Making Money While Reducing Exposure

It is all well and good that companies are extracting themselves from their obligations at a price. DS Norden A/S (“Norden”), on the other hand demonstrates that it can do it while turning a profit. Of course it is advantaged by its long-term charering-in strategy. In this instance, the company agreed to sell 2 Panamax and 4 Handymax bulk carriers for a gross price of $175 million yielding a $13 million profit after it exercises the purchase options and resells the vessels.

Following the sales, NORDEN expects total proceeds of USD 247 million and a profit of USD 25 million from already agreed sales of vessels in 2009. In 2010, proceeds of USD 140 million and a profit of USD 30 million from already agreed sales of vessels are expected.

Default II

In a report earlier this week, Fearnley Fonds reported that “Armada’s Singapore unit filed for bankruptcy following defaults by Fortescue Metals amounting to about USD 200m over the duration of contracts to 2014 and defaults of contracts worth about USD 170m with an unnamed Indian charterer. “The cumulative value of the total number of claims which the company could be facing in the course of the next few days, or weeks, at the very least, would be in the region of USD 500m,” Managing Director Tommy Jensen Rathleff said in the filing. Among a host of 64 creditors, Kawasaki Kisen is owed about USD 95.5m, while Transfield Shipping is owed USD 113m, according to an affidavit filed by Armada. With rates at current levels we believe there will be more bankruptcies within the dry bulk market.”

Default I

On the last day of the year, U.S. Shipping Partners filed an 8-K with the SEC announcing that it had failed to pay the interest and principal due under its senior credit facility ($332.6 million), which triggered an event of default. As a result of such failure, the lenders (CIBC, Lehman and Keybank) holding a majority-in-interest of the outstanding loans may declare all outstanding amounts immediately due and payable and to pursue their rights and remedies under the agreement. However in this instance the holders of a majority-in-interest had entered into a forbearance agreement the day before with the partnership pursuant to which they have agreed to forbear from taking any action or exercising any remedy permitted under the senior credit agreement as a result of the partnership’s failure to make the December 31st payment. The forbearance agreement terminates on the earliest to occur of: (i) February 10, 2009, (ii) the occurrence of any event of default other than the failure to make the December 31st payment and (iii) the failure to comply with the terms of the forbearance agreement. During this 40-day period, the parties agree to engage in good faith negotiations regarding restructuring and strategic alternatives, which shall include the possible sale of the partnership.  It should however be noted that the lender’s prior waivers relating to covenant defaults for the third and fourth quarters expire on January 31st. Unless waived or amended, the partnership will be in default under the terms of the forbearance agreement as of that date.
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Yes, The Markets Are Open

A few weeks after Ship Finance’s foray into the equity markets, Nordic American Tanker Shipping Ltd. (“NAT”) announced on Wednesday an underwritten public offering of 3 million shares pursuant to the company’s effective shelf registration statement. Morgan Stanley, acting as bookrunning manager, has agreed to purchase the shares which will be “offered for resale from time to time in negotiated transactions or otherwise, at market prices on the New York Stock Exchange prevailing at the time of sale, at prices related to such prevailing market prices or otherwise.” We have highlighted the key points in our guts of the deal below.
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“‘Twas the Night Before Christmas”

It is never to late to talk about a Christmas miracle and it appears that Messrs. Zoullas and Ginsberg of Eagle Bulk Shipping may have pulled one off. Although we do not know Mr. Zoullas all that well, we are well acquainted with Mr. Ginsberg’s capabilities under fire having watched him carefully manage the demise of the Nakash Brothers’ (Jordache ) adventure in shipping through its Kedma operation in the mid-1980s. With little support from the owners and the assistance of a chartering man, Alan was a proverbial one-armed paperhanger. In what was previously one of the most turbulent times in shipping, Alan was fixing, scrapping and repairing ships. Payables and receivables were carefully managed, as there was no cash. Yet somehow the banks, of which RBS was one, were paid off. Alan’s performance, in his first baptism under fire, created great credibility with the banks and will stand him in good stead during these times.
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Interest Rate Swap Linked With Freight Rates

By Evangelos Hahos, Chemnav Inc.

(How to pay lower interest when markets are down and higher interest when markets are up)

Interest rate risk
Cash flow is all companies’ lifeblood. Shipping companies, apart from the technical – operational and asset value risk, mainly face two risks:

1.     Freight rate risk (cash inflows from hires / freights).
2.     Interest rate risk (resulting from bank loan financing).

Traditionally, shipping companies have been bank financed and faced the implied exposure to interest rate risk (pricing at US$ Libor plus margin basis).

During the last two months, interest rates fluctuated very fast to both directions, and consequently interest expense borne by companies changed significantly.

Traditional interest rate risk hedging instruments
Several structures have been evolved in the past for interest risk mitigation.

