When the Borrower Defaults
What is the vessel actually worth when the lender needs to recover its collateral?
A practical look at marine collateral value when the expected holding period suddenly becomes an exit.
By George Beck, MBA, ASA, NAMS-CMS
A vessel may look like strong collateral on the day a loan closes.
The purchase price is known. The borrower has a plan for the vessel. A survey may document her condition, and market listings may appear to support the transaction.
Then the borrower defaults.
Now the lender is asking a very different question:
If we have to take control of this vessel and sell it, what can we realistically expect to recover?
The answer may be quite different from the number that made sense when the loan was originated.
THIS MONTH'S FOCUS
Marine collateral value depends on more than the vessel itself. The circumstances of the sale matter, too.
When a lender faces a distressed marine asset, condition matters. So does the buyer pool. The amount of time available to market the vessel can change the answer considerably.
Location, certificates, upcoming maintenance and the cost of holding the asset can all affect the lender's eventual recovery.
That's why understanding the exit matters long before anyone expects to need one.
THE SAME VESSEL CAN HAVE MORE THAN ONE VALUE
One of the easiest mistakes to make with marine collateral is treating “value” as one universal number.
It isn't.
The right number depends on the question you're trying to answer.
Fair Market Value
Fair market value generally assumes a willing buyer and willing seller, neither under compulsion, with both parties reasonably informed.
For a commercial vessel, however, identifying the right market matters.
A specialized offshore vessel doesn't necessarily compete with every vessel of similar size and age. Configuration, machinery, certificates, operating capabilities, condition and location can narrow the buyer pool quickly.
Orderly Liquidation Value
Now put a clock on the sale.
The lender has a reasonable period to expose the vessel to the market and find buyers, but it can't wait indefinitely for the perfect offer.
That shorter marketing period may change what buyers are willing to pay.
Forced Liquidation Value
Shorten the timetable again and you may be dealing with a very different market.
Potential buyers know the seller needs to transact. Some won't have enough time to inspect the vessel, arrange financing, investigate records or plan a move.
Others may participate—but price those uncertainties into their offers.
The vessel hasn't changed. The circumstances of the sale have.
That distinction matters.
LENDER'S CHECKPOINT
When you're reviewing a marine valuation, don't stop at the number.
Ask:
What definition of value does the appraisal use?
What is the effective date?
What condition is being assumed?
How much marketing time does the premise allow?
Where is the vessel?
Who would realistically buy her?
What costs or restrictions could affect a sale?
A precise number isn't particularly useful if it answers the wrong question.
THE PURCHASE PRICE IS HISTORY
When a borrower defaults, one of the easiest numbers to find is usually the original purchase price.
It's worth knowing. But it doesn't tell you what the vessel is worth today.
A lot can happen between closing and default.
The vessel may have accumulated thousands of additional engine hours. The owner may have deferred maintenance. Equipment could have been added, removed or replaced.
Certificates expire. Regulatory requirements change. Markets move.
A vessel that had steady employment when the loan originated may now be sitting idle.
Sometimes even the original transaction itself deserves another look. A purchase price may reflect equipment, contracts or other business considerations that don't belong to the vessel today.
The lender now has a collateral question, not a historical transaction.
The current asset and current market have to drive the analysis.
CASE STUDY
The $3 Million Vessel That Wasn't a $3 Million Exit
Consider a hypothetical commercial workboat financed several years ago.
The borrower paid approximately $3 million. At the time, the vessel was working, maintained for her intended service and supported by a reasonable market.
Several years pass.
Then the borrower defaults.
The lender pulls the file. There's the original purchase agreement, an older survey and several current online listings. Some of those vessels have asking prices close to $3 million.
At first glance, the collateral position doesn't look too bad.
Then someone starts digging.
The vessel has accumulated substantial engine hours. A major machinery overhaul is approaching. Several maintenance items have been deferred.
One certificate needs attention before the vessel can return to certain work.
There's another complication: she's nowhere near the strongest group of potential buyers.
Then there are those comparable listings.
Some have been sitting on the market for months. Others looked similar in the photographs but weren't nearly as comparable once machinery, certificates, condition and capabilities were considered.
The asking prices weren't meaningless.
They simply didn't answer the lender's question.
Three Questions. Three Potential Answers.
The lender could ask:
What would this vessel bring in a normal transaction with adequate exposure to the market?
That's one question.
What could we reasonably expect if we need to sell within a defined but limited period?
That's another.
What happens if we have to move the vessel quickly?
Different question again.
The same vessel can produce different defensible conclusions because the assumptions changed.
