Notes
6.12 Difference from Shipping Loans
Shipping bonds are debt instruments and therefore very similar conceptually to shipping loans. In both cases, money is borrowed and eventually has to be repaid, and again, in both cases, the money can be accessed at a cost primarily tied to the borrower’s creditworthiness and secondarily correlated to the per- formance of the investment or related to market conditions. However, there are crucial diff erences between shipping loans and shipping bonds, and based on the circumstances, the borrower may have a preference between obtaining a shipping loan or issuing a shipping bond.
When Mr Big Ship approaches his shipping bank to borrow money to fi nance the acquisition of a new vessel, the bank bases its decision on whether to extend a loan on factors that the bank’s management itself has qualifi ed.
Th ese can be objective, quantifi able criteria applicable to all the clients of the bank, such as the amount of leverage to be extended or the minimum spread over LIBOR. However, the bank’s credit committee may also wish to consider
“softer” subjective criteria for extending a shipping loan, such as the extent and length of the banking relationship with the borrower, complementary business opportunities (e.g. cross-selling of private wealth products) and the overall strategic value of the borrower to the bank. For a shipping bond issu- ing, since there will be several buyers in the primary market and several more investors afterwards in the secondary market, the criteria pertaining to the quality of the bond have to be objective and to the satisfaction of the plenti- ful investors. Th erefore, a shipping loan is typically a bilateral contract where the “personal element” may be of certain gravity, while a shipping bond is a multi-party agreement based on quantitative decision-making.
Information that a shipping bank has collected on a borrower is typically proprietary and often privileged information, while pertinent information about the borrower and the bond are in the public domain and fi led with the pertinent authorities. While a bank has its own credit committee to assess the creditworthiness of a borrower, a third-party rating agency is often engaged to evaluate the bonds and the probability that the borrower will perform on their obligations. In terms of expedience, although the time a shipping bank can authorize a loan depends on several factors, in general the issuing of bonds is much more time consuming in terms of preparing and fi ling documentation and mainly concerns communicating with investors, holding a roadshow and
getting the fund commitments. Accordingly, the associated costs and fees are much higher for bonds than the origination and commitment fees that a typi- cal shipping loan will cost. Th erefore, shipping loans depend upon and assure privacy and discretion between the parties, and they are typically time and cost effi cient as compared to shipping bonds where information is public, and time and costs required to access the public markets are of a higher order. As a rule of thumb, shipping bonds require approximately one month or more of eff ort and can cost twice as much in fees and expenses than a loan. However, for shipping bonds with principal amounts in the range of hundreds of mil- lion dollars, costs are very competitive and well justifi ed (2–3% of the prin- cipal amount, which is slightly higher than origination fees charged by most shipping banks for smaller amounts).
Given that shipping loans (a) can be facilitated by personal relationships and ancillary considerations, (b) do not require public disclosure and (c) are both time and cost effi cient, one may be tempted to say that shipping bonds should be a resource of last resort in the fi nancial arsenal of Mr Big Ship.
Indeed, traditional shipping loans (ship mortgages) dominate the shipping debt markets for independent, smaller shipowners. However, there are strong considerations in favor of shipping bonds as well. During the course of a full business cycle, the lending capacity of shipping banks can be limited and not extend credit to large shipowners, or be unable to provide suffi cient liquid- ity to meet competently market demand, or be dissatisfi ed with the quality of the credit of potential buyers (state of the market). Th e issuing of bonds typically has the full benefi t of the depth and breadth of the public capital markets where relatively large sums of money can be raised and where there are multiple investors with varying degrees of appetite for credit quality, asset class concentration and geographic focus.
Shipping loans can be in small amounts, as small as a few million dol- lars, depending on the shipping banks’ criteria. Like any other type of pub- licly traded security, a shipping bond must have a suffi cient amount off ered in order to be appealing to institutional investors and to sustain continued trading activity in the secondary market (liquidity). Th erefore, bond issuings have to be sizeable as a stand-alone off ering (usually more than USD50 mil- lion based on market conditions) or be smaller amounts for a series of bonds from the same issuer. However, such issuings could take place for substantially smaller amounts, often refl ecting the practical reason that shipping bonds are a small sub-set of the public bonds markets and that many bond issuers in the shipping industry are comparatively small; thus, smaller issuers have to be accommodated as well. It should be noted that substantial shipping compa- nies or shipowners with relatively large fl eets, businesses well established over
the long term, proven track records and business models often get the most attention and the best pricing and terms of issuing, including smaller transac- tion fees.
An aspect associated with shipping bonds, which is usually highly appreci- ated by shipowners, is that the whole amount borrowed (principal amount) is typically due as a bullet payment on the maturity date (a typical ship mort- gage requires at least partial repayment of the principal amount during the maturity period). In the bond issuing example above, the USD10,000,000 raised from the bond issuing is due at the end of year six, while for a similar amount of a shipping mortgage amortizing equally on the same period, there will be an additional principal payment of USD4,566 per diem; the timing of the principal repayment can free cash fl ows to invest elsewhere or lower the cost basis for operating the vessels. In a weak freight market that barely covers vessel operating expenses, a lower cost base can be an advantage of paramount importance.
Not that one wishes to see a borrower ever default on their debt obliga- tions, but it has happened in the shipping markets from time to time. In the event of default on debt, who the creditors are can have a profound impact on the options the borrower has. In the event of a loan default when a shipping bank (or syndicate of banks) is the creditor, discussions on fi nding a solution after the default are typically private, bilateral and discreet as the two sides try to work out an optimal solution. Th e outcome of the negotiations can be subjective as personalities and relationships can drive discussions, and there is usually one creditor (shipping bank) to be satisfi ed (or a group of like-minded creditors in the event of a syndicated loan). As a rule of thumb, shipping banks are known to prefer resolution over confrontation, in which case they can allow for several options to be explored. In the event of a default on a bond, the standard route is that the rule of law in the jurisdiction the bond was issued (and stipulated in the prospectus) takes precedence over personali- ties and negotiations, with much less patience and proclivity for working out a solution. In the event of a bond default, the bondholders create a commit- tee to represent their interests (diff erent types of creditors may end up having their own representative committee) and retain both a legal counselor and a fi nancial advisory in order to optimize their benefi t.
Bondholders may be both retail investors (small lenders having invested in the bonds but none of them holding a meaningful stake) or institutional investors (where one or a handful of them can hold a predominant position and thus can control the creditors’ committee). When the bondholders are institutional investors, they are professional money managers, driven mainly by returns on their investments and having in-house expertise and access to
advisors and bankruptcy lawyers (most likely they have had to deal with a bond default before, if not in shipping then in other industries). In the past, mostly during the defaults in the 1990s, there have been cases where the majority of retail bondholders didn’t manage to mount a spirited representa- tion and stance or the investment bank holding a stake in the bonds preferred, for their own reasons, to take a meaningful loss. However, as a rule of thumb, in the case of defaulting on shipping bonds where the bondholders’ commit- tee is controlled by institutional investors, typically the borrowers can expect stronger negotiations and professional eff orts to recover as much money as possible, exhausting all options and legal venues.