all of Greece’s problems. Lower-income individuals, employees of the large public sector and left-of-center voters have different views.

In my conversations with a large sample of private-sector businessmen — shipping magnates, other manufacturers, representatives of the financial sector — and members of the government, a similar view emerged: No one wants to even consider an exit from the EZ. Many forcefully argued — without any evidence — that Greece doesn’t have a competitiveness problem — despite data suggesting that unit labor costs rose by over 40% in the decade before the crisis — and blamed all of the problems of the private sector on the inefficiencies and tax burden of the public sector. Again, this sample of prominent Greeks is obviously as europhile as one could get, so can be regarded as somewhat biased.

… it was quite dissonant if not outright disturbing to hear 5 billionaire shipping owners claim that they care about Greece, but forcefully argue that they should not pay a single penny of tax because: Their shipping businesses are highly competitive globally; they cannot afford to pay tax; and, if the authorities try to tax them, they would move somewhere else. With its own business elite being so willing to contribute to Greece’s fiscal problems, one may rightfully despair that the country can ever successfully tackle its tax evasion problems.

Like what I saw in Argentina in 2000-01, when most Argentines wanted to stick with the currency board and fixed peg to the U.S. dollar, most Greeks have an irrational faith that, by some miracle, economic growth and competitiveness will be restored without an EZ exit. Frankly, most discussions with Greeks become emotional rather than rational assessments of whether an exit from the EZ — with all the collateral damage that it would imply — would be preferable to 5 more years of depression after 5 years of a deepening recession.

Sunday, August 19, 2012

Will Omega Navigation come out of Chapter 11 as a going concern or be liquidated as per the Marco Polo case?

This week a glimmer of hope surfaced for Omega Navigation (ONAV) in an article in the Tradewinds, where Aaron Kelley reported the signs of a deal where George Kassiotis puts in an additional US$ 2,6 million equity into the company and the company rolls out a rights offering that would give general unsecured creditors and junior lenders a chance to secure a stake in the reorganised company and has agreed to a cash distribution of 10% to unsecured creditors “over time: provided they accept the plan.  Talk of Omega coming out of Chapter 11 with a reorganization plan by November this year.

I have expressed pessimism in the past over Omega, as I saw George Kassiotis’s refuge to Chapter 11 more an defensive act of desperation with his lenders to buy time rather than a serious effort to recapitalize the company. Unlike the successful example of General Maritime (GMR) there was neither any private equity firm ready to provide substantial new funding nor any pre-agreement with senior lenders for a support package. To the contrary, Kassiotis had openly broken with his lenders with a nasty, high profile lawsuit in Piraeus seeking damages.

For Bracewell & Giuliani, Omega’s US attorneys, this was a show case to attract other shipping firms to US bankruptcy court, giving the US legal profession a franchise in maritime bankruptcy. For Jefferies, Omega was a source of badly needed fee-earning business given the collapse of fresh shipping placement deals in capital markets. Hamish Norton, who heads the marine business in Jefferies has a stellar reputation as a knowledgeable and serious investment banker with a high level of integrity and a history of well-structured deals.

Despite this support for Omega, the company financial woes are very challenging with limited room for maneuver. As a smaller listing, Omega lacked the scale of its peers to leverage capital markets and quickly fell behind its peers. The Principal, George Kassiotis, has limited personal wealth from other ventures that he could draw upon to support this Omega. In fact, he seems in an even weaker position than Antonio Zacchello of Marco Polo. All this puts Omega on the same path with a similar fate: move to Chapter 7 liquidation as their senior lenders, HSH Nordbank have already filed for and have been urging.

Meanwhile, whilst Omega has some high powered advisers, they are also some of the highest paid, so there is the specter of mounting costs and legal expenses that are the Achilles Heel in Chapter 11 proceedings. Peter Georgiopoulos had everything in place even before filing in the case of Genmar, to minimize the time and cost in this procedure.