LESSON FOR LENDERS
Don't wait until default to discover that the value sitting in the credit file was never intended to describe a distressed exit.
WHAT CAN REDUCE RECOVERY?
Some problems announce themselves.
Others don't.
A vessel can still look impressive at the dock while carrying issues that materially affect what a buyer will pay.
Deferred Maintenance
Marine assets can consume capital quickly.
Overdue machinery work, steel renewal, dry-docking, coatings and other deferred items can reduce the price buyers are willing to pay. Sometimes they reduce the number of interested buyers as well.
Machinery Hours and Overhaul History
Two otherwise similar vessels may occupy very different positions in the market because of their machinery.
Engine hours matter. Overhaul history matters.
And a buyer staring at a major overhaul shortly after acquisition is going to account for that cost somewhere.
Certificates and Regulatory Status
A commercial vessel's usefulness depends partly on what she is legally and practically able to do.
Expired certificates, operating restrictions or required upgrades can shrink the market.
Specialized Configuration
Specialization cuts both ways.
The right vessel can be extremely valuable to the right operator. But when that operator isn't buying, a highly specialized asset can become difficult to sell.
That's why the depth of the buyer pool matters.
Location
A vessel can move.
Moving her isn't necessarily cheap.
Towage, fuel, crew, insurance, regulatory requirements and preparation for a voyage can all affect what a distant buyer is willing to pay.
Under a short sale timetable, location can matter even more.
ASKING PRICE IS NOT EXIT VALUE
Online listings are useful. I use market listings in appraisal work regularly.
But they have to be investigated and interpreted.
An asking price tells us what a seller hopes to receive.
It doesn't necessarily tell us how long the vessel has been on the market, whether the price has already been reduced, what offers the seller has received or what the vessel will eventually sell for.
And two vessels that look nearly identical in photographs may compete in very different markets.
COLLATERAL INSIGHT
The vessel that looks most like yours isn't automatically the best comparable.
The useful comparable is the one that helps explain how buyers would view the subject vessel after considering its machinery, condition, equipment, capabilities, certificates and market.
THE COST OF HOLDING THE COLLATERAL
Sale price is only part of recovery.
Once a lender takes control of a vessel, the clock starts running.
Depending on the circumstances, the lender may face:
dockage;
insurance;
security;
crew or caretaking;
maintenance;
utilities;
inspections;
regulatory compliance;
machinery preservation;
towage or relocation; and
brokerage and other disposition expenses.
Waiting six months for a higher offer doesn't necessarily produce a better result if the vessel consumes a substantial amount of money while sitting at the dock.
Net recovery matters more than the headline sale price.
That's one reason the expected marketing period belongs in the valuation conversation from the start.
BEFORE YOU NEED THE EXIT
A lender doesn't need to wait for a problem to ask these questions.
In fact, that's probably the worst time to start.
At origination—and periodically on larger exposures—it can be useful to ask:
Who would buy this vessel if the current operator couldn't keep it?
How broad is that market?
Would another buyer need specialized contracts, equipment, licenses or operating capabilities?
What condition is the machinery in?
Are there major capital expenditures coming?
And what would change if the lender had a year to sell the vessel instead of 90 days?
Those questions often reveal risks that aren't obvious from purchase price or photographs.
KEEP THE QUESTIONS HANDY
We've put together a one-page Marine Collateral Exit-Value Checklist with the asset, regulatory, market and disposition questions lenders can use when evaluating a vessel.
Download the Marine Collateral Exit-Value Checklist
Save it with the credit file or pass it along to anyone on your team who works with marine collateral.
FROM THE APPRAISER'S DESK
When should a lender think about exit value?
Before the loan closes.
Hopefully, default never happens.
But understanding the potential exit market at origination gives the lender another way to look at collateral risk.
A survey can tell you a great deal about a vessel's condition.
Purchase documents tell you what someone paid.
Market listings show what sellers are asking.
None of those things, standing alone, necessarily tells you what the lender could recover if it suddenly became the seller.
That's a different question.
And it's worth asking early.
QUICK TAKEAWAYS
Define value before relying on it.
Fair market value, orderly liquidation value and forced liquidation value answer different questions.
Update the collateral story.
Purchase price and an old survey can't tell you everything that has happened to the vessel—or the market—since closing.
Look beyond asking prices.
Listings provide evidence. They aren't completed transactions.
Understand the buyer pool.
Specialized equipment may have fewer realistic buyers than its appearance suggests.
Consider the cost of time.
Holding and disposition expenses can materially affect net recovery.
Think about the exit before you need it.
The best time to understand a vessel's resale market is while the loan is still performing.
