What a Month!

We do not specialize in the analysis of financial markets and we cannot really point to direct and tangible consequences of the decision made yesterday in the House of Representatives. However, with the almost daily news about banks either folding or being bailed out by governments, the cost of funding and the limitations on funds available for lending leads us to believe that the current situation with respect to the financing of ships is going to get worse.

In addition to this, we are still in a situation where asset values are very high, and this goes for both ends of the age specter of the fleet: Vessels that are close to the end of their useful trading life (say, 25 years+) and modern units (less than five years) are all valued at extremely high levels. Two examples: a 1982-built Capesize was sold in September at 35 MUSD - the current scrap value is about 16.5 MUSD. Using the BSPA assessment, a five-year-old Capesize is currently worth 133 MUSD - this is about 138% of the corresponding newbuilding price. Pre October 2003 (when dry bulk markets took off) the ratio between five-year-old vessels and newbuildings was on average 81% for the preceding 12 years. Conservatively, assuming this ratio to be representative for the coming few years, the value of a five year old Capesize could fall to about 78 MUSD (given a stable newbuilding price). In other words, there is a downside of more than 50% for the “oldies" and around 40% for modern units.

These calculations can be carried out over the full range of sizes and ages, but the result is the same: prices are insanely high and the downside is huge.

This is where the banks come in. They, as well as most players in the market, know about current and historical pricing, and we believe it will become increasingly difficult to get projects past credit committees on the basis of current prices. We have witnessed in recent months that banks are reducing their exposure with projects that easily would have obtained a 70% mortgage financing 12 months ago now only receiving 50% (if at all) today.

The recent dramatic turn of events in financial markets will not make financing any easier, and we are of the opinion that we are not even close to the end of this ride. If the US housing market is the original root of all evil, it is significant to remember that the proposed package of USD 700 billion is only about 6% of the estimated USD 11.9 trillion housing mortgage market. If we are to include a slew of other troubled sectors on top of this, we believe that the proposed rescue package may be far too small to fix everything in a few months. So far this week (and it is only Tuesday…), three European and one US bank have been saved by governments. So far this year, 13 US banks have collapsed (in addition to investment banks and insurance companies) and another 123 banks are on the FDIC (Federal Deposit Insurance Corp.) watch list.

Outside the financial sector we also observe commodity prices falling and softening demand growth for raw materials in general, but for metals in particular. We also observe that inventories are high in several regions and that buyers are trying to postpone contractual deliveries of raw materials. Maybe not across the board, but we observe early signs of weakness for e.g. iron ore, steel scrap, and fertilizers.

Summing up, the current financial crisis is definitely impacting banks’ ability and willingness to finance vessel acquisition. The current high but declining asset values add to the uncertainty, and as if to add insult to injury, deteriorating freight markets are a cause of real concern.

From here the immediate future doesn’t look too bright.