Shipping Finance Articles at www.bmkaratzas.com by Karatzas Marine Advisors

12/22/13

Shipping Finance by Karatzas Marine | Equity, Debt, Leasing, Advisory & Restructuring

Shipping Finance by Karatzas Marine
Equity, Debt, Leasing, Advisory & Restructuring

China subsidizes locally; can
international shipping get a cold?
Posted on December 18, 2013
In the last week, the Chinese government announced a series of subsidies for the local shipping
market. In general the program has as follows: Chinese shipowners who scrap their Chineseflagged vessels at Chinese demolition shipyards within Chinese fiscal years 2013, 2014 and 2015
will obtain a subsidy of about 750 RMB (about US$ 125) per gross registered ton (GRT). Vessels
have to be eighteen years or newer for containerships, and twenty years old or newer for dry
bulk vessels. Also, Chinese shipowners who place orders to Chinese shipyards for vessels that
will fly the Chinese flag will be entitled to a subsidy of 750 RMB (about US$ 125) per GRT. Since
these two subsidies are ‘combinable’, for an owner who replaces an existing vessel with a new
contract, the total subsidy will be the sum of the two parts for a total of US$ 250 / GRT.
As a reminder, Gross Registered Tonnage (GRT) is a common measurement of the
internal volume of a ship with certain spaces excluded. One ton equals 100 cubic feet. GRT
depends on asset class, design, etc, so it’s a unique number for each vessel, but as a rule of
thumb, it’s about 5/8 of the vessel’s deadweight (again, a gross simplification for our purposes
here.) A 50,000-dwt supramax vessel would be about 35,000 GRT, and would generate about
US$ 4.2 million in demolition subsidies and another US$ 4.2 million in shipbuilding subsidies. And
average newbuilding contract for such a vessel would be around US$ 26 million today, and the
scrap price, in general, of such a vessel in China would be about US$ 2 million. Effectively,
between the subsidies and the scrap value of a supramax vessel, a Chinese owner will need
about $16 million to get their hands on a brand-new supramax vessel. This presumes that the
shipowner will not obtain any further subsidies (like cheap construction financing, cheap post
delivery financing, COAs from a local steel mill, etc)
Again, this subsidy pertains only to Chinese shipowners who will undertake demolition and
shipbuilding activities in China and keep their vessels under the Chinese registry. And, it pertains
to vessels that are scrapped much earlier than their design life (usually about 25 years) as vessels
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subsidized cannot be over twenty years of age when scrapped.

Follow “Shipping
On the surface of it, based on the information Finance bythe announcement, there will be
provided during Karatzas
no direct impact to international shipping from this program, presuming that it progresses as
Marine”

announced without glitches (you never know if a website doesn’t work these days!) and without

Get owner’? Could be someone
too many loopholes busted (i.e. who is a ‘Chinese every new post deliveredacting as a
to your Inbox.

front/JV-partner of a US-based private equity fund?) And, on paper, most likely this subsidy
program seems to have a neutral impact on the Chinese-flagfollowers fleet, as one would
Join 149 other merchant
expect that shipowners, in order to maximize the subsidies obtained, would order as many

Enter your does not mean
vessels as they scrap. However, a Chinese-flagged vessel email addressthat the vessel is
intended for coastal trade and cannot be used for international trade.
Sign me up
The subsidy obviously will benefit Chinese shipping-related activities as it will motivate more
demolition sales and thus create jobs for demolitionPowered by WordPress.com scrap steel plate;
yards and produce more
also, given the subsidy, it will make no sense whatsoever for a qualified vessel to ever get
scrapped in the sub-continent; the subsidy makes up much more than ballasting costs and any
market premium obtained from the scrap yards in the sub-continent. Thus, all being equal, more
demolition activity in China in general is to be expected, and the few vessels that could in the
past ‘leak’ to the Indian / Pakistani / Bangladeshi demolition yards will now be retained in China,
therefore, a small negative impact in terms of volume to sub-continent, and likely a bit better
news for international shipowners selling to scrap yards in the sub-continent and getting more
competition for their vessels from the scrap yards (again, presuming a perfect ‘model’ with no
inefficiencies around it.)
The subsidy obviously will also benefit the Chinese shipbuilders through increased volume of
business and more newbuilding orders. Shipbuilding jobs are good since create payroll and
payroll taxes and trickle down effect in the economy; and, shipbuilding jobs are also good as
they keep workers and shipbuilders sharp with their skills and internationally competitive, or at
least it provides for a chance to climb faster the shipbuilding learning curve (a well-known
Chinese goal.) Assuming that Chinese shipbuilding capacity is inelastic, these subsidies likely will
be bad news for international shipowners, as it will absorb shipbuilding capacity by local players
who could afford to bid prices higher given the subsidies, and thus, international shipowners will
have to pay higher prices for their contracts. Again, this outcome will take place if the
assumption of Chinese inelastic shipbuilding capacity holds, and, we all know with the greenfield
yards of 2005-2008, that that’s a tall assumption one to hang their hats from.
In our humble opinion, these subsidies could have a very negative effect on the international
shipping industry for a couple of other, major reasons:


