Hanjin may not be the new Lehman, but the learnings are much alike
One month ago Hanjin Shipping Co. sought bankruptcy protection, sending shivers down supply chain managers’ spines and creating fear among banks and counterparts. Gerry Wang, Seaspan’s CEO, called the event a “Lehman moment”. Although we find the analogy an exaggeration, there are important similarities and learnings to be had between the events.
The Lehman failure in September 2008 rocked the foundations of global finance with huge consequences to the real brick and mortar economy. The $600bn size of Lehman’s balance sheet, which was levered about 31:1 prior to the fall-out (compared with Hanjins’ 12:1), created fear that even bigger and “systemically financial important institutions” could be dragged down. The bankruptcy increased awareness of the complexity of credit exposures through derivatives and industry interconnectedness. Trust eroded overnight, lending in the interbank market froze, and as a consequence there was a scramble for liquidity. The situation eased only after the FED and ECB implemented programs to fund major banks and preventing failures of the likes of AIG.
No one is too great to fail
The major similarity between Lehman and Hanjin is not its consequences to the wider market (Lehman being grossly more important than a container line with 6% market share), but the fact that anything that is looked upon as “too great to fail” actually fails. In the case of Hanjin, it was the Korean Development Bank’s unwillingness to prop up modus operandi, where a company with wafer-thin equity is allowed to roll over short term liabilities to survive until markets eventually recovers. Consequently, the elephant in the room is: will banks increasingly pull the plug on shipping companies that have been in breach of covenants for a long time? If so, we could expect similar events. Listening to Mr. Wang, supply chain managers are seeking safety to reduce operational risk with a willingness to pay a premium for solid credits to ensure that goods arrive safely in time.
Key take aways from Hanjin’s default:
Witnessing Hanjin’s default and remembering the original Lehman moment, it is worth noticing how the financial industry learnt from the financial crisis and consider applying it within shipping:
1. Quantify, monitor and limit credit risk for individual accounts. This will increase understanding and cap potential loss.
2. Ask: “How big could the PnL of my contacts become before my counterparty defaults, and do I have sufficient capital to cover such loss?”, and add into the equation the likelihood of default and loss to get an idea of what counterparty credit risk costs, even before entering a new contract. Putting a number to credit cost introduces discipline and helps choosing business yielding optimal risk adjusted return.
3. Manage counterparty credit risk in your contracts: (near) default break clauses, contract PnL netting, parent guarantees and financial credit mitigating instruments, such as bank guarantees, credit default swaps and other derivatives, not only reduce overall credit costs, but could also enhance risk adjusted income.
Torvald Klaveness applies the principles as part of a wider credit management framework. Although we think counterparty credit losses will not be eliminated in shipping, our credit losses recent years have been minimal.