NIKOLAOS NOULEZAS

Advising an owner of methods of raising finance for the purchase of two five-year old Panamax dry bulk carriers. Will there be any difference of funding for a well established shipowner with a current fleet of over 20 similar vessels and a small independent owner with only two such vessels in the present climate?

Shipping Finance and Credit Institutions Shipping is a capital intensive industry where vast amounts are required to back up acquisitions. Financial institutions, in order to preserve liquidity at high levels and achieve minimization of credit risk through diversification, often consolidate. Groups of maybe 5 banks syndicate and with one of them operating as the arranger, issue (syndicated) loans divided into smaller packets. The shipping industry has always been considered as a risk-laden business therefore financiers insist on securities. Primarily it was also considered as the protection of the financial institution, but it is also an instrument for making owners more careful and prudent. A loan agreement is the important link between the financial institution and the borrower (ship-owner). Sometimes it is quite difficult to come into an agreement satisfactory to both loan officer and borrower. The reason is because both parties have different points of view and opposite interests. In general, an owner would like to see from the side of the bank the following: A minimum equity contribution, so in case the project goes right, he will make a very high return on the invested amount. A minimum collateral recourse to himself, which minimizes total losses if the project goes wrong. A maximum loan period to match the life of the asset, moratoriums, balloon and bullet terms. Cheap finance in terms of interest and other related fees. Fast response time, advices and other financial products from the bank and, last but not least, minimal documentation and covenants.

On the other hand the banker would like to get: A substantial equity contribution. Maximum collateral and recourse to beneficial owners. A minimum loan period, especially in the case of second-hand vessels. Expensive finance. Large time intervals between decisions and proposals. Provision of any kind of financial product and service. Maximum documentation to cover against every eventuality.

All this are valid, under the assumption that the borrower has the expected credibility and proven ability and capability to run the business, and off course that the project is sensible.

Many banks in the past years tried to categorize, standardize and homogenize their offers and requirements. Most of the efforts were actually a set of criteria for accepting the project as potential proposal, and a set of criteria-biases for the borrower and the company. The process may have not been as successful as it was supposed to be by minimizing the workload of the banker, but it established some market standards. As a result, almost every bank publishes a respectable booklet regarding its credit offers and policy. Banks credit policies are not the same, neither is their stance against credit risk. Some banks, while defending their shareholders best interests, are more conservative then others. Credit policy is the entirety of regulations, of organizational and economical nature, that administer a credit institution for the achievement of the greater possible financial outcome, for both private and social benefit. In the same way, loan practices may vary for a number of reasons. Sources of finance Corporations can raise capital in two principal ways: by issuing equity or by issuing debt. Issuing equity involves issuing common or preferred stocks. But, issuing debt offers much greater diversity. As a result, the various potential finance options for our customer (shipowner) are: EQUITY: a) Owner equity ( finance provided by owner from own funds and retained earnings) b) Limited Partnership ( funds provided by partners) c) Ship Fund ( shares in company bought privately by individuals or listed on stock exchange) d) Public Offering ( shares sold by subscription on public stock exchange) MEZZANINE FINANCE: Debt with high interest rate and possibly equity rights SENIOR DEBT: a) Bond Issue (security issued in the capital markets) b) Commercial Bank Loan (loan provided by bank. Large loans may be syndicated between several banks) c) Private Placement (debt finance arranged privately with pension fund, insurance company etc). LEASE: Finance Lease & Operating Lease (long term tax effective finance based on sale of ship to company which uses depreciation benefits. May be leveraged.)

Finance is an industry and as such, has to adapt and evolve following the market over all. This is why new methods of financing or raising capital make their appearance every now and then. Among traditional financial instruments are classified loans, subsidies or credits, equities and stock markets. Nevertheless newer, innovative methods have been developed, like mezzanine finance, offshore companies, securitization, venture capital and maritime joint ventures.

As mentioned, the raising of equity is among the options available, but these markets are also highly regulated and have much greater disclosure requirements and are more complex and expensive to arrange. In absolute numbers, the most important source of finance is debt. Indebted companies promise to make regular interest payments in addition to repaying the principal the initial capital borrowed. Notwithstanding, should the value of the companys assets become less than the value of the debt, stockholders have the right to default if they are willing to hand over the corporation to lenders. For the administration of such handovers there is a bankruptcy court. Conventional first mortgage remains the dominant source available to shipowners, considering the size of the shipowner with currently two owned vessels, it appears that this type of debt would be the most appropriate for his business plan.

Criteria review and classification In the same time we need to mention that there is no set way for financing a ship, either new-building or second-hand, and often more than one type of finance that is suitable. In any case, the borrower needs to pay attention to the level and predictability of future cash flow as well as cost minimization. Ship financing appraisal, is a profound task that encounters the uncertainty of the shipping industry and the individuality of each venture. All cases are different and need to be examined individually. There are however fixed criteria in the credit policies that aim to classify shipping companies according to their credit ability and others to be applied on specific ventures, all aiming to make the investment evaluation feasible. Same applies off course to our specific customer (shipowner) who wishes to finance two five-year old Panamax dry bulkers. It follows that the better rated clients have greater opportunities in obtaining finance, and the widest choice of financing options. In our example, the larger shipping company with a fleet of 20 similar vessels has most probably the scale to tap the whole range of financing, taking as granted a sound credit analysis and fundamentals. Consequently, the finance options for the shipowner with currently only two dry bulk vessels would be very different from those available to the larger company mentioned with a fleet of 20 similar dry bulk vessels, considering the high volatility in the freight market as well as the fiercer competition between the dedicated shipping banks which creates a greater pressure on banks return and a consolidation regarding willing shipping banks resulting from further consolidation in the banking industry. A further factor which will most probably not allow the smaller shipowner to obtain same financing options and range as the well established company in our example is the impact from the Basel Accord, known as Basel II, under the consideration that the larger company obtains also a much better credit-rating.

Nikolaos Noulezas 13.02.2009