Whilst unquestionably a sign of good faith on the part of Kassiotis, the sum of US$ 2,6 million is a paltry amount for recapitalization of Omega. I am especially intrigued by the rights offering for general unsecured creditors and junior lenders. Is this going to be the main source of funding for company recapitalization along with the sizeable ‘haircut’ to unsecured creditors with promises of the remaining 10% amount paid “over time”? Is not this a sign how bad the situation is?

Who are the largest unsecured creditors? What are liabilities of their advisors Jefferies and legal counsel Bracewell & Giuliani as credtiors. Are unsecured and junior creditors going to be asked to put in new money in this rights issue or will this be a conversion of debt for equity? Why would junior lenders like NIBC and BTMU put more money out on Omega that would in fact benefit HSH Nordbank, who has priority over their position?

Why is not HSH Nordbank sharing the pain in an exchange of debt converted to equity as RBS accepted in their loan restructuring in the case of Eagle Bulk? Would not that give some comfort for a rights offering? Finally who is providing this new restructured senior debt and working capital facility? Has HSH Nordbank changed tack here?

Unquestionably, it would appear that Omega has substantial debtor’s leverage here with creditors in serious jeopardy of severe losses for this formula to be workable. Perhaps it is the magnitude of losses that makes them hesitate to move for the dissolution of the company?

Frankly, the Tradewinds article opens more questions than answers. My reaction is that this tentative agreement is likely still fragile. I am troubled that I do not hear anything about a clear and substantial source of recapitalization for Omega to come out of Chapter 11 as a going concern.

Let’s see what happens by November!

Thursday, August 9, 2012

The Euro sovereign debt crisis finally gets interesting!

After several years of this slow-motion train wreck starting with the saga of Greece and its endless spiral to the bottom, the Spanish and Italian debt crisis is finally shaking things up in Eurozone politics. Greece with its leadership was an easy pushover. Spain and especially Italy as larger countries with more political and debtor leverage as well as better political leadership are a more difficult match for the EU elite. The most painful duet is Monti and Draghi: Draghi pushing for non-conventional monetary policy and Monti, keeping Frau Merkel up until the wee hours of the night for a banking union and debt mutualization.

The growing economic divergences from the Eurozone policy makers’ self-inflicted debt deflation coupled with their dubious techniques of "internal devaluation” is taking its economic and social toll. The Europhiles have created macabre Great Depression-level GDP collapses in places like Greece with appalling levels of unemployment and private sector bankruptcies. Whilst you hardly hear a peep from the Greek political elite, who continue to be ardent believers in the confidence fairy of Eurozone economics, this mess is causing the political leadership in Spain and Italy to balk and resist a similar fate, seeing what is in store for them where the EU has left scorched earth.

Private investors remain highly skeptical, looking at all this carnage.  Bill Gross of PIMCO recently wrote an interesting piece in the Financial Times, where he reveals the obvious: EU policy makers are looking for private sector money to reflate and cover their growing mountain of bad debt, but against a dismal track record where they have not hesitated repeatedly to bilk investors and leave them with significant losses to promote their political agenda.

Ambrose Evans-Pritchard, the business editor of the Telegraph has been very astute early on to see that Northern and Southern Europe are not compatible in a common currency zone. The crisis is accelerating the structural divergences and this is leading to growing political fractures.

Italy’s Silvio Berlusconi has already threatened the Eurozone that either Germany must leave or Italy will depart with a growing coalition of industrialists, who see the solid advantages of Euro exit for Italy as confirmed in a recent Merrill Lynch study. Mario Monti on the other side of the spectrum wants to keep Italy in the Euro project, is trying to muscle Germany to accede to debt mutualization and more flexible monetization policies by the ECB to deal with the debt overhang.

Clearly, as economic conditions deteriorate, the die is cast: either the Eurozone needs substantial structural changes so North and South can co-exist or there must be an amicable divorce. No political union of diverse peoples has every taken place without mass repression.

