Tuesday, January 21, 2014

New direction in the OSG Chapter 11 reorganization

Collapse of blue chip OSG was one of the biggest stories last year in the shipping space. OSG management got itself in such a corner, overwhelmed by evolving events, that they were forced into Chapter 11 reorganization proceedings without any clear exit plan. 

Now their options for potential exit are becoming clearer. Unsecured bondholders are likely to be a driving force, making an equity investment through back-stopped rights offering estimated at US$ 430 million. This will be used to refinance OSG lenders under the original revolving credit facility, pay off the IRS claim and give OSG some operating cash to emerge back into business

One of the biggest catalysts of the fall of OSG was their unexpected problems with the US Internal revenue on tax liabilities, but this appears to be heading for a happy end with an agreed settlement for US$ 267 million from the original IRS claim of US$ 463 million even below OSG provisions for US$ 308 million. This is very significant because it resolves one of the biggest sources of uncertainty around OSG and allows them to confront the remaining issues in an orderly fashion. 

Another positive development albeit indirect is the Kinder Morgan acquisition of the American Petroleum Tanker fleet as it sets a market benchmark for the value of their US flag tanker fleet, which is presently their most valuable asset. 

From press reports, the major thrust in the OSG reorganization plan will be a debt for equity exchange with the unsecured bond holders. This will result in massive dilution for existing OSG shareholders, who will be luck to retain about 10% of the company. This appears to be the major source of needed recapitalization. 

The bond and notes holders of distressed OSG debt are likely to have recoveries of 115% and 128-171% respectively, putting the noteholders in an especially profitable position. Conversely, the OSG senior debt holders, who are now mainly hedge funds with lenders having disposed of their debt holding, are likely to be repaid in cash as opposed to receiving any equity. This would certainly be a disappointment for the hedge funds, who bought into OSG debt, depending on their discount entry price.

All this presupposes that negotiated agreements that get OSG out of Chapter 11 are finalized by June this year.

Changing economic paradigms: Governments and financial industry crowding out capital and labor

The great divide of 19th and 20th century capitalism was the antithesis between capital and labor. Our perceptions today are molded in this framework, but this is slowly being displaced in the 21st century by a new divide line between governments, big bureaucracies like the European Union with their banking industry partners declaring war on capital and labor mutually, putting them both under severe pressure by massive socialization of losses created by their policy decisions at the expense of general society.

Essentially this new state corporatism is a modern form of rent extraction fuelled by ‘pretend and extend’ policies on unsustainable public debt levels. This is crowding out productive investment, creating negative returns on capital and reducing wages in a downward spiral of debt deflation and at best sub-par recovery with high levels of unemployment. 

The old Marxist theory was that capitalism was unstable because the capitalists were using their power to suppress wages and this was leading to ever deeper economic cycles of boom and bust. Gradually with mass production, entrepreneurs like Henry Ford realized the importance of a mass consumer markets to sell these products even to their own workforce. Later in the Great Depression era, this evolved to the Keynesian view that governments can soften the impact of economic downturns by increasing their spending for economic stimulus to reflate. 

In the last 30 years, we are experiencing very high debt levels in excess of those that preceded the Great Depression and overly saturated consumer markets primed by bank credit. Today we have an evolving system of state corporatism. 

There is nowhere where this is more heavily concentrated than the Eurozone in the European Union. The common currency system has made governments reliant on commercial banking system to finance their deficits. The trade deficits are locked in because there is no natural adjustment mechanism by currency devaluation. The only way for member states to adjust the imbalances is either to borrow or to reduce consumption by aggressive use of deflation. Use of deflation results in bankrupting the domestic banking and pension systems as well as massive unemployment. 

This process has created mountains of unsustainable government debt, it has infected the entire EU banking system and it is currently being shored up by ECB programs like LITRO and OMT. The hard monetary policy of the ECB militates against monetization and the Eurozone policy has been to increase tax levels and declare war on capital with increasing use of the banking system as means of tax collection. The high levels of taxation are pro-cyclical and deepen the recessions. Greece is a textbook case.

Despite years of austerity with GDP output decline to Great Depression levels and massive PSI+ haircuts, Greek public debt levels remain as high as ever and unsustainable. The ultimate in this policy thinking was the Cyprus bail-in where depositors become shareholders and were taxed directly to absorb the banking losses, generated from default and haircuts on government debt instruments. Decisions are arbitrarily made by EU policy makers and their governments without direct representation of the people affected in the member states. The old rules of no taxation without representation have been broken. 

