The shipping and ship finance markets have always seen strong cyclicality – but for once the current driver for change is not from the shipping market itself, but in the financial market with the banking liquidity crisis which originated in the US sub-prime housing market. So, what can an owner expect if it approaches its banks for finance for a ship right now? The most obvious message is that it is going to cost the owner more and it is unlikely to be able to borrow so much.
Spreads have gone up for everybody and even the stronger owners are facing increases of around 20 to 30 basis points – with the majority of shipowners now looking at margins of well over 100 basis points.
Whereas the banks were very regularly happy to lend amounts of up to 80-85 per cent (or beyond) of the value of a ship, now banks are very reluctant to look beyond around 65-70 per cent of the value of a ship being financed. So the owners will have to find more equity.
The issue for all the banks is their cost of funding. They simply cannot fund themselves in the Interbank market at LIBOR and there is a mismatch between short-term LIBOR rates for, say, three- or six-month interest periods and the cost of the longer term commitments the banks are required to put in place as underlying funding support. If the banks are paying as much as 60 basis points or more above LIBOR for their own funds, they simply cannot afford to lend at the old margins – so some of the banks are looking to get away from a purely LIBOR-based financing and agree a margin over their own specific cost of funds rather than above LIBOR.
The large syndications that dominated the shipping finance market until a few months ago have all but disappeared. The syndication desks at the banks are unable or are unwilling to underwrite very much more than the amount of that particular bank’s desired participation, so large underwritings are out and smaller club deals are in – indeed, you see some of the larger and more sophisticated shipowners pre-selling their deals to their banking contacts on behalf of their chosen mandated lead arrangers.
But there does remain a huge orderbook for newbuilding ships to be financed. China has seized a very large market share of the global orderbook of ships, but whilst some of the Chinese shipbuilding yards are highly efficient and well organised, analysts are increasingly saying that many of the ships ordered at some of the newer Chinese shipyards, which were ‘greenfield’ sites not so long ago, will simply never be delivered. That will afford considerable future work for the litigators, but there will still be a very large number of ships physically delivered and still needing financing.
So, with the credit from their bankers more expensive and much tighter, will the shipowners run into trouble? The fact is that most of the shipping markets remain very buoyant and profitable for the owners who have made a very large amount of money over the last few years. They therefore have much greater cash reserves to ride out the lean times than last time around in the cycle. There has also been a lot more consolidation amongst the shipping companies so both the fleets and the financing have been much larger scale. Therefore, when the downturn comes, as it inevitably will in a number of the different shipping sectors, it is likely that the effects will take some time to work through before companies are both suffering and bought to account by their banks. It is also likely that there will be fewer traditional ship mortgage enforcements but a greater emphasis on restructurings worked out by the companies and their bankers – with the various creditor protection arrangements such as Chapter 11 playing their part in helping companies keep their creditors, secured and unsecured, at bay while they try to survive and work their way through their particular crises.
Will leasing play its part?
UK tax based leasing changed dramatically for shipping after the changes in 2006 to transfer the capital allowances on ‘long funding leases’ to the lessee rather than the lessor. Activities in the ship lease market have resumed on a lower scale and with different structures, particularly short term leases (five years or less) or longer term operating leases where the lessor takes proper residual value risk on the ship and does not pass it all back to the lessee as it typically had done with the previous UK finance lease structures. Traditional finance leases are still allowed for shipping companies within the UK tonnage tax system but there are restrictions on what security the lessees are allowed to provide to the lessor.
In France, two tax-based finance lease structures are promising attractive benefits. The structures include the single investor tax lease and the recently implemented French tax lease based on Article 39C of the French Tax Code, which encourages new investment by French and overseas operators. These two tax leases rely on the ability of the lessor to offset losses created by accelerated tax depreciation in the early years of the lease against profits of the lessor’s shareholders. For shipping companies, these two lease products can be combined with the French tonnage tax regime to enhance the benefits and permit a partially tax-free disposal of the ship.
Nigel Thomas is a partner and head of the international shipping finance group at Watson, Farley & Williams