The first entry of the series features restructuring specialist Randee Day. During the industry crisis in the 1980s, Day was on the front lines, as head of JP Morgan’s transport banking division. In the years since, she has provided restructuring advice through her company, Day & Partners, which has been operating within the Goldin Associates platform since August. The following is an edited version of an interview conducted on 22 October.
Greg Miller: Before we get into lessons learned from the past 10 years, I want to get your opinion on how the current down-cycle compares with what happened in the 1980s, given that you were heavily involved during that earlier crisis when you were at JP Morgan. Is this one actually worse?
Randee Day: “This one is worse. We now have multiple sectors in crisis at the same time – dry bulk, offshore, and container lines – and in the 1980s, the banks were not insolvent. In the 1980s, most banks were able to take losses and the profitable banks were able to book write-offs to help their tax positions. The banks today are not in that position. Also, back then, if you had a syndicate and a smaller bank in the syndicate was being difficult, the bigger banks could just buy them out. We haven’t seen that happen in any of the bank negotiations today.
“We also have a crisis in Korea right now that I think has been grossly under-reported. We have one of the world’s biggest shipbuilding nations in a situation where its yards are insolvent and it could take a decade or more to recover, and there are also huge conglomerates in Korea with shipping companies that have major exposure. There is a global ripple effect from Korean bankruptcies that we’ve started to see with Hanjin and I don’t think it’s over.”
What is it about these South Korean shipping companies? Every time they go bankrupt, I’m continually amazed to see the high rates they have accepted for their long-term charters. Why are they agreeing to these rates?
“Well, you have to look at the other side as well. Why do the owners who charter to them accept these rates? If they had looked at any sort of historical standards, they would have seen that the rates were too high, they couldn’t be supported and they were not sustainable – and these owners would never have ordered those ships in the first place if they had not been backed up upon delivery by these charters.
“I think it is very hard to understand what the quality of the credit is for these quasi-government conglomerates, which is one of the problems we had with Japan in the 1980s. And I don’t know why companies would put up to a third of their fleet to a single charterer like this. You should never overly commit to one particular entity, even if you think it’s a sovereign.”
That’s a good ‘lesson learned’, particularly after Hanjin. Let’s talk about some of the other takeaways that have emerged over the past decade. What about public shipping companies, which really rose to the fore during this period?
“I think there will be considerable reflection over the kinds of companies that go public. For example, the 100% dividend pay-out model never made sense. This is a capital-intensive business and you have to grow and pay back large amounts of debt, and the average maturity is only seven or eight or maybe 10 years. If all your cash is going out every year [via dividends] and the market is lousy and you have a giant bullet payment due on your loan, you’re going to fall off a cliff.”
“I also think we need to look at the way the ‘pure play’ public companies have been structured and re-analyse that whole idea.”
An investment banker would say that you need pure plays, so that, for example, the tanker stocks can be sold to investors in the oil sector, and the dry bulk stocks can be sold to investors in the mining and commodities sectors.
“When the markets are bad, it doesn’t help you [to be a pure play], but diversification can save you. That’s what the Norwegians and Greeks have been doing for years. What the public companies have done instead is to have multiple listings [one for each shipping sector] and if an owner has separate listings for his dry bulk and tanker companies, the tanker company has not been able to help out over recent years when the dry bulk company was faced with a negative cash flow situation.”
“In general, I think it will take a period of sustained profitable performance by some of the larger companies in the different segments before new investors can be drawn back in. There has been a huge destruction of capital and I think there will be a lot of discussion on whether this type of business is well-suited for the public markets, because of its volatility. The real problem is that the industry is just not generating the kind of revenues that give any sort of decent return on capital.”
When it comes to returns, I think there’s also the issue of the European banks retreating from shipping. These were the providers of relatively cheap debt capital. What I’m hearing now is that this gap in funding is going to have to be filled by alternative credit providers who will be charging double-digit interest rates. So if the returns in shipping on a cross-cycle basis are not that good to begin with, say in the high single digits, then wouldn’t the higher cost of whatever debt capital is still available make the returns even weaker? Isn’t the cost of capital going to be higher from now?
“Oh, it will be. Also, don’t forget, the whole industry – which has hardly any investment-grade companies – was able to borrow at LIBOR plus 75-100 basis points during the whole credit bubble in the early 2000s. What other capital-intensive industry was able to get away with that?
“Now we have a situation in the dry bulk, liner and offshore sectors where there is minimal or no positive operating cash flow to cover interest payments. So, for these guys offering mezzanine structures at 15%, how would these companies be able to support that?
