The downturn had three root causes: The first was slowing global demand as world economies contracted; the second was the huge amount of oversupply of new builds on the order book and in the water; and the third was the crisis in the financial markets which saw banks retreat from normal lending practices. Each of these factors is still troubling the industry.
Although shipping is cyclical, and financial peaks and troughs have been periodic over the decades, there is something special about this case. Macroeconomics, market behavior and politics are conspiring to extend the downturn.
Recovery in global trade is slow
Certain indicators of recovery are good, but progress is disappointing. In April, the IMF revised down its 2013 global growth forecast 0.2 percent to 3.3 percent and kept the 2014 forecast constant at 4 percent.
The eurozone remains problematic, with several countries requiring financial aid, and even the likes of the United Kingdom, France and Germany failing to show significant improvement.
China’s growth has slowed. The IMF has cut its growth forecast in successive months, from 8.1 percent in March to 7.75 percent at the end of May. Now the world is watching in the hope that domestic demand picks up and policy announcements have an impact on trading activity.
While positive US employment figures and rising share prices offer some encouragement, the macroeconomic outlook is still offering little in the way of a real impetus for shipping.
Ships are still being built, despite overcapacity, and rates are low
Looking at the entire sector, current new build is outpacing scrappage. In 2012, shipyards built a near-record 152m dwt, according to Clarksons. And, although total orders for new ships were down during the year, significant deals are still being struck. Industry veteran Paul Slater, Chairman of First International, is concerned that the market is spending too freely: “I was hoping at the end of 2012 we were starting to move on. Yet with a thousand container ships laid up, companies are still buying. In a service industry that only makes money when it is carrying stuff, that cannot make sense.” Slater argues that the desire for new build— whether to attract investment, to bring down fuel bills or just for show—is contributing to the shortening life of ships in service. Maintenance on ships just a few years old, he says, has dropped to marginal levels—meaning the plunge in their rates and resale value is accelerating.
Many financial institutions hold underperforming portfolios
There are no definitive figures on the scale of shipping bank debt: “Hundreds of billions of dollars” was as far as our experts were prepared to approximate. Even against the backdrop of a recession so long and deep that nine-figure losses became mundane, such exposure to a single industry stands out. Contractions or withdrawals in lending have occurred, and more are expected.
Alternative capital sources previously tested, such as German KG funds, have been widely affected. Decisions must be made by the financial institutions supporting these funds as to whether to hold assets or to sell at prices that may result in less than full returns.
The net consequence is becoming clearer: In the future, a significant portion of the industry’s sources of finance will be found elsewhere—including from private equity and, potentially, the capital markets—and several banks will have retrenched.
Governments and regulators are acting to protect the industry and curb lending
Governments and export credit agencies (ECAs) have stepped in where jobs and “the national interest” have been in play. For those looking at financing a new build from a Chinese or Korean yard, for example, ECAs can provide a foundation for the deal. Such activity can be helpful in isolation, but widespread intervention is suggestive of systemic ill health. Furthermore, it can be seen that one instrumentality of government has the potential to undercut or limit the positive impact of another. ECA-related loans could, for instance, be prevented from achieving zero-risk weighting by the introduction of Basel III standards.
The financial regulations on liquidity and capital maintenance in Europe have been pre-empted by banks, and shipping loan books are being trimmed. The phasing-in of Basel III standards should make the banks more resilient. But the cost to them of meeting these improved requirements is already being reflected in the pricing of loans (which have historically been low for vessel financing when compared to other sources of capital). There has been shipping-specific action too: For example, BaFin has ordered a review of loans to the sector in Germany, forcing banks to take affirmative steps to deal with exposure.
Low prices and ongoing changes in the sector’s financing mean there are attractive prospects for investors who can deploy capital quickly and have a view on the cycle. New private equity is moving into the sector, and Greek money is coming back strongly. Meanwhile, China has expressed its ambition to emerge from the recession as the shipping capital of the world, and is looking to consolidate financing, infrastructure, shipbuilding and fleet control. And the global capital markets represent an intriguing potential new source of finance if appropriate credit profiles can be brought to market with structures that conform to expectations and practice.
While lethargic global trade growth is likely to keep many box-ships and bulkers laid up, there is more optimism regarding tankers. Shipment of liquid natural gas, industrial growth in non-OECD countries and moves by energy and other companies to own or manage their own vessels will help speed recovery. Related port and offshore infrastructural projects are likely to benefit proportionately. And the offshore rig business continues to demonstrate strength.