The ancient Phoenicians, plying their trade along the Mediterranean, were in thrall to the whims of the sea and never knew if their cargo would arrive safely or end up on the ocean floor. Today’s behemoth vessels are less threatened by wind and the waves than they are by government regulations and economic trade wars. George Mangos explains the complexity of restructuring in today’s maritime industry.
If adversity is an agent of change, then shipping, pummelled by forces from both within and without, is changing — and probably at the fastest pace in its long history.
In just the last three years, the industry has experienced:
Major environmental legislation: Shipping currently discharges the equivalent of 1.5 billion cars’ sulphur oxide emissions and 10 billion cars’ nitrogen oxide emissions into the atmosphere annually. The International Maritime Organization (IMO), a specialized agency of the United Nations responsible for regulating shipping, has implemented a regulation which seeks to substantially improve commercial shipping’s environmental footprint by forcing the industry to burn low-sulphur fuel. In combination with other impending regulation, such as the Ballast Water Management Convention, which will require a multi-million-dollar investment and bring no commercial benefits, the combined impact on older, inefficient tonnage is hard to exaggerate. The position of a lender with a large legacy fleet of obsolete vessels from bankrupt owners is particularly unenviable.
Trade war: Just as shipping had finally started to digest the waves of vessels built during the bull-run of 2005 to 2008 which caused earnings to crash in the subsequent period, the rise of populism around the world and the simmering, strategic unease between two world superpowers as they figure out a path to living with one another (and avoid the Thucydides Trap) is sharply affecting global growth and trade prospects.
Consolidation: New mega-players in the shipping space, whose economic incentives are not necessarily based on improving vessel income, are creating tidal waves in shipping. From major oil and product traders (liquid bulk shipping) to the big miners and trading companies (dry bulk shipping) to state-backed, national champions (container, wet and dry shipping), the equilibrium is shifting away from traditional, fragmented competitors towards players that can amass financing and cargo on a blockbuster scale.
Financial and compliance regulation: New rules are striking at the very lifeblood of the industry, from the impact of Basel III on asset-backed lending to increasingly onerous KYC requirements and sanctions compliance regulation.
The entrance of hedge fund money into ship lending: Inspiring a mixture of relief and dread, hedge funds have provided much-needed liquidity and created a market for traditional lenders seeking to price their exits from portfolios, while owners are struggling to come to terms with the change in regime.
The combined result is that lending in the shipping space is changing dramatically because:
• Debt instruments are repricing to reflect the investment risk of shipping
• Relief from covenant breaches is ending
• Lenders using their legal powers to restructure portfolios and relief from (often years-long) covenant breaches is coming to an end
This friction is playing out across myriad jurisdictions and takes several forms (legal, technical, commercial and financial). Enforcement of a loan can be particularly tricky especially against a determined opponent.
All at Sea
Once these liquidity breaches happen, the next step is typically a pre-planned or consensual work out. Where this isn’t possible, filing for insolvency or a forced restructuring becomes necessary. There has been a continuous flow of restructuring work in shipping over the last few years.
What differentiates shipping from almost all other industries in these circumstances is that (a) the assets wear quickly in the hostile marine environment if maintenance is not scrupulously observed, and (b) they are inherently mobile, able to move rapidly between jurisdictions where lender rights are variably observed.
The physical location and where the ship is flagged are just as critical as the applicable law.
Some jurisdictions, such as the UK, are obviously favorable for lenders with speciality courts and judges. Some are highly unfavorable, particularly if the borrower has strong local roots (inter alia the Philippines, Indonesia), and some, such as the U.S. and Singapore, can be surprisingly ambivalent, depending on the character and training of the judge.
Importance of Flag Jurisdiction
The flag jurisdiction — ships, like people can’t be stateless — is also important. Looking at some of the largest ship registries in the world (the so-called “flags of convenience”), there is considerable variation. While the Marshall Islands is extremely responsive and helpful, Panama’s laws are tricky, and the flag administration is suspicious of lender rights. Unfortunately, as yet, there’s no transnational law framework– such as ICAO provides for aviation — that creates a more harmonious link-up.
The outcome is that lender enforcement can be extremely onerous on time and resources, especially against a determined opponent.
In our experience supporting lenders to deal with problem cases, we’ve encountered a scarcely believable range of scenarios. In recent years, this has included intentional sabotage, facing off with the criminal underworld and chases across the high seas. The underlying organizational aspects may be more mundane, but are absolutely critical: providing safety, food and shelter to forlorn seafarers who have been abandoned by callous principals or intervening to protect the safety of the environment through pollution prevention from financially-abandoned assets.
Sink or Swim
In adapting to the rehabilitation of portfolios and dealing with problem cases, lenders looking to work out their portfolios — or just having purchased them — will have to prepare accordingly. Countering the unique challenges and complexities requires a highly developed skillset and mindset.
Agility: This is the first and by far the most important requirement. Institutional inertia and risk-averse decision-making will make it extremely easy for a bad-faith player to run loops around a lender. It is critical that the team handling a specific shipping workout is vested with decision-making authority from the outset. This includes, for example, being able to react to changing facts within minutes.
A couple of examples we have come across: being alerted that an owner plans to park a vessel in an unfavorable jurisdiction and proceeding immediately to an arrest before the vessel leaves a port; or a major security operation, boarding a vessel with a specialized team to take control and prevent loss of life or a serious environmental pollution incident.
Technical competence: Shipping is a series of interlinking, highly-technical professions. Finding a provider with a solid track record in supporting a lender in all these areas, technically and commercially, is crucial to minimizing costs and restoring asset value.
The basic description could be taking over distressed units, restoring them and operating them profitably and helping the lender time the disposal. Sometimes, however, this can prove extremely tricky.
In one instance we had to restore and reintroduce a distressed container vessel into an exceptionally poor market and then charter her against 115 open vessels competing for business. In a second case, we had to shift a highly-distressed vessel from the Indian subcontinent to the west coast of Africa for judicial sale — and then to Europe for major remedial work. Fortunately, thanks to our due diligence and on-the-ground expertise, in both cases lender recovery was substantial.
Resources: Shipping is an expensive business, especially when it goes wrong. A lender must have a clear vision on how it can properly fund a restructuring project or a work-out. Sometimes this can be through application of own funds or it can be by working with a specialist firm that will underwrite the project or even a combination of both.
Through Thick and Thin
In short, shipping restructuring is with us for the foreseeable future and is laden with pitfalls. It can take the form of either a catastrophic nightmare for the ill-prepared or an extremely lucrative opportunity for the determined, the agile and the professional. Often, that outcome is decided well before the battle begins. •