“You’ve got this whole group of public and private companies that have been through all of these restructurings during the past couple of years, and unless there is some sort of huge unforeseen boom, these companies, given the age of their fleets, will basically exist to service their debt. Their ships are 11 to 12 years old, a large amount of their debt [put in place in the early 2000s] is still there, their shareholders have lost their equity value, and their management is essentially working to service the bank loans. So where’s the return for a new investor coming into a situation like that?”
How are the banks handling this? They went through a long period where they ‘kicked the can’ and simply amended and extended the loans and just hoped that things would get better, but they’re facing new regulations in Europe and they’re talking tougher this year, basically insisting on new equity in return for debt extensions. What are you seeing?
“What’s happening now is that the owners are turning over tonnage to the banks and the banks are either selling it, scrapping it, or warehousing it. We’re hearing about these deals every week now. The banks are also writing things down more than they would probably admit. And I agree with you: restructurings are not getting done unless the existing shareholders put in additional capital, and I think you’ll see that continue.”
Speaking of the banks, you’ve been openly critical of their behaviour towards shipping borrowers. What have they been doing wrong over the latest cycle?
“People are probably sick of me saying this, but the senior secured loan model just doesn’t work in shipping. The loan-to-value (LTV) ratio shouldn’t matter to a bank unless it needs to foreclose on the vessel and recover the loan through the sale of the asset. What has happened over the last couple of the years is that banks have used the LTV covenant to force owners to use up scarce, precious liquidity [to maintain covenant compliance].
“This liquidity is needed by owners to keep their ships trading and make sure their ships are current on all their payables so they don’t get arrested. If the equity in a shipping company has already been wiped out, who’s the equity? The banks are. The banks have essentially stepped into the equity position. So why would the banks take cash away from a shipping company just to make someone on a bank’s committee happy that the LTV covenants are still in place if by doing so, the shipping company is late on its bunker payments? If the bunker supplier won’t provide bunkers on credit anymore and requires cash in advance, there may not be enough cash. How is the bank protecting the shipping assets by doing this?”
And on top of that, we also have the banks seeking to unload all those bad loans…
“We’ve been scratching our heads on that one. You have these banks that kicked the can down the road so long and now they’re packaging up all these rusty cans and trying to sell them, but who’s going to buy them? Where are these buyers going to come from?”
What about the investors and the shipping companies themselves? What mistakes have they made during the recent era that we can learn from?
“I think there has been too little attention on the ability of assets to generate cash flow. If you look at other industries, such as real estate, you want to build a building knowing that you can lease it for ‘x’ years at a reasonable rate and that there will be a certain return. Shipping has been so volatile that there has never been enough attention paid to what the historical rates have been.
“It’s not just about covering operating expenses and covering debt. There should also be a return-on-capital component. If people had focused on that more, many of these investments would have never been made. During the bubble period, prices went to the moon for absolutely no reason except that there was too much money with unfounded expectations. There were VLCCs priced over USD100 million and Capes for USD145-150 million. These ships can’t live long enough to ever get a return on that capital, or even to get that capital back. There are certain prices that just aren’t sustainable. There needs to be a reasonable rate of return based on reasonable assumptions based on the historical levels of rates and asset values.”
OK, we’ve talked a lot about things industry players have done wrong over the years. What have they done right that we can learn from? What strategy worked?
“Owners who sold tonnage when they looked ahead and thought the market was going to fall, who got a reasonable price by selling those ships and who raised their liquidity cushion early on. I think a lot of the private companies had the flexibility to do that, whereas you see a lot of public companies selling a lot of ships now, but everybody in the market knows they’re selling.”
So in other words, sell the ships before the market knows you need to sell the ships?
“Right. And a lot of Greeks did that in 2007-08 and got great prices and they were kicking themselves when prices kept going higher, driven by the credit bubble and the IPOs, but they got out before the collapse, and they were able to raise their liquidity.
“There is too much optimism in this business, which means a lot of people didn’t raise sufficient liquidity to sustain themselves through a long downturn in the market.”
On the subject of over-optimism, it seems to me that for many years now, people have been claiming that the recovery is two years away. It’s like a formula: the recovery timing is always the current year plus two, no matter what year it is. Any final advice?
“I think an important lesson is that we will continue to see more and more geopolitical factors affecting our industry. People seem to be surprised at all the macro events going on in the world that affect shipping, which has always amazed me.”
“The fact is that there are always these unforeseen international events, so you need to structure your company so that it’s well insulated from uncertainty and volatility. If you don’t have sufficient liquidity to provide for extreme volatility and the effect of that on the assets you’re trading, you are going to continue to have problems.”