Financing Will Be Critical To Health Of Changing, Growing Maritime Industry
Financing will be one of the most critical issues facing the global maritime industry over the next 10 years, as the need for shipping increases, industry consolidation continues, and equipment ages and, in some cases, becomes obsolete.
Financing this growth will be a challenge. Despite the fact that banks are making a comeback to the industry, business finance companies will be increasingly active in financing the shipping industry's growth. However, these companies will need to continue developing ways to meet the large and complex financing needs facing the maritime industry, resulting in some new and innovative financing structures. Shipping Opportunities Increase Most of the world's industrial nations are emerging from recession and the newly industrializing nations of Asia are experiencing explosive Gross Domestic Product growth — in some cases achieving double digit annual rates. The world's bulk and liner service trades are already beginning to benefit from the improving world economy that is increasingly becoming more integrated and interdependent. Mass geopolitical movements toward market economies are further strength- By Stephen Z. Serepca, senior vice president The CIT Group/Capital Equipment Financing ening shipping growth.
Worldwide environmental concerns are also having an impact.
For example, the need for refined hydrocarbon products out of the Middle East by the ecology-conscious U.S. and Europe will result in increased shipping activity. And, as more money is devoted to aiding needy nations, additional grain movements will further increase shipping demands.
Also fueling shipping growth is the rebuilding of the infrastructure of Eastern Europe and the CIS, and China's massive ongoing economic development program.
Consolidation in the Industry The growth in the world economy coupled with heightened global competition will also result in capital and maritime market dynamics forcing consolidations and mergers of fragmented and undercapitalized shipping companies over the next five years. After this wave of consolidation, performance and access to capital will rise to new levels for shipping firms, similar to the experience of recent activities in the Greek sector and in the liner service trades.
An Aging Fleet Although orders for new ships in the bulk sector slowed in 1992 and 1993, they were on the rise in 1994, and we expect that they will continue to rise through the end of the century. However, the world bulk fleet is aging and scrapping activity is on the rise.
Currently, approximately half of the world bulk fleet is older than 15 years, and almost two-thirds — 64 percent — of tankers are older than 20 years. And, tougher environmental standards being imposed by classification societies are making many vessels unusable. As a result, scrappings are at near-term record levels — 18 million dwt in 1993, with similar scrappings expected for 1994.
Of concern to the industry is that despite the fact that prices of vessels are down 10 to 15 percent from two years ago, charter rates do not support the cost of building new tonnage. Today, newbuildings are still about 50 percent more expensive than they were in the mid- 1980s, with a new VLCC now costing approximately $82 million versus $55 million in the mid-1980s. For example, it currently costs approximately $27 million to build a panamax bulker versus $18 million in the mid-1980s. Also, shipbuilding capacity has been reduced by about 40 percent since the late 1970s with delivery lead time for new vessels running approximately 18 months.
The combination of these factors will result in a short-term tightening in the supply of vessels needed to accommodate the expansion in the worldwide movements of basic commodities. As a result, demand for tankers and bulkers will increase through the latter part of the 1990s. The hundreds of billions of dollars that will be needed to replace and expand the aging world fleet of ships is not confined to the bulk sector of the maritime market. There are a dozen major sectors with more than 50 sub-sectors in the industry, each with different dynamics and needs. (Please see chart, left).
Capital Markets In 1993, the industry saw a resurgence of available capital from public debt and equity sources with over $3 billion ($2 billion in debt primarily placed in the U.S., and $1 billion in equity largely placed in Norway) flowing to shipping. In 1994, a resurgence in traditional financing occurred as banks worldwide have returned to the industry and as public debt and equity offerings slowed. In 1993,89 banks were actively involved in ship financing, up from 67 in 1992. And, we expect that this figure increased to approximately 100 banks in 1994.
However, the role of banks in financing the maritime industry will be limited by the fact that some banks have pre-set asset limitations and pre-set deal size and structure restrictions. Traditionally, non-bank business finance companies are able to lend to these companies and are likely to play a larger role in financing the industry's growth over the next decade.
Innovative Financing The term "innovative financing" refers to tailoring each element of a deal structure to accommodate the critical constraints of the borrower. Innovative financings provide the opportunity to create hybrids of different financial arrangements, including applying the most desirable features of leases to loans. Each element of deal structure is a candidate for lease type treatment.
When CIT/Capital Equipment Financing is discussing financing options with a shipping company, the first consideration is whether the financing should be structured as a lease or a loan. Here, the term lease refers to a passive, financiallyoriented lease rather than active operating chartering, which is the province of active owner/operators. Although leasing is not pervasive in the industry because ownership and unwinding entanglements impair flexibility, leasing is an attractive option for owners in sectors with long-term use for vessels and for those who provide services to cargo interests.
Lease transactions can take a few forms. One form is the true lease, where the risks and rewards of ownership reside with the lessor. Other forms are off-balance sheet financing and finance leases, where in both cases, the lessor is only a nominal owner. Leases can be leveraged or single-investor structures. In general, they provide a high level financing versus asset values, arelong-term commitments, and can involve complex, optimized repayment schedules, tax benefit transfers and residual risks and rewards. Loans, on the other hand, are ubiquitous in the industry and offer maximum flexibility for the borrower. Loans can be designed to incorporate the following features: • Advance rates can approach those of a lease; • Term can be almost as long as the asset's remaining useful life; • Repayment structures can be customized and optimized; • Loans can be partial or even fully non-recourse to borrowers with recourse to charterers; • Balloons can be partial or even fully non-recourse to borrowers;• Rates can be fixed or floating; • Substitution of asset flexibility can be provided for sales of pledged vessels in lieu of prepayment, thus avoiding break-funding costs; and • Back-end joint ventures can be structured involving shared recourse on aggressive residuals and upside residual sharing.
The degree to which financing can be innovatively structured is a function of: • The size and substance of the borrower or recourse charterer in relation to the size of the financing; • The quality and historical performance of the owner/operator; • The quality and projected market values of the collateral vessels; and • The characteristics of the market and the borrower's ability to generate adequate cash flow to comfortably service debt.
Innovative financing generally requires lending to a consolidated, audited business enterprise as lenders are somewhat investing in, rather than special-purpose lending to, an owner.
Financing the Growth of the Industry Non-bank involvement in financing the maritime industry will continue well into the next century.
Business finance companies like CIT/Capital Equipment Financing, with an in-depth knowledge of the industry, its needs and its realities, are well-positioned to provide the customized financing needed by the maritime industry.