Impact of China real estate slowdown on future cargo demand: is it the turn for the dry bulk sector to disappoint?

Despite present historically low freight rates, dry bulk owners continue to talk up their book with very rosy demand projections, as demonstrated in a recent Capital Link webinar on the dry bulk sector. Yet China observers see a hard landing coming and already  a very serious real estate slow-down. Last November, Chinese steel output was down -8.8% month-on-month, down for the sixth month in row.

Patrick Chovanec, a professor at Tsinghua University's School of Economics and Management, reports that Chinese domestic iron ore prices have plummeted as unused stockpiles have accumulated. In addition, more than one-third of Chinese steelmakers saw serious losses in October and November, and the industry as a whole saw a net loss of RMB920 million ($146 million) excluding investment gains. Chovanec sees real estate affecting as much as 20-25% of Chinese GDP. He makes the case of overall Chinese GDP growth down from 9.2% to 6.6% this year.

Wall Street shipping analysts like Cantor’s Natasha Boyden have begun taking a pessimistic view of 2012, expressing “concerns about a Chinese economic slowdown mean that there are real risks to weaker Chinese steel production growth in 2012” Evercore’s Jonathan Chappell expressed similar concerns about the oil tanker market due to slowing Chinese crude imports.

By contrast, RS Platou like many other shipping industry analysts, projects world trade in dry bulk commodities to increase some 5-6% per annum with iron ore and coal as the strongest drivers for tonnage demand. Participants in a recent Capital Link dry bulk webinar are similarly bullish on dry cargo demand from rising world steel production and fledgling Chinese coastal trade that soaks up dry bulk tonnage.

The conventional dry bulk industry viewpoint is that 2012 will continue to see low freight rates due to order book overhang, rather than any significant drop in demand. The tonnage supply-demand gap will narrow and finally will turn positive in 2013, bringing up rates. Jefferies’ Doug Mavrinac shares this recovery scenario.

No one expected the fall in dry cargo rates to be as large as it has been. Dry cargo owners are now suffering from the same margin pressures as their tanker owner brethren. There is a rash of cargo operators in increasing financial difficulties. The recent Deiulemar case, for example, led to the cancellation of a contract with Paragon for its Supramax tonnage. Paragon’s stock has been below $1 dollar since last fall. Now Cantor is setting a price target of 30 cents for Paragon stock with its Supramax tonnage on the market at rates close to vessel operating costs. Paragon is also facing loan covenant violations from deteriorating loan to hull value ratios.

There are plenty of other listed dry cargo operators who made over-valued purchases in the boom era and are saddled with very high leverage: Eagle Bulk, Excel Maritime Carriers, just to name two. They all have vessel provider business models with heavy exposure to charterer counter party risk and spot rates that cannot cover their debt obligations.

Indeed, 2012 may be the dry bulk sector’s turn to suffer what tanker owners like General Maritime and Frontline have been going through for some time now.

All this makes 2013 a very crucial year. In such a tight scenario, disappointing Chinese growth and lower demand for dry bulk raw materials for its steel and construction industry could mean serious structural market disruption unlike any we have seen in shipping since the 1980’s and aftermath of the petrodollar boom.

Greek Debt Crisis: The EU Political Trilemma and How Greeks have a bankrupt concept of National Sovereignty

The recent German proposal for an EU commissioner to supplant the Greek government raised a storm of protest in Athens, but in essence it brought home what is already the present status quo: Greece is a vassal state on economic life support from the European Union. Willfully entering what is essentially a greater Deutsche mark zone with a Central Bank in Frankfurt, Greeks mistakenly saw the abrogation of their national currency in 2002 as emancipation.  Few Greeks realized their over-dependency on the EU would ultimately lead to loss of nationial sovereignty at great cost to their well-being.

Dani Rodrik (Professor of International Political Economy at Harvard University and author of The Globalization Paradox: Democracy and the Future of the World Economy) has pointed out, economic globalization, political democracy, and the nation-state are mutually irreconcilable – something that the Greek political elite are woefully ignorant!

Greece retaining the nation-state with a borrowed currency and under an EZ bailout program must jettison democracy (as the EU has now done with the Troika and Commissioner proposal). Greece putting itself under direct control of Brussels is the end goal of EU forced integration, driven by the single currency zone.