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—

Searching for guidance (Image source: Basil Karatzas)

First, based on the supramax example above, it provides for about 30% markdown on sticker,
newbuilding prices for Chinese shipowners to replace their fleets; if we talk about 10 years old
vessels that have made operating profits during their life so far, and their market value is a
fraction of their replacement cost, the subsidies offered are extremely substantial. As it does not
seem to be any vessel limit per owner or subsidy amount claimed per owner or vessel size or
anything else to that effect (as least as this has been reported in the western press), then major
Chinese shipowners like COSCO effectively can replace their fleets very cheaply and become
much much more competitive on the international markets and give the Maersks of the world a
run for their money. It seems that the only ‘bottleneck’ in this subsidy program is the capacity to
scrap and build, as the program is valid until the end of Chinese fiscal year 2015 (same as
calendar year.) Therefore, Chinese shipowners are given the government’s blessing to get
aggressive and very competitive on the world trade stage.
Secondly, this program will be negative for the overall shipping market for many years to come,
and will delay further in the future any market recovery. Nominally, there are more than five
hundred shipbuilders in China, a sizeable number of them established in the last decade and still
a sizeable portion of them being ‘greenfield’ yards, meaning that they barely have had any
legitimate claim to building continuously competitive vessels, or even seaworthy vessels. Most of
these greenfield yards had primarily been active in the construction of small vessels, mostly in the
dry bulk market, and a lot of the vessels delivered from these yards over the last five years are
not commercially competitive and with little chance that they would ever traded until their design
life. A lot of these vessels ended up in the hands of Chinese ‘farmers’ since the yard collected
the forfeited down-payment of the original (international) buyer and then sold or ‘warehoused’

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these vessels locally. In our shipbrokerage practice, like many other brokers, we have seen
vessels where the hull is literally crooked, where handysize vessels burn as much bunkers as
panamax-size vessels, equipment list from makers unknown to the world, vessels whose designs
and all their paperwork and documentation are only in the Chinese language. One of the few
things that were going for shipping was that many of these ‘modern’ vessels from greenfield
yards were expected to get scrapped before their second special survey. And, now they will,
indeed; but, now, for each and every of these vessels that gets prematurely scrapped, there will
be a replacement, and if people have learned any lessons from the shipping crisis of our time,
these newbuildings will be of modern design and ‘eco friendly’ and will be market competitive for
their whole design life, 25 years from now, and will add up to the already bulging world
orderbook. And, by the way, they will be 30% cheaper than anyone else’s vessels.
Got to love ‘moats’ created by governments!
© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co. All Rights Reserved.
IMPORTANT DISCLAIMER: Access to this blog signifies the reader’s irrevocable acceptance
of this disclaimer. No part of this blog can be reproduced by any means and under any
circumstances, whatsoever, in whole or in part, without proper attribution or the
consent of the copyright and trademark holders of this website.Whilst every effort has
been made to ensure that information herewithin has been received from sources believed to be
reliable and such information is believed to be accurate at the time of publishing, no warranties or
assurances whatsoever are made in reference to accuracy or completeness of said information,
and no liability whatsoever will be accepted for taking or failing to take any action upon any
information contained in any part of this website. Thank you for the consideration.
Posted in Maritime Economics | Tagged Basil M Karatzas, Karatzas Marine Advisors &
Co. | Leave a reply

‘Things cannot get worse’
in shipping
Posted on November 25, 2013
In a week when the twenty-two-year-old Norwegian Magnus Carlsen was crowned the world’s
chess champion, when the crypto-currency Bitcoin reached $900 on behalf of Bernanke’s
quasi-endorsement for its potential for (legitimate) digital applications and China’s approval, when
the S&P closed above 16,000 for the first time, when the world’s ultimate ‘buy and hold’ value
investor Warren Buffett announced a new $3.5 billion position in an ‘old economy’ energy
company ExxonMobil, it was also a week when it was revealed that the world’s ultimate trader

