As 2024 arrives, the implementation of the Basel IV framework is fast approaching. This is focusing minds, not only in banking, but across capital-intensive industries as the reality of the new rules begin to take hold. With the process of implementation already well underway in many jurisdictions, including the EU, the shipping industry looks to be particularly exposed to the resulting changes in banks’ risk modelling.
Increases in capital requirements and expanded safety nets for financings, along with adjustments to risk-weighted assets, are expected to lead to a further retreat by banks lending to the shipping industry. Those that remain will likely further shift their focus away from the smaller and middle-tier traditional shipping companies towards those with the best credit ratings — generally the larger, long-established operators.
These changes come at a time when the requirement for capital in the shipping industry is set to grow substantially. The industry is undergoing fundamental change, moving away from traditional fossil fuels to alternative, more sustainable fuels and forms of propulsion. This change will require significant investment in new ships and technologies.
The requirements for substantial capital to build new ships is not just driven by regulators and cargo interests aiming towards a more sustainable industry. The global fleet is ageing fast and, over the next 10 years, approximately 15,000 ships are expected to reach the end of their economic life and will need to be replaced by new tonnage in order to keep the global economy running.
The role of private equity firms in the shipping industry
Since the 2008 financial crisis and the subsequent retreat of many banks from shipping, private equity has taken on a more prominent role as a source of financing for the industry. This trend is set to accelerate as a larger proportion of shipping projects will require support from beyond the traditional ship-financing banks.
This will be particularly true for smaller and medium-sized operators relying on the traditional asset financing model, as they will no longer have the same access to bank lending solutions as was available in the past. This is expected to result in a more delineated industry, with a few large companies benefitting from a narrower, but well-established pool of traditional banking finance, whilst other operators increasingly rely on alternative financing structures.
This development should present increased opportunity for private equity and other alternative capital providers to find attractive investment opportunities with well-regarded counterparties in the shipping industry.
Structural considerations for investors and lenders
As a result of the changing credit landscape, the traditional shipowning and credit model may evolve away from direct bank lending to shipowners based on the earnings capacity and residual value of a particular ship (or a number of ships), secured against that specific ship (or ships) and those earnings.
It is expected that fund structures will become more common and that senior debt will increasingly be coming in at the fund level rather than further down in the ownership structure in order to broaden the credit exposure.
Further, in order to attract competitively priced debt, many operators will be updating their chartering strategy by increasing the number of vessels in the fleet employed under long-term time charters (giving stable revenue), at the expense of spot trading and the potential advantage that the cyclicality of many shipping segments offer.
However, although ownership and investment structures in the shipping industry are changing, many of the old key rules of investing in, and lending to, the shipping industry will still hold as true as they ever have. Key considerations will always need to remain the reputation and track record of the vessels’ technical and commercial managers, charterer counterparty risk, general market conditions, and asset marketability and residual value.
The environment for banks remaining in the shipping sector
Banks lending to the shipping industry, in particular the larger institutions with bespoke and well-developed internal risk models, will be considering their future lending strategy carefully as a result of the standardisation of models required by Basel IV.
To a large extent, this involves a stronger focus on the largest shipping companies that offer the best credit ratings and opportunity for the cross-selling of other banking products.
There is, however, also a movement towards lending to funds and leasing houses providing capital to the shipping industry, often secured against the underlying assets — thus changing the risk profile.
The result is that, whilst the fundamental principles governing investment decisions remain recognisable, the nature of owning a ship is changing. In the wake of Basel III and IV, the once-clear delineation between lender and owner that defined the relationship between banks and shipping companies is being replaced by a more complex web of different interests, with private equity at the centre of this shift.
Gudmund Bernitz and Will MacLachlan are partners in law firm HFW.
