Monday, 12 August 2013

Will shipping herald next credit crunch?

All is not well in the shipping world, and by extension, the banking industry, as freight rates tumble, shipping companies enter bankruptcy protection and bankers tremble at their multi-billion pound exposures to non-performing shipping loans. The root causes include huge tonnage capacity increases, based on unrealistic world trade growth projections, at a time when the global credit crunch began to bite in 2008. The fall-out of that credit crunch and its body blow to shipping continues to restrain economic recovery today as banks struggle to clean up their balance sheets first before expanding lending to pre-crunch levels.

The ship owners desperately need a boost to world trade, partly because of collapsing freight rates but also because new accounting standards by 2017 are expected to force them to place bareboat charters and time charters exceeding one year on balance sheet, increasing liabilities/debt ratios and causing them to be in default on loan covenants. But how realistic are hoped-for boosts to world trade and, by implication, shipping freight rates? Not much, as we shall see, given the new forces at work which could stymie or weaken any recovery in freight rates long enough to pose a serious threat to world banking almost every bit as bad as the 2008 credit implosion. These forces are impossible to quantify because the future always defies certitude. Before we examine them, however, how parlous is the current shipping-banking partnership?

A perfect storm gathering?

Alarmingly, dud shipping loans are not the only worry for banks. In Britain, in particular, banks have still not come clean on their exposure to dud, multi-billion pound commercial property loans. On their own, these dud loans are containable, with patience, but when combined with huge shipping loan losses yet to be openly declared the fear is that a perfect storm is gathering in the financial markets, and all it would take to ensure it is a mismanaged exit from quantitative monetary easing, a euphemism for electronic money printing.

There is, admittedly, a glaring lack of detailed information about banks' portfolios of shipping loans but what facts can be gleaned make disturbing reading. Most of the banks heavily exposed to shipping loans are north European, including German, Scandinavian and British, and the fear is that most of them are in denial about potential losses. "It is probably the most serious commercial problem that the banks have," opined Paul Slater, chairman of the consultancy firm, The First International Corporation, of Naples, Florida. According to him banks are saying: "Give it time and it will work out," but it is not going to do that, he adds. He is almost certainly right, though for some reasons that he may not have perceived.

So how big are the shipping loan risks? German banks' exposure to them is estimated at US$129 billion, more than double the value of their government debt holdings in Greece, Italy, Ireland, Portugal and Spain. Commerzbank, Germany's second largest, has a shipping loan exposure of Euro 18.9 billion, of which the non-performing part is estimated at Euro 4.5 billion. Its second quarter profits in 2013 crashed 84% on the same period last year owing partly to a Euro 110 million loss on bad loans to build ships. The company is reportedly anxious to cut its shipping loans by 40% but it seems the bids received so far are so low that the necessary write-down would imperil Commerzbank's equity. This exposes all banks' double whammy from shipping loans --- non payment of interest and asset values far below the loans to finance the ships. According to some shipping specialist estimates, large vessels that might have sold for US$150 million in 2008 fetch only about $40 million today. Half of the cargo ships on the high seas, it is estimated, may no longer be worth as much as the debt they carry.

Another German bank, HSC Nordbank, of Hamburg, although only a mid-size lender, is the biggest lender to the shipping industry, with reportedly more than £39 billion  in outstanding loans. Other big players in shipping finance include the DNB Group in Norway, Nordea in Sweden and Britain's Lloyds Banking Group and Royal Bank of Scotland (RBS). Overall, it is estimated that global shipping loans amount to £350 billion and the growing fear is that some of the lenders have yet to confront the scale of potential losses.

The recent decline in freight rates brought on by the glut of shipping and weak global trade is alarming and has even spilled over into the oil tanker market. Rates for non-liquid cargo are half or less than the level needed for shipowners to break even, according to consultants, KPMG. Rates for the biggest crude oil carriers tumbled 68% in the past two weeks. A very large crude carrier holding 2 million barrels could expect only $7,954 a day on August 2nd, having risen to $24,493 as recently as July 12th, according to Clarkson, the world's biggest ship broker. This comes on the heels of America's largest tanker operator, Oversea Shipbuilding Group, filing for bankruptcy in November 2012.  

