This increase in capital availability is crashing into a larger trend – the decreasing effect to ‘lever up’. The increased SOFR rate is driving this, making lower leverage or all-equity investment is relatively more attractive. In response to pricing pressure both from this factor and increased competition between banks, margin compression is clear to see.From 2020 to 2022 the average margin arranged via oceanis dropped 1.50 percentage points while LTVs and loan amounts stayed the same. For the lower-LTV non-recourse bank financing of a reasonable size, margins in the 2s really have become the new 3s!
In addition, many financiers are developing new products or moving into new markets. Chinese Lessors are breaking new ground, offering terms to smaller shipowners also without corporate recourse. Their terms outcompete European banks on leverage, with pricing not far behind. Meanwhile Some European banks are returning to a forgotten friend: the Offshore sector. Non-recourse financing is back, having been unavailable for almost a decade. While currently only available for vessels with firm employment, this positive sign will benefit the recently underinvested sector.
So, given the bullish debt markets, where is the equity?
Using the words of Howard Marks: “We’ve gone from the low-return world of 2009-21 to a full-return world, and it may become more so in the near term. Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets”.
Attracting external equity from institutional investors for shipping assets has become an uphill battle. Institutional investors, seeking to maximise risk-adjusted returns are flocking towards less risky investments, which have been bolstered by the surge in base rates. Consequently, equity risk premiums have been propelled into the demanding terrain of double-digit returns, making equity positions in shipping assets a less enticing proposition.
Remarkably, asset valuations across various segments have not adapted to the escalating cost of capital. The resilience, it appears, is sustained by shipowners’ substantial liquidity, coupled with their limited willingness to look at investment alternatives at scale, aspirations for fleet revitalization, and often miscalculated equity pricing. Or are we missing something that the top names of the industry are anticipating and is not yet visible?
As things stand, institutional investors are veering towards debt investments in the shipping sector. The prospect of embracing shipping equity hinges on the emergence of counter-cyclical opportunities or the recalibration of discount rates for future cash flows, acknowledging the prevailing high interest rate landscape.
Project financing terms
The core of this report is an overview of projected financing terms across each of the major segments, showing the best terms available for vessels in the market today.We have assumed that each vessel is financed on a non-recourse basis with a 1 year Time Charter to a counterparty accepted by the lender. Further definitions for each case are below.
Age
We assume 5 year old vessels as ‘Young Eco’ and 13 year old vessels as ‘Mature’.
Leverage Aim
Low leverage refers to Bank financing, while High leverage refers to Alternative debt.
LTV
Loan-To-Value, the ratio of loan amount to Fair Market Value. We show the highest LTV possible; lower leverage reduces quarterly repayments and the interest margin.
Amortisation
Quarterly repayments which reduce the outstanding finance amount. This is shown as a structure and profile. The structure shows whether a financier will require accelerated payments during the first year or time charter period, while the profile shows the overall trajectory of the loan from the initial amount towards zero dollars outstanding at a set age.
As each individual vessel has a different market position and ability to earn, the exact dollar repayment during any period of front-loading will vary too much for a single report to cover. However, the overall repayment profiles are relatively standard across vessels so these can be shared in detail.
Interest Margin
Due to increasing levels of regulation in the banking sector, providing loans has become very expensive and time-consuming over the past decade. KYC and AML checks as well as other imposed costs are relatively consistent whether the loan amount is $7m or $70m, so banks are forced to charge higher interest rates for smaller loans to keep the same level of profitability.
A loan request of $15m or more will generally fit into the ‘sweet spot’ of the larger commercial lenders which are considerably cheaper than those offering loans of $5-10m, while a loan a request of $50m or more is suitable for the largest and most competitive lenders in the market.
Dry bulk
Perhaps the first quarter was not the bottom of the Dry Bulk market after all. Recent falls in earnings across segments, while asset values have remained surprisingly constant, have made investment in Dry Bulk vessels over the past few months more an exercise in faith than trust in the markets.
Unfortunately for owners seeking to acquire or refinance, banks and funds are almost exclusively held to today’s market projections which has limited financing volumes considerably. Exceeding 50% LTV with an older spot-trading vessel is very difficult indeed without resorting to higher-cost debt funds, as banks have retreated to the 40% level. Younger vessels enjoy more respite due to the potential for lengthened repayment profiles with breakevens set just below historic median earnings, but these repayments may prove difficult to maintain should current market projections be realised.
More positively, loan margins are continuing to be compressed by high competition as lenders struggle to maintain their portfolio volumes in the face of high repayments from Container and Tanker owners.
For those shipowners with a high level of conviction that better earnings will return, some high-cost options are available which can provide up to 75% leverage, even for older vessels. However, it should be noted that the repayments required exceed not only current market projections but even historic median earnings. The interest cost for this high-risk capital is also high, with margins in the region of 8%. In short, to avoid default there must be a clear view that earnings will be strong and that those strong earnings will come soon. We hope that this will be the case!
