The Unbearable Boredom of Marine Asset Prices

Posted on September 7, 2020 by Karatzas Marine Advisors & Co.

The COVID-19 pandemic has been the low-probability-high-impact novel risk that few people had seen coming and warned about it (mostly statisticians and epidemiologists) but the greater business community had ignored it till now. Coping with COVID-19 is still an evolving process, and the shipping industry has been learning to react and adjust to the forces the pandemic has unleashed on supply chains and logistics, some with a positive impact, but mostly with adverse or very adverse implications.

We have argued elsewhere on some of those implications, and we will follow up soon with a few more thoughts. However, for now, the subject of marine asset pricing and vessel values, more than six months since the pandemic has started in the West, seems to be too intriguing to pass up.

Once the magnitude of the pandemic started taking shape by March 2020, and the extent of lockdowns and closing of borders and travel restrictions were evident, the first expectations were that this is going to be very bad for the shipping industry and for shipping values. After all, once the industrial base of China and the United States and the European Union coming to a screeching halt, and trade volumes collapsed, one had to expect the worst. And, indeed, the first couple of weeks of the pandemic were brutal in anticipation, from the world stock markets to the long lines snaking outside supermarkets.

The Baltic Exchange [Disclaimer: Karatzas Marine Advisors is a Baltic Exchange member company] freight indices (both for dry bulk and tankers) were edging marginally higher at the beginning of the year on renewed hopes of market recovery. When COVID-19 smote the market, dry bulk freight rates quickly collapsed; it was not that demand for raw materials collapsed simultaneously with the rising of the pandemic, but port operations pushed forward any cargo requirements, thus pulling the freight market down fast in the short term. However, the very same disrupted port operations that pulled the freight market down had a completely different effect for tankers: combined with a glut of crude oil and petroleum products that brought the energy markets into a contango, and quickly tanker rates skyrocketed, at least temporarily. But, once oil companies and refineries managed to handle their excess inventory, as one would had predicted back in April, the tanker market deflated as well.

From the following graph of the Baltic Exchange Indices, freight rates presently are lower than at the same time last year (2019) and the year before (2018). There is a current, rather seasonal, rally in the dry bulk market (the US Dollar has lost appr. 10% of its value in 2020, and commodities priced in USD being cheaper in local currencies have spurred regional trades), but still below break-even cash levels. VLCCs are earning appr. $15,000 pd spot now (vs. $45,000 pd average 2019 earnings) and Capesize bulkers are earning $14,000 pd spot now (vs. $14,500 pd average 2019 earnings). Not great numbers, but again, as solace, in 2016 the market was much worse with Capesize vessels earning the grand sum of $4,500 pd. And, when considering the GDP of many OECD countries has dropped more than 10% in the first half of 2020, and the OECD formally expects global economic activity to drop by 6% to 7.6% annualized in 2020 (based on average scenarios), the current freight market is not bad at all.

Baltic Exchange Tanker & Dry Bulk Freight Indices since 2015

And, accordingly, since freight rates are highly correlated to marine asset prices, one’s attention turns to the secondary value of ships: at least the shipowners, and the shipping lenders and the investors as the use shipping asset prices as their main benchmark for equity (and wealth) creation, as collateral to shipping loans (Loan-to-Value or LTV) and the Net Asset Value (NAV) of the company. In the two graphs herebelow, we are using values of five-year old both dry bulk and tanker vessels, the major asset classes per market sector as a proxy, although prices for older and newer vessels show similar characteristics. The data were provided by the Baltic Exchange and Karatzas Marine Advisors.

For Capesize, Panamax and Ultramax dry bulk vessels, asset prices have declined since last year; in a sense, this is to be expected given the state of the market, but nominally, one would expect that dry bulk vessel prices to be lower at present than where they really stand. Not only freight rates are low, but also several complimentary factors (i.e. momentum, financing, etc) are worse than the freight market may imply. What is noteworthy is that although the overall marine asset pricing curve is negative, in the last several months, it’s effectively flatlined, showing signs of minimal variance and volatility. If the shipping industry is known for one thing is that it’s that flat lines rarely exist in shipping.

