Introduction
Tighter credit conditions in recent times have prompted shipping companies, which have traditionally relied on bank debt to finance their operations and the acquisition of vessels, to seek other forms of financing. One alternative source of finance that has been found suitable and, importantly, available, has been the international debt capital markets. Evidence of this trend is provided from the increasing number of bond issuances by shipping companies towards the end of 2009 and through 2010. An interesting feature of this trend is the variety of bond instruments which shipping companies have employed and which are tailored to their circumstances and market conditions. These range from relatively straight forward "plain vanilla" corporate bonds through to more "exotic" varieties such as convertible bonds and covered bonds. This is interesting, given that the bond markets have not historically been viewed as a typical source of ship finance other than junk bonds in the late 1990s and early 2000s.
The trend towards bond finance seems likely to continue, as does the willingness of shipping companies to seek less conventional varieties of bonds to meet their financing requirements. For example, shipping companies might seek to satisfy some of their financing requirements by accessing the Islamic capital markets through the issuance of sukuk, which are bonds structured in accordance with Islamic finance principles. The issuance of sukuk will provide shipping companies with access to an investor community which might have previously been unavailable to them. However, irrespective of the type of bond, the international capital markets represent a significant opportunity and a viable alternative financing option for shipping companies, especially those in the offshore drilling sector where capital expenditure tends to be relatively high.
Current trends
While the use of bonds by shipping companies to raise finance is certainly not a new development in the shipping industry, historically bond issuance by shipping companies has been less frequent and bond issuances typically have involved relatively small tranches which have been used to supplement much larger bank debt facilities. However, the end of 2009 and the first half of 2010 saw a surge in large bond issuances by shipping companies, including several repeat issuances by the same issuers. For example, Mitsui O.S.K. Lines (O.S.K.) has issued several series of bonds including two issuances in 2009 of ¥20 billion (approximately US$240 million) each. In addition, there have been a number of significant cross border transactions, including the issuance of US$100 million in convertible bonds by PT Berlian Laju Tanker TBK and the offering of US$1 billion senior secured bonds by Vantage Drilling Company which was offered to US qualified institutional buyers under Rule 144A.
The appeal of bond financing
After the severe dislocation to international debt capital markets during the global financial crisis, more recently those markets have become more active and liquidity has increased. Even though bond market interest rates can be higher than typical commercial bank lending rates, bonds carry the advantage of being issued with much longer tenors than bank loans. This can be particularly attractive to offshore drilling companies which require relatively high levels of long-term capital expenditure to fund the purchase, installation and operation of rigs and floating production storage offloading units (FPSOs).
The increasing popularity of bond financing in the shipping industry and the appetite of shipping companies and their advisers to devise innovative fund-raising structures has seen shipping companies issue not only plain vanilla bonds but also more complex bonds with structural enhancements. For example, there have been several recent issuances of convertible bonds which are convertible into newly issued shares of the issuer at the option of the investor, including the convertible bonds issued by PT Berlian Laju Tanker TBK and the US$125 million convertible bonds issued by Genco Shipping & Trading, both of which were issued in 2010. Convertible bonds are an attractive option for shipping companies because the equity component typically means that the convertible bonds bear lower coupon rates or yield and also allow shipping companies to defer equity raisings in circumstances where their share prices might be currently undervalued for any reason, including because overall market conditions are unfavourable. Convertible bonds can appeal to investors because they allow investors to hedge their investment risk while benefiting from capital appreciation if the underlying shares perform.
Covered bonds provide investors with recourse to a pool of assets that secure or "cover" the bonds if the originator becomes insolvent. Issuance of covered bonds by shipping financiers has been less common, but is another example of the innovative use of the international debt capital markets by shipping financiers more recently. Ship financiers with shipping loans on their books can utilise these loans as secured collateral for the covered bond and ring-fence them to enable the issuer of the covered bonds to achieve a higher credit rating for the covered bond than the issuer's own corporate credit rating. For example, the German based HSH Nordbank issued its first shipping loan covered bond (known in Germany as Pfandbrief, issued pursuant to the German Pfandbrief Act (Pfandbriefgesetz)) in 2008 in the amount of €1 billion and, more recently, in June 2010 in the amount of €500 million. Covered bonds appeal to investors because the collateral is securely ring-fenced and may only be used if the issuer defaults on the covered bonds and the collateral is needed to pay the investors amounts owing to them under the covered bonds.
A further innovative bond financing alternative which seems likely to be explored further by more participants in the shipping industry is the issuance of sukuk, especially given that the shipping industry regularly uses other forms of Sharia-compliant funding. Even though there are some examples of sukuk issuances in the shipping industry, such as the US$26 million sukuk issued by Pacific Star to fund a very large crude carrier (VLCC), the MT Venus Glory, the issuance of sukuk by shipping companies remains relatively unutilsed. However, shipping companies which are seeking to grow their fleet of vessels and require long term financing might well be the ideal candidates for issuing sukuk (which are required to be based upon underlying tangible assets). Admittedly, there are certain challenges in structuring a sukuk for ship finance which might not exist in conventional bond issuances. For instance, it will be necessary to structure the transaction to comply with both the relevant laws and relevant Sharia principles. In addition, in order to achieve a transfer of assets (for example through an ijara or sale-and-leaseback structure), the asset must be unencumbered and capable of transfer - this element might not always be possible for shipping companies which might have already encumbered their vessels in order to secure existing debt finance. Nevertheless, the fact that other forms of Sharia-compliant financing have been used in the shipping industry on a regular basis demonstrates that these challenges can be overcome through innovative structuring.
The future
The current trend of innovation in raising ship finance presents a significant opportunity for both shipping companies and financial institutions alike. It is anticipated that this trend will continue while the global shipping business sustains strong momentum and bank lending remains in relatively short supply. Shipping companies which are planning their future capital expenditure requirements could benefit from considering whether bond or sukuk issuances might provide them with suitable financing arrangements and accordingly a competitive edge by accessing a presently liquid bond market.
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