Maritime Currency Hedging Concerns

Transcription

1 Maritime Currency Hedging Concerns The falling dollar, an outgrowth of the ongoing credit market turmoil, has inflicted collateral damage in unforeseen ways. Earnings seasons always bring about surprisesthe only word that can be used to describe the reactions of analysts in Hong Kong and Norway, where Jinhui Shipping & Transportation ( Jinhui ) is dually listed. While the analysts were looking for strong 3Q 2007 earnings on the back of the strongest drybulk market in decades, Jinhui (which had attracted an 18.2% investment from Peter Georgiopoulos s savvy team at Genco Shipping & Trading) surprised both stock watchers and bankers. Instead of reporting earnings in line with the USD 21 Million consensus, 3Q profit came in at USD 9 Million- with the company blaming foreign exchange movements. For its part, Genco, playing the role of minority investor, was still holding a USD 96.2 Million unrealized gain on Jinhui shares (bought through the Norwegian market)- which are not consolidated into Genco s accounts. Its income statement did show a USD 0.5 Million gain, in 3Q 2007, on a foreign exchange forward hedge designed to protect its cost basis in the shares- but not the shares themselves. Throughout 2007, the US dollar, an important currency in shipping, has been dropping, on fears of a U.S. economic slowdown. Since mid August, when the sub-prime crisis emerged, the US Dollar Index (with symbol USDX, a measure of the greenback against a basket of Eurozone and five other currencies including the Japanese yen) has fallen from a level of 82, moved down as low as 74.5, before inching back up to around In theory, the dollar is a suitable currency for international shipping because most revenues are dollar-denominated. Where expenses are also in dollars, exchange rate risk is reduced. But challenges arise where revenues and expenses move out of kilter. With the vessel ordering boom that has occurred over the past few years, major mis-matches have occurred when big capital expenditures were incurred in currencies not pegged to the dollar. Jihnui provides a partial case in point. At end November, 2007, its on-the-water fleet consisted of eighteen modern drybulkersmainly in the Supramax class, complemented by a dozen chartered ships. Its orderbook reveals a capital program of nearly USD 871 Million (USD equivalent), with 22 vessels (mainly Supramax) slated for delivery through 3Q Eight of the vessels have been ordered from the Shanghai Shipyard, with the remaining 14 from top flight Japanese yards, with capital needs concentrated in 2008 (USD 228 Million) and 2009 (USD 218 Million).

2 In between the lines of its recent investor presentation, Jinhui was surprised by the strength of the Japanese yen during late 2007, which rose from around 123 ( / $) to 108 between midyear and late November. Yet, the situation appears to be more complex than simply a case of strengthening liabilities moving from the unrealized to realized accounts. Traditionally, Jinhui has had a predilection for the speculative markets. Even when its ships have been fixed on time-charter contracts (where fuel and operational risks like weather are transferred to the lessee), it had previously reported out-sized profits on trading of Forward Freight Agreements (FFAs). After an FFA loss of roughly USD 62 Million, in 2004, after liquidating long positions, Jinhui swore off such trading. Subsequently, long FFAs appreciated in value. Inside a late November 2007 press release, Jinhui reveals that its yen-sensitive activities went beyond hedging its shipbuilding commitments, saying: With the unexpected appreciation of Japanese Yen against United States Dollar during the quarter due to unwinding of Japanese Yen carry trades in the financial markets, the Group suffered from the loss on those long term forward foreign exchange contracts and options. In the typical carry trades, financial speculators would borrow in Yen (with minimal interest rates) and then purchase dollar denominated US Treasury securities, hoping for gains on interest rate arbitrage. Though vastly different from a shipbuilding contract, the depreciating Dollar has the same impact, in this case a quarterly exchange loss of roughly USD 28.6 Million and a resulting abstinence from paying a quarterly dividend. Jinhui, unwittingly a casualty of the Sub-Prime Crisis (with its weakened US currency), has now committed to tighten up its risk management. In promising not to pile on currency risk, it says: The total hedged notional amount including leveraged notional amount, if any, should not exceed the original expected underlying exposure and tenor; and the Company should monitor the mark-to-market values frequently of its underlying assets/liabilities on hedging instruments. At the end of 3Q 2007, Jinhui s Yen liabilities for Japanese vessels under construction (net of deposits already paid) totaled YEN 27.1 Trillion, worth roughly USD 235 Million at current exchange rates. Included here is the remaining 90% due on a YEN 4.1 Billion contract with Sumitomo Oshima shipyard for a Supramax entered into early November. An additional 10% progress payment, in Yen, is due in November 2008, with the balance- 80%, due, in Yen, at various intervals in 2012, when delivery will occur. In its new guidelines, the Buyers state: <Jinhui> will hedge the expected currency risk by means of derivative instruments including forward foreign exchange plain vanilla contracts, purchased options and option-combination strategies. One listed owner that got it right is New York based Eagle Bulk Shipping, like Jinhui, a specialist in sub-panamax drybulk ships. At the end of October, 2007, Eagle s orderbook consisted of 31 vessels, five of which will be delivered in from Japan s IHI yard and have been priced in Yen. The balance, priced in dollars, will be delivered from the Yangzhou Dayang Shipbuilding Co., part of China s Sino Pacific Group.