Tanker Vessel Assets Prices (5yr-old Vessels)

Likewise for tanker asset pricing, for five-year old VLCC, Suezmax, Aframax, Panamax LR1 and Medium Range MR2 and MR1 tankers, the overall trend is negative, but again, the several last months show a flat line as well. Minimal movement in tanker asset pricing, in a market that is known to move around widely.

Dry Bulk Vessel Assets Prices (5yr-old Vessels)

If any conclusions could be drawn from the current pricing activity (and a weak secondary market activity in the sale & purchase market) is that there is a tug of war between buyers and sellers that currently stands at equilibrium. Both buyers and sellers trade along the status quo and “last done” pricing as neither group has the upper hand. Despite the weak freight market, sellers still earn enough to pay their bills (and possibly their lenders, too), and buyers do not really have a reason to pay up to acquire tonnage (but also, they do not find “distressed” opportunities to feast on).

We would think that the market is bound to move, and rather strongly, in either direction in the near future. Both industry idiosyncratic variables (financing, banks, newbuilding activity, etc) or exogenous variables (the upcoming elections in the US are expected to be unusually contentious and impactful worldwide) could move the market and marine asset values, and the current boredom in the vessel value pricing is deceiving.

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How to Qualify a Vessel Appraiser

Posted on September 22, 2018 by Karatzas Marine Advisors & Co.

The shipping industry has been bobbing along ever since the financial crash of 2018. There is, of course, the expected market sector rotation with certain asset classes coming in and getting out of favor; at present, dry bulk vessels are cash flow positive, containerships rather weak, and tankers and offshore assets downright miserable. Following the whims of the freight market, values of ships fluctuate up and down; when certain sectors are out of favor, there have been sales on occasion at eye-popping low levels – and when the market improves, there may even be a chance for a shipowner’s favorite game, the famous “flipping of assets” to monetize on asset appreciation.

While the shipping market keeps doing what it does best – being volatile, shipping banks and capital for shipping are getting even tighter and costlier, which impacts not only vessel asset prices but also the volume of sale and purchase of vessels in the secondary market. For instance, at present, given the state of the tanker market, there have been months without the sale of tanker vessels in certain asset classes (there have been almost six months without the sale of modern VLCC, suezmax, aframax, LR2, MR2 and MR1 tankers that were not between affiliated parties or not subject to financing), which makes pricing and valuing of vessels all more complicated. All along, regulatory requirements keep piling on the industry (IMO2020 is the latest concern), while new technologies and innovation keep raising the technological risks for the industry.

Commercial considerations aside, the current state of the market is impacting not only vessel valuations but also the process of arriving at an accurate (and, some even say honest) vessel valuation. The standard definition of Fair Market Value (FMV) is premised upon the existence of a liquid secondary market; when the last comparable sale was six months ago, it might as well it had been six years ago given the volatility of the industry. As a result, delivering an accurate vessel appraisal when there is dearth of data, it can be considered an “art” at the very least, or worse, the subject of intense scrutiny of not only the outcome of the valuation but also of the process of the valuation, including questioning the qualification of the vessel valuator themselves. Valuation is not just the outcome, the value of something, but also, the qualification and the standards of the valuation process as well – the integrity of the process.

When times were easier for shipping… STS Leeuwin II in Fremantle, Perth, Australia. Image credit: Karatzas Images

Standard industry practice is that vessel valuations are commissioned from shipbrokers on the assumption that they have their finger on the pulse of the market. On the other hand, one has to keep in mind that there are concerns of the integrity of the process of deriving a number, especially when data is old and have to be “interpreted” and judgement comes into play. And, as uncomfortable as it is talking about it, there are conflicts as shipbrokers make much more money on commissions by selling vessels than providing valuations for vessels, thus, they may ensure when providing valuations to ingratiate themselves to the party that likely will give them more sale-and-purchase (“S&P”) business in the future. There are cases where shipbrokers and vessel valuators in the same shipbrokerage company are often at odds, given that they have conflicting interests: vessel valuations are a loss leader for many shipbrokerage companies (at a typical $1,000 per desktop valuation) while a commission of 1% on the sale of the same vessel can generate a much higher bonus. One does not want to upset the owner / seller of a vessel with a tight valuation of their property.

