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.

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.

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.

General Maritime Chapter 11 resolution may provide comfort for lenders, but will other stressed shipping companies have the same end?

General Maritime and its patron Oaktree Capital Management sweetened a deal with creditors, including holders of $300 million in high-yield bonds, to allow an estimated 5.4% recovery. With the hurdle removed, Genmar could emerge from Chapter 11 by next month. European ship finance bankers will, however, probably not have a high degree of comfort with Chapter 11. It is a game not played on their home court and there is no assurance that the next time around for a cram down of unsecured bondholders (as in the Genmar case) to absorb the brunt of the losses. .

Since the Global Financial Crisis, we have seen many times the dilemma of losses that nobody wants to take and everyone is looking to avoid. The first option is ‘pretend and extend’, hoping for a market recovery and rise in asset prices, etc. that proves that present losses are just a bad dream. Sometimes this is accompanied by new loans to assist in repaying old loans in a game of musical chairs with creditors to buy time.

Another option, at least for publicly listed companies, is finding a source of recapitalization. Dilution by “at the market” share offerings largely to retail investors is one technique. This was practiced by DryShips a few years ago. Decline of shareholding by key investors can be partially recouped by general stock awards later on, as happened in the case of George Economou. Eventually, DryShips did a spin-off of OceanRig to the benefit of their shareholders.

A more painful recapitalization option is bringing in private equity. We have seen this in the case of Beluga Shipping and General Maritime. The private equity player faces some difficult legal issues in the structuring of the participation, not to get caught in an equity position should the company ultimately go into bankruptcy. Normally they want, however, the option of getting full control of the company should things not work out, meaning that the original investors take painful losses and lose control of the business. Generally, shipowners do not like this option. In the case of the Omega Chapter 11 proceedings, George Kassiotis has not to date shown much enthusiasm for this approach. Peter Georgiopoulos brought Oaktree into Genmar to protect his position in his other listed companies. Kassiotis does not have this fall back.

The final option is sale of assets to pay down debt. We have seen this in the case of NewLead with its lenders in a series of forced sales. It will be very interesting to see how Berlian Laju Tankers resolve their financial woes. Will the Surya Family dig into their pockets like John Fredriksen to recapitalize the company? Will they split it up into parts? Will they sell of Chembulk to raise cash to retain the remaining portion of the company?  What will they do with their bondholders?

It was of great advantage in the Genmar case that the large class of unsecured bondholders and the opportunity for a cram down with this class of creditors to the benefit of the senior lenders, who are avoiding so far any losses. Holders of Genmar’s $300 million of November 2009 bonds stand to get back roughly $16 million in the deal — a huge savings for the cash-strapped shipowner. Oaktree is recapitalizing the company and taking control. There is a fleet of vessels to repay the senior lenders so that they may come out whole.

The European Union has done something similar in the case of Greece by a forced subordination of private Greek sovereign lenders to their position as public lenders in purported debtor in possession financing. In the case of Genmar unlike Greece, the company is being recapitalized by Oaktree and there is a fleet of vessels to repay the senior lenders so they may come out whole. The Greek State by contrast still has very high debt stock including a new EU Ponzi loan of EU 130 billion that exceeds the PSI+ cramdown; but with GDP shrinking by 5-7% per annum, there is a substantial issue on its capacity to service its crushing debt loan.

Of course, Genmar moved very fast to mitigate its cash burn. I do not see this happening in the case of Omega Navigation nor the Greek state. Most distressed ship owners out there who do not have a class of senior unsecured bondholders. Normally, it is just senior debt and some trade debt, and in those cases the usefulness of Chapter 11 is going to depend on the particular numbers in that situation. It is also expensive in legal fees and transaction costs, so this will apply only to companies who can afford to go through the process.

Obviously the HSH Nordbank, BTMU and NIB Capital are very concerned in the case of the Omega Chapter 11 proceedings that they will be taking substantial losses, being crowded out by the mounting legal expenses. In the case of the Greek State, they had run out of cash and needed IMF/ EU assistance in the spring of 2010 or they would have defaulted on their existing debt and would have had difficulties even in paying state employee salaries and pensions. Their acquiescence to increasingly harsh terms like the recent Memorandum II is due to their lack of resources and fear of collapse because they do not have any reserves to fall back on.

GasLog IPO Shortfall: Investors looking at new shipping issues with a great deal of skepticism and growing appetitive for discounted entry pricing

Goldman Sachs seems to have overplayed its hand in the recent GasLog IPO. GasLog completed the deal below its target price range of US$ 16-18. Since then, it proceeded to trade down from its $14 IPO pricing to close its second trading day off a further 11% from IPO price. It is presently trading around $11. Investors have sent a clear message that they will not tolerate overpriced offerings. There is a clear preference for discounted entry prices for shipping IPO’s since the boom years.

GasLog is a latecomer for capital in the LNG space, contracting new LNG tonnage at relatively high levels well after the 2011 upswing in the market. The Livanos family is a top shipping name and there is even minority participation from the Onassis Foundation and an indirect participation from the Radziwill Family. The GasLog IPO appears a plain vanilla LNG story, laced with some well-known shipping names, based on continual rising demand without taking account that this sector has been prone to booms and busts from over investment with historically modest average returns on capital. The LNG story is known from 2011 and most people have already made their bets there.