Unlike Greece, other EU members like the UK, Sweden and Denmark recognized this confronted with Eurozone participation; cognizant that foregoing monetary policy and using a borrowed currency was significant abrogation of national sovereignty. In the UK, Gordon Brown (Chancellor of the Exchequer) advised Tony Blair to avoid Euro membership with severe reservations on room of maneuver, should Britain face a debt crisis. Swedish and Danish constitutions required a plebiscite to abolish national currency. Their people wisely rejected the idea in the face of their politicians. Both countries outperform the EZ. All three enjoy better credit rating.

By contrast, Loucas Papademos, Governor of the Bank of Greece, ignored the risks of entering the Euro when not fully meeting Eurozone criteria, much less Mundell optimum conditions. Greek finance minister Yannos Papantoniou saw the Euro as a means of credit enhancement to reduce cost of borrowing and increase capacity to borrow ever more money. Despite these dreadfully bad policy decisions, they are now both presenting themselves as political reformers.

Unlike other European countries, Greeks never believed in their national currency. They preferred EU transfer money on projects fostering consumption rather than promoting exports like their neighbor Turkey and successful emerging market economies with control of their currency at competitive parities. The free trade zone in Eurozone soon made them a dumping ground for German exports, Greece running up huge commercial deficits. Years of living on EU transfer money and cheap credit created complete structural dependency on the EU.

Greeks, in their present quandary, have a very muddled idea of national sovereignty. They rail about selling public property to private investors as humiliating.  Yet many of these same individuals foster the concept of a loan from Russia in return for granting a naval base as emancipation, when this is an even more dependent relationship! Out of fear of public hostility, no major Greek political party dare openly express public positions that foster foreign direct investment, entrepreneurship and a market-driven economy in goods and services that would enable Greece to stand on its own two feet, as Far East emerging market counties did after their debt crises in the late 1990’s.

The Greek political elite cannot understand the importance of production, exports and foreign exchange earnings. Returning to the drachma would increase national sovereignty and give them more tools to do this, but they show very strong signs of “Stockholm Syndrome” sympathy with their jailors (or new jailors like the Russians, naively hoping for better terms than the EU).

Greek pre-packaged sovereign debt cram-down likely to break all precedents in rule of law and fair bankruptcy distribution

Greek PSI+ negotiations exhibit EU-engineered “survivor bias” making a mockery of core bankruptcy law principles. Capital losses are put on private sector bond holders whilst public bond holders are excluded from mark-downs of their debt. Only those private creditors with interests against outright default (large banks) are represented in the negotiation process. Troika bailout funding to Greece is nothing but a pre-petition Debtor in Possession (DIP) loan, with a first lien and collateral protection. The ECB is essentially conducting a quiet Greek debt-for-equity exchange in the purchase of Greek debt.

European Union (E.U.) policy planners have always shunned transparent market-driven pricing mechanisms in their currency union, showing contempt for rating agencies and market players. They consistently claim the right to be able to set asset prices arbitrarily as it suits them. The Greek PSI+ is a stealthy pre-packed bankruptcy restructuring, without being represented as such.

The main barrier to concluding this pre-packed Greek bankruptcy is the necessity of some majority of bondholders to ratify the final PSI+ debt exchange offer. As the bulk of Greek bonds do not have a collective action clause (CAC) (a framework which says what percentage of favorable votes is needed to enforce a decision), ratification would require 100% of investors to accept the new terms in order to avoid triggering a default, an almost impossible hurdle. Implicitly, the Greek negotiation process requires retroactive imposition of CAC. On one hand, retroactive CAC would facilitate the "exchange offer", however it would create great distrust of any bonds issued under domestic law in other European countries.

This would not, however, be the end of the ratification problem. Greece also has issued a modest amount in bonds, somewhere over €25 billion, under U.K.-law. While Greece could retroactively force local-law bondholders to do pretty much anything under local Greek law, it has no chance of doing this with this U.K. class of bond holders. It is precisely these bonds that allow some form of plurality to be enforced and which override the government's attempt to enforce a unilateral decision of creditor stripping.

Distressed asset investors seek these kinds of opportunities, which historically have had very high recovery rates in subsequent litigation. It is highly likely that some hedge fund cartels have already built up a blocking stake in the U.K.-bonds. It’s no surprise that E.U. policy planners have deliberately shut these creditors out of the PSI+ negotiations.

