Hanjin Shipping’s collapse was a long time coming, and may not be the last we see in a sector that’s in a mess. Finbarr Bermingham tracks the decline of Hanjin, and finds an industry that has been complicit in its own downfall.
On August 30, Korean company Hanjin Shipping underwent the biggest collapse the sector has ever seen, as it became unable to repay its US$5.5bn debts. Creditors, led by the Korean Development Bank (KDB), called time on a company that was sunk by its bloated container shipping business.
When the sun rose on September 1, it found 400,000 containers on 85 Hanjin ships, carrying US$14bn-worth of goods, marooned at sea. Port operators, wary of shipping companies being unable to pay docking fees, container storage and unloading bills in the tumultuous decade since the financial crisis, refused Hanjin’s ships entry to many ports around the world. The company’s name, overnight, became toxic.
Some of the 8,000-plus cargo owners scrambled their own boats to unload goods from the stranded ships. Samsung Electronics alone had US$38mn-worth of electrical goods bobbing around the sea, most of them bound for the US holiday season. Hundreds of sailors spent weeks stranded at sea.
Checking into rehab
The collapse of Hanjin Shipping had been in the works for a long time. James Gellert, the CEO of Rapid Ratings, tells GTR that his company had flagged Hanjin and many of its peers as “very high risk for a few years”. But even if it wasn’t a huge surprise to ratings companies, it caught much of the industry off guard.
Gellert says: “The most directly impacted were companies that had goods on vessels: that’s been a significant disruption to supply chains. Secondarily there’s a spill-on effect: when one supply chain is disrupted it means someone else’s supply chain is disrupted, so you have the trickle effect.”
Before going bust, Hanjin handled 3.2% of global container cargo and 7.8% of the trans-Pacific volume for the US. This “trickle effect” is being felt most keenly in America, where West Coast imports took a hammering in September: cargo entering Long Beach, the US’ second-largest container port, was down 15% year on year, with Oakland losing 4.2%.
Hanjin’s collapse caused immediate chaos in the logistics business. Ordinarily, when a container ship docks at a port, it unloads its cargo and leaves with the containers on board – either empty or reloaded with outbound goods. However, since Hanjin wasn’t fulfilling any further orders, it dropped 15,000 containers at various ports around Los Angeles, where they were left to gather dust in warehouses, yards and carparks around California.
Thousands of abandoned Hanjin containers are still attached to chassis, the wheeled trailer used for moving containers. As GTR went to press, they had taken 13% of all the chassis in California off the market, causing panic ahead of the busiest merchandising season of the year.
Comically, the Hanjin Miami was stranded offshore in New York for days, because nobody was sure how it would return to sea without the weight of reloaded containers. Without the containers, the Miami would have sailed too high in the water to fit under the Bayonne Bridge. A compromise was eventually reached, whereby the ship was temporarily loaded with enough ballast to make it under the bridge.
The financial impact is likely to feed through in coming months, but judging by the list of creditors Hanjin published on its website in October, it will be far-flung and deep.
The list consisted mostly of industry peers, such as container owners, bunkering companies, fuel providers, terminal operators and freight forwarders. There are more than 3,000 creditors (these debts are not included in the US$5.5bn default figure), all unsecured by collateral, meaning that their owners will have to take a haircut on the repayment – if they get anything at all.
This is the reality facing most companies exposed to Hanjin, particularly since a court in Seoul granted the company rehabilitation protection in September. Essentially, this means that the company’s assets cannot be seized to repay debts. A receiver will try to sell assets and manage Hanjin’s decline in an orderly fashion.
“In simple terms it gives the receiver breathing space to organise a gathering of debts and termination of contracts to see if there’s a company that can be saved at the end, or whether it is so indebted that the best thing for it is to put it into liquidation,” explains Beth Bradley, legal director at law firm Clyde & Co, who specialises in Korean shipping.
Hanjin then sought to have those proceedings recognised around the world, to stop creditors arresting Hanjin vessels when they docked. In the weeks after the collapse, the Hanjin California was arrested by Glencore in Sydney, while the Hanjin Rome was detained in Singapore.
At the time of writing, the protection had been recognised in the UK, US, Japan, Singapore and Germany. Others are pending in Belgium, Holland, Spain and Italy with possible proceedings to follow in Australia. Some jurisdictions, including China, won’t recognise foreign bankruptcy proceedings, meaning any ships that dock there are ripe for the picking.
But for a few months at least, Hanjin ships are safe in many of the world’s trading hubs.
Past the point of rescue
South Korea is the world’s third-largest exporter of container cargo, behind China and the US. Shipping and shipbuilding are synonymous with Korea Inc., providing huge levels of employment and prestige as the country blossomed into an exporting powerhouse. One of the most obvious questions to ask after the collapse, then, was: why did the Korean government allow the world’s ninth-largest container shipping company to fail?
