What a wild ride the shipping industry has had of late. While the pundits and prognosticators still talk of impending relief or doom depending on the market sector, others (including ostensibly neutral financial observers) have been more blunt as 2017 rolls in. To paraphrase one industry observer, recent market performance has been downright rotten with global shipping suffering one of the longest and deepest downturns in modern times. As Fitch Ratings noted in their outlook for 2017, "muted demand growth will exacerbate overcapacity for the shipping sector in 2017, putting pressure on freight rates and driving further consolidation and defaults". Clearly, the light at the end of the tunnel still seems so distant to many. Indeed, Fitch went on to say that "performance in all segments [will] be under pressure and [we] have therefore maintained our negative sector outlook. . .. Many container shipping and tanker shipping companies had sufficient cash to cover short-term maturities at their most recent reporting date, but they are still reliant on uninterrupted access to bank funding to cover negative free cash flow."
The observation regarding consolidation and defaults is undoubtedly correct. The end of 2016 witnessed the insolvency of Korean giant Hanjin Shipping and the recently announced acquisition of Hamburg Sud by Maersk. In one sector alone, container shipping, we are witness to both insolvency and mergers. What next? The container shipping segment has already seen its share of consolidations (Hapag Lloyd – CSAV and, prior to the most recent announced activity, Hamburg Sud's acquisition of the container operations of CCNI). Hanjin's collapse may have been a bit more of a shock to the system but collectively these items suggest a transformational era in container shipping. Merger and acquisitions activity could mean the container shipping industry will evolve into something analogous to the cruise industry with behemoths like Maersk and CMA CGM co-existing with small feeder container companies resembling the cruise industry giants Carnival and Royal Caribbean, on the one hand, and niche providers like Lindblad Expeditions and Hurtigruten on the other.
But what about the "uninterrupted access to bank funding" to which Fitch refers? Access to bank funding is certainly no longer a given. While bank funding may be critical for companies to cover upcoming maturities, the availability of that funding is far from assured. One could argue we have been here before and made it through. The withdrawal of so many banks from shipping following the financial crisis and the recovery from that crisis, albeit less than robust, surely provides some guidance or reason for hope and optimism, does it not? Many remain unconvinced. Few banks actually re-entered the market as the recovery in the financial markets gained steam. Indeed, if anything, the exits have accelerated. Several of the major German ship mortgage banks are effectively closed for new business no matter what they might say in public. Moreover, when a shipping finance stalwart like The Royal Bank of Scotland announces and then vigorously pursues its exit from the business the pressure on the shipping industry (and the remaining banks lending to it) intensifies.
For dry bulk shipping companies, the worst of the crisis might have passed though not without taking a heavy toll. Some dry bulk companies have now been through as many restructurings and/or bankruptcies as the major American airlines. Nonetheless, both the high profile companies and the smaller privately controlled ones have at least kicked the can down the road by extending maturities in exchange for new equity infusions. While there has been some consolidation, the dry bulk shipping industry remains largely fragmented. But although the dry bulk industry may have weathered the current storm, there was a toll taken on the banks and that toll contributes to decline in banks' lending capacity. And now, the process will repeat itself in the offshore segment of the shipping industry. With a collapse in world oil prices and the rapid expansion of the shale oil industry in the United States, demand in the offshore support vessel business has plummeted at a time when the supply of vessels peaked. Much of this business is funded by bank debt making it likely that what transpired in financings in the dry bulk business will play out in this segment. The wild card may be the tanker business which, in addition to being highly segmented, is not likely to suffer the same way dry bulk did or offshore is. Nonetheless, there is till the looming maturity of a number of loans in the tanker segments and the relative unavailability of capital.
Putting aside the complex workings of new regulations in respect of capital adequacy adopted globally following the financial crisis, for each dollar of principal payment otherwise due but now deferred by a restructuring, there is one less dollar available for banks to lend. That mathematical exercise is an easy one to understand.
Compound the scarcity of bank capital with a continuing reluctance of Wall Street and the other major public debt and equity markets to re-embrace shipping, and the picture gets potentially dire. Again, this is not unlike what developed following the financial crisis but there is one important element missing. When bank debt and the public capital markets retreated from shipping in the last decade, private equity stepped in the breach. Government export banks also plugged some holes along the way. Now, however, there may be some fatigue in the latter and the former – as a group – did not do as well as they had hoped and some took significant financial losses. While some new private equity is still coming into the market in the hope that market dynamics finally promise a reasonable chance at gains, the amount of this new money is a fraction of that to which we have become accustomed. The market has seen some growth in the number of alternative capital providers such as debt funds and family offices but this growth cannot match what has been lost from the banks.
So what does this mean? In the end, I am not certain we will see much consolidation in the more fragmented sectors of the shipping markets, but absent significant capacity reductions, defaults and bankruptcies loom. In particular, the use of Chapter 11 restructurings, "prepack" and "free fall", will increase as will the use of Chapter 15 proceedings ancillary proceedings. Legal practitioners and their clients should look ahead and prepare.