3 Eagle explicitly states that it does not hedge its revenues and expenses, all in US dollars, but says that it has entered into foreign exchange swap transactions to hedge foreign currency risks on its capital asset transactions (vessel newbuildings). The swaps are designated and qualify as cash flow hedges. In describing three of these ships ordered in the first half 2007, Eagle reveals a per vessel price of YEN 3.83 Billion each, with deposits amounting to USD 38.1 Million funded through borrowings from its <RBS> credit facility and the borrowing costs are capitalized and recorded under Advances for Vessel Construction. In the first half of 2007, Eagle entered into foreign currency swaps on YEN Billion (the equivalent of USD Million). The activities of D Amico International Shipping, which raised EURO 73.5 Million in an April 2007 IPO, highlight the challenges for companies with purchase options- rather than firm commitments to acquire tonnage. During 2006, DM Shipping ( a joint venture between D Amico- with a 51% share, and Mitsubishi) exercised an option to purchase two 46,000 ton product tankers with 2009 delivery from a Japanese yard. D Amico s share was an aggregate YEN 4.55 Billion, according to filings, which add that the vessel will be financed through long term bank debt and shareholder loans from both partners. D Amico states explicitly that its growth strategy: which may involve the acquisition of additional new buildings and secondhand vessels, which may be acquired under purchase options. begging the question of how currency hedging is handled. D Amico exercised a purchase option on a chartered in 2004 built vessel and purchased a yen forward contract for YEN 3.72 Billion in order to hedge the Yen exposure, that matured in Feb. 2007, shortly before the delivery of the vessel. The option price, USD 32 Million, was well below the USD 48 Million market value when the Buyers took delivery. Similarly to Genco s currency hedge (to protect the value of its paper ships in the form of shares), D Amico income statements showed the impacts of mark to market on currency forward contracts. A forward yen contract to hedge the cost of the DM Shipping newbuilding vessels is being held off the balance sheet, with YEN 4.32 Billion of payments still due. Currency risk begins when the exercise of an option is declared. Where options have not been declared (the case with more than a dozen vessels that it had on charter), D Amico offered the following guidance on its policy The exercise price of ten of these options is in Yen and we usually do not hedge our foreign exchange exposure to the cost of these options. Because of the actions of Chinese bankers, and their export promotion efforts, currency hedging has not been an issue for buyers from the burgeoning shipbuilders in China. Chinese policies towards currencies may eventually move towards a free float. Both the United States and European Union are engaged in high level dialogues regarding the West s desired appreciation of the Chinese currency- the Yuan. Typically, Chinese exports (in this case, ships) are priced in US dollars. The shipyards, upon receiving dollars, have relied on the Chinese State owned banking institutions to accomplish the conversion into Chinese currency. Thus, Chinese deals at Jinhui and Eagle are priced in dollars. From the time being, as long as the Chinese banking system keeps the Yuan

4 under its grip, not permitting it to rise precipitously, dollar pricing will be the norm for Chinese sellers. In past market cycles, particularly at times when the banking system was less flush with liquidity, the Japanese trading companies, or Sogoshosha, played an important role in marketing Japanese ships to buyers struggling through difficult markets. In providing a turnkey purchasing role, currency convertibility was part of a larger package. In the summer, 2007, Quintana Maritime engineered the purchase of a USD 92 Million Capesize bulk carrier delivering in 2008 from Japan s Imabari yard, through Itochu- one of Japan s large trading houses. An alternative strategy, when dealing directly with Japanese yards- is to simply insist on the Dollar as the currency of choice. Tsakos Energy Navigation (with an NYSE listing and symbol TNP ) has had long standing relations with Japanese yards. TNP s Chief Financial Officer (CFO), Paul Durham, told Janes: "We currently have eight vessels under construction for delivery To date, we have paid about a third of the total contract price out of own cash and expect to pay the remaining amount of USD 310 Million through debt, of which half has already been arranged. Six of the eight vessels are Aframax tankers under construction at Japan s Sumitomo yard, with the other two sourced in South Korea. Market observers have been cautious about credit woes touching the maritime sector, and expressed concern about bank finance going forward. Nevertheless, TNP, in talking to multiple lenders, is confident that finance will be available. Paul Durham added: We are considering proposals for the remainder and we are confident that we can complete arrangements on favourable terms". Durham told Janes: "All the contracts for our vessels under construction in Japan were fixed in dollars as a matter of policy. As a consequence, we have not had to hedge against possible adverse foreign exchange movements with respect to our newbuilding program". Other unintended transport impacts have emerged in the wake of the financial turmoil reverberating from the States and the resultant weak Dollar. Ship lessor FSL Trust, one of three such Singapore-based maritime trust vehicles, took the decision to price its shares in Singapore currency, rather than in US Dollars (which has softened within its band against the Singapore dollar). Mr Cheong Chee Tham, CFO of FSL Trust Management Pte Ltd (the trustee-manager) told Janes that the currency switch: is meant to facilitate easier trading for investors and also to enlarge the universe of potential investors as some Singapore insurance companies and funds can only invest in S$-denominated units. The FSL Trust recently used a US Dollar credit facility to fund the US Dollar purchase of two ice classed tankers. According to Cheong, There is no impact on the accounts and financial statements of the Trust. It will continue to report in USD and similarly declare distributions in USD.

5 FSL s move comes at a time that General Electric Commercial Aviation Services (GECAS) has pulled the IPO of a Singapore trust vehicle, the Altitude Aircraft Leasing Trust, citing market volatility and difficulties attracting cornerstone investors. The Altitude listing, which would have been worth the equivalent of roughly USD 400, would have been the first Singapore trust in the airline space. Market talk suggested that Singapore overall has seen a market-wide spate of liquidations by U.S. investors, freeing up cash to meet their obligations in the States. Collateral damage from the sub-prime crises might well describe the travails in the Singapore trusts market.