The Soviet Union that the predecessors of the present generation of Europhiles adored as a model of human progress in the 1930’s is a good example. The Austro-Hungarian Empire prior World War 1 with its efforts of benevolent reforms echoes the German domination today in the EU and policies towards the EU Periphery. By its nature, forced political integration and dissolution of the nation state means the end of the right of self-determination for diverse peoples and forced collectivization.

Indeed today’s utopia of a European super state with a common currency has an eerie resemblance to the Communist utopia of the Comintern, otherwise known as the 3rd International. The European Union operates by unelected officials, who currently dictate the majority of laws of its members and drive this sovereign debt crisis that is deepening in the Periphery and moving to the Eurozone Core. 

Whilst it not hard to understand how the European Left has embraced this concept, it is surprising how easily the European Right has capitulated to this forced collectivization and abandonment of the nation state together with the abrogation of civil and economic liberties as well as the right of national self-determination.  Their stand reminds one of the Girondists and let's not forget the chilling fate that they met in their time.

Greece is an astonishing case where the conservative New Democracy Party is leading a coalition government with two parties of the Left, embracing economic programs that are impoverishing large sectors of the population, especially in the private sector.  Most European parties of the Right behave in a similar ambivalent fashion.  Consider the present Spanish government in its current dilemma.  Even the UK Tories continue naively to believe that somehow they can build a firewall from this growing storm by promises of vague renegotiation of their EU membership.

Already the Eurozone has shown an iron fist of political and economic repression, making debt slaves of its weaker members like Greece, Ireland and Portugal; drastically reducing economic freedom and national sovereignty. Confronted with a similar fate, the larger Eurozone members of the Periphery are beginning to realize that these issues have real political substance. Remaining in the Eurozone, accepting the loss of national sovereignty, civil liberties and economic freedom is a question of balancing costs and benefits of Eurozone membership, something that was always taboo in the past.

If there is a break up, the costs would be different in terms of who is the first to leave. If the Germans leave and revalue, the costs will be less for the South. The larger PIGS like Spain and Italy are beginning to realize that they do not have much to lose, taking aggressive stands with the Germans.

On the other hand, the Germans for the first time now begin to feel Eurozone malaise and the burden of the costs. Debt mutualization will certain result in a credit downgrade, having to carry the burden of the over indebted South. Already Germany has been put on negative watch list. Monetization and non-conventional monetary policy would market the end of a comfortable system where the ECB is in Frankfurt and under rules that have made it a Bundesbank clone accommodating German needs, until Mr Draghi has begun to shake things up.

Leaving the Euro, the Germans would be forced to revalue, losing their comfortable advantage in exports and to revise their policies. They would be compelled to recapitalize their banks for the sovereign loan losses of the South. Long term that might be preferable than the present course of endless bailout loans to the South and taking on endless liabilities to carry a failed and dysfunctional currency zone, but few in German political elite are eager for this bitter pill to be swallowed up front.

Meanwhile, the Greeks live in an Alice in Wonderland state where the political elite still clings to the Eurozone concept even as a colony with limited sovereignty, political and economic freedom. Ultimately their outcome in the Eurozone as well as the fate of the Eurozone itself is not in their hands, but most of the Greek political elite – at least in their mindless public statements - seem hardly cognizant the major battles that are raging outside of Greece.

Monday, August 6, 2012

Is Box Ships latest purchase charter back deal with Overseas Orient really as rosy as claimed?

Michael Bodourglou’s Box Ships (TEU) has been a considerable reprieve from current woes of his bulk carrier business Paragon (PRGN), now a penny stock struggling with sagging profits, charter party defaults and loan covenant breaches from declining hull values. By contrast, Box Ships has seen its revenues double from last year and recently had a successful fund raiser.

We have expressed in the past our reservations on Bodouroglou’s diversification play because we see it as a pure asset and market cyclical play without any inherent competitive advantage. Containerships are attractive because they are very cheap. Charter-free 15-year old containerships are going for scrap value, probably the cheapest shipping assets of any sector of the marine market. The vessels require charters from major liner companies, who have had their own problems with stagnant box rates, price wars for market share and investment in ever large tonnage to lower unit costs and defend operating margins.

