Whose piggy bank is feeding the shipbuilding frenzy?

The stream of shipping industry news over the last 18 months could provide enough juicy material for a few episodes of Saturday Night Live. But SNL is not what inspired this article. No. It was my choice of entertainment on one of my recent flights. I decided to catch up with all those movies I missed over the last six months and settled in to watch The Big Short. If you have not watched it, you should check your Netflix library and watch it after reading this.

The Big Short is a story of greed, the idiots, the wise ones, and a few lucky ones. And let me tell you, in my opinion, it looks like the reality of ship financing market of 2016. Let’s recap the situation in a few words.

Bulk shipping is not making money. The industry seems to be in possession of the largest quantity of scrap steel in the world, well in excess of any new demands for steel production. If you don’t believe me, just check the statistics: today, you need between $30,000-40,000 per month to safely park a capesize, that only a few years ago was happily printing money on a $100,000 per month lease. In 2016, the capes are also dying younger than ever, barely going past their 20th birthdays before heading for the demolition yards.

The container business does not look any better. Reports of some shippers demanding and getting $0 rates for container shipments on the Asia-Europe trade lane make for uninspiring reading. Shipping companies are still able to apply some surcharges and pretend to cover their operating expenses, but that cannot possibly generate any profits. The ongoing changes in the Chinese economy show that the predicted comeback of massive container volumes shipped between China and other markets may never materialise.

Going back to the movie, why would the story of the American subprime mortgage crisis cause me to think of the ship financing market?

Well, it seems that the ship financing market is existing in a similar sort of suspended reality.

We have buckets and buckets of money being invested into new ships, even though additional capacity is not needed. Those new ships are being bought by the buyers solvent only on paper written up by the financing industry. Just like in the movie, we have the deserted estates in the form of the laid up ships strewn all over the available safe harbours. The owners of those laid up vessels are endlessly hoping for revenues that would allow them to repay the banks and cover ongoing costs.

Behind all of that industry stands the financial industry – the bankers and the reinsurers. As signs of stress come up to the surface, the banking industry seems to be able to find one or two captains of the shipping industry who publicly announce that while not everything is fine, the economy will turn around in no time and all will be fine. Everybody seems very relaxed and pretends that the total exposure of the bankers to shipping loans is simply someone else’s problem. Nobody seems to imagine that those loans cannot be called and actually paid back with cash instead of repossessed equity. Would it be possible that those loans were bundled together and resold in some form of CDOs to other bankers?

As you watch the movie, some well-known individuals appear in cute cameos to explain what collateralized loan obligations (CDOs) are and how many people really “understood” them. What’s missing in the shipping market story is some regulatory player pretending to be in control of the situation and a few renegades playing ‘the big short’: betting against the oblivious majority.

If you are wondering what is at stake, consider some of the facts.

Chinese shipping lines have placed massive order for valemaxes that have only one purpose – to transport iron ore from one Brazilian port to a few ports in China. Let’s be clear, iron ore which might not be even needed in China, as the country has finally ran out of patience financing its unprofitable steel industry and decided to cut down capacity. I would imagine the owner(s) of those valemaxes must be praying to some economic gods for change in economic direction. Whoever loaned money to this venture must be praying. The single-purpose valemaxes look a lot like the single-purpose capesizes, so the banks behind the first line lenders must be praying too. And whoever bought the CDOs bunching those loans on all those bulk ships may be praying too.

Is the container shipping situation any different? Just like in the case of bulk ships, new orders for massive ships are being continuously placed with the shipyards. The newbuilds are financed with money the carriers don’t have. They all hope to repay them in the future with the profits they don’t yet have. Even the most profitable carriers admit that 30% of their current shipments are transported below the cost breakeven points. To add to the misery of weaker and smaller carriers, the current and future owners of the ULCVs talk about cascading their older/smaller ships on the books, as if there was an infinite and profitable market somewhere “down there”. HMM shows what might come when the lines start leaning on the shipowners and demand better terms on assets that might not even be paid off. Could you guess what the value of the ships completely pushed out of the market will be? What about the value of the loans granted against those ships?

I am not looking forward to watching another version of The Big Short dedicated to the ship financing market, but should that ever happen, I want a cameo role in that movie.