Shipping Finance
Student’s Name
Institutional Affiliation
Shipping Finance
Question 1
Types of securities and protections used in mortgage-backed bank loans.
Mortgage-backed loan security is often pegged on the ship, which allows banks to lend to ship companies that would otherwise be uncreditworthy for the large loans needed to fund merchant ships. The transaction is often based on a structure comprising the borrower, the owner, and the lender. The borrower is the one ship- company that is registered in an acceptable jurisdiction. The company structure allows the owner’s business assets to be isolated from any claim that may arise elsewhere. The shipowner is expected to approach the banks and explain their case and requirements. Should the bank consider the loan, the bank officer creates a proposal while negotiating any contentious issues with the borrower. The lender is expected to obtain the ship’s valuation, which serves as the collateral depending on various ship features, including types, age, size, specialized facilities, and maker. Other types of security can be mortgages on other ships, time charter, and corporate or personal guarantees from the shipowner and other assets from the borrowers’ balance sheet.
Further, protection can be obtained using the ring fenced cash. Ring- fence cash refers to a virtual barrier meant to protect some portion of the company’s or individual financial asset. It carried out to reserve funds for specific purposes or to reduce the company’s tax obligations. Importantly, it guarantees the protection of assetts from losses emanating from riskier operations. The ring faced cash requires the borrower to reserve some cash for periodic interest and principal sum repayment. Other types of protection include covenants that ensure that assets held as security can cover the outstanding debt if sold.
Types of protections and securities executed and effectuated by banks to recover loan defaults by ship owner in the cases of mortgage loans.
The loan agreement includes a clause requiring a pledge of assets as collateral to which the bank can legally access in case the borrower defaults. The collateral is often the ship’s mortgage but can include security such as borrower’s assets, security over other ships, personal guarantees, and corporate guarantees. Protections include financial covenants whereby the borrower is limited to carry out some activities that can exacerbate the risk of default. The covenants outline the activities that the borrower can do or not do. For instance, the borrower is expected to maintain the class and condition of the ship. They are also expected to maintain the collateral value related to the loan and provide periodic financial information. Conversely, they are not required to engage in additional borrowing or pledge the assets to third parties. Studies by Cem and Christopher (2010) revealed that risker firms and those with fewer investment opportunities are often given tighter financial covenants.
Question 2
- Types of discounted cash flow analysis used in dual decision making
Net present Value
The net present value refers to the differences between the current value of the cash inflows and the current value of the cash outflows.
The internal rate of return
This refers to the annual growth rate that is expected from an investment.
Cost of capital
The cost of capital refers to the return that is necessary to make funding a project worthwhile. It comprises of three core and vital elements including financial risk, business risk and the zero risk (U.S treasury bond level)
The weighted average cost of capital
These refer to the cost of equity and cost of debt blended together. It is the average rate at which the organization can repay back its debts to the security holders who helped funds ist capital budgets.
- Elaborate and differentiate the various types of discounted cash flow analysis
Net present value
In NPV, cash flow items, including (discount rate- the cost of capital), are assumed to help calculate and estimate the NPV.
In IRR calculations, the discount rate (cost of capital) is not assumed, resulting in two unknowns (Net present value and discount rate). During calculations, the NPV is assumed to start at zero so that the discount rate is calculated, and the estimated assume represents the project’s minimum rate of return compared to the expected return rate.
Discounted payback period
This capital budgeting procedure establishes how profitable a venture is and provides the number of years a project breaks even after the initial expenditure while discounting future cash flows.
Profitability index
The profitability determines when a project is expected to break even. An index of 1 is an indication that the venture is highly likely to break even. An index of less than 1 indicates that the costs are more than the benefits, and the project might not break even. The technique is often used to overcome the limitation of the NPV method (Rangel et al. 2016).
Question 3
How the roles of “operator” and “owner/ investor” helps shipowners deploy” off – the-balance sheet – financing while and at the same time “cash- in” the owned ships while retaining operational control.
Sell
Buy
Figure 1.
Rogers and Lindstrom (1996) describe the off-balance-sheet as debt structuring and financial instruments that are not included in the firm’s balance sheet. The shipping industry refers to a situation where shipowners have no cash balances to acquire assets but still want to use their ships without placing them on the balance sheet. At the onset, the company buys the ship before reselling it to the leasing company. The funds for acquiring the asset are from the leasing company, whereby the asset is now the property of the leasing company. The leasing company is not interested in operating or owning the ship but only focused on the lease agreement to receive lease funds. Owning the vessel provides the leasing company with protection in cases where the leasing does not honor the payment.
