Freight rates in shipping have been at below cash break-even levels, in general, for more than a year now, in most shipping asset classes; this is even more so for bigger sized vessels such as tankers, dry bulk and containership vessels. When the charter revenue is not enough to cover even vessel daily operating expenses, stopgaps have to be found in terms of vessel operations, chartering and routing, vessel maintenance and spare parts onboard, among others, in an effort to preserve working capital and cash reserves.
When freight rates are barely sufficient, if at all, in a down market, for operating expenses, return on capital is usually less significant than return of capital; lenders have to make an effort, as painful as it may be, to restructure the loans (usually first preferred mortgages) in order to allow the debtor more cushion for liquidity to sustain the market. Usually in order of importance, loan covenants may be loosened and so-called soft covenants may be waived altogether, and the terms of principal repayment can be re-negotiated and re-profiled, and finally interest payments might be re-negotiated, although usually spreads have to be higher.
When freight rates are barely sufficient, if at all, in a down market, for operating expenses, return on capital is usually less significant than return of capital; lenders have to make an effort, as painful as it may be, to restructure the loans (usually first preferred mortgages) in order to allow the debtor more cushion for liquidity to sustain the market. Usually in order of importance, loan covenants may be loosened and so-called soft covenants may be waived altogether, and the terms of principal repayment can be re-negotiated and re-profiled, and finally interest payments might be re-negotiated, although usually spreads have to be higher.
While in previous industry downcycles there was only a shipping crisis, during the present cycle there is a shipping downcycle superimposing on a banking crisis (in Europe and the US), an economic downcycle (‘jobless recovery’ in the US and stagnation in the Eurozone), a financial crisis (mostly in the periphery of the Euroze) and finally a political crisis (mostly in the Eurozone and the political failure to act collectively, decisively and pro-actively). One can only surmise that this has the potential of an explosive cocktail.
As it is always the case with creditors, repossession of the collateral is an act of last resort. However, when the nominal value of shipping loans at the top of the market were valued at $500 billion, and there is the distinct possibility of a massive implosion of the industry, given a catastrophic scenario outlined above, the option set for creditors becomes smaller. Again, while creditors in shipping have been doing their best to avoid direct confrontation and action with borrowers, the anemic freight market and consensus expectations for its continuity in the foreseeable future, will force the hand of shipping lenders, to a limited extent (again, the option set is confined by greater financial and macro-problems).
How shipping lenders will react is the favorite topic of intense speculation for the last few years. There are many nuisances that can guide any such action or reaction, but the scale of the problem might indicate that banks might chose to apply one of their protective shields during the financial crisis when certain banks were deemed of too much systemic importance and thus ‘too big to fail’ and accordingly became the beneficiaries of special regulatory and monetary treatment. Similarly, while all ship-owners may suffer equally from a weak freight market, there are definitely owners who have a better capital and cost structure to sustain the cycle, better access to the capital and financial markets, better access to cargoes and charterers, better quality of vessels in markets with better dynamics, better negotiating power with counterparties, better management teams and reputation, etc Most likely, such owners will be the beneficiaries of more lenient treatment by the banks, including re-negotiation of loans and further restructuring, avoidance of vessel arrests, foreclosures and vessel auctions, etc
It will seem then than ‘too big to fail’ is a pertinent term in shipping as well…while however shipping is a commodity industry, the term ‘big’ may not necessarily imply seer size in terms of market cap or fleet size or anything strictly quantitative…probably the ‘big’ in shipping will have a qualitative dimension as well…
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