The global shipping industry is awash in junk.
During the first four months of this year, shipping companies issued $1.64 billion of high-yield bonds, 28% than during all of last year. In addition, three high-yield bond issues with a total value of more than $500 million are on the market.
Helping to fuel the new wave of deals is a boom in worldwide shipbuilding. Vessels built during the 1970s-a peak period for the industry-have reached the end of their useful life, and replacement demand is high.
The growth of seaborne trade due to the increasingly global economy is also increasing the demand for new vessels.
With the boom in new issues, a slip in credit quality has also come to the shipping industry, along with a corresponding spike in spreads.
According to Kirk Ludtke, a shipping high-yield analyst with Chase Securities Inc., most shipping companies issuing high-yield debt this year have been rated B by Standard & Poor's and B3 by Moody's Investors Service, with the ratings for a couple of issuers dipping even lower. Before 1997, most shipping issuers were rated BB by S&P and Ba or B1 by Moody's.
The popularity of these issues "is related to the market's receptivity to lower-rated deals," Mr. Ludtke said. "There is a lot of liquidity looking for higher return."
Shippers are paying margins higher than the market average for similarly rated companies, Mr. Ludtke said. The bonds issued by shipping companies rated B and BB averaged 513 basis points and 238 basis points, respectively, over comparable Treasuries. The market average for issuers rated B and BB was 348 basis points and 210 basis points, respectively.
"I think the premium is being paid for the underlying cyclicality of the industry as well as bringing people up to speed," Mr. Ludtke said. "There hasn't been a lot of shipping high-yield, so a lot of investors haven't been exposed to it."
In a recent report, Mr. Ludtke recommended that investors buy debt issued by large tanker lines. But at least one high-yield investor said she would not take the bait.
"A lot of these companies have everything I try to avoid," said Margaret D. Patel, a high-yield portfolio manager with Third Avenue Funds, New York.
She noted that most shipping issuers are small, foreign, and privately held-traits she said are red flags. The industry is also vulnerable to price swings and has relatively low barriers of entry.
"There is a yield advantage, but it is too small to justify the market risk," she said.
Mr. Ludtke said he favored companies operating in the tanker market, because he sees strong global demand for crude oil and refined petroleum continuing for at least a year.
Dry bulk shippers, which mostly transport coal, grain, and iron ore-are at a 10-year low in profitability.
"This portion of the market is more heavily reliant on Asia than the tanker market," Mr. Ludtke explained. He said the downturn in the Asian economy and a large Chinese grain harvest both contributed to reduced dry bulk traffic.
The container segment, which mostly transports manufactured goods, is also off, because of a trade imbalance between the United States and China, Mr. Ludtke said.
About half of the proceeds from shipping company's junk bonds are being used to refinance debt, primarily outstanding bank loans, Mr. Ludtke said. About the same amount is being used for fleet expansion-roughly split between new and secondhand vessels-with another 5% covering general corporate costs.
The high-yield shipping company deals now on the market are a $128 million, 10-year 144a note for Pacific & Atlantic Holdings Inc., which was priced last week at 610 basis points over comparable Treasuries; an estimated $130 million issue for GulfMark Offshore Inc.; and an estimated $300 million issue for Stenaline AB.
Morgan Stanley Dean Witter is leading Pacific & Atlantic; Lehman Brothers is leading GulfMark; and Chase Securities and ABN Amro are co- leading Stenaline.
