How low can it go?

Since 2015 the dry bulk market has been dancing the limbo, with each month a seemingly new, and lower, challenge to freight and charter rates. But in recent weeks the Baltic rates have inched upward, is the limbo dance over? There has been very little good news in dry bulk shipping since the beginning of 2015. It’s like the dry bulk sector has been dancing the limbo, with each month a seemingly new, and lower, challenge to freight and charter rates. Snapshots of the BDI (Baltic Dry Index) over the past few years tell the story. On December 13, 2014 the BDI was 2,330. Soon the limbo dance began and by November 7, 2015, the BDI was at 1,457. At that time, dry bulk operators were wondering what the “new normal” was going to be? After all, it had plunged to 555 on February 27, 2015 but “recovered” to 1200 by August 7^th. But the real limbo challenge didn’t begin until this year. On February 8^th the BDI sank to 297 and four days later bottomed out at 291. Dry bulk shipowners might have been inclined to have thrown themselves out a window had they not already been in the basement. The BDI was so low that it called into question the value of the assets – the ships themselves. Asset-wise was the dry bulk industry bankrupt? Since that sobering moment, the BDI has been inching upwards and at this writing is 746 – a long way from 1,000 or 1500 and still off over 30% for the year but heading in the right direction. But this is still troubling for the banks and finance houses vested to the industry.

Banking on it According to Reuters and a number of other reports, the European Central Bank (ECB) recently began a review of banks’ lending to shipowners/operators - many in the dry bulk sector. Even before the ECB assumed responsibility for supervising lenders from State institutions lending to the industry, the ECB already had run an assessment through its Asset Quality Review of the largest Euro Zone lenders in 2014. No surprise, banks and finance houses, particularly in Germany, look exposed to the need to provide more capital against higher loss provisions on loans to the shipping industry. And similar to the 2008/2009 financial crash the idea of stripping “bad” risk from the portfolio is again vogue. Like breaking up, dropping shipowner assets from the investment portfolio is hard to do…but this isn’t the first time around. Back in the Depression of 2009 European banks trimmed their beleaguered ship owning assets by the creation of “bad banks” which lumped together the “losers” in the bank’s investment portfolio. This time around it is a little different. The migration of assets to the Far East has shifted the source of finance, setting up a new dynamic and for now makes the process a little less unsettling. In fact, from a purely statistical perspective, little has changed. According to Greek-based Petrofin, the volume of global ship financing from the banking sector has remained steady over the course of the past 12 months, amounting close to $400 billion, almost identical to 2015. During that time, the world fleet rose by 1.76%, from 89,676 to 91,526 vessels. But why? Petrofin’s bank research, (released in June) suggests an answer. Enclosed were a number of significant observations on ship finance by the research house: “It is important to see the total ship finance figure in another light. Between 2014 and 2015, the total number of vessels in the world fleet rose by 1.76% from 89,676 to 91,256 vessels (Clarkson’s World Fleet Register). Such growth and fleet investment was achieved without an increase in ship finance. As such, it is fair to conclude that there was more reliance on non-bank finance sources and/or enhanced equity by owners.” Another important research factoid from the research was “ship finance is not a leading contender for loans.” While this refers to traditional European lenders, there are significant questions concerning the capacity for Far East lenders to pick up the slack in a deeply depressed market. The real question, which somewhat involves the nature of the Brexit negotiations, is should Western banks abandon the ship finance business, and will Far East interests fill the void? At this time, it is an open question as a market rebound could amount to a reset for European finance interest. There is transportation oriented funding available but it has been chasing non-asset based companies or technology based interests over hard assets such as ships. The real unknown factor in the mix is the non-banking lenders in the Far East. These include entities like the Chinese ship leasing companies – many of which are tied to local finance institutions and other public and private viaducts to investment monies. At this moment, alternative lending for shipbuilding purposes looks to be slowing down. This might be partly because of the restructuring in Chinese shipyards (weeding out underperforming units) and a general slowing in ship building demand with the current over capacity. How Low Tomorrow? The unbalanced supply-and-demand equation in the market means rates won’t rebound as too many vessels keep chasing too few shiploads. The beginning of 2016 was difficult even with the current first quarter bounce. Will China’s commodity inventory slow demand in second half and sabotage rates? Can the unexpectedly resilient U.S. market drag along the world economy? And in Asia, can Vietnam, Indonesia and indeed all of Southeast and South Asia offset potential slowdowns in Japan or Korea? At this writing the outlook for the remainder of the year remains very uncertain. And what hangs in the balance? More ships chasing incremental increases in volumes doesn’t bode well. Although vessel demolitions in 2016 are expected to hit a record high of 40 million deadweight tons (DWT) that won’t offset the 50 million new DWT expected to enter the fleet. So how low will it go with the new limbo?