There has been a renewed interest in the dry bulk sector. Is this a sign of a real reversal of fortunes in dry bulk shipping or something else?

In early 2016, Emanuele Lauro, CEO of the publicly traded dry bulk carrier Scorpio Bulkers, told The Wall Street Journal: “We will go under if this market persists.” His comments followed his company’s fire sale of six new ships, a threat of delisting on the New York Stock Exchange and the hemorrhaging of cash.

A year later, Lauro told industry analysts, “We’re generally pleased with the developments of our company.”

So, have the fortunes of Scorpio Bulkers – and rival dry bulk carriers for that matter – really changed so dramatically? The answer is no. But that hasn’t stopped at least some optimism from creeping into the industry.

Optimism with a Caveat

The key to this outward confidence isn’t strictly bottom line. Pretty much all the publicly traded dry bulk carriers continue to lose money, some at an alarming rate. That’s largely because their revenues can’t keep up with the huge debt they must service.

Instead, the optimism stems from a belief that cargo rates will improve sufficiently enough to buoy ship values, which remain close to historic lows. Since most loans are asset backed, and are based on a percentage of the asset’s value, a boost would mean these companies aren’t sailing so close to the edge.

“When the value of ships increases, there’s more room for error,” explained Basil Karatzas, who heads New York-based Karatzas Marine Advisors & Co., a ship brokerage and advisory service.

According to a new market survey by Arctic Securities, five-year Capesize ships have begun to increase in price, but, as of the end of the first quarter of this year, are still 45% less in value than what they were three years previous.

Scorpio, in its annual report last year, addressed just how low values had sunk. At the end of February 2016, “Panamax five-year old prices of approximately $11.0 million were at their lowest since the 1980s,” the company wrote. “However, from these lows, second-hand prices have shown some improvement, with Panamax five-year old values reaching approximately $14.0 million at the end of 2016.”

Some of the bigger carriers should be able to renegotiate loan terms, based on this assumption of an increased value in the future. “Refinancing should be possible given our view of a tighter market balance and higher rates going forward,” said Jo Ringheim, an analyst with Arctic Securities, based in Oslo, in an email. Ringheim added that improved asset values will “make refinancing easier and cheaper for the companies.”

Golden Ocean, for example, in early 2016, convinced creditors to amend certain loan terms. According to a recent Golden Ocean company presentation, that refinancing reduced the company’s cash break-even level by 25%.

Creditors gave carrier Star Bulk a similar lifeline last year, agreeing to defer repayment of principal owed from June 2016 until June 2018.

However, these actions and similar actions by rivals merely buy companies time. “They are not clear yet and need a market recovery in order to avoid dilutive capital transactions for shareholders,” said Ringheim in the email. “Golden and Star Bulk both need to refinance maturing debt in 2019 in order to stay away from restructurings or capital injections. That said, these are quality ship owners that will manage to do so given our optimistic view on the dry bulk market.”

Golden Ocean lost almost $18 million during the first quarter of this year, largely because it had to pay more than $12 million in interest. Star Bulk didn’t fare much better. During the first quarter of 2017, it lost about $16 million, with interest payments totaling $11 million. Star Bulk’s total debt stood at $976 million, while Golden Ocean topped $1 billion.

Even Scorpio has successfully renegotiated much of its debt, loosening loan conditions and extending payments. It has improved its financial picture substantially by cancelling or selling the contracts to 32 newbuildings. It now boasts a fleet of 46 Kamsarmax and Ultramax vessels with an average age of 1½ years.

What are the Banks Banking on?

So far, at least, creditor banks have been willing to throw most shipping companies extended lifelines. “Banks are being negotiable,” said Karatzas. When asked why aren’t creditors coming down harder, Karatzas replied: “They don’t want to take a huge loss now,” he said. “They’re trying to buy time.”

There are exceptions. One is the perpetually distressed DryShips, which hasn’t been able to dig its way out of financial trouble despite selling off most of its fleet and suspending repayments of loan principal. After banks refused to renegotiate loans, late last year, George Economou, DryShips’ biggest shareholder and company CEO, lent the company $200 million in a revolving credit from another of his companies, Sifnos, which paid off most existing loans.