The Overseas Orient deal is instructive. It is a purchase-charter back transaction from Orient Overseas (OOIL), which is a solid liner operator concentrating on inter Asia, Australia and trans-Pacific container routes and limited exposure on the currently problematic Asia Europe head haul route suffering from the Eurozone’s self-inflicted recession and debt deflation woes. The two 5.344 TEU vessels acquired by Box Ships are built 1995/ 1996.

Whilst charter free box ships of similar age are valued at scrap levels, Box Ships is paying the handsome price of US$ 62,3 million for these two aging units because OOIL will charter back the vessels at rates of US$ 26.800 per day for three years. Nominally assuming continuation of these rate levels on a five-year basis, this business brings returns on equity in the order of 16% per annum, which is very good performance in these difficult markets. After administrative expenses (namely the sizeable vessel management fees to AllSeas Maritime - Bodouroglou's privately held management company) the actual discounted cash flow returns to investors would be somewhat lower, but still this outshines returns on dry bulk and tanker business presently.

The issue is whether these rate levels are sustainable on renewal in three years’ time. There is as well as the matter of potential impairment charges on vessel values on a charter-free basis. So far the impressive revenue increases in Box Ships are mainly because Bodouroglou has been aggressively buying vessels and expanding the fleet. Yet the Box Ship share price has been steadily declining, initially around the US$ 10-11 level and now trading at the US$ 6-7 range.

Like all shipping transactions, these moves are a wager in hopes that the markets will turn around favorably and the cyclicality will boost returns. Bodouroglou could be well be correct in his investment timing.  Certainly he is getting plenty of banking and investor support in tough capital market conditions.

On the other hand there is tail risk here. In an expansion phase of a start-up venture like this, you double the number of vessels and get twice the revenue but does that is not the same as doubling your revenue on your existing fleet earning twice the freight income over the same expenses. Time will tell whether this strategy works out or Box Ships will disappoint and underperform expectations.

OSG in the doldrums: Is Morten Arntzen really one of the worst CEO’s in any industry?

Overseas Shipholding Group (OSG) is a blue chip tanker company that is currently in crisis with 13 quarters of operating losses, plummeting share value, rating downgrades (CCC+) and ominously its unsecured bond debt trading far below nominal value. Morten Arntzen claimed in the recent 2nd quarter earnings conference that OSG defensively drew to the maximum its current US$ 1,5 billion liquidity facility. With current market fixation on this facility expiring in February next year to be replaced by a smaller US$ 900 million facility, Arntzen did not provide much comfort to investors. To add insult to injury, Motley Fool named him one of the worst CEO's for the dismal stock performance and sizeable investor losses over the past year.

OSG is one of the oldest US tanker listings. It was founded back in 1948 by the Recanati family and listed in the US stock exchange in 1973. The Recanati are American Israeli with origin from Italy where they took their family name. Two of the Recanati family remain on the Board of Directors: Ariel and Oudi Recanati. Aside from shipping the family has a long tradition in banking and finance, having founded the Israel Discount Bank.

Morten Arntzen became CEO in 2004, coming from a banking background in New York. He ran the global transportation group for Chase Manhattan and Chemical Bank. Then he served as CEO for American Marine Advisers, a boutique NY marine merchant bank group with close associations with OSG and the Recanati family. Arntzen and the OSG finance director, Miles Itkin are mature executives both getting on in age and this is probably the first time that they ever been in an underdog crisis situation. Their strategy so far seems to have been to ride out the storm, hoping for a market improvement rather than making any serious sacrifices. At time goes on without market improvement, OSG’s alternatives get more costly and unpleasant so it is a difficult wager.

On the other hand, with over US$ 2 billion in debt, OSG has considerable debtor leverage. Given lenders accommodative stand towards lame duck shipping companies like Eagle Bulk and Berlian Laju Tankers, a “blue-chip” lame duck like OSG should merit equal or better treatment. This may be a fact that Arntzen is playing strongly behind the scenes.

