Rapidly deteriorating conditions in Greece

The latest EU 'Grand Bargain' illustrates how temptations and denial of individual responsibility is transforming the Eurozone into a pure Hell for its member states. The new ESM is pitifully underfunded and requires unanimous consent of its members to grant a facility, making it a colossal joke. The ECB is taking a hawkish stand on interest rates when its periphery laggards are insolvent and held alive by 'pretend and extend' loans that they refuse to restructure. Greece is about to collapse.  Nouriel Roubini's RGE forecasts Greek debt restructuring within 2011, which would mark a watershed for the EZ.

The Greek clientee-based political system has created a crushing national debt burden of 130% GDP and still rising. Their politicians systematically use public money to buy votes and have created a vast, corrupt state bureaucracy. They unleashed a class warfare mentality extremely hostile to private investment and entrepreneurship, which they view subservient to the state and their political purposes. They promised the people endless entitlements to be paid by other people's money. The Eurozone was seen as as means of perpetuating this dysfunctional system, where their European partners would cover them paternalistically.

As a result, Greek people were totally unprepared for austerity. Their politicians after years of dependency on the EU as a pseudo 'developmental' policy are terrified and have no idea how to face the present reality. They desperately need new money to fund the overbloated public sector.

The IMF is increasingly frustrated with the slow progress of their efforts to rebalance public finances and control public debt levels. Internally they seem to be pressing for immediate debt restructuring, but the EU is terribly afraid of a Greek default and refuses to discuss the issue. So as in previous EZ cases, the IMF and EU are at loggerheads.

With debt servicing needs of 6,4% GDP, it is hard to believe how growth will ever cover such a debt load, which is twice the amount in the late 1990's Russian default.  The growth rates for Greece would have to exceed China for a sustained period of time in a circular situation where the debt load and default risks inhibit productive investment.  The Euro 50 bn privatization plan seems dauntless given the slow progress and poor history of previous privatization efforts, where there is considerable political and local resistance.

Meanwhile the ECB is adding misery by its hawkish stand on interest rates despite little evidence of potential inflation, the deep recession and deteriorating financials of its laggard members. They seem to be firmly in favor of 'pretend and extend' and unconcerned about the massive debt pyramid that they are creating within the EZ.

Core Eurozone members like Germans, who are the payers in the system, are beginning to worry that their contingent liabilities on the mountains of debt in the system will lead to credit downgrades and increased funding costs for them. They are positioning themselves to limit their losses by reducing the initial paid-in capital to the new ESM facility and extending subscription over time. They have also pressed for a mechanism that would force debt restructuring on laggard EZ members and private creditors would share in the losses.

The Greeks domestically see the IMF/EU as an 'occupying' force. The composer Mikis Theodorakis has created a political movement 'Spitha " (spark) calling openly for overthrow of the system, debt repudiation and Cuba-style nationalizations.  The PASOK (socialist) government is in increasing disarray where Vaso Papandreou, a leading MP openly called for debt restructuring.  Politicians are frequently facing street attacks in public appearances. 

Dryships in record US$ 2 bn loan bonanza

Dryships has had an incredible run recently with banks lavishing credit on the group. A consortium led by Nordea Bank and ABN AMRO has coughed up US$ 800 mio to pay for the Ocean Rig Corcovado and Olympia. DVB Bank, Deutsche Bank, National Bank of Greece and Norway’s export credit agency GIEK are also in the deal. Deutsche Bank agreed to restructure a US$ 1.1 bn loan, of which US$ 495 mio has been earmarked to pay for the Ocean Rig Poseidon. The drillship is on hire to Petrobras.

Dryships has taken some hits from the Korean Line bankruptcy on a Capesize bulker and two Panamax vessels, marked down to spot rates from substantially higher time charter levels, deflating some of their 82% contract coverage for this year. Their 4th quarter results disappointed the Street at 20 cents a share by 6 cents below consensus forecast.

On the other hand, their drilling activities as they come on stream have provided a ten-fold increase in fourth quarter profits on the back of increased revenues. Dryships successfully raised US$ 500 mio by private placement for Ocean Rig in their plans discussed now for several years eventually to spin this off as a separate listing.

Added to this is an additional US$ 770 mio deal for tanker new buildings, where there have surfaced again some trust issues between the listed company and Economou's private company Cardiff related to how this order was originated and booked for the listed company. Economou had pledged no more intercompany transactions between Dryships and Cardiff.

Economou recently pulled in US$ 45 mio stock grant from his DryShips business in New York. The stock grants have allowed him to rebuild his share position in the business despite the substantial share dilution from repeated at the market follow-on offerings over the last two years.

Ocean Rig appears to be well capitalized. The financial risks from the tanker foray seem manageable, but it remains a speculative play when there is already a challenging market in the dry cargo sector and the company has suffered recent hits. Again Economou is challenging the 'pure-play' approach as he has done in the past.

Investors seem happy with the company albeit its shares trading currently at US$ 4,80 are far from the heady days of US$ 80-100 per share, but they have improved from previous lows in the US$ 3 range and even briefly traded in the US$ 6 range last December.