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investor George Soros took a position in several dry bulk, publicly traded companies in Q3 2013.
The collective investment by the Soros Fund Management is only a few million dollars (less than
$7 million, in all) and a very minor slice of the fund overall (less than 1%), but the message was
amplified in the shipping press that shipping is indeed in a cyclical recovery. The companies that
benefited from Soros’ seal of approval were Dryships (ticker: DRYS), Baltic Trading (ticker: BALT),
Navios Maritime Holdings (ticker: NM), Navios Maritime Partners (ticker: NMM), Safe Bulkers
(ticker: SB), Diana Shipping (ticker: DSX) and the product tanker company Ardmore Shipping
(ticker: ASC).
The momentum keeps building that shipping is indeed in cyclical recovery. Asset prices for
vessels have kept improving on fairly solid activity of vessel trading and acquisitions by mostly
financially-oriented or –sponsored buyers (as compared to buyers putting significant own equity in
the deals.) There are micro-trends within the market, and market segments are coming to and
moving from favor on a regular basis. While capesize vessels were definitely the flavor of the
month a couple of months ago (when rates at $40,000 pd but now below $20,000 pd), in the
mainstream shipping, the enthusiasm has moved over to the crude tanker market. For one
thing, freight rates for VLCCs have approached $50,000 pd recently (vs. $13,000 pd y-t-d
average); for another, the line of thinking in the crude tanker space is that ‘things in the tanker
market cannot get any worse’, so by default, the market has to move up. On that note, there
has been the acquisition of a 2014-VLCC tanker at a price believed to be just shy of $90 million,
while the ever active Scorpio Tankers (ticker: STNG) is rumored to have placed an order of four
VLCCs at S. Korea’s DSME at about $90 million per vessel; this order is on top of the ten (10)
VLCCs announced just this week by Navig8 and DHT Maritime. $90 million for modern VLCCs
while the year-to-date freight average of $15,000 pd is considered that ‘things cannot get
worse.’
Shale oil in the US was the development that had been the crude tanker market’s undoing,
originally in 2009, with the US not having to import as much crude oil as before. Product tankers
were the main beneficiaries of the market shift, with excess refined petroleum products getting
exported from the US. And, indeed, the product tanker market has benefited handsomely over
the last couple of years, so much so as some to believe that the market is now oversupplied.


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—

Gas is the Name of the Game!

But shale still has affected many markets, whether directly or indirectly. Dynagas LNG Partners
(ticker: DLNG) has been successful very recently with their listing on NASDAQ raising about $220
million, although the pricing of $18/sh was on the lower end of the pricing range. While crude oil
from the US is exported on a ‘ban unless basis’ while natural gas is exported on a ‘export unless
basis’, trade of natural gas has been on the ascendant which explains the interest in DLNG.
Staying with the gas products of the shale trade, Navigator Gas Holdings (ticker: NVGS) was the
beneficiary this week of the public markets with their robustly pricing IPO at $19/sh and raising
$230 million. The company has been sponsored by W.L. Ross and has been active in both the
handysize and VLGC sectors, with the latter being the major beneficiary of the shale gas trade in
the form of propane gas. Still serving the propane gas transport, BW LPG was very successful
and very well received in the US and able to price strongly to raise about $500 million this week,
again, despite any perceived competition from the NVGS offering. BW LPG is world’s largest
VLGC owner with 36 vessels overall, 19 of which are owned VLGCs. The news of these IPOs in
just a week for the gas trade bode well for more gas hopefuls in the US markets, Dorian LPG
(partially supported by Scorpio Tankers) and Avance Gas Holdings (a Frontline 2012, Stolt-Nielsen
and Sungas Holdings joint venture). This week’s earnings call with StealthGas (ticker: GASS)
however made it clear that the gas market has already started getting crowded and charterers
started preferring modern and bigger tonnage (a more critical point than the tramp dry bulk
market when fuel efficiencies and economies of scale do not translate directly to the bottom line.)
Fairly active times in shipping… when ‘things cannot get worse’…

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circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the
copyright and trademark holders of this website. Whilst every effort has been made to ensure
that information herewithin has been received from sources believed to be reliable and believed to
be accurate at the time of publishing, no warranties or assurances whatsoever are made in
reference to accuracy or completeness of said information, and no liability whatsoever will be
accepted for taking or failing to take any action upon any information contained in any part of this
website. Thank you for the consideration.
Posted in Maritime Economics | Tagged Basil M Karatzas, Karatzas Marine Advisors &
Co. | Leave a reply