OSG compared to peer tanker operators was slow to diversify into higher growth alternative marine investments like LNG or the offshore sector with better profit margins. To his credit, Arntzen succeeded early on as CEO in a merger with Stelmar that allowed the group a sizeable position in the product tanker sector in addition to their large fleet in crude oil. OSG’s investments in LNG and offshore have been timid and very conservative. In both cases, they opted for joint ventures and their position is relatively small. In fact, OSG has staked a lot in the US domestic tanker market, which until recently was making losses and limited in prospects.

Under US cabotage, the market is sort of an oligopoly with a limited number of operators, but several of them barely eking out an existence struggling with Chapter 11 reorganization. Lately with the Motiva Refinery project in Houston and US shale oil developments, the US domestic market has started to pick up, but Motiva is now shut down due construction problems.

OSG is counting on substantial MARAD Title 11 money for their US fleet that has been delayed. This subsidized loan money cannot be commingled in their overseas operation, but it is a very valuable resource in an exceeding difficult credit market conditions. Indeed, MARAD created recently some stir by its rejection of rival American Petroleum Tankers' (APT) application for Title 11 loan guarantees despite the company backing from Blackstone.  With the difficult conditions in the OSG international fleet, however, the profit from the US flag operation is unlikely to compensate and cover for the losses even with improved rates.

There is a lot of optimism for a turnaround in the product tanker sector. OSG is concentrated mainly in the MR size with focus on trans-Atlantic trades, but this sector has underperformed expectations. In the end, if new refinery projects come on stream and there is an increase in tonnage miles, it is possible that the LR size will benefit more than the smaller vessels.  Both Blackstone and the Prime/ Perella Weinberg Partners are concentrating on these larger units.  So is Scorpio Tankers, a financially much healthier company than OSG.

Otherwise, OSG share price currently around US$ 5 is not an attractive level to raise fresh equity and this would likely entail substantial share dilution in current Wall Street conditions. A bond issue would be expensive with OSG’s credit downgrade and require security given the current discount on its unsecured bond debt. OSG could sell and lease- back some of their unencumbered units, but this will be very expensive and the lease payments will weight on their cash flow and liquidity. Finally OSG could sell out its share in its LNG and FSO joint ventures.

Is it any surprise that Arntzen stresses over and over again that the tanker markets have reached their floor? He could be correct and in fact OSG 1st quarter results gave some comfort in this direction, but losses widened in the 2nd quarter.

Undoubtedly, it would be a big blow for Arntzen and Itken with their stature and age to be compelled to actual sacrifices, should tanker markets continue in the doldrums and OSG liquidity dries out. I believe, nevertheless, that OSG still has substantial support from its lenders, who will bend over backwards to keep them afloat until better days come.

Whether it is a profitable to own OSC common stock or take a position in its unsecured debt right now is another story. This depends on how quickly one expects a global turnaround in shipping markets. If freight markets remain at present levels into 2013, OSG will face some stressful times.

Tuesday, July 10, 2012

Banks distorting vessel values by keeping zombie shipping companies on life support, possibly delaying market recovery

According to Scorpio’s Robert Bugbee, bank deals like the recent Royal Bank of Scotland (RBS) equity for debt swap keeping their lame duck client Eagle Bulk (EGLE) on life support may actually be prolonging any meaningful market recovery. Instead of fleet renewal with this second hand tonnage moving to financially healthier and more efficient operators, this may encourage another round of speculative ordering for ‘econ-type’ tonnage financed on favorable terms by Asian banks to promote vessel exports and delay any recovery in rates for another two years.

“The problem is that the banks cannot afford to take write downs and private equity provides no better solution than the present operators,” Bugbee said. This keeps asset prices artificially high in markets where underlying cash flow from operations simply does not support these price levels. “This is combined with little available credit to buy second-hand tonnage and relatively low pricing for more efficient newbuildings, which will deliver at a later date and thereby avoid the present weak market. And these may have access to Asian finance.” Bugbee’s conclusion: “The result is that it’s probable that — on a ‘relative-return’ basis — fresh industry equity will continue to order newbuildings, thus lengthening the recovery process.”

