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.

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!

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.

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.

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.

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.