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Forced hiatus of shipping loan sales

Banks had been selling their shipping loans with gusto through 2018 and 2019, but the arrival of the Covid-19 pandemic combined with stricter selectiveness on the part of potential buyers has drastically reduced the market for shipping loans.

Record sales in 2018 and 2019 stemmed from the banks’ eagerness to reduce their shipping exposures, which have lengthened because of protracted volatility in the sector. They also need to reduce their US dollar funding and adhere to the higher capital demands of the incoming ‘Basel IV’ global bank capital requirements.

But a shrinking pool of buyers is making necessary disposals much harder to implement. “While banks are keener to reduce their exposure in preparation for Basel IV, finding willing buyers is proving increasingly challenging,” say PwC’s Panos Mizios and Nasos Tsarouchis, specialists in financial services and refinancing and restructuring. “Having already taken on significant shipping loan portfolio holdings, some private equity funds are becoming more selective in what further acquisitions they’re prepared to make.”

While Asian strategic buyers have demonstrated a keenness to expand their presence in Europe, they “generally prefer closely targeted performing portfolios over large acquisitions with a mix of vessels and loans of varying quality”.

Banks, therefore, need to work that much harder to find willing buyers for their shipping loan portfolios in the new normal.

PwC’s Mizios and Tsarouchis, drawing from their experience with buyers, sellers and potential funders, are advising banks to put in a lot more preparation than before, and to take “a stronger view on the long-term strategic options for the portfolio being sold or the pipeline being considered for origination”. This includes meeting the high information requirements of a small number of potential investors, especially for banks that are not as experienced in the portfolio disposal process, they add.

German challenges

Moody’s Investors Service warns that with German banks now among the least profitable in Europe – largely due to very high-cost bases – sizable cost cuts will be needed to prevent a slide to break-even or bottom-line losses for some banks. “Without management taking cost reduction actions, a further decline in German banks’ profitability is inevitable,” says Swen Metzler, vice president-senior credit officer at Moody’s Investors Service.

Moody’s has assessed the trajectory of German banks’ profitability under two scenarios through to the end of 2024. The first is a more benign scenario that projects a continuation of trends at German banks since 2014. The second scenario models a perhaps more likely – in Moody’s view – Japan-like economic backdrop, characterised by weak economic growth and persistently low or negative interest rates and very low inflation.

Under the first scenario, German banks can maintain their level of profitability if they reduce their costs by close to 10% over the next five years. However, under the Japan-like scenario, Moody’s projects that German banks’ system-wide profitability will be nearing break-even by 2024, meaning some will be loss-making – unless they target their costs much more aggressively. Traditionally a strong presence in the shipping loan world, many German banks have been shedding shipping loans for the past four years in a bid to reduce exposure from a sector beset by defaults on the back of persistent low rates.

With the pandemic adding to the woes of the sector, uncertainty and volatility are PwC’s key words for the shipping and offshore markets looking ahead. “This is likely to hold back bank lending and hasten loan portfolio divestment,” say Mizios and Tsarouchis. Notwithstanding some localised improvements of rates in 2020 and grace for operational costs as fuel prices fell, any upturn appears to be “running out of steam”. Add to this the challenges of trade tensions and economic weakness and loan defaults and disposals are expected to continue.

Non-bank options

PwC counsels shipping loan applicants to look beyond banks, which if still lending tend to be selective and focused on larger groups that offer cross-selling opportunities. Instead, export credit agencies and a limited number of highly experienced private equity funds could offer a financial lifeline through the provision of private placement bonds and structured financing, along with direct vessel ownership through the formation of joint ventures with shipping companies.

“In addition, new platforms with ex-banking shipping professionals are looking to enter the new loan origination market,” says PwC. “These new entrants are planning to partner with either experienced private equity or high net worth individuals that aim to generate IRRs in excess of 10%. The growth opportunities appear to be significant and the supply of financing to date has not, in our mind, been adequate to satisfy the financing needs, especially of mid-market shipping borrowers.”

But the caveat is that shipping companies securing non-bank lending will need to manage the higher margins required by private equity funders and the lack of flexibility in export credit agency lease transactions.

PwC expects that shipping loan portfolios will begin to circulate for sale again towards the end of 2021 or early 2022, as conditions begin to normalise. In the meantime, Mizios and Tsarouchis see a “significant opportunity for investors” with a longer-term horizon that are looking to expand their presence in the shipping market to take advantage of new financing opportunities, especially with mid-market creditworthy borrowers that are looking to expand their businesses.
Source: Baltic Exchange

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