Swaps, collars, floors & caps, futures, forwards etc. represent simple instruments contrary to more sophisticated and “financially engineered” structures  (tailor made swaps, options and swaptions, embedding more parameters and features, i.e. Bermudan, European or Asian styled, straddles, butterfly options etc).

Advantages of traditional interest rate risk hedging instruments
If such instruments are properly and timely contracted, the company will benefit from normal and predictable fixed interest payments and cash flows, irrespective of the market fluctuations.

Thus the company’s exposure will be limited to operating risks & costs, which are highly predictable for experienced owners – managers.

Drawbacks of traditional interest rate risk hedging instruments
Such tactics provide steady interest expense but are not interrelated with freight risk. Consequently the company pays fixed interest expense irrespective of its income.

Vessels’ cash flows operating in the spot market, without interest rate hedging are exposed to both freight and interest rate risks.

With shipping in prosperity phase interest expense is multiple times covered by daily income and thus becomes “immaterial”.

With falling markets a few hundred dollars’ savings a day in interest and operating expenses turns a negative cash flow to break even or positive.

Interest rate swap linked with freight rates
Alternatively for vessels operating spot an interest rate swap linked with freight rates can be structured and offer the following advantages:

•    Link interest expense with freight rates. Higher income in spot market, pay increased interest rate. Lower income in spot market, pay reduced interest rate.

•    Flexibility to operate in the spot market together with the security of lower interest expense in recession periods.

•    Competitive advantage in recession periods.

•    As provided in many loan agreements, the applicable margin is subject to hull to debt ratio. Thus, the company on the one hand will pay increased margin due to deteriorated hull to debt ratio (as per loan agreement) but on the other hand it will benefit from lower interest payment.

•    This instrument is not necessary to be tailor made to a certain vessel’s loan. The management may hedge a certain notional amount that will match the average vessels’ number (and total loans) operating in spot market.

Factors that should be taken into consideration
•    Such instruments require the payment / receipt of significant cash flows and consequently several assumptions should be taken into consideration.

•    In abnormal global economic conditions such as the current one (both freight and interest rates are too low), the effectiveness of this instrument depends on the time contracted and the terms provided.

•    The timing as well as, the freight market and the interest rate expectations are very important factors in establishing the pricing and structure of the interest rate swap linked with freight rates.

•    Basis risk. During the lifetime of the instrument, the vessels should be able to earn the average of the “linked” index.

•    The correlation of the reference index with the spot market where the vessels operate should also be taken into consideration.

•    Swap agreements, are separate legal documents. Consequently if the company sells the vessel, this swap should be treated as a normal swap transaction i.e. it should be either unwound, or transferred to other vessel’s loan, or kept for speculation purposes.

•    Financial instruments are marked to market. Unless this strategy meets the very strict “hedging” criteria of accounting and reporting frameworks, the difference in the marked to market value of the instrument will be charged to the profit and loss account.

Conclusions
No hedging transaction is a panacea.

Owners’ risk appetite should be in parallel with the hedging strategies chosen from a plethora of alternatives available (FFA’s, SPFA’s, swaps, options, forwards, futures etc).

Improper and ineffective hedging becomes speculation with expensive and possibly catastrophic results.

Market awareness, timely information, proper risk management and luck can make the difference.

Mr. Hahos is the Chief financial officer of Chemnav Inc. He can be reached at +30 210 6200975 and ehahos@chemnav.gr

Derivatives and Bankruptcy: Where do the Safe Harbors Begin and End?

By Barbra R. Parlin, Partner & Francois Janson, Senior Counsel, Holland & Knight LLP

Swaps. Repos. CDOs. CMOs. Commodity futures. Options. Currency hedges. Credit enhancements. Freight forward contracts. Once the sole province of Wall Street investment banks and brokers, these and many other types of derivative instruments have become a common part of the every day business strategy of many enterprises such as airlines, utilities, manufacturers and retailers.  In fact, trading in derivatives has become a key method by which enterprises that are reliant on commodities such as heating oil, jet fuel, corn, or bauxite that are subject to wide market price swings, or which trade globally and thus are subject to fluctuations in currency exchange, moderate or hedge their risk.

In the United States, derivatives can be traded on national exchanges, such as the New York Mercantile Exchange (“NYMEX”) or the New York Stock Exchange (“NYSE”) and this on-exchange trading activity typically is accomplished through a broker or other professional.  Trades on a national exchange are made subject to the rules of the particular exchange and its self regulating organization, as well as any applicable federal or state statutory or regulatory scheme.  Millions of derivative transactions also are entered into privately, “off exchange” or over the counter (“OTC”), with the trades negotiated directly between two counterparties.  In many cases, individual OTC transactions are entered into and made subject to master netting agreements between the trading parties that follow a form developed by the International Swaps and Dealers Association (“ISDA”).  The ISDA form contains the non-economic terms, such as termination, acceleration and liquidation rights, of each OTC trade, while the economic terms, such as rate, price, term, volume, set forth in individual confirmations that can be generated electronically or on paper.   Although the ISDA form is widely used, in some cases the documentation may not be so formal or even complete.  Derivative trades often are not closed and cashed out, nor are they settled in hard goods.  Rather the parties’ obligations to each other are rolled over and the obligations netted out on a daily, weekly or other basis, with the “out of the money” party making a margin or net settlement payment or increasing the collateral it posts to offset its liability to the counterparty.  The ability to continually net, roll over, and demand additional margin or collateral are key to the smooth functioning of the securities, commodities and derivative markets.  Indeed, these trades are often done back to back, such that in one instance a party is a seller and in the next a buyer.