With the massive economic scandals in Greece with the TT and arms procurement, the Greek political elite are increasingly looking like a class of robber barons. This same class of people has been aggressively increasing levels of taxation on businesses and private individuals with new draconian and repressive tax laws with powers of garnishment and expropriation of bank accounts and income streams for collection. Backlash and resentment is rising to the boiling point in Greece. 

In the shipping community, we have an interesting phenomenon of ship owners, office staff and Piraeus port dock workers all adversely affected by these policies. The Greek shipping SME’s (small medium businesses) cannot get sufficient bank credit from the Greek banking system to roll over and renew their fleets, the management companies are forced to pay double Greek flag tonnage tax on their vessels, the service offices have been arbitrarily taxed (even retroactively) on their imported foreign exchange to pay general office expenses, the office staff is being taxed right and left reducing their disposable income and the dock workers face low wages, unemployment and competition from foreign immigrants for labor needs. 

Admittedly, these groups do not perceive necessarily that they are all in the same basket with common adversaries, but in fact a new dividing line is becoming increasingly clear. The zero sum game is between EU policy makers, the political elite with their banking system partners diverting resources from the general population and the business class. The resources are going to sustain the Eurocurrency system and the political elite at the expense of both capital and labour, putting them mutually under increasing pressure, resulting in increasing business closures and high unemployment.  

Added to this, the political dynamics of the Eurozone are changing with the recent turn of the French government (presently at record lows in public opinion polls} in complete capitulation to the Germans by embracing of Say’s Law (supply creates its own demand). The old French-German partnership that drove the European Union is being superseded by an all-powerful Germany, who drives major policy decisions as it sees fit. This is more than just a calamity of economic policy but an event of major political consequences. 

  • It fuels domestically in France the Eurosceptic movement of Marine LePen leading in the polls for the forthcoming Euro parliament elections. 
  • It reinforces the German supply-side consensus and establishes the principle that the only way to co-exist in a monetary union with Germany and the other Nordics is to become like them. 
  • This makes Eurozone membership virtually compulsory to stay in the EU, which will ultimately lead to the exit of the United Kingdom. 
  •  It also makes adjustment in EU periphery countries like Greece likewise virtually impossible to remain in the Eurozone and EU. 
In the forthcoming Euro-elections there is a deepening divide between the Federalists, who want more EU centralization and integration and those, who want to break up the Eurozone, want to reaffirm the sovereignty of the nation-state with a smaller, weaker EU that functions as a trade zone.

For these reasons, the party system in Greece is fragmenting and the two main political parties are in disrepute. There is likely going to be increasing instability in Greece and the European Union in the coming months. The Europarliamentary elections are likely to be a catalyst for major policy changes, should the prevailing 'status quo' be altered by the results.

Monday, January 20, 2014

Shrinking credit markets?

The Eurozone crisis has taken a new turn for the shipping industry this year with more stringent ECB rules on asset quality control. This process may further restrict shipping credit from European banks, which still remain today a major source of senior debt financing for the shipping industry. The new rules may restrict bank options in working out the non-performing loans on their books, warehousing shipping assets and selling off portions of their loan portfolios to hedge funds and distressed asset investors. Auditors are unsure of the impact of these new rules on their banking client’s balance sheets. 

German shipping banks have been the largest source of senior debt for the Greek fleet. DvB Bank last year was one of the few major banks still expanding its shipping loan portfolio and a leader in putting new shipping loans on their books. 

There was considerable discussion about the ship finance deficit at the annual ICS Forum in Athens last December. The Greek banking system is in very poor shape. Speakers like Michael Bodouroglou and Ted Petropoulos are estimating a huge funding deficit for needed fleet renewal. The facts from their presentations are that whilst there has been a rise in non-conventional funding sources like private equity and capital markets, it is still small comparatively to the bank lending and does not come close to filling the finance gap. 

Old timers like Petropoulos are still quite hostile to private equity partnerships in shipping, emphasizing non-alignment of interests, but events and times are overtaking them out of necessity to deal with the pressures of the funding gap. Petropoulos himself admits Greek SME shipping companies face presently a bleak future due collapse of the local banking system and there will be immense pressure for consolidation. Petropoulos also made the point that Greeks for the first time in decades are beginning to fund vessel purchases on a cash basis. 

