On a positive side, the collapse of SVB is not remotely as troublesome as the banking crisis of a decade ago, when banks were casually making “NINJA loans” (no income, no job, no strong asset collateral); this time, the trouble started not with bad loans—something to possibly be expected from a bank specializing in the niche start-up world whereby lack of creditworthiness as expressed by cashflows is the default scenario— but due to poor risk management when the maturities of the bank’s bond portfolio and deposits were terribly mismatched.
Irrespective of the cause of SVB’s failure and the emergency actions of the Fed and the US Treasury, the risk of market contagion is very tangible, both in the US and also overseas. In the US, regional banks seem most vulnerable, while internationally, big names such as Credit Suisse and Commerzbank have seen their share prices take a dive. For an industry where faith (credit) is of paramount importance, the contagion concern is the biggest problem to have after an actual default proper.
No doubt that for time being, smaller and larger banks will focus on maximizing “cash at hand” strategy; better to keep more cash around than necessary; it’s sort of “cash is king” again days, at least for now. Once again, out of abundance of precaution and even at a cost of a negative impact of return-on-equity rather than come remotely close to a run-on-a-bank scenario.
What would such new attitude mean for the market? What would mean for the marine industry?
At the very least, as banks take another look of their risk assessment, one would expect that any transactions already in progress ought to expect delays, as another layer of checks to be instituted, at least for time being. Likely, legitimate deals that were on a path to approval will see their day in the sun, but after some delays. A month of delay or more, time will tell. Transactions on the margin of acceptance likely to be rejected, after first getting delayed for allowing for an extra “looksy” first.
And, as banks pull back, at least for time being, both to preserve their cash and re-assess their risk profile—especially under the scenario of a contagion—market activity likely to come to a crawl. This necessarily may not be a bad scenario, broadly speaking, as it may actually get the Fed’s job done, actually getting to slow down the economy; after seven interest rates increases in 2022, the U.S.—and world economies—still going strong, with the Fed was found at the crossroads of having to trade into un-chartered territory to tame inflation.
As a historical parallel, Paul Volcker stopped increasing interest rates in the 1980s after the Continental Illinois National Bank and Trust Company collapse during the S&L crisis, and the hope is that the Fed again stop increasing interest rates having the banking system execute on its mandate.
In any event, the outcome will be a cooling economy, and that will mean lower asset prices: lower asset prices due to lower earnings and freight (cooling economy) and lack of plentiful debt financing, thus requiring more equity.
Lower marine asset prices have the possibility of negatively impacting portfolio reviews, especially as compared to 2022 asset price levels, whereby replacement cost values were in the stratosphere. A mark-to-market based on reduced marine asset prices can actually cause real trouble, as it can trigger actual losses and setting aside additional reserves.
For not bank-related debt financiers, i.e., opportunity credit funds, private-equity-sponsored lessors, etc., the current developments may be manna from heaven. With the banks pulling off from conventional debt financing and/or tightening credit criteria, non-regulated debt financiers will see more deal flow, and more importantly, less competition, and accordingly able to pass along higher costs and/or achieve higher returns.
You see, the ballistic increase of interest rates by the Fed in the last year was unexpected. It was not just that interest rates increased seven times in the twelve months in 2022, but the fact that they were increasing by seventy-five base points (four consecutive such increases), gargantuan steps for a Fed that opts to mostly move in minimal and well-orchestrated steps of twenty-five base points at a time. There have been concerns that such rapid increase of rates would have cause trouble with “stress points” but generally it was considered that borrowers with heavy debt loads at un-hedged interest rates would be the weaker link the system. At least, we know that certain banks with exposure to niche markets (i.e., start-ups, crypto, commercial real estate, high net worth individuals, etc.) comprise the weakest links in the system.
The rapidly increasing interest rates of last year likely to cause trouble for borrowers in the marine industry in other ways, as we understand that a sizeable number of ship mortgages and other debt financing were addictively done at historically low interest rates and with a cavalier attitude that a low interest rate environment was the new norm, and thus interest rates hedging costs unnecessary. It’s not documented how many of the debt financings of the last few years were “naked” or with floating interest rates, but we think it’s not a negligible percentage. As long as sufficiently high freight rates (able to support high interest rates) do not fall due to a cooling economy, there will be limited loan defaults. And, a loan default scenario that may be a real problem, for both international and also domestic shipping.
Marine asset values—for both international shipping and the Jones Act market—have been coming down—for most types of vessels, but not all—as the cost of capital (higher interest rates) kept increasing; a declining equities market and higher market risk also pushed the Weighted Average Cost of Capital (WACC) higher, too. Replacement cost values remained stubbornly high—due primarily to logistics supply chain disruptions—but values on the income appraisal method had been declining (and also, under the market comparable method,, in general). The knee-jerk reaction to the SVB’s collapse will further make cost of capital even higher, further weighing on marine asset values.
Otherwise, the direct fall-out from the SVB situation on the shipping industry seems minimal at least. After all, and despite the recent very strong activity in start-ups, fin-tech, HiFi, online shipping finance platforms, etc. in the shipping industry, SVB’s core business and that of shipping could not have been further apart. And, to the extent that it’s known, with the start-ups in the marine industry lacking any meaningful clusters—least of all any concentration in the Palo Alto area where SVB was HQ’ed, no shipping start-ups were expected to lose their deposits with SVB even before the Fed stepped in to make depositors whole, well beyond the $250,000 FDIC maximum guaranteed.
Once again, banking is on much sounder ground now than it was during the financial crisis, and the present contagion concerns seem a generally well-fenced scenario. The main concern however remains that interest rates had been too low for too long, un-historically low, and many parties—some banks and borrowers—took that as a certainty in terms of borrowing practices and also maximizing banks’ equity returns by looking for optimal yield at the risk of mismatching maturities. A re-set may be on the cards, now.
Contributed by Basil M Karatzas
https://www.linkedin.com/in/basilkaratzas/
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