Distressed???

Last year, everyone you spoke with was searching for "distressed" deals. First, after the drybulk market collapsed, hedge funds, private equity funds and shipowners alike were chasing banks, shipyards and owners begging to be privy to distressed deals.  The drybulk market rebounded and values started to rise with very few distressed assets being sold. Then tanker rates fell off a cliff and everyone is now switching their focus to this industry in search of the distressed deal. It has become the "White Whale" of the industry, vultures are all circulating the distressed banks and owners waiting to jump at the first chance of a distressed deal. These deals, rumor has it, will offer returns far in excess of a typical deal, making the investors rich beyond their wildest dreams.

But will there be enough bloodshed in the industry to create such "once in a lifetime" opportunities? Hell, are these deals really even that great if they do arise? Let’s review the specifics of a said distressed deal, and see if they would really exist or be worth it at the end of the day.

The definition of a distressed asset/liability from the Financial Times is: An asset that is put on sale, usually at a cheap price, because its owner is forced to sell it. There could be various reasons for this, including bankruptcy, excessive debt and regulatory constraints. Debt itself can be sold on to a new owner at below face value (distressed debt).

So in order for an asset to be distressed it must have been purchased at a very high price and now the owner is being forced to sell it at a discount because of problems or lack of cash flow. The truth is that the tanker industry is characterized by strong owners and there have been several years of high earnings so there are a lot of reserves on the sidelines that should help them make it through these tough times.  In addition, as long as owners are willing to make their loan payments, banks are not going to go after the assets. Banks are also very slow to take any write downs that may cause increased downward pressure on values, and start a spiraling effect. Even if the the owners refused to pay and the banks were to act, it appears that there are so many vultures waiting for distressed deals that the prices will be bid up to non-distressed levels.

One type of distressed deal we are hearing about is where a bank has seized an asset and transferred the liability to a stronger shipowner. The terms of these deals typically allow the shipowner to purchase the vessel with little or no equity up front as long as they assume the liability on the vessel, but with values where they are today this liability is usually higher than the true value of the vessel in the open market would be. These deals also include a typical profit sharing agreement with the bank, so any earnings the vessel makes would be split by some predetermined formula. Does this sound like a great deal for the owner, lots or risk and little upside?

The only place we can see distressed deals occurring is at the shipyards, since if an owner has walked away from a deal, losing their deposits, the shipyards may be easily able to lower the price of a newbuilding to a lower level using the forfeited deposit as a subsidy. But even these deals are rare and everyone is fighting to be part of these deals, which will again cause the assets to be bit up to possible pre-distressed levels.

Given the above information, we don't expect to see many distressed deals in today’s markets unless the banks turn very aggressive against owners, or that rates stay very depressed for a longer period of time. We think a lot of people will be severely disappointed in their continued search for distressed tanker assets.