At unprecedented times, attention to details and minor concepts for the shipping appraisal practice
The COVID-19 pandemic has caused real turbulence to every lifestyle and everyday activities, whether social or business-related. Specifically for the shipping industry, while most of the focus currently has been on shipping operations and supply chain disruptions, questions have started arising on shipping asset valuations and values, and how these can affect underlying transactions and specifically shipping loans and leasing transactions.
There have been many inputs and variables to consider, and this still is a developing story, that seems to be running in parallel to developments with COVID-19, and also, to a great extent, in correlation to the oil industry.
For starters, there is a collapse in shipping asset secondary market transactions in the last couple of months; in terms of the number of outright sale & purchase transactions for the overall shipping market, year-to-day there have been 30% fewer transactions than same period last year. One has to keep in mind that shipping asset sale & purchase is not a fluid and smooth market even at the best of times, but definitely this year there has been a drop in terms of transactions, especially for certain asset classes like containership vessels. For other types of vessels such as Very Large Crude Carriers (VLCCs), and tankers in general, there has been stronger than usual interest, given the strong – but extremely volatile freight market, whose Brownian pattern is driven by the latest news of crude oil pricing and the prospects of the contango play.
The reason for the decline in number of sales can partially be explained due to operational reasons, as buying a ship requires a pre-purchase survey condition reporting and also crew changes, etc, activities that have been heavily curtailed in the last few months. Also, at a time of fast moving developments worldwide, for any shipowner, the focus has been on acting and reacting quickly and ensuring smooth vessels operations and trying to make the best out of a hot tanker freight market rather than on paying attention to ship acquisitions, unless, of course, there are vessels offered for sale at bargain prices. Thus, when it comes to shipping valuations, as far as the market comparable approach is concerned, there has been a lower volume of data-points, and values recorded have been processed via the COVID-19 lens.
Another shipping activity that requires extensive traveling and face-to-face negotiations is newbuilding activity. As one would surmise, overall newbuilding ordering has dropped by almost 60% so far this year when compared to newbuilding activity over same period last year. [Incidentally, other shipyard-related activities such as completion of vessels under construction, ship repairs, installation of scrubbers, etc have been running on slow motion as well.] Once again, in a fast moving and highly unpredictable world, making a decision that is expected to last several decades, such as committing to newbuilding orders, is very low on the list of priorities of shipowners and shipping companies. Given the declining outstanding orderbook and also declining commodity prices, logically, replacement costs for shipping assets likely to trend lower in the near future once the market returns to its (new) normal. But for now, we have to satisfy with the dearth of fresh data-points for newbuilding prices and the replacement cost new, when it comes to vessel appraisal process.
Besides the market comparable approach and the replacement cost approach, there is, of course, the income approach for appraisal purposes. The income approach is by nature the most “logically” inclined valuation methodology, but again, it contains hard to estimate variables for many years in the future, even under normal conditions; what the assumptions can be at the age of COVID-19 when we even do not know whether there will be any summer vacation time this year (and all what that entails to driving and fuel consumption, discretionary spending, etc) How does one estimate growth for the next couple of years when China, EU-28 and US have all reported several hundred basis points drops in growth and shrinking GDPs, when current unemployment in the US exceeds Great Depression levels and, brutally, we do not know what percentage of the workforce will survive this pandemic crisis? What would be the cost of capital and cost of debt for shipping assets looking forward when, between the Fed and the U.S. Treasury, more than $2.5 trillion have so far pumped into the system? Would such numbers be inflationary, deflationary or indifferent, and what the input should be for Weighted Average Cost of Capital (WACC) in DCF modeling? Apparently, the income approach method is hard to be applied for shipping assets under this market environment. As an exception, for vessels under long employment contracts whether as time-charters or contracts of affreightment (COAs), especially with bankable counterparties, the range of the variables for the income approach method gets narrower, even with the COVID-19 uncertainty.
Transactions of shipping assets in the secondary market still happen, despite the operational hiccups and the uncertainty. Pricing has been moving from last known data-points and “last done” transactions along the vicissitude of the freight market; for dry bulk and containerships, there is little to be excited in the freight market, so prices seem to slope downwards slowly; buyers tend to see a weaker market going forward. For tanker vessels, sellers wish to think that the currently strong freight market (due to storage and contango) will last and supersede even under a scenario of a global monstrous recession, and they keep their “ask” as high as they can; buyers of tankers, on the other hand, take a robust-future-freight-market claim at a discount-to-face value, but no-one can argue that tankers now are having a good six-month run between Iranian sanctions, OPEC’s inability to control the market and COVID-19’s slashing of market trends. For the offshore industry, the current market and COVID-19 have been the last nail on the coffin, but again, it has been a necropolis-like industry for a while in search of a resurrection miracle.
And, as one would expect, in an uncertain market environment with few data-points (some of them already biased), there has been quite a gap between “bid” and “ask” as buyers and sellers value shipping assets from a different perspective. In terms of the appraisal process, such gap between “bid” and “ask” can be shown as a greater gap between Fair Market Value (FMV), Orderly Liquidation Value (OLV) and Forced Liquidation Value (FLV). For definition of FMV, OLV and FLV please see here!
Besides a wider gap between FMV, OLV and FLV, we think that two additional terms of the appraisal process under the Uniform Standards of the Professional Appraisal Practice (USPAP) become relevant:
Hypothetical Condition is a condition made during a specific appraisal assignment which assumption is contrary to known facts; appraisals done currently may be based on last known transactions, transaction concluded on pre-COVID-19 reality (effectively assuming that the pandemic is not happening) are providing values based on a hypothetical condition level. Similarly, with
Extraordinary Assumption, an assumption based during a specific appraisal assignment which assumption is considered true but if proven true would materially affect the value provided. Little is still known on COVID-19 and according to some estimates, it may just be yet another crisis the world faces every so often; however, if this (extraordinary) assumption is proven false and COVID-19 turns out to be a historic event of epic proportions, then values provided today can be materially different with what reality dictates.
We appreciate that these considerations may be too esoteric by many people’s standards, but again, such concepts cannot be completely ignored when providing appraisals in today’s highly uncertain market.
In the last decade, catalyzed by the Great Recession, a great deal of the shipping financing has shifted towards corporate lending that is based on cash-flows (as opposed to pure asset-backed financing with ship mortgages); also, given that today’s shipping asset values are a fraction of those in 2008, any asset devaluation likely to be relatively small in absolute numbers (and, accordingly, a smaller problem for the banks than in 2008). Although financiers and lenders have considered re-appraising the value of their shipping asset portfolios, under the current circumstances, unless more is known on COVID-19 and also its impact on our lives and on business, any re-appraisal for now will be conditional and likely in need to be re-done in the next few months when hopefully more will be known.
Until then, let’s make do with market transaction data and try to draw as much info out of them as possible, not only in terms of numbers and values, but also “soft info” out of these transactions, such of the nature of the sellers and buyers, terms of sale, etc
And, let’s take solace in the fact that so far, shipping asset prices have not moved materially due to COVID-19. That’s something in and by itself, when the world’s most sought-after commodity, crude oil, was actually negatively valued at one point recently…
Basil M Karatzas is an Accredited Senior Appraiser (ASA), Accredited in Business Valuation (ABV), a Certified Marine Surveyor (CMS) and Fellow with the Institute of Chartered Shipbrokers in the UK. Basil is the Founder and CEO of Karatzas Marine Advisors & Co.