Of course, there have been online platforms whereby automated vessel valuations can be provided instantly via an algorithmic process. Such an automated approach would presume there is no bias, such as un-intentional personal judgement of interpreting the data or intentional skewing the results of the valuation to favor a certain party. While such a presumptions seem credible, on the other hand, one has to be aware that the algorithmic process is backward looking (historical data with historical bias), and still it has to depend on judgement as certain sales should be adjusted or disqualified since they may not be true comparable sales (judicial sales, auctions, subject to financing, sale-and-leaseback transactions, etc) In our experience, and convenience aside, algorithmic valuations overall do not provide much higher accuracy than qualified, unbiased actual vessel appraisers.

As we have discussed elsewhere in previous post, there are also additional valuation methods to be considered than the market comparable approach, such as the income approach method and the replacement cost method. However, such methodology often gets beyond the realm of expertise of a shipbroker as concepts of finance, economics, accounting, and possibly taxation may come into play. We have seen in the past, a partner at a shipbrokerage shop googling for Net Present Value (NPV) formulas in order to provide an income approach for a vessel valuation; we feel disheartened for such practices and for people being so cavalier with asset values; and, coincidentally, we would love to see such partner explain themselves in a court of law under oath in a scenario of litigation, where they would had to explain their methodology – when it’s clear they lacked any fundamental understanding for the valuation process. There is clearly legal liability for poorly prepared valuations.

Reflections on watery matters… Image credit: Karatzas Images

Most U.S. banks, leasing companies, commercial asset finance and equipment finance companies have now raised the bar for the firms and the people providing valuations; as such firms have a fiduciary duty to ensure that they look diligently after the money of their depositors and investors, it would make absolute sense that whoever is providing ship valuations has to meet certain academic standards, are subject to continuing education and that they have to abide by a set of professional rules and code of ethics. “Gray lenders” such as credit funds and other investment firms active in shipping seem to keep working with their preferred brokers, but this can be a liability claim in the waiting. The Securities and Exchange Commission (SEC) have been known to have taken an extra look in the last few years at certain publicly listed entities and their vessel valuation methodology and accounting practices. When investors lose money with their shipping investments, it’s hard to see what would stop them from pursuing legally asset managers for not credentialing properly their vessel valuation practices.

We do not want to be warmongers but in an environment of higher regulations for banks and investors, as well as people in shipping, one should be surprised to see how vessel appraisals are delegated as a matter of favor or a matter of inconvenience. Reality should be expected to soon catch up.

The sponsor of this blog, Karatzas Marine Advisors & Co., is pleased to announce that they have taken the matter of ship valuations or vessel valuations or ship valuations or ship appraisals – however valuation of marine assets is called, to a higher level. The firm employs Accredited Senior Appraisers (ASA) for Machinery and Technical Specialties who have met high academic standards, have passed qualifying exams, and most importantly, have to strictly abide to an extensive code of ethics. The firm also employs Fellows of the Institute of Chartered Shipbrokers (FICS) who have passed extensive exams and had to demonstrate years of experience in the maritime industry to qualify for such accreditation. Additional qualifications for the firm’s personnel include Accredited in Business Valuation (ABV) by the American Institute of Certified Public Accountants (AICPA) and Certified Marine Surveyor (CMS) by the National Association of Marine Surveyors (NAMS). The firm is a member of BIMCO and the Baltic Exchange among several professional memberships. The firm also employs Ivy League MBAs and graduates who can provide an income approach valuation without having to google the NPV formula!

The Institution of Shipping

Posted on February 6, 2018 by Karatzas Marine Advisors & Co.