Genmar restructuring and its costs

Genmar is one of those companies too big to fail because of borrower leverage from the high quantum of loss in case of default. Also as a publicly listed company, it has the option of raising equity to cover its senior lenders as a sort of private bailout facility. In this case, Genmar (NYSE: GMR) seems to be pursuing both avenues with a Oaktree Capital taking a pricey US$ 200 mio secured position with priority and warrants plus a US$ 53 mio follow-on offer. Peter G's aura seems still there.

The Oaktree deal appears to be dependent on Genmar refinancing existing senior bank debt. Ostensibly, Oaktree wants to see the payments pushed out and no risk of covenant violations in the near future since it looks unlikely that the company will be able to make an cash payments over the next two years and the principal amount will rise with the accumulated compound interest. Oaktree also holds warrants to purchase up to 19.9% of common stock. Perhaps this is a measure to get control of the company should market conditions worsen, but also to reap profits should the shares ultimately rise in value if the company survives in its present form.

I would expect the existing senior creditors to play along with these moves for increased liquidity, even the new priority position of Oaktree over existing bondholders. The troubling thing is that debt and leverage will continue to rise and debt service costs will go up. A more classical approach would have been debt for  equity swaps or more asset sales to get the leverage down, but today debt is king and debt pyramiding is the fashion.

The proposed follow-on equity offering is priced US$ 2 (at par) with the proceeds to pay a portion of the remaining purchase price for a Suezmax tanker that was booked at a high price by last year's levels, which would be very likely less today. Personally I cannot understand why investors would accept to buy in at par for a deal like this. Adding to the risk, there is dilution from the Oaktree warrants, the high debt servicing costs and the restriction on dividend payout. Would not they want a steep discount for their money?  The alternative of reselling the unit would probably mean Genmar taking balance sheet losses on the transaction.

None of these announcements has resulted in share price improvement, but there is stabilization at the US$ 2 level for the time being.

BLT continues to leverage up and does not seem concerned about risks or cost

Berlian Laju Tankers has made a news splash with its recent US$ 685 mio senior debt restructuring by a 6-bank consortium plus a US$ 90 mio sale leaseback deal for four chemical tankers including one new building with Standard & Chartered (S&C). S&C also participated in the consortium deal that refinanced US$ 593 mio debt to repay 10 outstanding loans. Another too big to fail company with substantial borrower leverage.

In addition to its 65 chemical tankers, BLT also operates a fleet of 14 gas tankers and 14 oil tankers. It has an oil tanker subsidiary Buana Listy Tarna owning three tankers and an FSPO. BLT is hoping to get benefit of new Indonesian cabotage rules in the FSPO sector. The company is expected to have negative free cash flow this year but a surplus next year.

There is talk about selling off a 40% interest in Buana as well as two Suezmax crude tankers as early as spring this year.

In the market place, it is said that BLT is almost as good as sovereign risk with a prominent Indonesian family as controlling shareholders. The banks seem eager to lend to them more money despite the high leverage. On the other hand, the company seems delighted to pay the increased financial cost from the high leverage, betting on a market turnaround bonanza.

Management continues to have an extremely bullish view on the chemical tanker sector. This year there has been some stabilization in rates and from 2012 the orderbook overhang will be substantially reduced, so perhaps there lies ahead a silver lining  for the sector.

BLT is the most leveraged play in the chemical tanker market so they will profit the most in an upturn, but they will face potential problems should there be further unexpected downturn. The senior lenders seem to be betting on the rosy scenario.

Greece, the Eurozone and the Garden of Eden

Once upon a time there was a country in the Balkan peninsula, living in the Eden of the Eurozone. They were told to keep the Stability Pact to avoid deficits and debt. Instead they succumbed to temptation of low interest rates, generated huge trade deficits and ran up public debt to 130% GDP plus. Now with the IMF/ EU bailout, they are suddenly in Eurohell. The question is whether God was right in expelling Adam and Eve or should he have simply killed the snake? Let us consider below.

Their politicians were always spending money to buy votes and creating deficits financed by rising public debt for which the citizens cheered, promised that others would foot the bills and they would get endless benefits. They were delighted to discard their national currency and give up their monetary policy. They saw this as a national emancipation.

Ideally they would have liked the EU to guard their borders and undertake their national defense so they could spend less in doing so themselves. They consider that this another reason why it is the fault of the EU that they are so much in debt and they have been had.

Some think that the Russians would give them a cheaper loan in exchange for military bases and they did not actually need the IMF/ EU facility in the first place. Others say that this would be a viable alternative to liberate themselves from the Euro 50 bn privatization suggested by the IMF and made mandatory by the EU. They feel feel that private investment is bad and most entrepreneurs are crooks, but at the same time they should pay for all their entitlements.

They are furious and feel that IMF/ EU Memorandum is illegal and has robbed them of their national sovereignty. They are also upset that the Germans and other EU trading partners made profits on selling them their goods. They consider their high spreads from declining credit rating to be usury, unfair and grounds for walking away from the debt.

Generally everyone else is to blame but themselves. They just want some more 'cheap' debt without conditions. They cannot understand why they cannot continue to live on other people's money. How outrageous for those who pay to have any rights to impose their terms! They should be the ones to decide how to spend the money of others.

