The Shipping Industry: Financing in Turbulent Times
The shipping industry is both broad and complex. Operating companies cover a number of different sub-sectors including dry bulk, tanker, container, offshore and other services. These sub-sectors are not necessarily synchronised, adding to the industry’s intricacy. Furthermore, the financing environment has changed dramatically across the industry during the past three years. Fewer banks are active in the sector, while approximately US$200bn of financing is required.
A greater proportion of this funding is being provided with the support of export credit agencies (ECAs). In fact most of the large fleet acquisitions that take place in the current environment have an element of export finance.
Depreciation and asset value in the shipping industry are unique from other industries. For example, if a company orders a vessel for US$50m today, the value could fluctuate to between US$20m-US$100m by the time the vessel is delivered in two years’ time – subject to market volatility. A successful shipping company, particularly within the dry bulk and tanker sector, profits by ordering vessels when the market is low and selling when the market is high.
However, predicting the market cycle has become increasingly challenging in the current economic environment. The most recent shipping down-cycle coincided with the financial crisis, forcing banks to look more closely at the vessel owners and carefully assess the risk involved in financing such large projects.
Under the current challenging environment trading existing assets is very limited. Ships are a long-term investment and owners do not want to crystallise a loss; many owners have vessels that are in negative equity and if they can afford to keep them on their books, they will.
Moreover, many sales transactions have not been completed due to the scarcity of funding. Because the shipping industry is of great importance to particular countries, governments tend to subsidise shipyards, meaning that financing the construction of a new ship is more readily available than financing for a purchase of an existing vessel.
There is some variation when analysing specific industry sectors. For example, rates have recently increased in the dry bulk shipping subsector. Capesize, or large 180,000 tonnes cargo ships, have risen from US$17,000 per day to US$28,000. With that said, such vessels earned US$180,000 per day in 2007, illustrating how far the market has fallen over the past few years. The asset value of Capesize vessels has also decreased significantly. In mid-2008 they sold for approximately US$100m while they are now worth approximately US$50m.
Market saturation has made the tanker subsector increasingly volatile. The rates for very large crude carriers (VLCCs) have reached historic lows at approximately US$6,000-US$10,000 per day. Yet these vessels have operating costs of US$10,000-US$15,000 per day.
Post-2007, four of the primary ship financing banks pulled out of the market. These institutions were funding over US$4bn annual financing. The absence of these banks has had a profound impact on the market. Now the majority of ship financing is provided by approximately 15-20 banks.
As a result ship-owners have been forced to consider other sources of financing. Many highly capitalised companies have self-funded, using the equity and cash on their balance sheets. Others have engaged with the capital markets, either through private placements or via the Norwegian high yield paper market.
In addition, ECAs are becoming more popular with shipping companies as they provide increasing levels of capital. ECA support, along with Citi’s Export and Agency Finance (EAF), represents an efficient way of allocating capital, allowing longer, more variable tenors and attracting banks that are perhaps less familiar with the shipping industry. Under ECA financing, approximately 95% of the loan is covered by a specific sovereign agency. The remaining 5% is a small level of risk and makes the credit process easier.
The ECA deals in the shipping industry are predominantly driven by the location of the ship construction. Therefore, Asian and Norwegian ECAs are playing a significant role in the offshore segment.
The Korea Trade Insurance Corporation (K-sure) recently worked with Hapag-Lloyd to finance a series of container ships. The deal was completed in March 2011 and represents the largest Korean ECA shipping financing deal. The deal was widely syndicated providing US$925m under K-sure cover, financing a fleet of 10 ships for the Hamburg-based company. This was not structured as a club deal but a true syndication which was heavily oversubscribed. It was encouraging to see this ECA deal to be syndicated in the true sense of the word.
Over the past five years, Korea has played a leading role in the ship building industry. However the Chinese shipbuilding industry is rapidly advancing, which poses a threat to Korea’s leadership position. Citi recently partnered with Sinosure, a Chinese ECA, providing support to a Greek client. The transaction was co-financed by China Exim and insured by Sinosure. Citi partnered with another bank to provide financing.
The Chinese government encourages Chinese banks to be involved in funding. Meanwhile, Chinese banks are obliged to provide funding at rates that are higher than those of many international banks. While this results in pricing flexibility for Chinese ECA deals, the constraints may relax as the market continues to develop.
Having been a dominant ship building market 20 years ago, both funding from Japanese ECAs and ship production have recently slowed. However, in the past year there has been increased activity, particularly as strict rules on financing have been relaxed. For example, Citi recently partnered with Nippon Export and Investment Insurance (NEXI) and Japan Bank for International Cooperation (JBIC) to finance three Greek bulk carriers. This transaction demonstrates that the Japanese agencies are mindful of constraints in the banking sector and willing to fill the gap in capacity.
At present there is a significant investment programme in the offshore sector, primarily driven by Brazil’s energy company Petrobras, and other oil companies in Latin America. Meanwhile, large investment in rigs, drill ships, and platforms, for example, are driving a great deal of the production in Korea and China, along with Norway, which is a leader in the drilling segment.
The Norwegian Guarantee Institute for Export Credits (GIEK) and Eksportfinans, which is a joint venture with Norway’s central and commercial banks, have played a critical role in providing financing in the offshore sector. Both can credit wrap deals with high quality ECA support, marked against Norwegian sovereign risk. Their support is critical in an environment where many institutions are challenged when it comes to funding, particularly in US dollars.
As the liquefied natural gas (LNG) market continues to expand, we have seen a significant number of new building orders for LNG carriers. These vessels are primarily built in Korea; however, China is rapidly securing new orders. The value of these vessels is approximately US$250m-US$300m, resulting in shipping companies’ heavy reliance on ECA financing.
Urbanisation has been identified as a megatrend by market consultancies such as McKinsey, and corporate treasurers are taking this into consideration as they look to their long-term growth strategies. With over 100 million people moving into cities every year, there is significant need to invest in infrastructure development such as shipping ports to connect megacities around the world.
Shipping ports in both developing and developed markets are already congested. For example, ports in Rotterdam, Amsterdam and Hamburg currently require infrastructure development to cope with the rising influx of goods.
It is estimated that over US$500bn will be invested in port infrastructure over the next 20 years. This, along with the very complex and cyclical nature of the shipping business further elevates the role of corporate treasurers within the industry.
Visibility and control of cash remain a key priority, particularly as activities expand into new regions and new markets. Further, enhancing the efficiency of working capital management and the treasury processes becomes increasingly important given the significant capital investment required to maintain fleets and invest in the future growth of the business.