There is another dimension to this as well. The EU/ ECB is the home of austerian economics thinking and aggressive use of deflation to lower domestic prices by ‘internal devaluation’. They are challenged by poor results from these policies in weak economic growth and increasing bad debt as well as massive social cost. The more successful Anglo-Saxons have fared better – by comparison – with QE due their distaste for economic depressions that Europeans seem more willing to accept. 

These kinds of AQR (asset quality review) policies are a direct result of EU thinking. Presumably, the ECB is trying to shore up EU banks for all the government NPL’s that the Eurozone system produces by the way that they work. Greece is a textbook case. Five years of recession, 20-30% of GDP destroyed, 30% unemployment/ 60% unemployment, bankrupt local banking system, bankrupt pension system and a major private creditor PSA+ restructuring, yet still extremely high level of public debt that the IMF wants restructured with the EU/ECB balking. The present Greek government turned down an IMF proposal to help them pursue an OSI (public sector debt restructing with their EZ partners), claiming that they are an EU success story. 

Politics is likely driving this AQR thinking because of the debt deflation situation and this is creating a negative feedback loop. Contracting bank credit means most likely more recessionary drag and deflation. In any case, it is far from certain in any way that the Far East, particularly Chinese banks will be able ultimately to fill the slack for shipping. Likely they have, however, plenty of their own NPL’s to Chinese SOE’s that are catching up with them. Their existing shipping loan holdings are small compared to the major European banks. It is certainly easier to fund new building because of the available export credits over purchase of older tonnage, where credit is virtually non-existent for non-Chinese shipping companies from Far East banks. 

On this basis, these EU/ ECB policies are likely to contribute to more anemic sub-par recovery. The credit deficit and deflationary climate bodes badly for asset prices. On the other hand, the present climate has opened significant opportunities for listed shipping companies like Navios and their deals with HSH. 

Ship finance is very much an increasing case of ‘haves’ and ‘have-nots’. Those shipping companies who presciently and successfully established themselves in capital markets have access to financial resources thgat their their private competitors, who are heavily reliant on bank finance, do not have.  Further industry consolidation seems a direct consequence.

Scorpio Bulk: new ground in shipping investments

Scorpio Bulk is attracting massive media attention. It is start-up dry bulk company with no operational history, riding on the name of Scorpio Tankers and their management team. 

Following the tanker fleet strategy, the concept has been to build up a large fleet by aggressively acquiring yard slots. They currently have a fleet entirely on paper that consists of 23 Capesize bulkers, 23 Kamsarmax bulkers and 28 Ultramax bulkers from various yards all for delivery between 2015 and 2016. They have to build an organization for the commercial and technical management of this very large fleet. This amounts to a massive futures position in dry bulk assets that depends on market conditions in 12 - 24 months for employment. It is fairly concentrated shipping risk. 

 It is not surprising that there have been mixed comments about Scorpio Bulk. This venture has a very different history from Scorpio Tankers. Emmanuelle Lauro built the tanker operation methodically concentrating initially on a tanker pool with partners and building up a substantial commercial team. He also had a tanker fleet in the water that he was managing and operating. He then hired Robert Bugbee and organized an IPO to acquire tanker assets. 

This venture conversely is contracting new buildings without any vessels in the water. Indeed prior to Scorpio Bulk that was supposed to be an impossible schema for a public shipping company because investors wanted operating cash flow with vessels in the water before funding any shipping projects with forward deliveries and were not prepared to endure negative cash flow for prolonged periods before the vessels hit the water. Scorpio broke revolutionary ground that had never been done before in public markets. 

What Scorpio wants ultimately to do with this company and its assets is yet to be seen. Bugbee may be trying to replicate OMI and look at an opportune moment to cash in and sell out the company or its assets for profit. Prima facie, however, they are looking to build an operating dry bulk company alongside their tanker operation. 

The key factor here is how the dry bulk markets will be faring when the vessels hit the water. The prevailing school of thought today is that dry bulk markets are likely to be good for the next two years with Chinese closure of domestic mines and increasing imports of coal and iron ore from cheaper and more efficient overseas sources. After two years, this substitution process will have been completed and the surge in demand will level off to inventory restocking needs. This is especially important for Scorpio Bulk since their fleet is larger bulk carriers, where these are primary trade. There are no handysize vessels in their fleet. 

