If shipping companies have had an uncomfortable few years, so have the financial institutions that have historically provided the mainstay of the sector’s financing.
The boom that pushed Capesize day rates above US$100,000 and sent the world into a ship-building frenzy caused traditional lending multiples and loan-to-value ratios to swell. When the credit crisis struck, loans were left looking impossibly generous as asset values retracted and earnings capacity dwindled.
What remains is an industry looking, for the first time in the modern era, outside traditional bank lending for its core capital requirements. Meanwhile, some financial institutions have made it clear they are reappraising their commitment to the sector, and new money is working out how to get involved as recovery picks up.
Banks in Europe are not acting en masse, despite circumstances and regulatory pressures being common to many. Some have openly committed to the sector, despite having a large portfolio of investments under strict management. Others have made efforts to shrink, sell or wind down their loan portfolios.
Though new bank lending is hard to come by, it can still find a way through. That is not necessarily good news, according to Erik Nikolai Stavseth, an analyst at Arctic Securities. “The overall environment for commercial debt has cooled considerably. But the shortfall is partly being filled by enhanced capital allowances and export-import finance orders, and by government support for the industry. This represents a risk to recovery, as most segments need to have their access to additional capacity constrained.” In other words, an absence of cheap money might be helpful to the industry as a whole. One senior director at a bank choosing not to grow its shipping portfolio said that rock-bottom prices offer institutions “good opportunities.” But he suggested that leverage would be conservative, most likely between 50 and 60 percent loan-to-value.
Stavseth sees certain European banks’ strategic withdrawal as typical in a down cycle and has already spotted those looking for fresh opportunities. Whether banks stay committed, turn their backs on the sector temporarily or quit in perpetuity is yet to be seen, but Albert Stein, managing director at AlixPartners, senses lasting change: “The new banking regulations look pretty permanent. American banks got out of balance sheet lending 15 years ago, and European banks may do the same.”
By any reckoning, the sector has offered poor returns to banks and their shareholders over time. Paul Slater feels the asset class can sometimes be misunderstood: “There is occasionally inadequate recognition that ships depreciate. Too often they are treated in the same way as real estate. But they will only ever see a fleeting uplift in value. In the long run they lose value until they are scrapped, and that should never be forgotten.” Slater equates the flood of money into shipping in the boom—from banks, KGs and other sources—to 1980s Wall Street, fueled in this case by dreams of unstoppable growth in China and other emerging markets. He and others who have watched the industry over decades from a steady frame of reference are entirely unsurprised by what has unfolded.
Banks sticking by their long-term clients have good prospects, if they can be flexible. A senior banker in the sector was confident that “those [banks] that can afford to be patient should see asset values and rates lift high enough for debts to be repaid in full.”
But what does “being patient” involve? At a minimum, a company that cannot pay its debts to the bank must negotiate new terms or risk adverse action. The downturn has seen players on both sides in near-constant negotiation, with contracts extended further and further. Such voluntary flexibility is often the best option for lender and borrower alike. Banks tend not to want to seize assets and surrender any chance of their debts being repaid in full. Companies, meanwhile, have a mission to keep trading by any reasonable means.
If the repayments are not affordable in the long term, and the assets remain below the value of the loan against them, restructuring a company’s entire financing can be the last hope. No two restructurings will be exactly alike: The relative bargaining power of the creditors, the nuances of the capital structure and other factors (such as the jurisdictions involved and the possibility of maritime arrest actions) can significantly affect the dynamics of the process and the solutions proposed.
Restructuring in detail: TORM—a consensual approach
TORM A/S is a Danish ship owner and operator that enjoyed steep growth after the turn of the millennium.
To service customer demand above and beyond its owned capacity, TORM leased vessels through time charter (TC) contracts. As the economy faltered, and demand and rates fell, TORM remained locked into TCs negotiated when rates were far higher. The drop in income left the company vulnerable and unable to service its contracts long term and with dwindling cash reserves.
White & Case was appointed by the secured creditors to explore the options. Partner David Manson, who advised on the restructuring, describes the criticality involved: “In the interests of all parties, the main objective was for TORM to remain a going concern. To avoid bankruptcy and stabilize the business, additional financing would be required. Improvements to cash flow would also be sought, with the existing debt and TCs the main targets for renegotiation.”
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After a number of options were considered, a consensual out-of-court restructuring was the chosen route. This strategy avoided an insolvency process, so TORM could continue trading as the same legal entity, and maintain its public listing and liquidity in shares. It also allowed for the renegotiation of debt and TCs to occur with minimal disruption to normal business operations.
The major difficulty with this kind of restructuring is gaining the approval of all stakeholders. But in this instance, an acceptable compensation model was found and agreement reached. In return for their support, the banks and TC counterparties would now hold 90 percent of the equity, with the existing shareholders retaining 10 percent of the company. It was through this compensation offer to the TC partners that the loaned fleet was reduced significantly, creating an immediate improvement in cash flows and a US$270 million rise in TORM’s mark-to-market value. The banks received their equity stake in return for deferring the maturity of their debt and restructuring their secured indebtedness, and approving a new US$100 million capital facility.
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