For someone to get an academic degree in accounting, for instance, it does not automatically qualify them to represent clients on accounting matters. This approach to qualification is not a judgment against the institution granting the degree, but the premise that the professional society of accountants – wherever they may be – make the effort to ensure that their members have to meet certain standards – professional, academic, legal, ethical, etc – and practice the profession under a certain set of rules. There are people who have studied accounting but failed to pass the professional exam, and as a consequence, they ended up slaving in the back office doing book-keeping at a substantially lower pay scale. For the professionals in law or medicine, “passing the bar” is even more critical and demanding. Professional societies go to a great length to ensure that their members are knowledgeable and current and of a certain standing; and they do weed out the “bad apples”. In exchange for maintaining (certain) standards, the profession enjoys a high degree of reputation and its members earn a respectable living.

Having ourselves being in the shipping profession for almost two decades, and only becoming a member – after passing a series of exams – of the Institute of Chartered Shipbrokers (ICS) in the UK in the last three years, and now in the final stages of becoming an accredited appraiser (valuator) with the American Society of Appraisers (ASA) (after again passing series of exams of law, ethics and subject matter) in the USA, it got us thinking that the shipping industry really lacks professional organizations whose credentials are a sine qua non in the industry.

To be a practitioner shipbroker, there are really no professional certifications to hold or minimum body of knowledge to possess in order to practice the profession. True, most young shipbrokers usually have studied a subject matter related to the maritime industry, but there are no minimum standards of the breadth and depth of such knowledge or some uniformity. And, given that ship-brokerage involves aspects of law and finance, the actual field of knowledge can be quite substantial. Most ship-brokerage offices would hire people apparently good at selling and getting compensated on commission and let Darwin’s law of survival do the rest of the work. And, true, certain ship-brokerage houses have their own in-house training, but again, this rests with the employer, who still can opt how to train young professionals.

Why there should not be a mandatory license in order to practice the profession of a shipbroker? Why there should not be professional assurances of standards of practice and also of ethics – including consequences for breaking the rules?

Likewise, almost all shipbroker houses advertise their vessel valuation service as part of their set of services offered. Most of vessel valuations are so-called “desktop valuations” where no physical inspection of the asset is required, and typically ships are valued based on the “last done” – a process shipbrokers should be good at. However, when valuing an asset to the tune of millions of dollars, one would expect more effort and detail to reach a complete valuation, and, actually assurances of the integrity of the valuation process. Ship valuations and appraisals are used for loan documentation and on-going loan-to-value (LTV) tests for the loan, are used for insurance and claims purposes, for arbitration and court proceedings, and many other factions, where small detail is crucial. Yet, the ship appraisal process is approached in a cavalier way in terms of competence, or even worse. It has been known that vessel valuations services can be used to curry favor with principals and shipowners for shipbroking business, and there have been known instances of “broker shopping” for vessel valuations that will render the highest vessel value (dear reader, please keep in mind when asset prices are low and sometimes “underwater” in terms of LTV, vessel values are critical for triggering default clauses with severe consequences). Once again however, there is no professional body ensuring accuracy and integrity of ship valuations. The “loss leader” model seem to work for many parties when it comes to vessel valuations, with the exception of US banks and lessors and equipment finance companies that steadily are demanding that vessel appraisers to be certified, qualified and obeying by a professional code of ethics by the American Society of Appraisers.

The Baltic Exchange’s –another venerable maritime organization to which Karatzas Marine Advisors is a member of – keystone premise is “Our word our bond”, an expression that is rather encompassing of the mentality of the shipping industry. In an industry of perfect competition, it’s an open field for providing services in the maritime industry: the qualified and less-qualified, the competent and not, the good and the bad… There is room for many a “cowboy” and “buccaneer” in the shipping industry, and sometimes lots of caveat emptor, along with people in shipping whose word is their bond.

For strangers new to the shipping industry, sometimes it’s a learning curve before finding one’s bearings in terms of people to depend on. The push for new technologies in shipping is offering a quick bypass to professional credentials as now an agnostic algorithm can be programmed to provide the services; an algorithm build (hopefully) by experts in the field, an algorithm that obeys a set of rules (but not a code of ethics).

