With the constant dynamic flow of world trade, commercial shipping remains a vital part of our modern worldwide economy. No matter how isolationist or jingoistic, no nation is entirely self-sufficient. In spite of any liquidity crisis, the two most basic of all economic principles, supply and demand, mean that international trade – as well as the primary physical means by which it is delivered – commercial shipping – will continue.
From the most basic raw material and minerals, food stuffs, energy and manufactured goods, all things and all goods are constantly imported and exported. The highways and byways of this international trade are founded through shipping’s global trade routes. It remains a basic fact that the vast majority by volume of that trade is moved by ship. Recent International Maritime Organization (IMO) reports put this figure as high as 90%. And this basic dynamic is not about to change. Nor is the fact that the key assets which make this trade possible, whether they be the simplest coastal bulk carrier or the most sophisticated LNG tanker, all have a finite commercial life.
Hence, despite any fall in a vessel’s intrinsic value and the perceived lack of readily available liquid debt to finance its replacement, all such vessels will eventually need to be replaced. This is due to them either becoming economically unviable or physically capable of operation. It is also a reality that a large proportion of these new build constructions will require third party financing.
It should be noted early on that it is dangerous to speak of the international shipping industry as single monogamous block. This industry is incredibly varied and complex. The diversity of its vessels is only matched by that of its vessel owners. The latter range from massive corporate owning groups, to the smallest coastal trading entities and single owner/operators. Similarly while many elements of ship finance are discussed in this article, others such as corporate or other bonds have not been included due to their intricacy.
As such, it should not be surprising that no singular approach can accurately describe or adequately service such a large and diverse industry or its finance requirements.
However, what follows is a very high level and brief outline of the types of financing available. Those both traditionally used and those used currently. As the global economy develops and grows, certain parts of these traditional elements come in and out of fashion while others develop. Elements such as basic functionality and appeal continually alter and advance depending on their relevant end users, the global economic itself and its larger finance trends. Nowhere is this basic dynamic more evident that in the recent Hanjin situation.
In order to understand the current condition of this diverse international industry, we first need to take a step back and look back to the basic economic building blocks of its finance.
For example, key elements include:-
The traditional single recourse new build financing with loan to value ratios of 60% to 70% are, for the vast majority of ship owners, long gone. The levels of equity that owners or other interested parties are now expected to contribute are very different than just a few short years ago.
At the very least, most lenders are looking for a much greater input in the form of direct investment in each new financing from the borrowers themselves. The most obvious source of this investment is greater owner equity in borrowing vehicle itself. This seems fair and simple enough, but given the recent low bulk and day charter rates in an already tight market, it is not often that the owners/borrowers have access to such a greater liquidity pool.
Greater Loan-to-Value (LTV) Ratio's
These are the obvious answer to a lack of debt capital and a natural consequence of borrowers having greater investments in the form of equity in the new deals. A lower percentage in this headline figure is pleasing to credit committees and heads of risk in many a finance house. The problem is that while comforting, such an approach does not alter, in any way, the basic fundamental volatility of both the asset class itself and its underlying market. Such volatility is a fundamental fact of which many potential borrowers are constantly reminded.
Corporate Debt Financing Models
As equity levels or “skin the game” are often deal (i.e. vessel) specific, the next logical step (if those numbers aren’t enough to allow the flow of debt) is to bring even more of such collateral into the deal. As highlighted earlier, single recourse financing to the asset alone is simply no longer acceptable to many financiers.
The next logical step for those borrowers/owners who have the other assets is to bring them in to the mix. These assets can be, in so far as they are not already indebted, other sister vessels within the owner/borrower group. Of course secondary security is possible as noted in the builder credit section below but it is not ideal nor proving not be that popular.
But if such additional vessel security alone is not enough from a combined unencumbered asset value basis, and/or is simply not desirable from a commercial fleet management perspective, other group assets are often considered. Subsidiary shares, group revenue streams, land, buildings and real plant can all be brought into the security package. To delve into this point further, these assets may not simply be limited to those of the borrower but can be expanded to include those of the borrower group.
The net result is a facility and security package that is much more recognisable to a corporate financier than a traditional shipping lender.
While many combinations of the above three elements can, in the new post 2008 financial crisis era, get many deals over the line to drawdown, they do all rely on there being a potential traditional debt supplier in the mix to satisfy. As many an interested party knows, that is not always the case. Often, despite the greater depth and breadth of a particular security package on offer, there is not a sole lender who (even given the very real potential of post drawdown syndication) is willing to provide 100% of the necessary debt.
In such cases the resulting inter-creditor complexities of even a tripartite deal can be viewed as too complex and cumbersome. As a result of such a view, they are often never even written….
Builder Debt Financing
The next option is to bring in the next most interested party. To make money, the ship owners need to borrow to raise capital to fund replacement vessels. To make money, the lenders need to keep deploying their funds.
But if these two principle parties cannot reach a satisfactory deal with respect to price, level of risk and security package, enter the other next most interested party; the vessel builders themselves.
Simply put, to make their money, the ship builder needs to continue to build and to deliver their vessels.
To fund this business, the shipbuilder not only needs new orders, it also needs the existing ones to be paid for. That way, delivery can occur and new building slots become available so the whole process can begin again. Once you couple this basic cash flow reality with the usual payment terms of a standard ship building contract (i.e. five instalments during the build phase with the fifth (often 70% to 90%) being due at delivery), these two factors combine to create a problem for both the new intended owner and the builder in the event of lack of funds at the delivery stage.
Enter the concept of builder credit.
We have recently helped many highly reputed international builders, not least of which some major Korean ones, to become bankers. Their reaction to the liquidity crisis and risk of order cancellation or worse, completed vessel non-delivery has been, in some cases, to offer secondary secured or unsecured credit for that final delivery instalment under the Ship Building Contracts (SBC). This loan is – by way of deferred payment – can be secured by second ranking mortgages and/or charter and other assignments.
While many of the traditional UK and German banks are now out of this loan market, some American banks still remain. Most notably Citigroup and BoA both still hold and are willing, for the right deal, to expand their significant traditional debt in this sector. Other European lenders such as ABN Amro and Rabobank still remain active. The Scandinavian sectors, with active players such as Nord/LB, should not be ignored nor should new debt structures such as the Norwegian Limited Partnership (KS). There will undoubtedly be more.
Chinese Investment Banks / Export Credit Agencies (ECA)
The China Development Bank or the China Construction Bank can be sources for tradition debt finance deals, but of course these will be limited to Chinese new builds only. For non-Chinese builders, national export credit agencies in traditional commercial shipping countries such as the Netherlands, South Korea, Norway, Japan and the Scandinavian counties can potentially assist. These ECA’s themselves have recently been more willing to adopt novel debt structures and related security packages for the right parties. But of course, there are no guarantees with ECA’s. They are bodies that not only react to economic conditions, they have significant internal and variable policy considerations as well.
Unfortunately, there is no magic solution nor, despite the recent stormy financial weather, any pot of gold at the end of the rainbow here. Instead greater flexibility and the need to stay aware of market developments – but also to ensure that you have the right advisors lined up in advance – are now even more crucial.
Advisors not only need to know their particular trade, they also need to know and have a great depth of experience in their particular section of the shipping industry and its key financial requirements. Only with such advisors will you be able to help ensure that:-
- you are ready and able to successfully take advantage of the financing opportunities as and when they present themselves; and
- you don’t waste time, money and key operational focus in doing so.
While, you might never be the proverbial pot of gold as a result, this approach will most certainly prove more rewarding for those seeking and offering finance than the alternative.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.