Of the secured debt – the US$5.5bn Hanjin defaulted on – 20% is owned by international banks (a look through Hanjin’s records on the Company’s House website shows outstanding mortgage debt to banks such as BNP Paribas and Crédit Agricole, most likely for ship purchases). The remainder is owed to Korean banks, primarily the state-owned KDB, according to Rahul Kapoor, a maritime analyst at Drewry Financial Research Services.
When the KDB and other Korean lenders announced that they would not be extending support for Hanjin, Hanjin’s debt-to-equity ratio was 850% and it had been ambling along unprofitably for a number of years, as had its domestic rival Hyundai Merchant Marine (HMM).
The companies, between them, handle most of South Korea’s exports and employ tens of thousands of Korean people. But having had its fingers burnt by previous bailouts (last year, Daewoo Shipbuilding and Marine Engineering was handed a US$3.77bn rescue package by the KDB), Seoul officials were faced with a stark choice: continue to back two losing horses, or concentrate efforts on returning one to health.
“HMM is struggling: it has huge debt. But Korea can’t let go of both its container shipping companies. It’s a major exporting country, they have Busan terminal, one of the biggest shipping terminals as well. They let Hanjin go, but it was give or take in that respect,” Kapoor tells GTR.
Both Hanjin and HMM had been given a number of months to restructure their commercial contracts and sell off assets to reduce their debt burden, with the threat of losing any additional financing if they failed to comply. Hanjin failed, and the KDB pulled the plug.
“I was in Seoul the week they sought rehabilitation protection and my impression there was of surprise that the KDB and the Korean government had allowed one of their jewel ship lines to go into rehabilitation measure, but the converse is that their debt position has been so high it’s difficult to justify using taxpayers’ money to fund them further,” says Bradley.
The KDB realised that there was no point throwing good money after bad. Hanjin was operating in a market that was arguably a major downturn away from complete collapse.
In the weeks after the bankruptcy, Hanjin’s chairman Cho Yang-ho told a parliamentary hearing in Seoul that his company “lost the game of shipping played among large shippers”. The implication is that without government support, any of the big shippers could have failed. His point has merit: but to exempt Hanjin from blame in creating the conditions in which government backing is necessary would be glib.
Container ships are described by the OECD as “the work-horses of the globalised economy”. They are intrinsically linked to trade, so when trade is booming, so is shipping. Throughout the 1990s and 2000s, the growth rate of global trade was double that of global GDP. Even as the financial crisis hollowed out the global economy, shipping’s salad days continued with the commodities boom, spurred primarily by the unprecedented growth of China’s industry and infrastructure.
“Over 13 years in dry bulk cargo we went from the ships achieving the highest peak of over US$120,000 a day to US$6,000 today. The same happened with container ships,” says Rasmus Kilde, who worked as a ship charterer for British shipbroker Simpson Spence Young until it closed its Indonesian office this year.
But the boom didn’t last forever: China’s economy has slowed and commodities markets have crashed. As trading and production habits change, shipping lines are getting shorter, while underlying economic conditions are arguably not much stronger than at the turn of the decade.
Michael Lum, a political risk underwriter at insurance company Beazley, tells GTR: “The statistics suggests that for the second time since 1950, GDP growth has outstripped container traffic. One factor of low traffic is the shift in production and manufacturing patterns, where these activities are taking place closer to their markets – not to mention the current global aversion to bilateral, let alone international, free trade agreements. This is creating very tough operating conditions which ultimately benefit the fittest and nimblest.”
Across the board, much of the post-financial crisis supercycle has been built on debt and defined by bad decision-making. Container shipping – bloated and over-leveraged – epitomises this largesse.
The madness of the sector can be seen in the fact that as global trade growth is flat-lining, companies continue to bring more ships online. The world’s four largest container ships are due to set sail in 2017. Built by Samsung Heavy Industries for Mitsui OSK Lines, each will have a deck as large as four football fields and will stretch 1,300 feet along the ocean, holding more than 20,000 containers apiece.
Consider that there are a million twenty-foot equivalent unit (TEU) slots already available on container ships around the world, and the industry’s extravagance is clear. Throughout the boom years, the top shipping companies built more and more, bigger and bigger, in an effort to reduce the cost of each container. In the last decade, the maximum container ship size has doubled. These actions have little root in economic reality.
Detached from reality
A 2015 OECD report exploring the impact of megaships describes “the complete disconnect of ship size development from developments in the actual economy”. In a traditionally cyclical sector, where amplified periods of over and under-capacity are the norm, and which are reflected in fluctuating freight rates, the last few years have been abnormal.
Huge orders were lodged amid economic stagnation and now, the levels of commerce needed to absorb this capacity simply does not exist. The OECD report presciently forecast “shipping lines building up overcapacity that will most likely be fatal to at least some of them”.
