SHIPPING finance is looking increasingly daunting from a variety of perspectives. Depressed vessel earnings and values, together with limited options for raising new funds for investment or refinancing, are posing major challenges for chief finance officers.
This is in the context of increasingly worrying global economic indicators. Recoveries are stalling in many key consuming countries, including the US, while China and India are trying to bear down on inflation and sovereign debt problems mount in some of the eurozone countries in particular.
As more shipping companies struggle to break even at present earnings levels, more are running into financial trouble, seeking bankruptcy protection and having ships repossessed by lenders.
There is a widespread expectation that the number of shipping companies being forced out of business will rise in the coming months as lenders lose patience and other sources of funds dry up. Ship values are falling again and distress funds waiting in the wings might finally get their chance to snap up bargains.
Even though some shipping banks have more funds available, most are simply recycling repayments and not increasing their aggregate lending.
Banks are focusing heavily on relationship banking, supporting existing clients. Few are offering a welcome to newcomers. In the present state of shipping and finance markets that is hardly surprising, but it means that many shipping firms have limited options when seeking funds.
The bond markets hold out limited possibilities for rated companies and conditions are unfavourable, so some planned issues have been shelved and few initial public offerings have been completed.
Ratings agency Moody’s Investors Services recently published a report downgrading shipping’s outlook from stable to negative due to sustained overcapacity. Shipping industry conditions will deteriorate in the next 12-18 months because of continuing oversupply.
The dry bulk market will be hardest hit, with earnings remaining at below breakeven levels for many owners. Their prospects depend heavily on their degree of spot market exposure, but Moody’s warns that some companies will not be able to survive.
The tanker market, despite rising oil demand, will remain challenging for shipping companies with no sustained recovery until the second half of 2012 or into 2013.
The heightened downside risk from oversupply is increasing negative pressure on container company ratings.
Current poor earnings are putting many shipping companies’ cash flows under increasing pressure and the spectre of running out of cash is raising the fear factor.
There have already been some high- profile casualties, including South Korean dry bulk operator Korea Line, product tanker operator Omega Shipping and container market newcomer The Containership Company. Many others have had to undertake varying degrees of financial restructuring and new fundraising, such as tanker operator General Maritime Co.
The longer earnings remain at depressed levels more companies are likely to run into cash flow problems and have to try and raise new finance from new funding sources or by selling assets. But this latter strategy risks reinforcing the downward spiral by driving values lower.
Ship operators’ problems are being compounded by high fuel costs, which are expected to remain high as global oil demand increases. Bunkering is often a pinch point for companies in trouble as bunker suppliers are acutely aware of the credit risks of some shipping firms and will tighten credit terms accordingly.
For shipping companies, the failure of a contracted charterer can prove a fatal blow if they are unable to secure new employment for vessels and end up exposed to depressed spot markets. The failure of Korea Line, for example, plunged many owners into serious problems as cash flow suddenly ended.
Banks encourage shipping companies running into problems to talk to them at an early stage so that there is time to come up with possible solutions and financial restructuring options.
Most major shipping banks are still wary of the wider consequences of defaulting shipping loans. As long as they are confident of longer-term prospects and believe that they will continue to receive some repayments of interest at least, they will seek to keep client companies trading rather than risk being left with vessel assets with falling values on their hands.
However, some operators could run into such dire straits that banks are left with little option. As earlier restructuring to remedy breaches of loan covenants come to an end, options become more limited. Banks are likely to continue holding off pulling the plug for as long as possible, but there is a danger of one failure triggering a flood of others.
Despite earnings often below breakeven, so far there have been relatively few shipping company failures and there is no expectation of failures among the largest shipping groups. However, failures are not always flagged in advance and can often be triggered suddenly by a relatively minor payment default. Public shipping companies tend to be in the spotlight because their finances are transparent. The large majority of shipping companies are still in private ownership and their finances are largely opaque, except hopefully to their bankers.
As long as they are paying their bills it is assumed that they are financially sound. Many shipping companies piled up cash during the boom years, but it is not clear what happened to it and, if it is still there, how long it can cushion current losses.
Depressed freight rates have forced many shipowners into negative operating cash flows this year, except for those with most of their income secured on earlier long-term charters when rates were healthier.
Companies with cash flow issues will typically cut back on non-essential spending such as dividends and investments, giving priority to expenditure necessary to keep ships trading. Banks would rather companies renegotiate loan repayments if it enables them to keep paying for bunkers than suddenly find ships being arrested for non-payment of relatively small sums to suppliers.
Shipping companies in the three mainstream markets are being financially squeezed from all sides. Earnings are often below breakeven and are likely to remain depressed for some time. Costs are rising, cash flow is under pressure but banks and other finance sources are limited to all but a favoured few.
Many companies are getting by on the basis of astute short-term cash flow management enabling them to keep paying creditors, but they are often cutting things fine and operating within days of running out of liquid funds. It must be increasingly doubtful that some companies can survive on this basis for much longer. More casualties seem certain.