Selling Shipping Loans
With half-a-decade loose monetary policy, with interest rates kept at historically very low levels by
central banks and overall corporate defaults rate at very manageable levels, investors seeking
yield have been investing in ever higher risk credit instruments expecting ever lower returns. For
instance, Triple C corporate bonds – the lowest credit rating possible, at present yield 7.75%,
down from 9.8% from a year ago, and there has been a great demand for them, to the tune of
$38.1 billion so far this year (vs $37 billion for the whole calendar 2012.)
In shipping, freight rates in the last six months have moved above cash break-even levels in most
market segments, and on occasion, the momentum of the increase has been impressive, i.e.
capesize rates moved from less than $10,000 pd in July to over $40,000 pd by the end of
September, and likewise for VLLC rates, when last week $40,000 pd spot rates were recorded
for the first time in more than nine months. For right or wrong, the prevailing consensus at
present is that shipping is in a cyclical recovery phase with the worst behind us, and, therefore,
taking ‘long positions’ or ‘risk on’ is the right strategy.
While a few private equity funds and institutional investors have been setting up JVs with vessel
owners and managers to buy actual vessels in order to benefit from the market recovery (the JV
between Oaktree and Oceanbulk is the most quoted example), an ‘easier’ approach to benefit
opportunistically from a market recover is to invest in corporate transactions in the public
markets, whether in equities or debt. For the former, the Oslo OTC market has been very hot
this year, and the Scorpio Group (whether in the product tankers with Scorpio Tankers (STNG) or
in the dry bulk market with Scorpio Bulk (SALT)) have been the most successful examples of
riding the equity raising wave for all its worth. In the debt markets, there has also been activity for
some time with the sale of shipping loan portfolios. Lloyd’s Banking Group has gradually been
systematically divesting their shipping portfolio since 2010, with their latest sale of a $500 million

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tranche taking place just two weeks ago to likely Bank of America (BofA), who where acting in
an intermediary capacity and providing debt financing to the equity providers. The transactions
that really caught everyone’s attention however were the sale of DnB’s total shipping loan
exposure to Genco Shipping and Trading (GNK) of $520 million (part of a $1.01 billion revolving
credit facility), and the sale of Royal Bank of Scotland’s (RBS) entire shipping loan exposure of
$720 million on Eagle Bulk (EGLE), part of a $1.1 billion term loan facility (after the restructuring in
summer 2012). The exact details of both these transactions are still sketchy, but it has been
rumored that the Genco debt was sold for about 91% of its face value, while the debt for Eagle
Bulk brought just shy of 90% of its face value; it is believed that in both cases Bank of America is
the buyer and arranger of the sales, with Bank of America also providing debt financing to the
funds eventually buying these loans. There has been a long list of funds mentioned as the
buyers, some known to shipping but some complete newcomers, but the names Oaktree and
Centerbridge are most frequently quoted.

—

MV „GENCO CONSTANTINE” – 91% of the nominal value? (Image
source: http://www.shipspotting.com)

The quoted pricing of about 90% has been exceptionally strong both in absolute and relative
terms, and it presumes that the borrowers will perform in every respect, an assumption that is
heavily contingent on a market recovery. As mentioned earlier, with interest rates very low,
credit investors have to really search hard for deals, even in ‘obscure’ industries like shipping, and
when they find them, they have to be very competitive in their terms and pricing, which has
brought about the competitive pricing in these two transactions. However, the fact that both
Genco and Eagle Bulk are publicly traded companies in the US (from where a tremendous pool
of institutional money is invested) with relatively modern, uniform fleets in the recently buoyant dry
bulk market and with significant market exposure if/when the market recovers (a great deal of
the original charters have expired or expiring soon) has called for very competitive pricing, which
has surprised many market players, and likely the sellers themselves. This is a recurring theme