The E.U. continues to believe that it can shortchange market pricing mechanisms and manipulate its way over financial markets to preserve the currency union and avoid the day of reckoning. Yet demand for risk comes from a sense of stability, of fair and efficient markets, and equitability. A coercive cram down on any one, or all, Greek bondholder classes would make it crystal clear that E.U. authorities will put private sector investors into junior position arbitrarily any time they see fit, adding to the perils of holding E.U. sovereign paper.

A hard sovereign default would make “mark to market” unavoidable, thus exposing the underlying fragility of the banking system and triggering the collapse of the E.U. Ponzi debt structures used to keep weaker members on life support. E.U. policy makers have been calling for a €1.5 trillion rescue umbrella, but are unable to come with any real funding. Predictably, the ECB is rapidly expanding its balance sheet; there is no way to fund their Ponzi debt pyramid other than with massive back-door money printing.

This risks a broad sell-off of indenture bonds of the other PIIGS nations that might eventually lead to the collapse of demand for European paper and severe loss of confidence in the ECB.

Even Germany has a perilously undercapitalized banking system. Already they are discussing a delay in implementing the Basel 3 accords. State recapitalization of the German banking sector would likely lead to a sovereign credit downgrade.

Is it any wonder that institutional investors seem reluctant to take the bait in the face of this fudging, financial manipulation and fraudulent accounting?

Berlian Laju Tankers defaults on US$ 418 million senior debt and lease payments

Just a few months after major loan restructuring as well as new large leasing deal that led to a credit upgrade, Berlian Laju (BLT) has frozen their debt repayments and is facing a serious financial crisis. The major issue will be recapitalization and restructuring. It may follow its Indonesian compatriot, Arpeni Pratama, into US Chapter 11 proceedings.

If you look at the BLT balance sheet over the years, it has never been a tremendously profitable company. Their expansion was heavily financed by debt. They acquired assets at high prices in the boom years. Accordingly, BLT was the darling of the banking community because it was 1.) too big to fail and 2.) in need of money and willing to pay more than sounder companies to get it. Lenders could get loan pricing with BLT that would be impossible with mature peer chemical tanker operators like Stolt or Odfjell.

The rating agencies had downgraded BLT to CCC by this time last year. BLT was upgraded to B- in spring 2011 after a massive $685 million restructuring plus another $90 million leasing deal. Fitch brought the rating back to CCC last December and very recently C.

The lenders do not appear to have done a very good credit analysis given this massive default less than 12 months later. Indeed they even gave BLT additional funds, increasing their loan exposure to the beleaguered company. There was apparently no request for a significant increase of capitalization nor does there appear to have been any demands for asset sales to reduce exposure. It was very clear that BLT would face serious funding problems in 2012 both for capital expenditure needs and as well as US$ 122 million bond maturities to be refunded.

Now the recapitalization issue is likely to be paramount for BLT. Will the controlling Indonesian shareholder family follow the footsteps of Big John Fredriksen and put up substantial capital of their own to save the company and retain control? Alternately, will they chose the route of Peter Georgiopoulos and find a private equity partner like Oaktree and risk losing control of the company?

One thing that BLT could do to raise cash and deleverage would be to sell their Chembulk operation, one of their most valuable assets. Doug MacShane (the founder and previous owner of Chembulk) is already rebuilding MTM (MTM controlled the Chembulk operation prior Doug MacShane’s divestiture) with fleet expansion at prevailing low tanker prices. MTM’s Singapore subsidiary continued the technical management of the vessels for some time after BLT acquisition. MTM could easily start poaching Chembulk’s customers, with whom Doug MacShane has had 20 to 30 year relationships and where they might feel more comfortable.

Stolt Tankers has the money to buy BLT’s Chembulk operation, if they wish. So could its rival Odfjell, who could potentially secure Lindsay, Goldberg backing. Linday Goldberg, a first class NY-based private equity firm, is already a 49% partner in Odfjell’s chemical storage business.

This possible spin off would allow the Indonesians to concentrate on their cabotage business, Buana Listya, and concentrate on FPSO contracts in its home market. BLT also has smaller chemical tankers suitable for the Asian market as well as a fleet of LPG vessels, some fitted for ethylene.

