Countercyclical Ship Finance Using Bonds
The bond market has been gaining popularity as a tool for both companies to raise capital and for investors to get a good return. Banks usually follow a procyclical approach when it comes to shipping, leaving shipping companies dry on funds during the bad times. Shipowners have three basic options when financing, which are, in order of preference for a company: internal funds, debt, and new equity. When companies cannot finance themselves internally they must either take on debt or offer equity; and when traditional bank finance is hard to find, alternative instruments may be used. Bonds have been making a comeback after the bad name they had made for themselves in the 90s, when a string of defaults left investors with great losses.
Generally, the announcement of a stock offering it taken by the market as a signal that the company’s prospects might not be that optimistic, managers with a positive outlook for the future would avoid selling stock and seek capital from alternative sources. A debt offering on the other hand may emit the opposite signal. Traditionally the bond market has not been the first choice for shipowners as the low interest rates have made banking finance much more attractive. The price which the bond will be sold at depends on many factors such as if the company is approaching the market for the first time in a primary offering or if they are well known and have been successfully borrowing for many years, the credit rating, and the liquidity of the bond issue.
The Basel III capital adequacy rules will make financing riskier markets more expensive, especially for small companies, and we might see owners flock to the high yield bond market. Specifically, to the Norwegian HYBM which offers many benefits for both the issuers and the holders. A bond can be placed fairly quickly with the overall process taking from two to six weeks (including a five-day roadshow), with no requirement for a prospectus and an efficient standardised term sheet and loan agreement. Additionally, no official ratings are required. This results in an inexpensive issue which leaves more room for profit for both the issuer and the holder. Subsequently, the bonds can then be listed on OSE or Nordic ABM.
International investors are sceptical of the shipping finance market – the nature of the cyclical, volatile, and highly leveraged shipping industry may jeopardise shipping company expected cash flows and result in the deterioration of the credit of the company and may even lead to a default on the debt. Bonds offer an advantage as the principle is repaid on the date of maturity, leaving the shipowner with excess cash – wish is useful, especially in bad market conditions where cash flows are very tight. The shipowner that does not have to make capital repayments, until the maturity of the bond, and in bad markets has excess cash flow to be more competitive and make countercyclical investments. Long term maturity bonds match the financial needs of the shipowners much better than that of a bank, the debt duration is matched with the vessel life more closely than the traditional bank loans.
Songa Bulk ASA recently tapped the market for USD 45 Mn, and with a total nominal amount outstanding following the issue is USD 120 Mn. Soga is a special investment vehicle established in August of 2016 to invest in the dry bulk sector – taking advantage of the historically low asset prices (with Panamax vessels at a 70 per cent discount over the 10-year historical average). The bond is secured on a first lien basis on all current vessels and future acquisitions, priced at 3-month LIBOR + 4.5 per cent, and matures in 2022. The covenant structure targets a vessel hull-to-debt ratio of not more than 75 per cent and a liquidity minimum set to no less than the sum of the next 4 interest payments. The company is also not permitted to incur any additional interest-bearing debt. The bond can be called after the first 2.5 years at a premium. MPC Containerships also recently raised USD 100 Mn through a bond sale in the Oslo market at LIBOR + 4.75 per cent. In a statement MPC stated that the issue received strong demand and was oversubscribed.
It doesn’t seem that the traditional bank finance structure is disappearing. However, bonds, as an instrument are very effective in allowing investors to act quickly and pounce on potential opportunities more aggressively. The quick, lean, and efficient structure allows a more opportunistic approach to investing. The long tenors then allow companies to invest in market lows and hold on to the assets while only paying interest until maturity where the market is (hopefully) at higher levels.
Source: Efthimios Tsirlis, MSc Shipping, Trade, & Finance