After the severe dislocation to international debt capital markets during the global financial crisis, more recently those markets have become more active and liquidity has increased. Even though bond market interest rates can be higher than typical commercial bank lending rates, bonds carry the advantage of being issued with much longer tenors than bank loans. This can be particularly attractive to offshore drilling companies which require relatively high levels of long-term capital expenditure to fund the purchase, installation and operation of rigs and floating production storage offloading units (FPSOs).
The increasing popularity of bond financing in the shipping industry and the appetite of shipping companies and their advisers to devise innovative fund-raising structures has seen shipping companies issue not only plain vanilla bonds but also more complex bonds with structural enhancements. For example, there have been several recent issuances of convertible bonds which are convertible into newly issued shares of the issuer at the option of the investor, including the convertible bonds issued by PT Berlian Laju Tanker TBK and the US$125 million convertible bonds issued by Genco Shipping & Trading, both of which were issued in 2010. Convertible bonds are an attractive option for shipping companies because the equity component typically means that the convertible bonds bear lower coupon rates or yield and also allow shipping companies to defer equity raisings in circumstances where their share prices might be currently undervalued for any reason, including because overall market conditions are unfavourable. Convertible bonds can appeal to investors because they allow investors to hedge their investment risk while benefiting from capital appreciation if the underlying shares perform.
Covered bonds provide investors with recourse to a pool of assets that secure or “cover” the bonds if the originator becomes insolvent. Issuance of covered bonds by shipping financiers has been less common, but is another example of the innovative use of the international debt capital markets by shipping financiers more recently. Ship financiers with shipping loans on their books can utilise these loans as secured collateral for the covered bond and ring-fence them to enable the issuer of the covered bonds to achieve a higher credit rating for the covered bond than the issuer’s own corporate credit rating. For example, the German based HSH Nordbank issued its first shipping loan covered bond (known in Germany as Pfandbrief, issued pursuant to the German Pfandbrief Act (Pfandbriefgesetz)) in 2008 in the amount of €1 billion and, more recently, in June 2010 in the amount of €500 million. Covered bonds appeal to investors because the collateral is securely ring-fenced and may only be used if the issuer defaults on the covered bonds and the collateral is needed to pay the investors amounts owing to them under the covered bonds.
A further innovative bond financing alternative which seems likely to be explored further by more participants in the shipping industry is the issuance of sukuk, especially given that the shipping industry regularly uses other forms of Sharia-compliant funding. Even though there are some examples of sukuk issuances in the shipping industry, such as the US$26 million sukuk issued by Pacific Star to fund a very large crude carrier (VLCC), the MT Venus Glory, the issuance of sukuk by shipping companies remains relatively unutilsed. However, shipping companies which are seeking to grow their fleet of vessels and require long term financing might well be the ideal candidates for issuing sukuk (which are required to be based upon underlying tangible assets). Admittedly, there are certain challenges in structuring a sukuk for ship finance which might not exist in conventional bond issuances. For instance, it will be necessary to structure the transaction to comply with both the relevant laws and relevant Sharia principles. In addition, in order to achieve a transfer of assets (for example through an ijara or sale-and-leaseback structure), the asset must be unencumbered and capable of transfer - this element might not always be possible for shipping companies which might have already encumbered their vessels in order to secure existing debt finance. Nevertheless, the fact that other forms of Sharia-compliant financing have been used in the shipping industry on a regular basis demonstrates that these challenges can be overcome through innovative structuring.