We will see shortly what route BLT takes to get out of this financial impasse.

U.S. Chapter 11 procedure proves traumatic for Omega Navigation’s senior lenders

The Bracewell & Guiliani franchise on Chapter 11 proceedings for beleaguered shipping companies is proving a disaster for major shipping banks which are ill prepared for this ‘brave new world’. HSH Nordbank seems to have badly overplayed its hand with poor legal counsel. Bracewell is demonstrating that a shipping company can use these proceedings to stave off for months – or even years, - any bank foreclosures, without producing any credible reorganization plan.

An adverse court ruling for HSH gives Omega until May to produce any reorganization plans, when that was supposed to be the key issue in this hearing since time is of the essence for its Omega’s creditors. Instead, the main thrust was the ‘soap opera’ scenes between HSH, Omega and its directors for which Bracewell & Guiliani seems to have had a cakewalk in denouncing HSH and avoiding any substantive discussion of the financial issues.

Certain parts of the Bracewell presentation, such as their objections to surveys were amateurish, but even this impressed the court. Actually, banks commonly demand physical surveys of vessels to monitor condition in insolvency cases. These borrowers have little money for vessel maintenance and this impacts asset prices and collateral value.

HSH seems to have been incredibly sloppy in throwing allegations on Omega and then flip-flopping. As a result, Karen Brown, the U.S. judge, threw the book at HSH and allowed Omega to kick the can and continue operations with its lenders in limbo.

Remember that Omega went into Chapter 11 with a frontal attack on its senior lenders and without any clear means of recapitalization. By contrast, Omega compatriot General Maritime went into Chapter 11 with support both from its bankers and with fresh equity money from Oaktree. This US court ruling ignoring economic substance illustrates the perils for shipping banks in Chapter 11 proceedings.

Omega’s senior lenders are frustrated and in deep trouble. If the case is as they portray it, they may to lose an immense amount of money. Omega, on the other hand, likely increases its debtor leverage, making bank foreclosure ever more painful for the lenders. The company also buys itself time to continue operations.

Trust seems to have broken down entirely between Omega and its lenders. How or if this will ever be re-established under the circumstances is a big question. The senior lenders do not seem to want to have anything to do with Omega CEO George Kassiotis and his management.

Whether Kassiotis has alternative backers for recapitalization, like an Oaktree in the Genmar case, is another open question. Peter Georgiopoulos, he is going to lose his equity holding in Genmar as Oaktree becomes the major shareholder. Is Kassiotis prepared for this or is he just trying to maximize his personal position at the expense of his creditors? Perhaps he is simply hoping that an unexpected market upturn will get him and his company out of its current mess if he drags out the Chapter 11 legal proceedings long enough? We may have some answers by spring.

The U.S. courts are becoming a major forum in marine bankruptcies, taking such exotic cases as PT Arpeni Pratama, a local Indonesian company, which operates mainly in domestic trades. Foreclosure has become a far more difficult course for marine lenders.

Mediterranean Shipping Co (MSC) and CMA CGM join up to stem the Maersk challenge

The latest shipping news is that these former rivals have had to team up on several key liner services in order to compete with Maersk Line on the key Asia-Europe route. As a privately held company, MSC’s financial information is not easily available, but they are just behind Maersk in TEU capacity. CMA is in third place. The partnership is operational for a two-year period. There has not been any discussion of corporate merger.

The direct goal of the MSC, CMA commercial partnership is to offer a liner product comparable to the “Daily Maersk” service.

They are doing this on five Asia-to-Europe services, deploying 53 ships of 9,500 TEU to 14,000 TEU capacity. Four are cover routes to northern Europe (the Swan, Silk, Lion and Condor services) using ships of 11,400 TEU to 14,000 TEU. The fifth is the Asia-to-Mediterranean Jade service using nine ships of 9,500 TEU. Together, the two lines will control one-third of capacity of the over 10,000 TEU fleet (operating and on order), compared to Maersk’s 20%.

This move reflects the lack of volumes in the market as a consequence of the economic crisis and the difficulties of managing the vessels on these liner services. It is likely to make it very difficult to compete on these routes using vessels smaller than 10.000 TEU. Both partners need to bolster their balance sheets and have been selling ships and chartering them back at a time of loss-making Asia-Europe rates. The collaboration will allow both to cut costs and fill ships at the expense of other lines.

