In Shipping Law News 28/11/2016
Capital markets financings have gained traction with the shipping industry in recent years. The issuance of bonds and equity by shipping companies more than doubled in value between 2008 and 2014, as banks, traditionally the industry’s main source of funding, became more and more selective in their lending following the global financial crisis and particularly in light of increased regulations under Basel III and the upcoming implementation of Basel IV. The continuing difficulties in obtaining bank financing for the shipping industry can be seen in situations such as the bankruptcy of Hanjin Shipping, South Korea’s largest shipping group, which entered into receivership in September 2016 as it was unable to find new financing or restructure its existing debt.
Since 2014 however, increasingly tough trading conditions in the shipping industry have stemmed the flow of capital markets transactions. The oversupply of ships, depressed freight rates, unsustainable debt and negative macroeconomic environment have led to a slowdown in capital markets activity. Bond and equity financing (excluding leasing, M&A and restructuring) dropped from $23.2 billion in 2014 to $10.3 billion in 2015. In the first eight months of 2016, approximately $1.8 billion was raised through bond and equity financing. Given the dramatic reduction in the use of capital markets funding by the industry, where are the opportunities for shipowners now?
Recent developments in shipping capital markets
Financing orders for new ships is often one of the initial drivers for capital markets financing. Orders for newbuild ships made in the years following 2008 have resulted in a flood of surplus ships as demand failed to keep pace with capacity, eventually, leading the shipbuilding industry to suffer considerable losses, and a dramatic drop in new orders.
The glut of vessels poses an overcapacity problem exacerbated by global economic conditions. In particular, the slowdown in the Chinese economy has led to a decrease in demand for goods, in turn reducing demand for shipping. Many of the fleets which commissioned new ships are now underutilized, which has simultaneously raised unit costs and reduced revenues. Shipping companies with leased ships have also suffered from the abrupt fall in freight rates in the last few years as many of their charter rates were fixed at high rates during previous boom times.
This toxic mix has affected profitability and the negative results are evident in the capital markets as many listed shipping companies continually trade below net asset value and shipping bonds increasingly default. No major shipping company has successfully pursued an Initial Public Offering (IPO) for over a year. Capital markets proceeds raised by US-listed ship owners in the first half of 2016 amounted to $944 million, down 59 per cent from the same period in 2015 and down 80 per cent from the same period in 2014.
Regulators have responded to the industry’s downturn. A review of recent US-SEC comment letters to shipping companies’ filings reveals that the SEC now frequently challenges the use of 10-year historical average charter rates for impairment analysis. The shipping industry had commonly used moving 10-year historical average charter rates as a standard of comparison to capture the market’s long-term cyclical highs and lows. However, SEC comment letters to shipping companies often note that because of the recent volatility of the market and the continued poor outlook, shorter term historical average rates may provide a better benchmark. Shifting to average rates over a shorter period of time results in decreasing the value of the ships, which in turn negatively impacts the companies’ financial condition. Changes in disclosure practices for registered deals are often eventually adopted into Rule 144A and subsequently Regulation S deals. Increasing requirements for negative disclosure may have a discouraging effect on shipping companies concerned about releasing sensitive business information.
Alternative financing options
Despite the current gloomy market conditions, shipping companies are exploring a variety of alternative funding through different financing options as evidenced by our recent The way ahead transport survey.
Export credit agency (ECA) financing has become one of the most popular sources of alternative funding in recent years. Before 2008, ECAs accounted for approximately 10 per cent of shipping and offshore-related debt finance. Since then, their contribution has increased to over 33 per cent.
One example of how ECAs are supporting capital markets financings is a $200 million fixed rate bond offering by ICBC Financial Leasing. This transaction, which completed in February 2016, was a combination of a commercial facility, an ECA-backed facility and a bond offering. It was also a debut collaboration between a Chinese financial lessor and the Export-Import Bank of Korea, which guaranteed the bond as the ECA lender, to support the financing of high-end ships built in Korea for use by leading global operators. This deal demonstrated that even during downturns, the capital markets are still open for the right kinds of transactions. The stability provided by an ECA-backed bond with major banks as underwriters sparked sufficient interest to support a bond deal at favorable pricing terms.
Another recent trend is the use of debt and equity private placements to obtain financing. According to IHS Fairplay, in the first half of 2014 and 2015, private placements accounted for less than 1 per cent of proceeds raised in the capital markets by US-listed ship owners, whereas in the first half of 2016, private placements accounted for approximately 70 per cent of such proceeds. With public investors on Wall Street reluctant to invest in a volatile market, the shipping industry has turned to smaller and more targeted private placements, including private equity funds created by capital management companies focusing on the shipping industry. Debt capital markets transactions are also attractive to shipping companies since they provide longer maturities, fixed rates and higher flexibility in extending credit for riskier projects that banks do not finance.
The future
The shipping business is ultimately cyclical. Newbuilds have already dropped off and the surplus of ships will eventually diminish as older ships are retired and shipping demand picks up. A significant drop in oil prices in early 2016 increased oil tanker transport and helped keep freight costs manageable. However, dry bulk and container shipping markets remain in a slump which has not been fully mitigated.
The overall shipping market remains vulnerable due to the slowdown in global economic activity. Industry experts believe it will likely be a year or two before industry recovers and are generally not optimistic about the prospects of the IPO market in the near term. In the meantime, shipping companies will continue to seek financing through alternative capital markets options. Debt deals are possible for the right names and where the structure is robust, such as with the participation of a major ECA. The equity market will likely continue to be driven by private financing.
Source: Norton Rose Fulbright