The major investment premise is that the vessels have been contracted at historically low prices and markets have nowhere to go but upwards in the coming years. The vessels are new and fuel efficient. The major risk hypothetically is that Chinese growth rates disappoint and the rebalancing, including Chinese long positions in commodities need to be liquidated at losses. Historically, falling commodities prices has been a negative factor for freight rates. China finds itself in a middle income trap and there is no other source of fresh demand so that shipping markets face a prolonged downturn of low rates. 

Another risk that the present type of eco vessel is rapidly superseded by change of fuel and becomes obsolescent prematurely. This concerns the general strategy of Scorpio, heavily predicated on the eco-ship story and heavily invested in current eco-designs. 

Most shipping experts are confident that these are unlikely scenarios, but shipping is always unpredictable because trade relations are constantly in flux. Scorpio has undoubtedly considerable new building risk with a very concentrated position. No rewards without taking on risks.

Saturday, January 11, 2014

Goodbye Greece, Hello Hellas: Rebranding of Greece in troubled waters

 Christos Alexopoulos has written a thoughtful book, calling for the rebirth of Greece from its present decline. He represents the views of a very large part of the Greek middle class. Their hopes were for Greece’s accession to the European Union and participation in the Eurozone as a springboard for prosperity. Now with the pain of the fourth Greek bankruptcy, humiliation of the EU/ IMF workout program, massive unemployment and declining living standards from five years of recession, they feel in a quandary about their national future. They look back to Classical Greece and feel that this heritage entitles them to play a key role in Europe. 

The problem is two-fold: the failure of the developmental model of the last 30 years based on EU bootstrapping and the rapidly changing dynamics within the EU that undermine the very premises of their belief system. 

Greeks tend to see the European Union as a means of emancipation from the days of the Cold War and their relationship with the US for which they blame the Greek Junta period. For them, the European Union is everything. Membership in the Eurozone was to give them economic empowerment as a developed country, part of a unified Europe that would be on the same terms as the US, China and Russia as a major power. This viewpoint is a product of their political elite, set by Konstantinos Karamanlis on his return from self-imposed exile in France called back by the Greek general staff after the first phase of the Turkish invasion of Cyprus in July 1974. This marked the beginning of a new political era in Greece. 

Karamanlis ratified the actions of previous Dictator George Papadopoulos in abolishing the Greek Monarchy and establishing a Republic. He legalized the Greek Communist Party and generally entered into a period of expanded entitlements, hostility to private enterprise and foreign direct investments, trying to fend off the rising Pan Hellenic Socialist movement of his rival Andreas Papandreou.

His major achievement was convincing Giscard D’Etaing to support full Greek membership in the then European Community. This was meant to ensure political stability in Greece and provide economic resources in the way of transfer money for economic development. His ultimate successor, Andreas Papandreou pushed these policies to the limit, massively expanding entitlements funded by rapidly increasing national debt and socializing large sectors of the Greek economy by absorbing over indebted and failing Greek private companies already suffering from the adverse climate of the Karamanlis period. This led to an expanded state bureaucracy and speeded up the deindustrialization and decline of productive base in Greece.

The final phase before the fall was set by the Simitis government, who made membership in the Eurozone a national priority, proudly proclaiming Greece as a powerful and developed country. Eurozone membership was meant to resolve the increasingly serious problems of disturbingly high levels of public debt and weakening trade balances. The 2004 Athens Olympics Games was the showcase project of this era, despite the drug scandals of some high profile Greek athletes – tell-tale signs of the immorality of the times. 

In this belief system, the EU was good and on the rise. The US was bad and in decline. Greece in the EU was a politically and economically powerful country. The Greek political elite cultivated this belief system over the last 30 years. It never spoke honestly or openly to the Greek people on national issues. 

For example, despite months away from an IMF bailout request and full knowledge of the impending disaster from the Bank of Greece, George Papandreou – scion of an old Greek political family, ran for elections in 2009 on a platform that money was no problem. In power, he had no coherent plan to deal with the crisis and he appointed a totally inexperienced and inadequate finance minister. By the next elections in May 2012, his socialist party’s share of vote plummeted from 43% to 13%, yet even today with polls running around 5%, this party essentially controls all the key posts in the state machinery and major positions in the Greek government. The present government continues on the same path: the EU remains a nirvana, turnaround is around the corner and what happened since 2009 is just a bad dream. Greece lives today on EU/ IMF handouts in small amounts until the next IMF review.