It is also likely that this synergy will attempt to tighten the screws on beleaguered vessel provider companies. MSC and CMA are reputed to be among the toughest negotiators in the charter market. There is concern that they might seek to renegotiate charters in the face of falling freight rates, potentially causing overstretched companies like Danaos serious problems. Shippers, on the other hand, are expressing concerns that the two mega lines may attempt to restrict capacity to maintain higher rate levels, making the Asia-Europe route an oligopoly.

There is a window of opportunity in this partnership for the next 12 months as Maersk has no large ships for delivery, while MSC and CMA CGM will receive 21 new buildings of over 13,000 TEU by the end of 2012. This will cause Maersk to lose market share until it starts to take delivery of their 10 Triple-E 18,000 TEU vessels. The Swiss-Italian carrier MSC would keep its fleet employed while allowing CMA CGM to achieve its growth plans, which have been derailed by the crisis and financial problems.

Maersk Line pioneered the advent of larger vessels with its E-class vessels (+15,000 TEU) back in 2006-7 and last year it embarked upon the new Triple E series.

It is clear that the liner industry suffers from serious earning margins problems, and another downturn in expected cargo volume will come with the growing recession in the E.U. Maersk, MSC and CMA are trying to face this challenge with larger vessels for lower unit costs as well as commercial strategies that give them some pricing power over rates, such as this potentially oligopoly of two mega carriers on the Asia-Europe route, squeezing out smaller liner companies.

Genmar Chapter 11 reorganization: The importance of distressed asset investors being earnest lenders

Oaktree Capital Management (OCM) has their hands full with General Maritime in bankruptcy. The market is questioning the wisdom of taking a position last March in this beleaguered shipping company just months before this Chapter 11 filing. In the meantime, unsecured creditors are trying to make life difficult; they are opening issues that have implications for other shipping companies contemplating this path. The looming question is what would OCM do with a revamped Genmar?

OCM is now obliged to pump a further $175 million into the Peter Georgiopoulos-led company to shore up its original $200 million outlay. Some might call this throwing good money after bad. A common Wall Street expression when investments go bad is: ‘Don’t frown, double down.’ The European Union is a grand master in these kinds of ‘pretend and pray’ lending practices, but OCM are professionals dealing with a distressed asset situations, where doubling up is generally frowned upon as poor risk management.

The immediate challenges are one minor and one major issue. The lesser issue is the unsecured creditors’ court petition, filed in New York, to get control of the Genmar’s cash flow from all accounts. Genmar’s senior lenders are European-based shipping banks. Nordea Bank is one of Genmar’s lead banks and heads a group providing Genmar with a $75 million in debtor-in-possession (DIP) financing to see the company through the Chapter 11 process, which Genmar hopes to exit in April. This would be a generic issue for any shipping company in Chapter 11 proceedings. Nearly all the major shipping banks are European and based outside New York. We will see whether they can find a temporary solution through a large U.S. clearer like Citibank.

The more substantive issue is the negotiation of the “haircut” for unsecured bondholders. They are being sandwiched between OCM and senior lenders, who already appear to be in pre-agreement with one another.

Genmar was in no position to make the $18 million semi-annual coupon payment on these bonds on November 15; The company was virtually out of operating cash. One key to successful restructuring is to get out from under the bond burden, paying only a fraction of the face amount. It’s telling that Genmar’s bonds were trading at around 10 cents on the dollar just prior to the filing, reflecting the market’s view of their worth.

The unsecured bondholders will try to argue that OCM is not a lender, but in an equity position pari passu with them in distribution. This is a common cause in any bankruptcy situation. We can safely assume that OCM studied this matter carefully with its legal counsel in structuring their first $200 million capital injection into the company. It was done in loan form with warrants and controls on stock dilution.

Once these legal issues are resolved, the really interesting part will be what OCM - presumably the new owner of General Maritime – will do with the company? There are a number of aging vessels close to scrap value. Genmar does not have the comparative advantages of peer tanker operators like TeeKay or OSG. Even Frontline has more options. It will take no small effort to make Genmar competitive again, but perhaps OCM is really looking to sell it off to the highest bidder for profit once the tanker markets improve.