Ship Finance Update: Many Choices, Few Options

Ever since the market collapsed in 2008 and banks active in the shipping industry experienced heavy losses, many have been expecting a changing landscape (or is it “seascape”?) in shipping finance. Shipping banks have traditionally financed ship owners and provided most of the funding to the industry, which stood close to $700 billion at the top of the market. The critical question has always been: Who else would consider providing capital to the industry, and on what terms?

The capital markets and private equity were the obvious candidates, but soon reality settled in. Capital markets would not consider any companies with less than a billion-dollar market value and a longstanding track record. Moreover, institutional investors and private equity funds soon discovered that there are many ways to lose money in shipping, even when one gets the overall trend right (but generally, most get it wrong).  

At present, there is precious little interest from the capital markets and institutional investors in committing new capital to the industry, which brings us back to the original question: Where and on what terms will new money find its way into shipping?

Having just traveled extensively in Europe and held discussions with many players in banking and finance, there seem to be some patterns emerging for new norms of shipping finance. Given that our firm may be involved in certain transactions and that these conversations took place under the presumption of privacy, we will state our observations only in general terms and without “name dropping.” 

“Alternative Capital”

Sources of so-called “alternative capital,” such as credit funds, have been popping up on almost a monthly basis. It’s hard to estimate their firepower as these are not regulated entities and do not have to provide any public information – although several have stated they committed capital for marketing reasons and thus an estimate of the overall total can be made. 

Some of these funds are backed by brand-name, bulge-bracket private equity funds (with “more money than God,” as they say) that can provide additional funding to these alternative capital funds on a project-by-project basis. Given that some of these funds intend to seek “back-leverage” (borrow against their portfolio once a certain amount of transactions has been placed), there is the potential for more liquidity if and when such leverage is poured back into shipping.  

Based on belief and experience, we estimate that funding of approximately $30 billion has been committed to these funds, which – as respectable a number as it may seem, is a far cry from the previous capacity of the shipping banks.

In general, these credit funds congregate around two different clusters. First are those that lend usually around 50% LTV (Loan-to-Value) and at approximately 5% above Libor (about 7% at today’s market). These funds generally opt for as conservative as possible debt financing with select owners and select tonnage. 

The second cluster are those that opt for more exotic transactions and could lend as high as 80% LTV but at an interest rate in excess of 8% above Libor. Typically these funds are more hands-on and can structure their financing in tranches, including senior and junior financing, or participate in structured financing transactions where they can take junior and subordinate positions.  

It’s little surprise that fees for such structuring are high (at least 2-3% at origination), and there may also be certain tight covenants – although vintage tonnage and spot market employment can be considered and can make up for the high financing cost. 

It also comes as no surprise that some of these funds mark-to-market their underlying fleet on a daily basis (indeed!), and when there is an LTV breach the borrower better be prepared for a lengthy phone call to discuss an additional equity contribution or an increase in the financing cost.  

Another caveat is that several of these credit funds have already established strategic relationships with vessel managers, so a takeover of the asset is not as remotely complicated as if a bank had to repossess it. And since some of these transactions are structured as leasing, taking over an asset can be legally expedient and smooth compared to a vessel arrest.

Not Dead Yet

As far as banks’ activity is concerned, there’s a clear tendency to focus on corporate accounts or shipowners with a proper corporate structure and an orientation toward upcoming Basel IV, IFRS 16 and even the Poseidon Principles in terms of ESG (Environment, Society and Governance) when doing new business.  

While each bank seems to have its own business model, a certain few shipowners (and, yes, private shipowners!) have been known to borrow as low as 1.50% over Libor while the majority of banks still active in shipping are in the 3.00% – 4.00% range (over Libor, always). And amazingly, there seems to be intense competition among banks as they all focus on the same few names that “check all the boxes.” For certain banks originating loans on behalf of their institutional investor partners, the financing cost tends to be closer to 5.00%, reflecting a higher cost of capital. 

And it’s no surprise that shipping banks focus on shipowners with solid business plans (i.e., access to cargoes or charters) or critical mass (shipowners with fewer than twenty vessels need not apply) or cross-product selling (private wealth management). Start-up shipowners and small shipowners are generally excluded from the traditional shipping banking system.  

The positive takeaway is that traditional shipping banks are not dead yet, and a great deal of them (including Greek shipping banks) are still active with new originations, albeit at a fraction of their previous activity.

Few Real Options

Of course, there is still Chinese leasing and a few more options for certain shipowners, but the reality for the average shipowner is that of many choices but few real options. Unless you are a big corporate entity, you can choose any financier you wish as long as you are happy with approximately 10% cost of debt all in, more or less. 

The effects on the shipping market can be noticed on the periphery as smaller shipowners are forced out of the market, professional third-party vessel management becomes a viable option for many small owners, and the orderbook is relatively low. But as mentioned earlier, the maritime seascape has been changing.