Behind the official rhetoric of the last 30 years has been the constant decline of productive base in Greece, the waste of human resources in a poor and substandard educational system, deteriorating demographics and a rapacious political elite, who enriched themselves in various rent-seeking activities and maintained power with a bloated state sector, financed by deficits and debt. Greece entered the Euro with already very high levels of public debt on the hope that the technically lower interest rates would resolve these problems. Instead, the Euro accession fuelled consumption and consumer debt as well as a real estate and stock market bubble. The hard currency all but decimated what little was left of any productive base and destabilized the balance of payments. Eventually Greece crashed when investors woke up to the risks, public debt interest rates soared and Greece was shut out of financial markets.

The aura of prosperity proved an illusion. Bad policies, poor decisions and general incompetency of the Greek political elite caught up with reality. Still most Greeks blame foreigners (especially the Americans ….. the usual villains for almost anything in Greece by various conspiracy theories), rather than trying responsibly to understand what actually went wrong. The Greek political elite remain totally dependent on the European Union for what to do. Rather than emancipation, Greek dependency on the European Union degenerated to a bipolar disorder.

Large swathes of Greek society are being marginalized economically. Laws are now rammed through in the Greek Parliament by fast track procedure in single articles, avoiding substantive debate or objections. MP’s have been imprisoned for the first time since the Greek Junta. The government now charges people and keeps them imprisoned indefinitely pending trial. It is even passing new laws that deprive the accused of basic civil rights simply for being charged pending adjudication. Greece is a country of very limited sovereignty under full control of its EU government creditors. Effectively no elections or government can happen without prior Brussels approval.

Poorer Greeks and self-employed are revolting against the system, in the face of the high unemployment and confiscatory taxation. They see their fate on the wall, having to compete with immigrants for low-paying jobs or compelled to emigrate. The middle class in the more affluent neighborhoods especially in the northern suburbs tends to remain smugly complacent longing to be “Europeans” albeit overlooking their overtly second class EU status.

As one parish priest put it in a sermon on Greek Independence Day 2013: “we became impassioned by money and material well-being, we lost our spiritual independence and this ultimately resulted in our loss of national sovereignty and civil rights.” The Greek middle class has an entirely shattered belief system and yet no other clear alternative.

This dilemma is very apparent in Goodbye Greece, Hello Hellas. The author suggests that Greece be renamed ‘Hellas’ (in official documents ‘Greece’ is already Hellenic Republic…..) for national regeneration. He lists various issues that confront Greece but avoids any direct confrontation with the already largely discredited status-quo in Greece of the EU automatic pilot that has led to the present national predicament. As the psychology of the author reveals, most middle class Greeks still cling desperately to these concepts, hoping that they just in a bad dream. 

The sad thing is that Greece is in a negative feedback loop. It is probably the weakest and most dependent country in the Eurozone. Despite the EU/IMF workout programs and formal haircuts in private sector debt, the public debt burden remains as crushingly high as ever, only mitigated by artificially manipulated interest rates. Eurozone debt deflation economics is heavily responsible for this phenomenon, yet middle class Greeks are terrified of returning to a national currency and proper central bank. A large part of this is due to insecurity and lack of belief in their country and its people. Yet there remains the romantic and naive belief that somehow the glories of classical Greece allow them to be a shining beacon for the rest of Europe and mankind. Panayiotis Kondylis described this paradoxical viewpoint In his work on Greece back in the late 1990’s and proved prescient about the current national predicament, emphasizing lack of coherent national policy. 

The book calls for a revised constitution by a committee of academics. It is a static viewpoint and does not really offer any answers or fresh concepts. Its biggest value is that it presents a very revealing view of how Greek middle class society sees the world externally.

Greeks are ill prepared for the storm ahead in the EU where there remains a high probability of Eurozone breakup as unemployment remains high and economic growth low. Other larger countries like France and Spain have not been willing to accept the harsh conditions that Greeks are willing to endure. A spirit of nationalism is sweeping throughout Europe. This is happening even in Greece but only among poorer Greeks so far. The Greek government response has been to threaten those who openly question the present system with jail, but the polls show that this tactic has so far backfired. Public rage is growing against the ruling Greek political elite. 

The striking impression that the book leaves is how far divorced is the Greek middle class from the reality around them with a totally discredited political elite, no sign of credible fresh leadership, serious loss of valuable human resources by youth emigration and a European Union under serious challenges and threat of partial break up.