Tankers
This quarter could be well described as a ‘pause for breath’ amongst financiers who, after spending the first half of the year taking opportunities to rebalance portfolios back into the sector, decided to reconsider these moves.
Loan amounts and margins, which both improved rapidly over the nine months to June, have seen no great change since then. Indeed, some lenders are now becoming more cautious and adding additional liquidity covenants or dividend restrictions as their confidence declines slightly.
In many ways, this gives the same feeling as container markets in early 2022; the party is still going strong, but some are thinking of booking a taxi home. From experience in obtaining finance for container vessels in late 2022, we would highly recommend entering the market while the music is still playing.And this music is certainly playing! Banks, funds and leasing houses remain exceptionally keen to fund for the time being. Loan amounts on offer remain high, though as asset values have increased more quickly over the past six months the LTVs available have contracted slightly. Margins continue to fall, with banks partially offsetting base rate rises as well as reacting to more intense competition for new loans.
Container
Container financing has seen little change over the past quarter, mainly due to the consistency in earnings; financiers remain comfortable with charters even from second-tier operators for new build, while banks have a keen preference for top-tier counterparties on mature vessels to avoid exposure to renegotiations.
It has been interesting to see how different banks have dealt with issues such as LTV covenants over the past 6-12 months; while some choose not to place such covenants in their loan documentation during the post-Covid boom, others are now imposing restrictions on dividends or requiring early repayments for vessels which are performing under well-paying charters. This has very clearly highlighted the need for a strong relationship between shipowner and financier so that these issues can be communicated ahead of time, and most importantly the need to consider how each individual covenant might affect cash flows given various potential scenarios for earnings and asset values during any financing.
Relatively little transaction volume is seen due to the majority of financings and sales having been closed during 2021 and 2022, but new builds and sold vessels do still require financing. For these vessels, we are seeing the same charter-based repayment profiles as have been prevalent over the past two years, though with slowly decreasing margins as charter rates are now more conservative and asset values have retreated from their Icarus-like highs. For a non recourse new build facility with a second-tier charterer, European lenders can offer terms with up to 70% LTV at drawdown and a margin in the very low 3% region.
Offshore
Lenders are continuing to return to offshore financing, with this quarter seeing the first non-recourse terms shared via the oceanis platform from one European Bank which is new to the sector. At the same time, several other banks and funds are maintaining their presence in an increasingly competitive market. We still observe that financing for offshore assets is highly reliant on firm employment with strong counterparties. Most financiers within the segment are looking to finance strong offshore owners with a proven track record of operating vessels successfully.
For the right counterparty we are now seeing moderate LTV requests receiving margins around 4-5% and higher leverage requests receiving margins in the region of 5-6%. Increasing competition between lenders looks set to further reduce these margins in the years to come.
With OSV markets continuing to firm up, we believe financing for offshore vessels will follow as we expect the oil and gas companies to offer longer term employment to secure their need for tonnage as rates continue to increase. However, opportunities still exist for offshore owners looking to keep their vessels out of long-term employment due to expectations of higher rates in the years to come. This is perhaps best shown by the terms indicated for a pair of vessels under construction without a fixed charter which attracted 85% financing at a margin of around 8%. This pricing, comparable to that seen for similar leverage in cargo vessel financings, is a sure sign of the increased confidence of lenders in the renewed strength of the offshore market. The future here looks bright.
Overall
This quarter has been relatively subdued, with the declining Dry Bulk markets putting a small damper on the still-strong Tanker and stable container financing markets. The overall picture remains positive, with gently declining margins and a wide variety of competitive lenders available to shipowners worldwide, and this is a feature which we expect to continue for some time to come.
Average margins are continuing to fall when adjusting for leverage as banks continue to compete in maintaining their portfolio levels. The increased spread earned by retail banks on their deposits, as overnight earnings have grown much faster than savings account rates, have given these banks the ability to move more aggressively which will greatly benefit shipowners especially should base rates decrease.As a counterpoint, LTVs have decreased somewhat as asset values have outpaced earnings. There is a lot of faith that great earnings are ‘just around the corner’ due to factors such as low order book to fleet ratios and trust in a resurgent world economy.
What happens next? We expect more of the same. With shipping remaining a profitable area for banks, margins are likely to continue in their downward trend while loan amounts will directly follow spot earnings projections in Dry and Tanker financings or remaining charter cash flows for Container and Offshore vessels. And at the same time as banks slowly open up to more geographies and a wider range of assets, we look forward to a more open and transparent world of ship finance.Should any shipowners aim to diversify their financing counterparts or explore options for an acquisition or refinancing, now remains a good time to do so.
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