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Recent trends in shipping finance

by contributors Stuart H. Gelfond, Vasiliki B. Tsaganos and Melina Kapeliou, Fried Frank | Published June 22, 2012 at 12:50 PM

Shipping companies have traditionally relied on bank debt and equity markets to finance their operations and the acquisition of vessels. Since 2008, however, we have been witnessing significant changes in the shipping finance landscape, with the availability of bank finance declining and shipping companies seeking increased access to international bond markets and introductions to private equity, which has not been widely used in shipping until recently.

Outlook for the shipping bank debt market is not overly promising. Banks (including European banks that have traditionally been the top lenders to shipping companies) have tightened credit lines (except to the best shipping credits) and have recently started taking or threatening enforcement action against defaulting shipping companies as banks face heightened regulatory requirements and certain risks amid the euro-zone crisis. We expect to see more repossessions and enforcement actions, if shipping companies do not obtain access to other sources of financing and market conditions do not improve. A number of shipping companies have also proactively filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.

The market for initial public offerings in shipping has been almost closed, and it appears that only financially strong players in the right segment of the shipping market can access the IPO market at this stage. Since 2010, we have seen very few IPOs by shipping companies in the U.S. and non-U.S. markets, with the most recent U.S. IPOs being in the liquefied natural gas space. By contrast, follow-on public offerings of already listed shipping companies have been relatively more active. It remains to be seen whether shipping companies will be able to take advantage of the recently enacted Jumpstart Our Business Startups Act, which is designed to facilitate capital formation in the U.S. by easing regulatory requirements for emerging-growth companies (that is, companies with less than $1 billion in revenue). The JOBS Act, among other items, allows confidential treatment of the filing and review process of the registration statement for an IPO until 21 days before the IPO road show; permits scaled-back financial statement and executive compensation disclosure; exempts emerging-growth companies from the auditor attestation report for internal controls required by the Sarbanes-Oxley Act of 2002; eases restrictions on prelaunch marketing activities with institutional investors; and reduces restrictions with respect to the publication of analyst reports in connection with IPOs. Although the JOBS Act makes the process easier, companies still need to find investors at acceptable valuations. With shipping company valuations down significantly from the mid-2000s, it is painful for shipping companies to raise equity at low prices and dilute their shareholders.

At-the-market continuous equity financing programs have been used recently as a supplemental means to access equity capital in a broad range of industries, including shipping, as shown by the recently announced $35 million at-the-market programs by Greece's Excel Maritime Carriers Ltd. Such programs allow issuers to quickly and opportunistically access equity markets, especially during periods of high volatility and have been used by issuers to raise equity capital as the need arises by selling shares of their common stock from time to time through a sales agent at current market prices. The upsides of at-the-market programs compared to follow-on offerings are that they give issuers considerable control over the timing, amount and price of each issuance and sale of their stock and generally offer lower underwriting costs. However, such programs do not allow for large equity issuances and are largely dependent on the issuer's market liquidity.

Starting from the late 2000s, we have been seeing more and larger bond issuances by shipping companies in the international bond market. Historically, bond offerings by shipping companies involved small tranches and aimed to supplement large bank debt. This increased use of bonds has been significantly driven by limited availability of bank debt. The upsides of bonds compared to bank debt for issuers are that they provide access to a larger pool of investors; offer greater flexibility in terms of covenants; have significantly longer tenors; may not require security (many bond offerings by shipping companies have been secured, as security increases investors' appetite and allows larger issuances); and do not have annual amortization. However, the interest rates on bonds are typically significantly higher than bank debt and given the current economics in shipping, the added interest costs can be untenable. Additionally, bonds are not prepayable for a number of years, which can be problematic if the bonds' interest rate is high.

The weakening of valuations, cheap interest rates and the unavailability of credit have seemingly made shipping companies attractive opportunities for PE investments. There are a broad range of PE investment strategies that focus on different segments ranging from leveraged buyouts that acquire mature businesses as a whole, growth capital, distressed investing to joint ventures and rollups by acquiring vessels. PE funds often seek to invest at or near cyclical lows, typically look for a three- to five-year exit window (in the form of a private sale or IPO), seek high return requirements of greater than 25% and look for assets that are financeable.

PE funds have substantial committed and undrawn capital. In the past two years, there has been some notable PE activity in shipping, and this is perhaps an indication that PE can serve as a significant part of the bridge until the capital markets open again. Financial investors (often new to shipping) have been entering into joint ventures with shipping operators or acquiring stakes in distressed companies with the view to share (in the medium term) in a potential upturn in the shipping market. For example, in 2011, WL Ross & Co., the PE firm that specializes in distressed properties, entered the shipping industry by participating in Diamond S Shipping's purchase of 30 oil product tankers from Cido Shipping (Korea) Co. Ltd., and Oaktree Capital Management LP invested $375 million in General Maritime Corp. (including $175 million after the company had entered bankruptcy).

Generally, in a PE investment, an investor will typically ask for preferred stock (with pre-emptive rights, registration rights and anti-dilution adjustments); significant board representation; close monitoring of the company's performance and veto rights over major decisions (for example, acquisitions, budgets and capital expenditure, dividends, debt incurrence); broad information rights (for example, regular financial statements, forecasts and management and board meetings); and control over the timing and form of exit (for example, tag-along and/or drag-along rights, and registration rights for IPO). Distressed investing can include "loan to own" strategies, which permit investors to emerge from restructuring controlling the company. Rollup strategies by acquiring vessels, which could prove attractive due to currently depressed vessel prices, have the additional benefits of releasing investors from the burden of incurring the costs of a public company and assuming historical liabilities.

PE may experience some increased activity as shipping companies remain distressed and other financing sources remain limited. Banks may push shipping companies for an injection of PE as a precondition for providing waivers or otherwise restructuring. However, there are many challenges to PE investment in shipping. From a fund's perspective, most PE funds are new to the industry, have limited operational experience, if any, and are concerned about timing the downward point of the cycle. From the perspective of shipping companies (which have traditionally been run by families), it may be hard to accept that PE funds will have an active involvement in how the company is managed and the three- to five-year exit strategy and finding the right balance.

In a nutshell, securing funding has been challenging (to a varying extent) for shipping companies. Despite the challenges that are lasting longer than the market had initially anticipated, opportunities may lie ahead for well-advised players. The challenge for new money coming in is how to create value, as the bank debt is greater than asset value at this time. It appears that banks are going to need to take the necessary charges in order to create equity value in the new money.

Stuart H. Gelfond is a corporate partner in the New York office, Vasiliki B. Tsaganos is a corporate partner in the Washington office, and Melina Kapeliou is a corporate associate in the London office of Fried, Frank, Harris, Shriver & Jacobson LLP.

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