What is ominous presently is the Chinese slowdown in growth rates, falling steel production and lower scrap prices. This may impact negatively vessel values. Not only will there be more fuel efficient designs, but replacement cost will fall.

Generally, commodities prices are soft and falling. This does not bode well for freight rates and cargo volume.

The stronger healthier shipping companies may adopt a similar strategy to some of the large liner companies like Maersk where they look to move into new technologically advanced tonnage that allows them to operate at lower cost than their beleaguered and financially-stretched competitors in a war of attrition. In this manner, they keep and expand their market share maintaining their earnings margins by efficiency and low financial cost, letting their competitors slowly bleed to death as they are slowly marginalized under their crushing debt stock and heavy financial expense in a prolonged weak freight market.

The only thing that could turn around this downward spiral is increased demand. Indeed so far, demand has been relatively firm as opposed to the shipping crisis of the 1980’s and the main issue is over-ordering. The wager in RBS lame duck support deals like Eagle restructuring is a speedy market recovery than brings up asset prices and improves cashflow.

Asset inflation has been a driving force in the shipping industry for many years now along with the Chinese double digit growth story. Should this environment change structurally, the industry (and its bankers) would be open to some severe readjustment shocks.

Monday, June 25, 2012

Eagle Bulk in trend-setting equity for debt exchange

After the TORM restructuring earlier this year, we now see another “equity for debt” exchange deal between Royal Bank of Scotland (RBS) and its beleaguered client, Eagle Bulk Shipping (EGLE).  RBS takes warrants for conversion into a 19.99% stake in EGLE.  To reduce the effects of dilution on shareholders, only one third of the shares can be cashed immediately.  There are share price triggers of US$ 10 and 12 per share for the cash out of the remaining shares in two tranches.  This sort of deal sets a new precedent for the shipping industry to keep weak companies alive a significant runway for a market recovery.

EGLE is carrying a crushing US$ 1.2 billion debt load, which was the result of massive block deal to expand its fleet at the peak of the boom cycle. As many shipping companies prior the 2008 financial crisis, EGLE preferred to expand its fleet by paying a premium to a private shipping company for a package deal rather than generating directly its own business for added value. The deal resulted in higher term debt leverage. Then with deteriorating market conditions, the company faced declining hull values and asset impairment charges as well as loan covenant violations as vessel values dropped below hull coverage ratios. The last two years, EGLE has been plagued with charter party defaults, declining revenues, growing operating losses. It is a highly leveraged player at the wrong time and place of the cycle.

This year, EGLE has seen considerable press about protracted negotiations with its senior lenders. Recently, EGLE and RBS settled a dispute over defaults to the huge loan and won a repayment holiday into 2015. The bank also offered up a new facility to the tune of US$ 20 million. An integral part of the deal was that the RBS would take a substantial equity share in the company as detailed above.

Doug Mavrinac of Jefferies was reportedly ebullient about the deal :

“Given that EGLE shares are effectively a call option at current levels, we believe the agreement is very attractive as it significantly lengthens the runway time for the market to improve and removes bankruptcy risk over the medium term,” he added:

“We also believe the move has positive implications for other large dry bulk shipowners regarding the banks' willingness to work through debt issues.”

Whilst I would agree that this deal sets a useful precedent for other troubled owners, I am not so sure that it is as beneficial to shareholders as he describes. I find this a bit like having your cake and eating it, too.

Inevitably, no one is going to come out whole in this unless the dry bulk markets improve, the company becomes profitable again, debt is paid down and vessel values rise. The Chinese growth cycle in infrastructure investment seems to be at an end. There are far too many ships. Scrap and steel prices are falling. There is a potential issue about new ship designs with lower fuel consumption.

EGLE remains badly exposed due to bad investment decisions of the past. Not only has management failed in delivering value to shareholders, but there have also been concerns about continued high remuneration levels despite the poor results. Added to this, the lenders now have an equity share in the upside, which means less to other common shareholders.

