No Hype. We Delivered!

Our Chairman’s promotions are sheer artistry and we constantly marvel at these masterful gems. Of course, there are issues with punctuation but why let that get in the way of a great pitch. The amazing thing is that despite his protests otherwise, he really does get it. Our problem is that he is rubbing off on us and we are moving from analytical and objective to the dark side where it’s all about the love as both Matt and he are fond of saying. In the case of this year’s Marine Money week, there is no doubt we got it right. The numbers speak for themselves. This year we went out on a limb denoting the theme as the Comeback or Confidence Returns to Ship Finance. Whether or not that was the case and we believe it is, 1,078 registered guest wanted to hear the answer. This was a new record surpassing 2008’s 1042 guests. Uncertainty + optimism trump a boom.

We relish the awards afternoon. We devote a great deal of energy, although far less than the dealmakers themselves, in choosing the transactions from the many submissions we receive and it is a pleasure to see the winners bask in the recognition they rightfully deserve. It is also educational as the latest structures and ideas are on display for all to see and take advantage of as appropriate. Nigel Thomas and Dan Rodgers of Watson, Farlay & Williams did a masterful job moderating the session which included presentations by Sheldon Goldman, Efthymios Bouloutas of Marfin, Ronny Bjornadal of Nordea, Sean Durkin of NSF, Gerrit Parker of Citi and Craig Fuehrer of Deutsche Bank.
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Do What I Say, Not What I Do

Last week, we utilized FBR’s Paul Miller’s analysis of the large bank’s 3rd quarter’s earnings in order to shed some light on what these results might indicate to the shipping world. This week we intend to draw again on his experience to drill down and look at the reporting and disclosure by banks of non-performing loans (“NPL”). Mr. Miller sets the stage as follows:

“While several recent bank earnings reports for 3Q09 have highlighted improvements in early-stage delinquencies and NPLs, we are concerned with the surge in loan modifications and “troubled debt restructurings” (“TDRs”), which allow banks to move loans away from non-accrual status, effectively just delaying credit deterioration. We expect this trend to continue as most banks report earnings over the next few weeks, and while delinquencies may appear to be stabilizing on the surface, re-default rates on TDRs are generally very high and could lead to prolonged credit pressure across the industry. Currently, GAAP rules do not specifically define non-performing assets (NPAs), allowing for some flexibility from bank management teams in what they classify as an NPA. For FBR’s interpretation of NPAs, we include all non-accruing loans (NALs), TDRs, real estate owned (REO), and all other non-accruals, in accordance with regulatory filings. Interestingly, out of the top 25 banks and thrifts by asset size, we estimate 2Q09 NPA levels under regulatory filings were 17% higher than that reported under GAAP accounting, on average. That said, we view loan modifications themselves positively, and we realize that not all loan mods re-default. The issue is that accounting for loan mods is not transparent and makes delinquency data appear better on the surface. We are drawing attention to this because we are concerned about comparing early-stage delinquency and NPA data for banks when it is not apples to apples for all banks. When you include TDRs in NPAs, stabilization in the credit metrics becomes more unclear.”

To have a clearer understanding of the issue, one needs to have a rudimentary knowledge of the various forms of restructures. Again, Mr. Miller helps. Loan restructures can take several forms. “Loans can be classified as TDRs if they are modified and grant a concession to borrowers, not in accordance with a bank’s regular modification policy. They generally take the form of lower interest rates, loan balances, accrued interest, or an extension of the maturity date.” Alternatively, “a bank can restructure a loan without classifying it as a TDR if the terms of the modification are in line with the bank’s normal refinance or restructuring policies. In addition, a loan extended or renewed at an interest rate equal to the current interest rate for new debt with similar risk is not to be reported as a TDR. As a result, while TDRs likely capture the more severe modifications, requiring concessions to borrowers that would not normally be granted, a large number of other loans become modified in the regular course of business and often go unreported.”  Moreover, if a restructured loan is in compliance with its modified terms, it may be re-classified as performing if it remains current for at least six months. These belie the issue of re-default, which is not unlikely in these perilous economic times. Banks, of course cannot create revenues or profitability they can only try to align payments with forecasted cash flow.

In short, all is not what it appears to be. A lack of definition, two sets of books (regulatory vs. GAAP) and management discretion do not add up to full disclosure and the transparency banks demand of their clients.  And notwithstanding the various classifications of problem loans, the banks in all likelihood will literally have to face the music and acknowledge the diminished value of the assets underlying their loan portfolios as their fiscal year ends and waivers begin to expire.

Delaying delinquency merely defers the problem it does not remedy it. Lacking disclosure and transparency, the true financial condition of the banks is not correctly portrayed or understood.

Whither the Banks?

While we, in shipping, focus daily on the macro picture, primarily the world economy and micro data, such as commodity prices, steel production, oil prices, charter rates, etc, in order to gauge what is happening, it may well be that the health of our industry is, for the moment, more directly correlated to the condition of the banking industry, particularly in light of the supply side issue. While the capital markets have filled a void in the availability of capital in the interim, the question remains as to whether the banks will be back and if so when?

In his excellent report, What We Have Learned from the Large Financial’s Results, Paul Miller of FBR Capital Markets provides insights into the earnings and the credit and financial condition of a select group of the largest U.S. banks including Bank of America, JPMorgan, Citigroup and Goldman Sachs based upon their most recent quarterly reports. We believe the results of these company’s are indicative of the general condition of the banking world. His key takeaways are as follows:
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The Economy and the Markets

STAY HOPEFUL
Investor sentiment is very often unpredictable and moody, especially today when economic data continues to come in mixed and casts doubts on whether the economic stabilization will be able to materialise into a recovery. And against this uncertain backdrop, it was refreshing to listen to an optimistic voice among the crowd on where the global economy is heading. François Trahan, Senior Managing Director and Chief Investment Strategist, ISI Group started off the Wednesday’s session of Marine Money Week on a positive note by reminding the audience that even though consumer deleveraging has already begun and may well continue for the next decade, equities can rally even during such times if the government is able to offset the consumer contraction. He pointed out that the US stimulus package is still very much in its infancy stage considering the fact that the government has only spent 5% or USD 42 billion out of the USD 787 billion.

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