Blog: Show Me the Money Please
By Siri Wennevik and June Ho
Shipping loans, including export credit financing and lease financing, have been the traditional sources of finance in shipping for several decades. In the last couple of years however, waves of private equity (PE) money have flowed into shipping, fuelled by a financial environment where banks no longer have the lending capacity or appetite for perceived high-risk lending.
What are Private Equity funds?
These are collective investment schemes used for making investments in various equity or debt securities – typically seeking high investment returns over a fixed term. There are several ways in which private equity funds can make investments within the shipping sector. These may include entering into joint ventures with ship owners, taking direct ownership stakes in vessels, acting as mezzanine lenders, or by purchasing existing debt from banks. Increasingly, these funds are becoming a prominent feature on the ship finance landscape.
So what does this fundamental shift in “who your lenders are” mean for shipowners in general? In today’s market, banks are still willing to lend, albeit more cautiously and judiciously. So unless you are a top tier shipowner or operate in the high value sectors, you may have to look elsewhere for funding.
Private equity funds on the other hand are mostly counter-cyclical and have been accumulating shipping debts at an rapid pace as shipping companies have turned (and continue to turn) to them to bridge the funding gap created by the scaling down of the banks’ shipping portfolios.
Benefits of taking on a private equity partner
Shipowners can realize many benefits from taking on a private equity partner. Upsides include a ready and available source of funding when banks are not willing to lend, better access to financial, commercial and related markets in which the private equity investor group have relations with, and enhanced business resources by utilizing the private equity investor’s broad investor base.
In addition, since private equity funds are less regulated than traditional banks, they are able to offer more flexible lending solutions.
Short sightedness and oversupply?
However, unlike traditional banks, private equity funds do not typically have any previous relationships with the shipowner, and to many private equity funds the shipping business is unchartered territory. This poses several challenges for traditional shipowners.
Private equity funds often do not share the same long-term interest and goals as the shipowners. For starters, private equity funds expect a high level of return for their investment and usually within a fixed term – this may not always be possible in a highly cyclical shipping industry, where shipowners expect their financiers to ride out the down cycles with them.
For the funds, their views on financing strategies are generally myopic – buy in quickly when it is on the down cycle and exit as soon as the light starts to shine. Exit strategies within three to five years of investment are relatively short when measured against the long recovery phase in shipping cycles.
Readily available PE cash has also been blamed for an over-supply of vessels in the market. This type of finance has made it easier for smaller third-tier companies to enter the shipping market, causing a supply glut of tonnage and an uneasy fragmentation of the industry.
Control and corporate governance
Private equity funds also expect to play active roles in managing their investment, demanding extensive reporting requirements. This happens formally when they become owners/co-owners but also happens informally whilst they are still lenders. This may not sit well with many shipowners who are cautious about ceding control of their family owned business – shipping is, after all, a very personal business which does not always see eye-to-eye with the demands of “new” money.
There is also a fundamental conflict inherent in such arrangements. Many decisions in shipping are made by shipowners with the long term interest of the vessel in mind. However, since the funds are in for the short haul, their approach to decision making (even whilst they are only wearing their hat as lenders) may be in stark contrast to the shipowner. As a result, shipowners may have to live with the consequences of decisions made by the private equity fund long after the exit of such investor.
There is a concern that private equity’s entry into shipping may not end well, especially if a fund is the majority partner controlling the board as well as demanding a say in key investment, divestment and operational decisions.
The defaulting shipowner and inevitable consolidation?
Inherent in the opportunist nature of private equity funds is their impatience in enforcing exit strategies. In a prolonged down cycle where shipowners are driven into default, private equity funds may be more prepared than banks to take over ownership of the vessels themselves (whereas banks typically would prefer to sell the distressed debt rather than put the ships on their balance sheet).
Consequently, the theme of consolidation has been touted as the “cure” for shipping companies in distress. On paper, market consolidation makes a lot of sense - the private equity fund with a portfolio of largely similar ships with several borrowers in default can combine them and save administrative costs, overheads, etc. and shipowners themselves can benefit from economies of scale with an increased fleet size leading to increased profits for everyone.
It remains to be seen if this will be well received by shipowners who are typically hostile when it comes to discussions on mergers and/or consolidation, since it would mean that the board seats and control, traditionally dominated by one family, will then have to be shared possibly with their previous competing shipowning families (in addition to the private equity fund investors).
Is it all bad news?
Despite the initial bad press and the lingering suspicions surrounding the entry and role of private equity funds into ship finance, it remains to be seen if such participation will change the landscape of shipping for good or for bad. The only certainty is this - capital for shipping is never scarce even in the down cycle, but unless you are a top name or are state-owned, you may have little choice but to seek alternative non-bank forms of finance.
In a properly conceived and well executed transaction, there should be no reason why private equity cannot emerge as a comparable source of financing for shipowners.
Siri Wennevik heads Wikborg Rein’s Singapore office and is part of the firm’s Shipping and Offshore practice. She is an experienced transactional lawyer within the shipping and offshore sectors.
June Ho is a Partner in Wikborg Rein's Singapore office and is part of the firms Shipping and Offshore practice. She is English law qualified and specialises in banking and finance, mergers and acquisitions and maritime corporate law.
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.