With Supramax rate expectations of US$11,000 per day on average the outlook still looks challenging. Prior this restructuring agreement, even market improvement expectations of US$ 13,000 perday for spot earnings in 2013 were not sufficient to service the crushing US$ 108 million debt maturities falling due.

So is EGLE an attractive company to buy as opposed to invest in peer dry bulk companies with better management performance, market position, lower leverage and healthier financial results?  Probably not!

EGLE is going to have to prove itself to be credible again.  This will take time and luck.

Wednesday, May 30, 2012

Pain in Spain and new elections in Greece: Investors are in a panic

Doubling up on failed policies in the EU is leading to the specter of massive and costly defaults of  hapless Eurozone members. As EU policy makers keep increasing the cost of abandoning the Euro to prevent Eurozone governments from willingly “misbehaving” and abandoning the euro, they ignore the accelerating amount of damage to the country and its creditors if things fail and social turmoil leads to this outcome. This is really spooking the markets and investors, who are withdrawing from the Eurozone.

Greece will inevitably be forced back to its national currency. The Greek public debt will have to be restructured with deep haircuts. The PSI+ is a dead letter. The really big issue will be the EU public debt to Greece, which needs to be written off in large percentages and the political fall-out thereafter in the lender countries for these “pretend and extend” follies.

In effect, the Euro is a greater Deutschemark zone. It never met the Mundell optimal conditions for a proper currency zone. The Germans have used this to promote a mercantilist export machine based on internal wage restraint and financial repression. This generates for them nice surpluses whereas the other hapless EZ members face growing deficits. The deficit countries have been pushed into massive increase of public debt to cover the growing trade balance deficits to avoid massive unemployment. EU policy makers and political elite knew that the system was defective, but they counted on using any crisis to promote forced political integration. They did not count on how difficult this would be under circumstances of deep economic recession and political stress.

The Euro works as a gold standard where the brunt of adjustment falls on the deficit countries. The only means to readjust is mass wage, salary and pension cuts, so this causes enormous social unrest from the severe deflation. The deflation makes the debt burden significantly worse, leading to spectacular drops in GDP and growing risk of huge and unmanageable debt defaults. Politically, the elite in the EU and Greece have lost legitimacy.

So in Greece, there is fragmentation of the political system. The whole basis of the 3rd Greek Republic is in question. There is a vacuum of political leadership. Greece is basically a poor country, living on a borrowed currency under colonial status within the EU. The two major contenders in this election are the “conservative” New Democracy party calling for Greece to “stay” in the Eurozone at any price and the Leftist SYRIZA declaring the IMF/ EZ/ ECB memorandum signed earlier this year a dead letter open for renegotiation. ND is basically living in the past, hoping to put “Humpty-Dumpty” together again with the EU and Eurozone. By chasing the impossible, refusing to admit insolvency and the impossibility of remaining in the Euro economic strait jacket; they are courting the worst possible outcome of disorderly default.

SYRIZA is the poster child of the last 30 years in Greece on Eurozone dependency as a welfare ward. They have discovered debtor’s leverage and challenge the EZ to continue the transfer money without the Memorandum austerity conditions. This puts the dilemma back on the EZ. If the EZ elite want Greece to stay in the Eurozone, effectively they have to convert their bailout loans to transfer money, something that the IMF has already been timidly suggesting in their latest debt sustainability reports. SYRIZA is forcing the issue that ND wants to avoid in direct confrontation with the EZ Core.

Neither party has any plan for Greece to stand on its own two feet, develop a proper productive base, etc. Greece is like a third or fourth generation family living on welfare entitlements. The Greek people are very ill prepared for the chaos that is confronting them.

The contagion issue of Greece leaving the Eurozone is probably overblown for political consumption but it difficult to see how the EU has enough resources to hold the Eurozone together with all the debt pyramiding to cover up the trade imbalances, especially falling into ever deeper recession. The current turmoil in Spain regarding Bankia and the failed attempt of the Spanish government to force the ECB to undertake its recapitalization to avoid losing sovereignty in another EU bailout program is illustrative of the challenges.

