Ship financing is entering a transitional phase. Traditional sources of capital for shipbuilding are drying up with many of the long-standing ship financing banks leaving the business behind. But what instruments will emerge to fill the ship-lending niche and will shipowners have to dig deeper into their own pockets to build the next generation of ships? In the wake of the 2008 global financial crisis, traditional ship financing collapsed alongside charter rates. In the years that followed, companies looked to alternative sources of funding to take up the slack: Private equity sank billions of dollars into the industry, trawling for assets on the cheap. Hedge funds bought up massive amounts of discounted debt. Insurance companies and other non-traditional sources offered financing. “The winds have shifted. The markets have shifted. The money sources have shifted,” said Brian Devine, a New York-based lawyer with Norton Rose Fulbright. All the while, Asian shipyards continued to crank out newbuildings. That just exacerbated a shipping glut and held down prices of both vessels and charters, delaying an expected recovery and complicating financing even more. This year, shipping companies continue to face a challenged and, in some ways, even more uncertain financing horizon. Commercial bank lending to the shipping industry has yet to recover and it may never regain pre-crisis levels. Some believe more banks will follow German Commerzbank’s 2012 lead and leave the field altogether, with attention these days particularly focused on imperiled Greek banks. Private equity is becoming more cautious. (See related article on page 8) The stock market is a tough slog. “One year ago, we thought that the bottom of the down-cycle in the shipping industry had been reached, and that the industry was beginning to enter the recovery phase,” said Brett Esber, a Washington-based lawyer with Blank Rome. “But we might say that things are not that much better than 12 months ago.” Dangers of Over Ordering Economic factors don’t help. China’s economy has cooled, depressing demand for commodities, which in turn lessens the need for ships. The European economy remains in the doldrums. At the same time, the global financial system remains awash in cheap money through quantitative easing. Export credit agencies provide funding incentives for new construction, enabling ship owners to invest less money up front. Some Asian banks also are becoming more aggressive in their support for indigenous shipyards, which remain locked in punishing competition. Over-ordering is still a feature in many markets. “As we have seen in dry bulk, if there is cheap and abundant money, it is very easy to order ships that nobody needs,” warned Gust Biesbroeck, head of transportation at the Dutch bank ABN AMRO. He was speaking at a recent shipping forum in New York, sponsored by Capital Link. At the Capital Link forum, financing got center stage. Speaker after speaker attempted to clarify what’s hot and what’s not. The consensus, if one exists, is that shipping industry financing is being buffeted by crosscurrents that aren’t about to go away, regardless of charter rates. The result is an ongoing change in both ownership structure and funding sources. “Shipping is in a transitional phase from being privately owned and financed by the European banking sector to [being] institutionally owned and financed by different sources of capital,” said Martijn van Tuijl, senior vice president at the Frankfurt-based DVB Bank, still a major commercial lender in the shipping industry. Shipping companies and their investors will look to mergers as a way to bulk up, gain financial strength, and, in some cases, create an entity big enough to attract Wall Street, many analysts believe. With a few exceptions, shipping companies have failed in recent years to tap the public markets, notably initial public offerings. One reason is size. These days, a company must have an enterprise value of at least $1 billion to go public. In the shipping industry, that’s a high bar. “There’s going to be consolidation for sure,” said Esber. Private equity firms are “going to have to create their own exit strategy,” he said, and mergers and acquisitions will be part of that strategy. Some European banks such as ABN AMRO and DVB are reengaging the industry, and the larger, better-managed shipping companies continue to have access to funding. However, the shakeout in traditional commercial lending lingers. Exit from Shipping Sector “There will be another round of exits of shipping banks from the industry,” said van Tuijl. “Because of the scarcity of capital, banks will have to continue making choices what businesses they are or not active in. I think you will see a couple of banks who are not able to make those returns and be forced to exit.” It’s not just that banks have been burned by bad loans. Shipping lacks both the sex appeal and the heft of some other industries competing for funds. “Shipping is not a hobby that bank boards will tolerate,” said Michael Parker, global industry head for shipping at Citi. “Shipping is just another industry and quite a small industry.” Changes in banking regulations could further diminish that appeal. European Central Bank regulators have already begun to more closely examine lending criteria, said Biesbroeck. Parker warned that a new global regulatory framework, which must be implemented by 2019, “will have a dramatic effect on shipping.” Commercial banks are becoming more cautious in their lending and choosier about who they lend to. Analysts talk of a “flight to quality” where banks attempt to support their better clients, but not to the degree they did before. The result is that even the most stable ship owners are being forced to put up more money themselves or find alternative – often more expensive—sources of money elsewhere for new acquisitions. Gone are the days when ship owners could expect banks to lend 70% or even more of the value of a ship. A typical loan is now down to about 50-55% of the purchase price. And, of course, the cost of a newbuild is less, so in dollar terms, lending is way down. That doesn’t mean money has dried up completely. Alternative funding sources abound. “A lot of owners who have difficulties finding bank loans can look at other sources of capital,” said Jeffrey McGee, principal at Makai Marine Advisors, an independent shipping research and consultancy, based in Dallas and New York. Private equity, for one, not only buys ships and sinks equity into shipping companies, but provides as well loans to ship owners. Along with hedge funds, PE also buys existing debt from commercial banks, debt that is either unwanted or considered too risky. Because of aggressive bidding by hedge funds and private equity, said McGee, banks have been able to sell off their often-distressed debt at a hefty percentage of face value, often 90% or even more. “There hasn’t been as many fire sales as expected,” he said. So far, at least, shipping companies have largely avoided loans that carry with them higher interest rates, but are either less secured, or unsecured by assets. That so-called high yield market, funded by a variety of sources, is waiting anxiously in the wings, ready to pounce. The high-yield market “is wide open,” said Joseph Maly, a managing director at investment bank Seaport Global Securities, at the conference. “It’s just a matter of time before we see more shipping transactions.” On the other end of the funding spectrum, government-owned export credit agencies continue to back their countries’ shipyards by offering funding incentives for ship buyers, usually in the form of loan guarantees. Japan Bank for International Cooperation, for example, has become very active in providing loan guarantees in an effort to keep Japanese shipbuilding afloat. Japanese commercial banks have joined that effort and become more aggressive in ship lending.