Besides technology, there is an underlying trend to bring shipping into an age of an “institution” where services and products are better defined and where the buccaneer and un-predictability element of the business go away. Charterers want to see bigger shipowners with efficiencies and critical mass and predictability of service, shipping financiers want to see bigger shipowners with better practices and efficiencies, etc, Taking inefficiencies and un-predictability out of the system, professional accreditation for services would go a long way.

A new day, a new epoch for shipping? Image credit: Karatzas Images

Dry Bulk Vessel Prices Lagging the Freight Market

Posted on October 27, 2017 by Karatzas Marine Advisors & Co.

The turnaround of the dry bulk freight market in the last eighteen months has been impressive and a welcome reminder that the shipping industry is an extremely volatile business. The overall Baltic Dry Index (BDI) has quintupled from March 2016 till now, while more spectacularly, the Baltic Capesize Index (BCI_2014) has decupled in the same period.

Still, in absolute terms, daily freight rates are just moving above operating break-even levels, and for vessels with recent or high mortgages, present earnings do not suffice to fully cover the financing cost component of the ownership. Such was the depth (and desperation) of the market that multifold increases in freight rates and barely managing to keep our heads above water!

The improvement of the freight market can be attributed to several factors such as delays in newbuilding deliveries in the short term (and precipitous drop in additional newbuilding ordering in the longer term), an accelerated scrapping pace for older and less-than-older bulkers (bringing the tonnage supply and demand balance to a relatively favorable equilibrium), a Chinese economy that keeps impressing with its strong demand for raw materials, miners that keep expanding supply (legacy projects, mostly), new trading routes and patterns expanding ton-mile, and yes, anti-globalization political rhetoric that seems to favor shipping by inserting inefficiencies in the world trade.

None of factors above single-handedly has driven the market higher, but all have contributed to a better shipping. As a word of caution, almost all of the above factors are reversible or cancellable on short order, and any thought of popping campaign bottles is premature. And still, there are several additional risk factors that still lurking in the background.

In past times, such a strong improvement in freight rates would had set dry bulk prices on fire. Vessels are valued on earnings, and quite often, on expected earnings (which explains, inter alia, how the shipping market finds itself flooded with newbuildings so often); a freight market that has been galloping ahead in the last few months would had triggered major asset appreciation and incited even loftier hopes for higher prices.

Given that capesize tonnage is the most volatile among the dry bulk sectors, we chose in the following chart to show the Baltic Capesize Index (BCI_2014) and the price of a 5yr-old capesize vessel since January 2015 (data by Karatzas Marine Advisors & Co. (KMA), and the Baltic Exchange to which KMA maintains membership). Back in January 2015, capesize prices were overvalued comparatively to the freight market and the index, as expectations and hopes were strong for shipowners to accept lower bids. A further dip where BCI dropped from 500 points to 250 points by early 2016, and capesize asset prices were dropping fast, from almost $38 mil to $25 mil. Since March 2016, the BCI_2014 index has decupled to above 3,000 points at present, but capesize asset prices have only moved up to currently $34 mil for a 5yr old capesize vessel. Quite a disconnect, a 35% increase in asset prices when the freight market is up by a multiple of ten (1,100%).

Capesize freight rates (LHS) vs capesize vessel prices (RHS) since January 2015: under-appreciating. Source: Karatzas Marine Advisors & Co.

Taking a broader look for other asset classes (panamax dry bulk, ultramax/supramax, and handysize tonnage) in the following graph, a similar trend of improving prices can be seen among all asset classes, in the range of 30-50%. There have been cases when dry bulk vessels were bought at the dark depths of the market in spring 2016 and a year later were flipped by as much as 130% actual profit, but those were few selected transactions, for older tonnage (and different economics and risk), and probably a few of those transactions were opportunistic with an element of luck. The corollaries to the story is that money can still be made in shipping for asset play (“buy low, sell high”) if timing is right, and that when shipowners were pounding the table to raise money to buy cheap ships were correct (but again, many of those owners were pounding the table to buy cheap ships at the peak of the market in 2013/2014). However, the real lesson is that there is a disconnect at present between freight rates today (and also freight rate expectations) and the level of asset prices in the dry bulk market.

