In late August, Hanjin Shipping, a South Korea-based containership liner company, filed for receivership in bankruptcy court in Seoul, a few days after its primary creditors announced their disapproval of the company’s restructuring plan.
It has been an open secret that the shipping industry is in terrible shape since defaults have been happening with almost metronomic accuracy. However, Hanjin is the seventh biggest containership liner company in the world, with almost 140 vessels under ownership and management, the premier shipping company of the export-oriented South Korean economy and it was bankrolled by several of the country’s state-run banks. In short, Hanjin was considered “too big to fail,” reminiscent of the banking crisis days in 2008.
One could say, that Hanjin’s filing caught many people by surprise; so much so that, at the time of the filing, $14.5 billion worth of merchandise was stuck in containers onboard Hanjin-controlled vessels.
The Hanjin bankruptcy petition is unique in several respects. First, despite the weakness of the shipping industry in the last few years, the next largest containership liner bankruptcy after Hanjin happened exactly 30 years ago (United States Lines in 1986), indicating that liner companies are better positioned than dry bulk and tanker companies to sustain the rogue waves of bad markets.
It really takes an exceptionally bad market to rock containership liner companies and now the industry is in the midst of one.
Filings of containership liner companies are inexecrable logistical nightmares where cargo from thousands of shippers gets derailed simultaneously in different legal jurisdictions and several ports worldwide, where port operators demand advance payment in order to dock and unload the vessels. Technically speaking, each of the containers onboard even on the same ship can constitute a distinct legal claim, with potentially thousands of claims just deriving from one of today’s monster behemoths.
The fact that containership liner companies operate in so-called alliances – in the CKYHE Alliance in the case of Hanjin Shipping – and that many of their vessels are chartered-in from other shipowners can only amplify the impact of the default, and potentially trigger a domino effect of more defaults by other companies.
In the case of Hanjin, Danaos, a publicly listed shipowner who charters out its vessels on long-term contracts (tonnage provider in maritime lingo), has approximately $560 million of outstanding contractual revenue now in jeopardy. This shortfall may force many of Danaos’ own lenders to take another look at the company and possibly demand more assurances in the form of equity, etc.
It will take some time for the Hanjin situation to settle, and given the circumstances of the company, liquidation is the probable outcome. Hanjin will be forced to sell its vessels to satisfy creditor demands. And with the company name severely undermined to command any customer loyalty, the company will soon be relayed to maritime history business books or feature only on the smokestacks of small vessels as a marginal, regional shipowner.
There will be litigation for the next couple of years with counterparties trying to salvage as much as they can from their unfortunate exposure to Hanjin. It is a sad outcome and an inglorious conclusion to an otherwise respectful effort to be a shipowner with global reach.
But, what has gone so awry?
For starters, the crisis in the shipping industry has been the worst of the last 30 years. Demand for shipping has been slowing down because of decelerating world economies, at a time when the world’s fleet is relatively new. Lots of today’s ships were financed and built when the shipping banks were expanding their balance sheets in the last decade. And this modern fleet keeps growing even today, due to the time lapse between placing a newbuilding order and the physical delivery of a vessel. Today’s ships were ordered two years ago.
There is a structural imbalance between tonnage supply and demand that will take time to tend to equilibrium. To understand just how oversupplied the market is, one has to consider that between February and August 2016, the Baltic Dry Index, proxy for the dry overall dry bulk market, more than doubled but dry bulk vessels today still do not earn enough freight revenue to cover their operating expenses.
The market is so oversupplied that it costs a shipper now on average $600 to have a container shipped from China to North America, but a containership liner company like Hanjin has to charge more than $1,500 for the same container in order to break even. It’s a bad market no doubt, with no easy solutions for a recovery, and with victims along the way.
While waiting for a swift and strong recovery, one has to ponder how companies like Hanjin came down so badly? How can a company with a strong contract base in its native Korean export industry and other manufacturers worldwide that is so well integrated into the world’s liner shipping network manage to fold so badly?
Poor strategy and financial mismanagement cannot be excluded, as of the 140 vessels operated by the company, only 40 were self-owned and the remaining 100 were chartered-in; effectively a form of off-balance financing where other shipowners’ ships were chartered at higher rates when market expectations were more optimistic.
This top-heavy house-of-cards has been burning $2 million per day between its contractual obligations to other owners’ vessels and what Hanjin was able to earn in the present market.
At current market rates, it would have cost $700 million for Hanjin to buy a year’s time for market recovery, $1.4 billion for two years’ runway. Bad markets can be bad for all shipowners, but they are unforgiving for those who are over-levered or least prepared.
And, this bad market is causing problems for many entities in shipping. It is not about problems in a vacuum any more, but cascading problems that have to be faced on a comparative and timely basis. As big and crucial as Hanjin has been as a shipping interest, and as solid and strong as their primary creditors have been, including the state-owned Korean Development Bank (KDB), there have been bigger considerations.
KDB had to bail out Korean shipbuilders and notably Daewoo Shipbuilding and Marine Engineering (DSME) earlier in 2016 at a price of close to $2 billion, given that the weak freight market has been causing defaults on shipbuilders as well, and not just shipowners.
In the summer of 2016, KDB also had to bail out a smaller domestic shipping company, Hyundai Merchant Marine, that was also affected by weak freight rates. Having spent lots of dry powder on DSME and HMM – and taking lots of heat domestically for using taxpayer funding to support preferred members of the chaebol nexus – when Hanjin decided finally to seek help, there was little political will left for support.
All players in shipping have problems these days, and there is increasing risk of a cascading effect. Extracting a solution requires one to be first to the altar while there is still some enthusiasm and dry powder and while a solution to one’s problems can be lined up within a greater platform solution.
There is still plenty of risk for contagion from charterers, shipowners, shipping banks, and shipbuilders, and being proactive is better than being reactive to a crisis.
Hanjin’s case is only one example of the shipping industry adapting to an oversupplied market, as many of the variables create headwinds for the industry, at least in the short term. From slowing economies to shipping banks leaving the shipping industry – a topic covered previously in these pages, shipping companies are facing a new reality and business model. Some will have to fail, but the survivors will have to have a bigger balance sheet, through consolidation and M&A, and a more efficient and lenient structure.