Moral Hazard Case Study: Hanjin Shipping
Not a week has passed since we posted an article on The Maritime Executive’s website about moral hazard in shipping and already the shipping world has got a big-proportioned, real-life case study of the risks in the industry. We argued that when shipowners are over their heads in debt with little promise of ever recovering any equity, they care precious little about financing, operations, trade, safety and even the environment.
Last week Hanjin Shipping, based in South Korea and the world’s seventh largest containership company, filed for protection in South Korean courts and subsequently started filing for protection and restructuring in several jurisdictions worldwide, including the United States federal bankruptcy court (filing for Chapter 15 restructuring in Newark, NJ). As of the end of this year’s second quarter, the company had outstanding obligations of close to $5.5 billion, approximately $900 million of which is due by the end of 2017. There was approximately $700 million in equity on the balance sheet.
Hanjin stands as the manager of 142 vessels, 98 of them container ships and the rest tankers and bulkers. Only one-fourth of Hanjin’s fleet – 38 vessels – is self-owned. The other 104 are chartered in from leasing companies and other financially-minded shipowners. The ownership mix indicates more of a light-asset trading company than an asset-heavy, shipowning balance sheet. The current value of the owned fleet stands at roughly $1.7 billion.
Many details are still too opaque and covered by bilateral non-disclosure agreements, but where several of the counterparties have been publicly listed companies one can draw certain conclusions: Hanjin had chartered in two 2010-built Capesize vessels from publicly listed Navios Maritime Partners (ticker: NNA), the MV Navios Luz and MV Navios Buena Ventura, at a daily rate of $29,356 each when the average daily spot rate for Capesize tonnage was barely $6,000 during the last year. Presuming that Hanjin was trading the vessels on the spot market, they were each losing $23,000 every single day for the last year.
That’s $16 million down the drain for just two vessels in the last year alone!
But it gets even worse. Each of the vessels had more than four years of employment remaining with the shipowner. Presuming that the spot Capesize market would remain at present levels, Hanjin stood to lose another $90 million for the two vessels.
Similarly, eight containerships chartered in from Danaos (ticker: DAC) had charter payment obligations of approximately $565 million while three Neopanamax containerships from Seaspan (ticker: SSW) had outstanding charter obligations of close to $370 million. These obligations add up to over $900 million. Under present market conditions, reasonable estimates would be for losses of more than $500 million. And these are the calculations based on publicly available information for only 13 of the 104 vessels chartered in with only three counterparties. There are unaccounted obligations for more than 90 vessels that have been chartered in from other owners.
$23,000 in losses every single day in the last year for each of the two Capes chartered from Navios. Talk about destruction of value!
House of Cards
What options does a “shipowner” such as Hanjin (effectively a structured house of cards) have under the circumstances? As one would suspect, very few. There is little in the way of equity. There is little in the way of collateral. There is lots of debt, most of it in relatively unsecured position since it's in the form of charter obligations for the leased-in vessels.
Playing devil’s advocate I would ask surreal but economically oriented questions. How much vested interest does the shipowner have in the assets and the business? Precious little, at this stage. What are the odds that they will recover any equity? Probably better than hitting the jackpot in a national lottery, which we all know is not a fair proposition. What would any rational economic being do under the circumstances? Briefly, either plead for mercy from their creditors or, having little to lose, just stop paying them and pass the buck to the other side – what we called moral hazard in the previous posting.
Hanjin had been rumored (along with its compatriot Hyundai Merchant Marine (HMM)) to be facing financial problems and was an accident waiting to happen. HMM, being slicker and faster and part of a big chaebol (traditional corporate conglomerate structure in South Korea strongly affiliated with family management style and running businesses deemed strategically important to the State in exchange of the State’s preferential treatment), managed in August to find its way out of its financial pickle.
When Hanjin tried to secure additional financing from its lenders (mostly Korean banks and the state-owned Korean Development Bank), there was little empathy. This made perfect sense as the lenders were in a relatively preferred senior position and any new financing would be considered either “throwing good money after bad” or diluting their position and getting lower on the scale of claimants. It made economic sense to refuse any new financing and let the unsecured creditors (that is, the shipowners of the 100+ vessels on charter to Hanjin like Navios, Diana and Seaspan) accept a less demanding solution.
Again, Hanjin and its major financers decided to drop the moral hazard bomb on the parties with a lower legal claim, the shipowners of the vessels.
Passing the Buck
Hanjin Shipping is the seventh largest containership company in the world but has only about a 3% market share, thus belonging in the lower tier of containership companies as compared to behemoths like Maersk, Cosco, MSC and CMA CGM. A default by Hanjin cannot be expected to have a major domino effect on the overall shipping or containership markets. The majority of Hanjin’s lenders are Korean banks, including the Korean Development Bank, and the Korean banking system (and the Korean taxpayer, if so required) can absorb the losses without posing a systemic risk to the nation’s economy, at least at this stage.
Hanjin had been a major carrier for LG electronics, but again, even Hanjin’s demise would not be detrimental to LG and the Korean electronics and manufacturing industries. Why? Because with HMM’s successful restructuring in the summer, there was now an alternative, an alterative based in Korea itself (subsequent reports state that LG has already been shifting its shipments to HMM). Thus, once the situation was “ring fenced” and the fallout was determined to be contained, Hanjin and its main creditors stopped paying the lower-standing creditors (other shipowners with charter-in tonnage). An example of moral hazard in all its glory.
Hanjin has filed for restructuring (not for liquidation), expecting to find a way to save the company as a going concern over the long term. However, owners of vessels on charter to Hanjin, companies like Danaos, Seaspan, Navios and many other smaller, private owners, stand to lose the most. In an oversupplied market of low freight rates, it will be difficult to withdraw their vessels from Hanjin and seek equally profitable charter rates elsewhere in the present market.
They will more likely have to accept the lower and extended rates that Hanjin will offer them and possibly some equity upside if and when the company recovers. Otherwise, they will have to seek legal remedies, which are costly and time-consuming and always risky in terms of whether there will be a chance to ever collect. After all, the events of the last week have shown that Hanjin is not systemically important to the Korean economy, that there is little Korean constituents have to lose, and that there is little left for Hanjin’s management and shareholders to lose. Heads I win, tails you lose.
A case of moral hazard of the highest caliber. – MarEx
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.