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Analysts at Compass Maritime recently noted that despite higher interest rates and reports of fewer buyers offering on sales candidates, a large number of tanker and bulker sales of all sizes and ages have been completed in the last month or so. The US shipbroker stated that on the other hand rising interest rates this year have had an impact on ship pricing, observing that last year's shipping deals were done at Libor + 85-90 basis points compared to today's Libor + 550 basis points. For more than four decades, the London Interbank Offered Rate—commonly known as Libor—was a key benchmark for determining the interest rates charged on adjustable-rate loans, mortgages and corporate debt. Libor will no longer be used to issue new loans in the US and is being replaced by the Secured Overnight Financing Rate (SOFR), which many experts agree is a more accurate and secure pricing benchmark. We frequently see disconnections between the prices paid for vessels and the true earnings potential According to banking veteran Dagfinn Lunde of eShipFinance.com, Libor, or SOFR, as the reference or base rate is now known, has risen from 0.15 a year ago to 4.60, and borrowing costs have gone up by around 6% on average. Shipping, just like any other sector, has not been immune to these changes, with most owners reporting increased interest expense and finance costs at the end of Q3. Nonetheless, shipowners and market experts tell Splash Extra that while in theory ships should go up in price due to higher interest rates, market conditions dictate the values. Lunde finds that borrowing costs influence the yield to equity for an investment and cautions people when looking at the price of a ship, but in strong markets like tankers right now, "it does not seem that the increased cost of borrowing has had an influence." The US Federal Reserve announced a fourth consecutive three-quarter point interest rate increase in November and is expected to do the same in December as it struggles to dampen inflation. When the Fed hikes the funds target rate, the intention is to raise the cost of credit across the economy. Higher interest rates make loans more expensive for both businesses and consumers, resulting in increased interest payments for everyone. Those who are unable or unwilling to make the higher payments postpone projects that require financing. It also encourages people to save money in order to earn higher interest payments. This reduces the amount of money in circulation, which lowers inflation and moderates economic activity. Andy Dacy, global head of transportation for JP Morgan Global Alternatives, reckons a lower leveraged spot player may be less sensitive to interest rates than a more highly levered owner seeking to charter vessels out for longer periods. He goes on to say that rising newbuilding input costs may be putting upward pressure on vessel values in certain sectors, but that "all of these factors must be balanced against rising concerns about a global recession and associated demand destruction." "If interest rates increase or decrease, would influence the decision to buy or sell an asset like ships priced at astronomical levels, and not their earning capacity or the asset value's relationship with replacement costs, then I think you are studying the wrong industry," argues Khalid Hashim, the managing director of Thai dry bulk owner Precious Shipping. Hashim stresses that bulkers are down by over 25% since the end of last year, not because of spikes in interest rates but because the Baltic Dry Index is down by 25% in the first nine months of 2022 compared to the same time last year. "On the other hand, if you compare asset values of tankers, especially VLCCs last year with this year, you would find the opposite to be true as VLCC freight markets are alight today and were dead last year," he notes. Jonathan Chappell, a shipping analyst with Evercore ISI, also doesn't think the higher cost of borrowing has much of an impact on the price of secondhand ships. "The strength in the market, lack of newbuildings, and higher long-term contract rates are much more responsible for the stronger S&P pricing environment than the basis points on debt," assures Chappell. Markus Wenker, the outgoing chief of finance at Singapore's FSL Trust who is joining Malaysian FPSO operator Yinson, explains that the most common method for determining the value of an asset is to discount the future cash flows, whereby the discount rate applied is the weighted average cost of capital. This is influenced by the cost of debt due to the use of leverage as well as the fact that rising interest rates lead to higher discount rates and, in theory, lower asset values. The reality, however, according to Wenker, is that actual prices are influenced more by the market participants’ expectations of the future markets (and freight rates) than anything else. "This is why we frequently see disconnections between the prices paid for vessels and the true earnings potential and this is why we see some companies making huge profits from selling or flipping assets and some companies being required to book impairments on their assets – either their market expectation played out or not,” he says, adding : "It is like in the stock market, where euphoria and fear or, say, not always rational behaviours of the market participants drive the asset prices up or down." For Greek shipowner Harry Vafias, what is actually affecting the prices in sectors such as container and bulkers, as would be expected with current freight rate conditions, is that inflation is at around 10-12% per year and "if you have $10m in the bank and don’t use it, you will lose at least $1m from inflation, so that’s an extra reason why the prices for dry bulk/containers aren’t falling that fast." The economic outlook is highly uncertain, as is how economic agents will respond to rising interest rates and costs. The risk of a downturn has increased, as has the outlook for financial stability. The ship finance market has seen increased interest and activity from lenders over the past two years or so, and this is still said to be the case "as shipping still offers relatively attractive pricing compared to most other asset classes." As the end of the year approaches, there is usually a rush to place or obtain cash as lenders look to shore up their balance sheets, rebalance portfolios, and transfer funds. But this year, with US gauges of market volatility back at levels seen at the height of the covid pandemic and an uncertain economic outlook, banks are finding it more difficult than usual to take risks on their balance sheets. "I have noticed is that lenders have become more cautious in the wake of the increased geopolitical tensions and macroeconomic uncertainties," remarks Wenker. Money markets indicate that securing the cash and quality assets required by investors to make a smooth transition into 2023 will be costly. However, lenders that have been competing hard for business with shipowners now generally find them less needy of financing than they have been for quite a few years. Although he has observed borrowing costs soar due to the "non-stop Libor increases", affecting prices negatively, particularly on dry bulk and containers, StealthGas boss Vafias hasn’t yet seen an effect on energy-carrying ships, where prices are constantly firming. "Most buyers on the tanker side are buying these ships with cash and no debt, especially the 15-20-year-old ships, so the increased cost of debt doesn’t really matter to them," he says.

Are surging borrowing costs affecting ship prices?

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