The EU elite suffer from a siege mentality. They have staked their political careers on the Euro project. If it fails, they are in disgrace and discredit and this reflected in an increasingly angry and desperate electorate whenever national elections are held. This highly problematic currency zone is failing and any attempt to manage the risks and minimize the damages falls on deaf ears in Brussels.

Tuesday, April 24, 2012

Pierpaolo Barbieri in the WSJ misstates Nouriel Roubini and fails to comprehend what went wrong in Argentina and is going wrong in Europe

This article makes a poignant plea for the Eurozone as a “worthy” project and supports the disastrous Argentina experiment to peg the Peso to the US dollar.  Whilst the writer makes some good points about the present populist regime in Argentina and recent expropriation of YPF, the Argentine oil company controlled by Spain's Repsol; he cannot seem to get it together on the politics and economics that led Argentina to collapse nor what is happening in the Eurozone.

Barbieri first puts his foot in his mouth when he accuses Nouriel Roubini of “making Argentina a model for Greece.” What he seems to mean is Greece leaving the Eurozone. I doubt that he has read seriously anything that Roubini has written on Greece. He does not appear to understand why Argentina collapsed and how this has affected the thinking of those like MIT’s Simon Johnson, who were involved personally at the IMF in this debacle.

Both Nouriel and Simon have been urging Greece and the E.U. to take measures to avoid economic collapse and disorderly debt default. Roubini has been calling for a consensual divorce from the Eurozone with serious debt restructuring. He even calls for measures to avoid a devaluation overshoot.

Barbieri, like many Greek commentators, makes the specious argument that the peso-dollar peg and single currency union is a necessary agent for structural reforms. In fact, linking a weak economy to a hard currency was essentially a political gimmick that has had disastrous results.

Both countries have suffered from corrupt populist regimes centered on charismatic personality cults. These leaders led them to economic ruin: Argentina has the Peron legacy and Peronistas, Greece has the Papandreou legacy and PASOK – an entrenched, rapacious and highly corrupt political elite.

In Greece, the purpose of Eurozone entry was to promote this populist and corrupt regime, not to build a sound economy. Even today, the political elite in Greece have no scruples about putting the general Greek population into abject poverty if it means preserving their privileges. Barbieri is a professor of government at Harvard. His inability to recognize the political and economic dimensions of these situations and how difficult structural changes are in such an environment is inexcusable.

In fact, Barbieri has got matters upside down: there no sense for a country moving to hard money unless structural reforms are already in place. He clearly does not understand the inherent dangers in artificially locking into a hard foreign currency, as the Argentine and Greek political elite did, for lower interest rates to whitewash a weak economy. He doesn’t seem to realize how mispriced credit can lead to destabilizing asset bubbles and crippling over indebtedness in such cases.

He claims spuriously that Argentina and Greece achieved “hard-won low interest rates.” In fact, the low interest rates were never earned, rather they were 'borrowed” as credit enhancement from the currency peg! There was huge resistance to structural reforms in these countries. The decoupling between actual credit risks and underlying economic fundamentals proved lethal. The borrowing and spending binge in these two countries, unleashed by this artificial hard currency link, eventually crashed and degenerated into sky-high unemployment, widespread poverty and credit lines from the International Monetary Fund.

At this point, Barbieri accuses the Argentine politicians of clinging “to an overvalued exchange rate” in the face of chronic deficits, capital flight and deepening recession. Well, this was the poison fruit of the currency peg. Greece is in the same unenviable position in the Eurozone.

As for his “harder, productivity-enhancing reforms like decreasing bureaucracy or improving labor-market dynamism,” this would take many years to achieve and would be a challenge even in a normal Greek or Argentine political climate. It would never be feasible in a deep recession with the ensuing social and economic chaos.

The sad truth is that countries with the political culture of Greece and Argentina require a soft currency for survival. Forcing change by currency pegs or currency zone memberships leads to insurmountable imbalances that degenerate into major credit defaults.