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with institutional investors who would pay aggressively for ‘paper’ which they can trade from their
screen rather than having to deal with potentially logistical and operational matters (buying
vessels or arresting vessels); a year ago, Santander Bank, holding a small position in the OSG
syndicate, attempted to sell their position, expecting a 60% related pricing; to their surprise, and
everyone else’s in the syndicate surprise, the pricing soon got into the 90’s levels, again,
reflecting that OSG was a US-based, publicly listed company and easy to trade on a computer
screen.
The fact the shipping debt, very selectively of course, can fetch pricing in the 90’s is definitely a
positive event for many shipping banks, who may find such pricing irresistible and start exploring
their own sales. We are not sure whether there will be an upcoming avalanche of shipping loan
sales, but there are many constraints: borrowers ideally have to be public companies (much less
preference for private companies) with underlying assets in active markets (doubtful that loans on
containerships would be as competitively priced and received) with governing jurisdiction English
or US law and while there is this (short?) window of low interest rates, market stability with low
corporate defaults and debt financing for shipping loan acquisitions is competitively available.
But again, seeing that 17% of the world fleet is still on order and many more newbuilding orders
are getting placed on a weekly basis, paying aggressively for shipping loans presumes a
substantial freight rate recovery (which presupposes tighter control of tonnage supply) and also
better asset pricing as loan collateral (which again presupposes tighter control of tonnage supply).
It will be interesting seeing whether 90% pricing would make much sense. It also will be
interesting seeing how ‘patient’ and tolerant of the corporate managements the institutional
buyers of shipping debt will be, being ‘active creditors’ as part of their DNA of managing risk
actively vs a traditional banker’s relatively passive and non-confrontational approach.
circumstances, whatsoever, in whole or in part, without proper attribution or the
consent of the copyright and trademark holders of this website. Whilst every effort has
been made to ensure that information herewithin has been received from sources believed to be
reliable and such information is believed to be accurate at the time of publishing, no warranties or
assurances whatsoever are made in reference to accuracy or completeness of said information,
and no liability whatsoever will be accepted for taking or failing to take any action upon any
information contained in any part of this website. Thank you for the consideration.
Posted in Shipping Loans | Tagged Basil M Karatzas, Karatzas Marine Advisors & Co. |
Leave a reply


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Private Equity and Shipping:
Another Take
The prolonged trough of the shipping industry has drawn the attention of many newcomers to
the industry, from distressed instrument investors to third-party vessel managers and operators.
It’s not only that all these newcomers (along with existing players) position themselves for a
market recovery; a sea change has taking place in the shipping industry, from shifts in shipping
finance to competition from more fuel efficient newbuilding designs to geo-political issues such as
China’s support of domestic shipbuilders and their fostering of a local shipping industry that create
business and investment opportunities.
Among the participants in the shipping world, traditional shipping finance, and namely the
shipping banks, like a modern day Aeolus – the Greek god of winds - have the power, whether
actively or passively, to shift the market at will. With an outstanding shipping loan portfolio of more
than $500 billion at the top of the market, at present, shipping banks have been trying to find
their balance while having one eye on the rear view mirror and their ‘legacy issues’ (shipping, but
also sub-prime, real estate, sovereign bonds, etc) and the other eye on Basel III and the new
capital requirements.
Institutional investors have been drawn to shipping partially because of the collapse of the asset
prices and partially because the lack of debt had opened the doors for alternative sources of
finance such as mezz financing, leasing, yield-driven equity, alpha-seeking private equity, etc
Recently, the private equity firm KKR announced the formation of the Maritime Finance
Company with the funding of a few hundred million dollars for the purpose of primarily filling the
gap left by the lack of capacity from the traditional shipping banks. The concept of institutional
investors with private equity minded returns entering the debt financing market in shipping is not
exactly unique. Based on our experience and dealing with small banks and seasoned shipping
bankers, the concept has been around at least for the last two years and we are aware of
institutional investors providing small funding to boutique shipping banks for origination of new
loans for double-digit returns (returns on the equity investment, not necessarily double digit
interest rates). No doubt that such debt financing cannot be replicated on a massive scale given
the cost of financing. On the other hand, it has been calculated, that for banks to fully comply
with Basel III capital requirements, their spread on shipping loans will have to be more than 600
basis points. If one were to calculate the total cost of debt financing on a historical average of
LIBOR, that numbers would not be much lower than 10%.
Probably in the near term of the next two years it will be difficult to deploy large amount of capital
as debt financing for new projects while charging interest rates high enough to generate double

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digit returns. After all, current undertakers of new projects in shipping usually have their financing
in place and access to different and cost competitive forms of capital from many geographic
markets (such as export credit, Norwegian bond markets, highest priority receiving debt financing
from shipping banks to the extent possible, etc). On the other hand, there are still plenty of
‘legacy projects’ with banks and shipowners from the better days of the cycle, projects that are
not completely doomed but definitely could utilize some restructuring and some capital injection,
not exactly equity but neither debt, mostly around the ‘mezz’ section of the capital structure,
that could deliver low double-digit returns with low risk while bypassing most of the ‘issues’ an
institutional passive investors loves to hate in shipping.
© Basil M. Karatzas 2013. All Rights Reserved.
No part of this blog may be reproduced, in whole or in part, under any circumstances,
without the prior written consent of the copyright holder.
Posted in Private Equity | Tagged Basil M Karatzas, Karatzas Marine Advisors & Co. |
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