Then, there’s Eagle Bulk Shipping, which declared Chapter 11 bankruptcy in 2014. It appeared last year to be on the verge of another bankruptcy filing, when it fashioned a restructuring with some lenders of so-called second lien debt, loans that are second in line to collect. This pretty much wiped out shareholders’ equity. Earlier this year, Eagle Bulk announced it was acquiring nine Ultramax ships from Greenship Bulk for a total of $153 million. It then announced the ships would secure a new $100 million credit agreement.

The biggest bank lenders are aggressively trying to trim their loan portfolios. Perhaps the most active has been HSH Nordbank, once the biggest ship lender in the world, owned by the German states of Hamburg and Schleswig-Holstein since the global financial crisis in 2009. The bank’s shipping portfolio value is down to €6.7 billion, a decline of almost €10 billion in less than three years. Part of this decline can be attributed to selling off loans at a huge discount. More was because the bank offloaded last year €5 billion in non-performing loans to its shareholders. It holds only €1.8 billion in bulker related loans. Still, some 26% of these are considered non-performing, according to a bank presentation.

Bankers, in turn, have blamed private equity for pumping up shipping companies with cash, which has enabled even more vessel purchases. Three years back, maritime fund management company Tufton Oceanic said private equity and hedge funds invested some $32 billion in shipping between 2012 and 2014 alone, according to a Reuters report. Believing that the shipping industry was poised to recover, PE firms bought existing companies, set up new ones, acquired ships and even bought out loan books on shipping assets from banks.

Dry bulk was no exception to this splurge. When the recovery stalled, private equity subsequently tried to sell off many of its investments, although they remain reluctant owners.

Private Equity

One of the biggest examples is private equity firm Oaktree Capital, which now owns 51.4% of Star Bulk, as well as 18% of Eagle Bulk.

Other companies have raised more capital by issuing shares to the public. Diana Shipping, for example, raised $70 million in a public offering in April. The company said it would use all the money to acquire two Post-Panamax vessels and a Kamsarmax vessel, all built in 2013.

Scorpio was even more aggressive. Last year, it had two public offerings that raised almost $130 million.

Despite being the financial equivalent of the Demolition Derby, DryShips has acquired 17 vessels this year. It’s done so by issuing new shares at a blistering pace. According to the investor website The Motley Fool, DryShips in three weeks increased outstanding shares by 370%. This came days after the company engineered what’s called a reverse stock split, issuing one share for every five held before, to avoid being delisted on Nasdaq, because its share price was below $1. That share price has retreated once more and looks headed toward ruin. The company has lost 90% of its stock market value in the past month, and more than 99% this year.

Leaving aside DryShips, analysts have begun to be more bullish on some of the larger dry bulk carriers, including Golden Ocean, Star, Eagle Bulk and Scorpio. Again, that feeling of optimism is linked to the value of the ships. According to Arctic Securities analysis, a 10% increase in ships’ value translates into a 22% jump in the company’s net asset value, or NAV, which is defined as total assets minus total liabilities. Stock pickers often look to net asset value as a leading indicator of company health.

The relationship between asset value and lending goes something like this: A financial institution will lend a percentage of the ship’s value, say, 70% of the purchase price. If that value goes down, then the borrower has to cover the difference, or renegotiate, or take out another loan. If, on the other hand, values go up, borrowers will either have a great financial cushion or can borrow even more money.

If, for example, ship asset values return to the 2014 levels, Golden Ocean’s net asset value will double and its net loan to value, or NAV, will fall below 40%, according to Arctic calculations.

Of course, that’s a big if. And some of the bulk carriers have already paid a huge price for the loss in value of their fleet. Scorpio, for example, wrote down the value of 24 ships and construction contracts by more than $400 million in 2015.

Scorpio, in its annual report, explained just how far new builds have fallen. According to the carrier, Panamax bulk carrier newbuilding prices in Japan “peaked at $56 million in the third quarter of 2008 and subsequently fell to $29 million in the final quarter of 2012. By the end of 2013 Japanese prices had climbed to a 38-month high of $35 million, chiefly as the result of recovering newbuilding demand, and remained at similar levels through much of 2014. However, prices entered a downward spiral in 2015, which continued into 2016 and, by the final quarter of last year, Japanese Panamax newbuilding prices reached their lowest level since 2003 at an estimated $23.5 million.”