Here they have bitten the forbidden fruit of unlimited cheap credit, but they have yet to gain from the Tree of Knowledge. Contrary to the biblical version of Eden, they think that they are still wearing clothes and there is further paradise in the EU, but actually they are increasingly naked......

Also their creditors are naked because they do not seem concerned enough about limiting their losses rather than still dreaming about getting out whole.

Will there be open revolt in the Eurozone?

Massive loan bailout facilities that pyramid Ponzi level public debt together with austerity programs that cause recession and shrink GDP, reducing capacity to service public debt are among the many contradictions in the thinking of the EU elite to preserve their currency union at all costs. Yves Smith compares EU methods of internal (infernal?) devaluation to Medieval torture. Will voters in EU laggards like Greece and Ireland ultimately revolt and this debacle end in sovereign default?

Classic economic theory of the unholy triangle illustrates the impossibility of having at the same time:

• A fixed exchange rate.
• Free capital movement (absence of capital controls).
• An independent monetary policy.

Eurozone members like Greece and Ireland gave up an independent monetary policy for a fixed exchange rate in an environment of free capital movement. The result was uncontrollable credit bubbles and price distortions under the ECB one-size-all monetary policy locked by fiat to the rules of the German Central bank. Greece and Ireland have very different paths to their present insolvency, but both cases illustrate the tension between European integration and democracy.  EZ policies have exacerbated the growing divergences between the core and periphery countries, resulting in this ongoing crisis that threatens the future of the currency union experiment.

As Bernard Connolly explains in his book "Rotten Heart of Europe", the single currency project was designed to generate an irresistible momentum for full scale political union in Europe, dominated by an implicit power-sharing agreement between the German and French political elites.

The problem is that democracy, national sovereignty and global economic integration are mutually incompatible. Deep economic integration requires the elimination of all transaction costs in cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream.

The EZ currency union illustrates the limits of global federalism. Making hapless EZ member countries responsive only to the needs of the ECB at the expense of domestic objectives is inherently incompatible with democracy. We could return to something like the post-war Bretton Woods regime with its capital controls and limited trade liberalization as alternative, but that would negate EU free trade. Finally, we could resolve this trilemma maintaining free capital movement, abandoning the currency union and reverting to flexible exchange rates with independent monetary policy.

I would suggest that the least painful and most desirable path would be breaking up the EZ currency union, preserving the nation states and democracy.

The Genmar saga rolls on with equity infusion and restructuring package

In vessel provider business models, there is little any private equity firm can add in efficiencies. Success is largely a matter of the freight market cycle and asset speculation. The only means for high returns is scaling up in huge leveraged block purchase deals, arguing expanded earnings multiples despite marginal (often diminishing) returns on asset. Peter G managed last year to raise capital for Genmar on such expectations without discount. The timing was bad. Now Genmar is in a mess.

Genmar's share price has been in steady decline since the heady days of 2007 when it was trading close to US$ 40. It stabilized after the 2008 meltdown just above US$ 7 and even briefly exceeded the US$ 8 level on the euphoria of the ill-fated Metrostar block deal and capital raise.

The Group is now in a fight for survival with weak cash flows, unfunded capex, mounting debt maturities and a requirement of new equity by year end by its beleaguered senior lenders. The Company has been trying to sell unencumbered vessels to raise cash via leading, which is the first resort when a shipping company faces financial problems. This brings a nice cash infusion that later slowly erodes with the payment of the lease obligations that reduce free cash flow.

The likelihood of a dilutive equity offering increases day by day with the prospects of the entry of a private equity financial investor. Oaktree Capital is a prospect. Other names mentioned include the Blackstone group and Maritime Equity Partners. Oaktree is deeply involved with the Beluga bankruptcy. Another option for Genmar shareholders would be a firm like Advent with its system of operating partners that would bring new blood into Genmar management. As Paul Slater has remarked, it is time that underperforming shipping companies are compelled to fire management in the same way as other listed companies when shareholders lose money and value is impaired. As usual, only the senior leaders have any clout and shareholders are at the mercy of the management and its lenders.

Platou Markets estimate Genmar has no equity value, assuming a 10% decline in asset values in their current supply/demand outlook. Genmar has severe cashflow and liquidity problems. There are two credit facilities: the 2005 credit facility of US$ 745 mio still outstanding (LIBOR + 250 bps, but US$ 580 mio swapped at 4.2%) and a new 2010 credit facility of US$ 372 mio (LIBOR +300 bps) for the acquisition of the 7 Metrostar vessels. It also has US$ 300 mio 12% notes due 2017. Of the 2005 credit facility, US$ 50 mio falls due in 2011 and the remaining US$ 695 mio in 2012. The 2010 credit facility has a repayment schedule starting September 2010 estimated at US$ 33 mio per year. Cash deficits of US$ 67 mio/ US$ 787 mio are projected in 2011/ 2012.

The company needs substantial restructuring and new business plan. A merger with a larger, stronger group with a better commercial base is another option. The quality of the fleet could make this attractive.