In the second instance depicted in figure 2, the company leases the ship from the leasing company for operations by repaying the lease funds often in terms of a long term lease that covers a significant part of the ship’s life span. The lessee (shipowner) ” buys” back the asset using funds from the lessor (leasing company) (Maritime Industry Foundation, n.d.)
Lease payment
The ship is leased back Asset
Figure 2.
Part b.
In what conditions do these types of banks provide financing to ship owners for their long term projects?
The primary sources of financing for the shipping industry include commercial banks, investment banks, finance houses, and leasing companies. Commercial banks are a vital source of debt for the shipping sector, and most have a dedicated shipping finance department. They provide loans of between 2 and 8 years, which are often funded by borrowing from the money and capital markets. Balloon payments are commonly used to reduce the burden of debt servicing on modern ships. Loans are often quoted as a margin over the London Interbank Offered Rate (LIBOR) with spreads ranging from 0.2% to 2% basis points. The banks also offer other services such as financial advisory, mergers and acquisitions, and risk management services (Hultin, 2004). Further, investment banks arrange loans, bond issues, and public offerings. While investment banks often arrange and underwrite loan financing, they do provide the capital themselves. Instead, they organize loan syndications, public offerings, and bond issues from the capital market. They also offer private placement of equity with private investors or financial institutions. Some large investment banks have departments specializing in shipping expertise. Lastly, finance houses provide loans from their fund and include institutions such as Fidelity Capital and G.E Capital. Some brokers and organizers have specialized in innovating financing packages from the shipping sector within the finance houses. Leasing companies have departments that arrange for long – run leasing of ships.
Question 4
The three types of banks that finance the shipping industry.
The types of banks that finance the shipping industry include mortgage-backed loans, corporate loans, and shipyard credit. Mortgage loans are terms of loans offered by the bank and are often secured using the ship as a mortgage. Large loans can be syndicated by several banks (Syriopoulos, 2007). Corporate loans are secured against the shipping company’s balance sheet and can include assured credit line or term loan. Shipyard credit is loans guaranteed or provided by the government or agencies to assist local shipyards.
Part b.
Mortgage-Backed Loans
These loans depend on the ship as security and allow banks to lend to shipping companies that are not worthy of credit primarily for large loans that are needed to fund merchant ships. Financing long term investment projects require several conditions and situations including the loan should not be more than 50% of the ship’s market value, extra security in terms of the time charter, owner’s corporate guarantee and other assets within the borrower’s balance sheet. However, successful shipowners can get loans of up to 80% of the ship’s market value. Another condition is leverage whereby the return on equity should be greater than borrowing cost. Other considerations incudes assignment of earnings and insurance, loan size, tenor, repayment method, fees, interest rate, and financial covenants (Kavussanos & Visvikis, 2016).
Corporate Bank Loan
Borrowing against individual ships can be inconvenient for large shipping companies as it can be time – consuming. Thus, such companies prefer to borrow against their balance sheets. Financing long term investment projects using a corporate bank loan requires several conditions and situations such as the amount of term loans and revolving credit. There is also a consideration of the repayment period, the interest payable, and whether the loan should be syndicated. The security for the loans is also determined and should be above 50% of the committed loans.
Shipping credit
These are loans that are mainly concerned with shipbuilding companies. Financing long term investment projects require several conditions and situations, including that the shipowners require a guarantee from their banks to help in refunding stage payments if there is a failure of completion in any stage of the shipbuilding process. Shipowners with government support can receive direct support from shipyard credit. The loan can be provided without collateral during the initial stages of shipbuilding.
References
Demiroglu, C., & James, C. M. (2010). The information content of bank loan covenants. Review of Financial Studies, 23(10), 3700-3737. doi:10.1093/rfs/hhq054
Hultin, D. (2004). Financing sources for shipping – A case study at Wonsild & Son. Retrieved from https://lup.lub.lu.se/luur/download?func=downloadFile&recordOId=1349945&fileOId=2433679
Kavussanos, M. G., & Visvikis, I. D. (2016). The international handbook of shipping finance: Theory and practice. Palgrave Macmillan.
Maritime Industry Foundation. (n.d.). Finance. Retrieved from https://www.maritimeinfo.org/en/Maritime-Directory/finance
Range, A. D., Santos, J. C., & Savoia, J. R. (2016). Modified profitability index and internal rate of return. Journal of International Business and Economics, 4(2). doi:10.15640/jibe.v4n2a2
Rogers, E. R., & Lindstrom, G. (1996). Ethical implications of off-balance-Sheet financing. Business and Professional Ethics Journal, 15(2), 19-32. doi:10.5840/bpej199615215
Syriopoulos, T. C. (2007). Chapter 6 Financing Greek Shipping: Modern Instruments, Methods and Markets. Research in Transportation Economics, 21, 171-219. doi:10.1016/s0739-8859(07)21006-6