Dry bulk vessel asset prices: hot, but not hot enough. Credit: Karatzas Marine Advisors & Co.

Lack of finance is, in our opinion, the real culprit for asset prices not being on fire at present (and this is not necessarily a terrible thing, in our opinion.) Shipping banks have been very tight with new business, capital markets and institutional investors are not perceiving shipping to be an industry of great prospects at the moment, and export credit from newbuilding nations is low on the list. Besides seed equity and selectively follow-ons in the capital markets and anecdotal evidence of ship mortgages from banks, financial leverage in shipping can be obtained from alternative capital funds, at levels that can easily exceed 10%; not necessarily too expensive, but barely sustainable unless one expects a great freight market looking forward.

Opportunistically dry bulk is still a great market to enter although the “easy money” has already been made in the early stage of the market bouncing from the bottom. We do not espouse a blind expansion strategy in the sector but there is an arbitrage opportunity for money to be made, especially where investments can be structured to minimize the (many) risks that are still lurking in the background. There are still cargoes to be moved worldwide, and contracts of affreightment (COAs) are still available, and strategic partnerships can be set, instead of someone jumping speculatively in the market, even today, when there is the disconnect of freight and asset prices.

A bulker in the Big Apple… probably looking for money? Image credit: Karatzas Images

‘Shipshape 10’ News for Week Ending November 13, 2016

Posted on November 11, 2016 by Karatzas Marine Advisors & Co.

The major event of the week of course has been the election of Donald J Trump as the 45th President of the United States. The event has been surprising as most predictors had this event as the less favorable outcome (“The American Brexit”); also, given that most of the election campaign took place on personal and not on substantive debating terms, there is has been lots of head-scratching since Wednesday morning on what would happen next; the major consensus is that the new Administration is in general in favor of anti-globalization, re-shoring, and higher barriers for trade (tariffs, ‘currency manipulator’ and anti-dumping have been heard with come frequency), the consensus has been that trade and shipping stand to suffer in the next four years:

1. Shipping Industry Feels Shock Waves From Donald Trump Election (The Wall Street Journal, Logistics Report)

2. On trade and expectations, America and the world, The Piecemaker (The Economist)

3. While in the same week, the United Nations Conference on Trade and Development (UNCTAD) published some sobering thoughts on the maritime industry: Review of Maritime Transport 2016 (UNCTAD)

4. In the short term however, the dry bulk market has had a great week, especially for the capesize market on behalf of coal trades to China:
Dry Bulk FFA: Market Explodes as Atlantic Cargoes Offer Ample Support (FIS)

5. An interesting reading on China and ‘One Belt, One Road’ from the respected Week in China:
All at Sea (Week in China)

6. Another week, and another shipping bank wish ‘Bon voyage’ to the shipping industry: Bank of Ireland joins other banks in shipping loan wind down (Reuters)

7. while, another shipping bank is looking to raise more capital; one gets the picture, with the shipping banks: Shipping Bank DVB Prepares Capital Increase (Reuters, via the Maritime Executive)

8. The Singapore Exchange (SGX) has formally closed on the acquisition of the legendary Baltic Exchange, producer of the well-known Baltic Exchange Dry Bulk Index (BDI); the transaction is indicative of a changing world, where shipping cannot be considered a stand-alone industry any more, while at the same time it seems that the center of gravity has been shifting eastwards: Baltic Exchange Takeover Complete (The Maritime Executive)

9. For some interesting reading on how shipping has been evolving, an article from BBC and Remote Container Management (RCM) technology:
How do you keep bananas fresh as they cross the oceans?

10. And, for those who wish to take a minute and smell the roses, actually feel nostalgic about the past and the times past, an interesting piece on lighthouses in Ireland:
Keeping the Fire of Irish Lighthouses Alive (The New York Times)

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