New constraints on sea-borne trade?

Global trade will strengthen but that does not necessarily mean a concomitant growth in freight rates that shipping and banking so desperately need to keep that sinking feeling at bay. Some of the factors holding back growth are obvious enough, like the uncertainty about banks' true financial health which fosters mistrust among institutions, making them reluctant to lend to each other, and is partly responsible for a shortage of credit for businesses and consumers. Other reasons, however, are less obvious, impossible to quantify but which only the foolish would ignore. These include:

1) Development of inter-continental, rail-based land routes
2) Super-sized container ships whose economies of scale will undermine smaller box ships
3) Trends to re-shore manufacturing back to homeland countries or nearby
4) Green issues, which in part could spawn hybrid gas/sail vessels.
5) Technical developments like 3D printing and very much cheaper assembly robots
6) Shale oil developments in major oil-importing countries.

Good examples of continental, rail-based cargo transport are the German rail operator, Deutsche Bahn AG, which has started another direct train link on the Europe-China trade route, extending its reach into a domain dominated by shipping companies like Moller Maersk and Hapag-Lloyd AG. The journey takes just 15 days compared with the 30-40 days container ships need on the Asian-Europe route. This has two significant advantages for businesses. Ships should be viewed as floating warehouses and like all warehouses they put money to sleep. If the transit time can be drastically cut then that means stock can be converted into sales so much quicker. The second advantage is that electronics and automotive companies, particularly, find that the value of goods lost during the longer sea journeys is relatively high.

The super-sized container ships of 18,000 TEU or more coming on stream add further to the container shipping glut but because of their economies of scale they are likely to undercut much smaller box vessels and drive them into the breakers' yards.

The trend to re-shore manufacturing may only be a trickle so far but it is gathering momentum and now has new allies to bolster it. In the rush two decades ago to outsource manufacturing to the Far East where labour rates were much lower, certain hidden costs, if perceived, were ignored. These include rampant, intellectual property theft, natural calamity risks that severely disrupt JIT supplies, inflexibility to react quickly enough to changes in demand, poor quality issues and long production runs. To these must now be added rapidly soaring labour costs in China which can now make even the cost of high end apparel cheaper to produce in Britain than in China.

The new allies promoting re-shoring must now include developments like 3D printing and much cheaper assembly robots. These mobile robots will be able to perform basic assembly tasks and move around humans safely for a cost of about $25,000, compared with the $225,000 or so for welding and paint sprayer robots.

All these forces could restrain world growth based on ship-borne trade, and so depress freight rates for years to come but will that be enough to herald a second global credit crunch? Undoubtedly, the huge suspect shipping loans are a worry but when combined with heavy exposure to non-performing commercial property loans they put some big banks on a knife edge. Britain's tax payer-funded RBS and Lloyds Banking may show signs of recovery but it could be a false dawn. The UK commercial property market remains a major threat, with £38 billion of the £190 billion UK book in negative equity, and £93 billion on a loan to value ratio of more than 70%. RBS and Lloyds, according to Britain's Daily Telegraph in November 2012, have the largest exposures of £69 billion and £64 billion respectively. These banks are now under regulatory pressure to come clean on their dud property loans. Meanwhile, Commerzbank has dumped the UK commercial property market by selling Euro 5 billion of holdings.

The most likely scenario is that the first credit crunch will continue agonisingly for a few more years, along with rock bottom interest rates which are key to propping up the shipping industry, domestic and commercial property. What can be in no doubt, however, is the hell that awaits shipping lines and, perhaps, ship building yards. Soon, an inevitable financial cleansing will require the financial institutions to cease hiding the real value of their assets and that, in turn, could force governments into more bail-outs. Then, as the ancient Chinese curse goes, they will live through interesting times.

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