Mining is another industry anchored to macroeconomic cycles, and there are clear parallels to draw between the two. Dotted along the Queensland coast, abandoned coalmines act as headstones for the freewheeling boom years in Australia. Many mine owners still pay rail and port operators fees for infrastructure access even though the mines are defunct. Rival mining giants are sharing assets in a bid to desperately cut costs: the folly of making big money investments without any consideration for what happens when the music stops.
Speaking from his office in Jakarta, Kilde can see the similarities with the coal industry there. “It’s exactly the same. The shit hits the fan and investments are too high. People made good money on the coal industry in Indonesia five to seven years ago, but they thought prices were going to stay high. Now they’re not able to mine because their production costs are too high.”
He adds: “If you twist that around to a ship, everybody went out and invested in new tonnage in the shipping industry to keep their costs down and make as much money as possible on the container. But they forgot to take ships out of the equation.”
To compound matters, as shippers were bringing megaships online, they weren’t disposing of the ships they already had. Rather than selling them to scrapyards, they sold to other shippers. The excess capacity was not being taken out of the market, it was shuffled around.
You’re left with the ridiculous overcapacity that plagues the market today. Removing Hanjin would make some difference, but 3% is – if you’ll excuse the pun – a drop in the ocean. There was an immediate spike in container rates after the collapse, but that was a product of opportunism rather than market forces.
“There’s no reason why it [the spike] should be maintained,” Zvi Schreiber, the CEO of online freight marketplace Freightos, tells GTR. “The fundamental reason for low prices was significant overcapacity in the industry: about a million free slots on ships, due to building too many ships and due to world trade not growing as fast as expected. 3% from Hanjin is a lot less than the overcapacity.”
From what we know about the sector, we can assume that even as Hanjin sinks, its ships will sail again. As long as there’s a buck to be made, there will be a company willing to buy cut-price vessels from the KDB and other creditors and put them to work. If the bank recoups 40% of value, most experts would consider it a good deal.
The world’s largest container shipping company Maersk Line has already been mooted as a potential buyer, while the bailed-out HMM may also acquire some of the fleet. Shipping is moving towards a new phase, one of “consolidation”. The benefit to the industry, however, will be limited.
The Lehman of shipping
“In general, we welcome consolidation – M&A as well as alliances. The container shipping industry is fragmented and consolidation will enable carriers to create economies of scale and to optimise networks,” Maersk Line’s Asia Pacific CEO Robbert Van Trooijen tells GTR in an email exchange. He echoes the views of his boss Soren Skou, the company CEO who said this year that “there are enough ships in the world”.
Maersk Line is weaning itself off its megaship addiction, in favour of acquisition. But one carrier absorbing the ships of a defunct rival is not going to do anything to reduce the levels of overcapacity in the market. If the ship is owned by Hanjin or Maersk, it’s still the same ship.
Consolidation, of carriers and ships, may allow companies to be more efficient and cut costs, but it will not magically produce more cargo for them to transport. Nor will it address some of the industry’s fundamental issues.
Schreiber also warns that consolidation might add to the industry’s price-fixing problems. In September, South African authorities raided the offices of six shipping companies, including Moeller-Maersk and MSC, over allegations that they colluded to fix incremental cargo rates between Asia and South Africa.
Rapid Ratings data, compiled for GTR, shows what a sorry state some of the most important companies are in. The data looks at five companies: COSCO, Evergreen, Hanjin, HMM and Moeller-Maersk, finding that the average gross profit margin is just 0.37%.
Debt to assets averages 54.11%, while the return on assets rate is -5.81%. Only Maersk is rated as being low risk, with the others either medium (COSCO), high (Evergreen) or very high (Hanjin and HMM).
“What I see from the core health perspective, the longer-term efficiencies in the companies, I see weakness across the board,” Rapid Ratings CEO Gellert says. “From a 30,000-foot level, looking at the ratings of the group, they’d really better get their minds around it [overcapacity] as quickly as they can, because the long-term prospects for all of them are quite challenged.”
There is the hope that Hanjin’s collapse may act as a reality check. In the aftermath, the CEO of Hong Kong-based container shipper Seaspan compared it to the collapse of Lehman Brothers. Gerry Wang said: “It’s a huge, huge nuclear bomb. It shakes up the supply chain, the cornerstone of globalisation.”
In the sense that it shook people’s misconceptions of the market, Gellert agrees with the comparison. In commodities too, the bankruptcy of MF Global in 2011 shook the industry to the core and had long-term ramifications. As an established, erstwhile successful player with significant market share that went to the wall, taking with it a complex supply chain, the company bears many similarities to Hanjin.
“In a handful of industries, we have seen seminal bankruptcies that change the way people feel about an industry from a comfort level. I believe that’s what is going to happen with shipping,” says Gellert.
Size is not a proxy for risk management. As with banking and trading, no shipping company is too big to fail. We can be sure the effects of Hanjin’s collapse will permeate the industry for years to come.
