The shipping & offshore sector has been one of the most active parts of the restructuring market over the last couple of years given the low oil price environment and the consequential reduction in oil companies’ offshore capex spend. Certain segments in the wider shipping market such as dry bulk and container also continue to be plagued with overcapacity, uneconomic rates and lack lustre returns for investors.
We see these challenges continuing throughout 2017 with little evidence of optimism that market dynamics are going to change over the next 18-24 months. A number of companies, particularly in dry bulk and container segments, have withstood the challenging conditions so far, but with cash buffers eroding some inevitably will face a financing crunch this year or next.
Restructurings for these businesses often involve complex capital structures with multiple creditors (bondholders, bilateral and/or syndicated banking facilities, lease/charter creditors and significant liabilities with shipyards and shipbuilders) lent into a web of special purpose vehicle (SPV) companies.
Intercreditor tensions, coupled with poor market conditions make reaching a consensual deal extremely challenging. Consequently, there have been a number of insolvency filings in the sector recently e.g. Swiber, Atlantic Offshore, and restructuring filings, for example Ultrapetrol, Toisa Ltd to name a few. That said, insolvency generally remains an unattractive option without careful planning to preserve value.
The most successful restructurings have laid out clear principles from the outset and have engaged with all stakeholders - not just lenders and shareholders - so that, where possible, common ground can be established early in the proceedings.
Inevitably in the circumstances, sticking plasters have been applied in a number of cases in the hope of better pricing conditions materialising by the end of the decade. We expect some of these companies will require a second round of restructuring in a couple of years’ time to address over-levered capital structures and in some cases to shore up liquidity with new money.
Since the middle of 2015, performance across the shipping sector has declined markedly, as illustrated by the 'relative performance' chart, which compares the Dow Jones Global Shipping Index with the S&P 500. Whilst the decline bottomed out in 2016, as yet there is no sign of a significant uptick. Further, the turmoil created by the high-profile failure of Hanjin in August 2016 sent shockwaves through the container and dry bulk segments. In dry bulk there were also ongoing challenges, as throughout much of the year most owners struggled to obtain freight rates that allowed them to operate at break-even.
From a debt perspective, distress has largely been focused in offshore where there have been a number of defaults and amendments for offshore supply vessel (OSV) and rig companies across a range of bank facilities and bond debt. The Nordic high yield bond market has been particularly hard hit with the 12-month trailing default rate for oil & gas related corporates (including a number of OSVs) reaching 38.4% by the end of 2016 (Source: Stamdata).
Source: Datastream, PwC analysis
In its recent outlook for 2017, Fitch predicts that there will be more defaults in the sector, unless there is a recovery in economic fundamentals. In our view, given the anaemic outlook for the offshore industry (with oil majors shifting capex to onshore projects), there will continue to be more defaults in the coming year. For other shipping segments, we are seeing a number of cases where the absence of any market correction in supply-demand dynamics for vessels will necessitate some restructuring of debt in due course.
During 2016 the level of distress in offshore companies has been particularly acute for a number of reasons:
binary nature of contracts for vessels. Utilisation of vessels has been correlated with contract activity and as contracts have either been terminated, or not renewed utilisation has largely dropped;
significant overcapacity of vessels resulting in a marked supply-demand imbalance, this has led to:
a) an increase in lay up of vessels – particularly for production support vessel (PSV) and anchor handling tug supply (AHTS) operators (see figure below); and
b) lower contract and spot rates for those vessels which are utilised.
low incentives to scrap - given the relatively low cost of laying up and young age of certain fleets;
declining asset values - impacting covenants and loan-to-value (LTV) ratios; and
high levels of gearing going into the downturn providing limited buffer to withstand weak market conditions.
Restructurings for offshore companies have focused on ensuring sufficient liquidity, which in general appears to run to 2020. However, in most cases the deterioration in earnings for vessels has reduced the ability to service existing interest and amortisation profiles, resulting in unsustainably high leverage levels. Consequently, absent any upturn in the market, there is likely to be a second wave of restructuring in 2018 / 2019 that will need to address over levered capital structures and upcoming maturities.
For 2017, initial indicators suggest that, rather than seeing a recovery, exploration and production capex could fall by up to 15%. Hence our short-term outlook is that demand will fall even further in 2017 and it may be at least 2018 before there is any potential recovery. For many OSV players, this could result in a higher level of lay-ups and lower utilisation of vessels.
Significant headwinds have continued to put pressure on the dry bulk and container segments, which, largely, have been characterised by low freight rates and deteriorating asset values. Both segments continue to suffer from over capacity relative to the likely demand outlook over the short to medium term. In 2016, there was some increase in scrapping and re-phasing of new deliveries in dry bulk, which appeared to support a modest improvement in rates, but not sufficient to shake-off the longer term trend of the last few years.
For container, the failure of Hanjin Shipping, one of the largest recent casualties, provided further evidence that the industry cannot continue in its current form. The outlook appears to show relatively strong supply growth against a backdrop of benign demand, therefore there may be continued pressure on crude rates over the course of 2017. Many of these trends also apply for the product tanker market.
Source: Data stream
For 2017, we see that weaker credits across these segments will continue to utilise cash to fund ongoing operating losses and that absent, a market uptick, or any significantly operational turnaround we would expect to see available liquidity reducing. Accordingly, we will see borrowers likely looking to amend facilities to increase operational headroom.
During 2016, there was continued divestment of shipping portfolios by German and UK banks. German banks with shipping exposure of c.€70bn (based on 2015 data) face significant regulatory pressure to reduce their exposure and there have been several processes run by RBS, NordLB, Commerzbank and HSH Nordbank. The increasing capital ratio requirements from the banks, and the imminent Basel III implementation, will place a higher pressure on the banks’ capital intensive shipping portfolios which may translate in further divestments.
This has two consequences. Firstly, owners may struggle to refinance due to reluctance on the part of banks to increase exposure, so may need to turn to alternative sources of financing, either in the bond market or from alternative investors. Secondly, the opportunity remains for new investors to acquire shipping assets at a discount. That said, significant differences can be expected between the price expectations of buyers and sellers constraining the level of deal activity. Banks with poorer credits, or non-performing loans, may therefore have to continue to work these out.
For a number of corporates, particularly those in dry bulk and container, 2017 is likely to be decisive year. Many have withstood the challenging environment so far, but cash buffers are continuing to erode, and absent new sources of liquidity some will inevitably face a financing crunch either this year or next.
We expect further restructuring activity across the sector, whether in the form of simple resets/ waivers of covenants, involuntary refinancings, or even ship enforcements. In particular, offshore will remain deeply distressed with reduced activity and increasing pressure on liquidity, which will give rise to new money requirements for some and a greater pragmatism to deliver sustainable capital structures.