Investors were left wondering how much upside story was left for the higher asset prices involved and whether this was a good entry level. Indeed GasLog’s charter cover on six of the eight newbuildings in its fleet (averaging approximately US$ 75,000 per day over five years) was not a plus for the IPO because it illustrates limited upside on higher asset prices.

The GasLog have been technical managers for many years with a solid relationship with the BG Group, who charter their present fleet of two LNG units delivered in 2010. Their management suffers by comparison to their peer company Golar because they were late in commercial timing and behind the curve in deal structure. The issue lacked the attraction of high dividend yield or an MLP structure. Arctic Securities analyst Erik Nikolai Stavseth, said from the outset that GasLog was overpriced — at least compared to fellow LNG owner Golar LNG Partners, one of his recommended “buys”.

Of course, Goldman did manage to raise US$ 329 million for GasLog despite the reduced pricing level. There have not been many shipping IPOs in the last five years raise more than US$ 200 million and shortfalls are now more the rule than the exception. Consider that of the last round of shipping IPOs in 2010, all four traded down from their IPO price and only one (Costamare) managed to get investors their money back over the next two years.

Should GasLog cover the shortfall in capital by raising more senior debt, this would be ample justification for the shares to trade down even further. A quick reading of the GasLog prospectus filing with the SEC shows that the company itself warns about substantial debt level. There was US$ 283.11 million of outstanding indebtedness as of December 31, 2011 and GasLog expected to borrow an additional US$ 1.13 billion in connection with the financing of contracted newbuildings. GasLog openly admitted in their prospectus potentially limited flexibility under this debt load to obtain additional financing and pursue other business opportunities. This flexibility is now negatively impacted by the shortfall in the equity raise.

There is no doubt that it is a much more demanding market for investment bankers to raise capital for shipping issues than the heady boom years. People really have to work hard to develop a value proposition in the business plan and it is difficult to find shipping deals with good investment yield at present charter rates.

The Gounaris Syndrome: Greece, Expansionary deflation and the Euro

The Greek political elite have taken public debt to 168% of GDP, done a debt restructuring that crams down private creditors, but increases E.U. public debt by roughly the same amount (€110bn “haircut”/ €130bn EU Ponzi loan money), hoping to reduce public debt to 120% of GDP by 2020. Greek GDP is declining at a rate of 5-7% per annum in this deep recession. The elite’s efforts are reminiscent of former Greek Prime Minister Dimitrios Gounaris, who chased Ataturk into the depths of Asia Minor for an elusive victory. Will the current obstinate, incompetent leadership meet the same tragic end of Gounaris at Goudi?

With a growing pre-election climate, the Greek political class does not seem to have learned much from the Greek sovereign debt crisis. They seem dangerously out of touch with changing circumstances in Greece and the EU, with slogans that largely belong to the past. The major Greek parties still see Eurozone membership as the key to prosperity, despite massive 20% unemployment, bankruptcy of 25% of the Greek private sector and 15% GDP compression to date from IMF/ EU financial engineering. They continue to cling to EU transfer money and public investments as a developmental model. The two major parties – PASOK and New Democracy – claim an economic recovery around the corner totally overlooking the difficulties in implementing needed structural changes and the rapidly dimishing capacity to service crushing debt burden as the country moves into every deeper economic depression in a Fisher vortex.

They discard the work of economists like Nouriel Roubini and others, who see deep structural flaws in the Eurozone system and Greece with an insurmountable debt load in a state of debt deflation that may well oblige Greece to return to the drachma. They ignore that Greek EZ membership never met the Mundell optimal area criteria. They are indifferent to trade balance issues and the real exchange rate. They do not seem to have any understanding of the purpose of central banks much less the fact that the ECB's failure to stabilize and restore nominal spending to expected levels - as proxied by the 1995-2006 trend - during the crisis as the real culprit behind the Eurozone crisis.

They continue to see a bright future in the EU with the domineering Germans, the inflation-hawk culture of the ECB inherited from the Germans and its influence on the evolution of ECB monetary policy. This expansionary deflation crank economics does not address the serious trade balance problems from these locked exchange rates and puts the adjustment entirely on the EU Periphery, (trade deficit countries) without any demands for change in German export policies that largely generate these trade imbalances; thus, the Greek leadership has not even come close to a proper framing of the issues. Their mind-set remains in the previous status-quo. It still has not dawned on them that these policies drowning Greece and impoverishing the general Greek population have changed everything in the minds of the voters. There is really no open debate in Greece on these matters.

The Greek political establishment has not been truthful to the general population. Their psychology seems dangerously close to their predecessor, Dimitris Gounaris. They want to be liked by their allies with a false sense that they will always support them without dealing with the substantive challenges. They chase impossible targets without the slightest scruples to put the heaviest of burdens on the Greek population; meanwhile, they retain their positions and privileges despite their enormous policy failures

If economic conditions do not improve in Greece and Greece is obliged to move to hard default and Eurozone exit, as many American economists foresee and is reflected in market pricing of Greek securities; it seems that no one in Greece has any Plan B to leave the Eurozone and renegotiate its debt in as orderly and negotiated a matter as possible. This means a very high risk of disorderly default. How will Greece’s political elite survive such an enormous Tsunami?