'Mark to Model' Redux

One would have thought that, given the debacle in last fall's markets, it would be QUITE some time before that method of valuing assets would be used by banks, or other lenders. It seems that one would be mistaken, however, according to an article in Monday's (Oct. 26) FT.

Two of the largest banks involved in ship financing, HSH Nordbank, the world's largest shipping bank, and Deutsche Schiffsbank, Germany's second largest, are set to use the Hamburg Shipbrokers' Association's "Hamburg Ship Evaluation Standard" in computing the value of the ships that form the collateral for loans, rather than using "market value".

Given the glut of shipping tonnage, both in bulk dry carriers, as well as tankers, it's no surprise that the value of these vessels has plummeted, meaning that the banks that provided the financing are facing a very real possibility of having to take very sharp write-downs on the loans they made against the purchase of these vessels. Is this sounding a trifle familiar?

The method that the Hamburg Shipbrokers' Association came up with values ships by their potential future earnings, rather than by what the "market" says is the going value for a comparable vessel. As in the real estate meltdown, the argument is made that "distressed" prices do not provide a "realistic" measure of value.

At this point, it's not entirely clear whether the proposed valuation methodology would be used for all accounting purposes, including financial reporting, or only to decide if a shipowner is in compliance with loan covenants, regarding LTV. Both banks mentioned above in a press conference last month, suggested the valuation method would have "wide-ranging applications".

The one bright note is that there seems to be some sharp dissension from other bankers and ship brokers, so perhaps fiscal reason will prevail.

Source: Financial Times

Full Disclosure: Long DHT

Comments

[Messin' w/S...:]

You assume too much.

There are important, and unjustifiable, differences between the way commercial ship assets are now valued and the way commercial real estate is valued. Most significant, chartered commercial ships (i.e., ships equivalent to an office building that has tenants under lease) are valued today only on the basis of their unchartered resale value.

Thus, two identical ships, one unchartered and the other bound under a 10-year charter at rates established in the peak of the 2007 season, are valued the same according to today's banking fiction, a.k.a. mark-to-market. Which ship would you rather own? Is there really no difference between the two in today's market*?

By excluding consideration of charter revenue, today's ship valuation standard has no claim to reflecting genuine market value of ship assets. So the Hamburg standard is an attempt to bring the cash flowing value of ship assets into the equation.

There are perhaps some problems in the fine print proposed by Hamburg ship appraisers, one of which is that German owners have historically operated their vessels under short term charters ranging from a few months to one or two years, feasting in tight markets and suffering today. The suspicion underpinning your article has some basis, and to address this concern the Hamburg standard should be tweaked to reveal more clearly the distinct visibility premium which should be afforded to ships with actual remaining charter terms of 3, 5, and 7 or more years. Ships on shorter or dwindling terms should appraise much closer to unchartered resale.

Much brighter folks can debate the further and finer points. However, it seems clear to me that the ship value process at present is not based on genuine market value, as you assert by assumption above, despite the mark-to-market moniker. Indeed, pinning ship values to the immediate boom and bust of unchartered resale is skewed very procyclically, being much more chaotic and less realistic than the alternative of incorporating actual cash flows over time.

Nov 24 10:28 AM