What happens, then, when a party to one of these transactions files for protection under the United States Bankruptcy Code, 11 U.S.C. § 101, et seq.?  Does the music stop and if so, who has the power to stop it?  Can a debtor continue to trade and when and under what circumstances would either the debtor or a non-debtor counterparty want to do so?
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Shipping, Finance, and Insolvencies: The Black Swan Comes Home to Roost

By Jeremy J.O. Harwood, Partner, Blank Rome LLP

In 2007, in discussing the new Bankruptcy Code chapter, Chapter 15, in respect of foreign bankruptcy cases, we wrote “international financial markets ‘correct’ themselves…. [t]he international shipping industry, which has seen all time highs in recent years, may ponder its own fate.”1 In March of this year our article on the same subject was followed by the question “A Homeport In The United States?”  The Chapter 15 filing of Britannia Bulk PLC (“Brit Bulk”) in the New York Bankruptcy Court on November 17, 2008 is evidence of the Black Swan2  (“what you don’t know is more relevant that what you do know”) coming home to roost in the U.S. Bankruptcy system.  This note will examine the Brit Bulk filing; the efficacy  and practical purpose of Chapter 15 filing for maritime companies in New York and re-cap the primary requirements and effects of Chapter 15.
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Marine Bankruptcies – U.S. Chapters 11 and 15

By Holland & Knight Marine Bankruptcy Team – Nancy Hengen, Jovi Tenev, Jim Hohenstein, Arthur Rosenberg, Francesca Morris

A U.S. or foreign company may reorganize its business as an ongoing concern under Chapter 11 of the U.S. Bankruptcy Code (in which it is called the “debtor”), and, if successful, it may emerge from the Chapter 11 proceeding with modified debts and other contracts. If not successful, the Chapter 11 reorganization will mutate into a proceeding in which the debtor liquidates and goes out of business. Chapter 11 is considered a relatively debtor-friendly process that allows existing corporate management to remain in charge of the debtor, preserves jobs for employees, and allows the debtor to renegotiate, affirm or reject executory contracts (e.g. contracts requiring future performance by both parties).  Chapter 11 has been widely used by such entities as airlines to operate their businesses and preserve assets from being seized by creditors while also forcing renegotiation of onerous contract terms (such as union labor contracts and other agreements).

Chapter 15 is a relatively new section of the U.S. Bankruptcy Code,h which is designed to recognize and provide mechanisms for transferring control of a non-U.S. debtor’s U.S. assets to the debtor’s non-U.S. bankruptcy proceedings.

Chapter 11 and Chapter 15 are both part of the legal framework that should be considered by a potential debtor, as well as by its secured and unsecured creditors and contract counterparties.  Some of the highlights of each of Chapter 11 and Chapter 15 are described below.
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Surviving the Present Shipping Cycle: A Shipbroker’s Perspective

By Basil Karatzas, Compass Maritime Services

Who ever would have thought that shipping in 2008 would have been replete with pyrotechnics?  While the fireworks at the Beijing Olympics in late August were definitely epoch defining, they were also eerily symbolic for the spectacular growth of shipping in recent memory.  The minute the Olympic flame was extinguished, it seems the breath of the markets has gone with it.  The freight indices, the broader Baltic Dry Index (BDI) and the narrower Baltic Capesize Index (BCI), both hit all time highs in late May and June 2008, but by early December 2008 both indices recorded all time lows, both indices down more than 90% from the peak.

While a slow down in shipping was widely expected by virtue of the fact that freight rates and asset prices were too high to be sustainable in the long-term, few people could have seen that we would experience such a summer-winter inversion with an almost calendar precision.  We are not sure what the exact cause of the present turmoil was, but the following could all be logical explanations: reduced demand after the Olympics-induced super-boom in China; reduced demand due to recessionary pressures worldwide; sub-prime loans and real-estate speculation; commodities inflation and speculation; lack of trade finance; de-leveraging of banks’ balance sheets; lack of financing (debt and equity); excess tonnage supply; the overextended state of the consumer worldwide; the high cost of raw materials; excess of liquidity and easy credit that caused asset inflation, commodity inflation and oversupply of tonnage.
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