Singapore: Show Me The Money – Private Equity Funds As Lenders

Last Updated: 15 February 2016
Article by Siri Wennevik, June Ho and Maria Aguilera

Shipping loans, including export credit financing and leasing, have been the traditional source of finance in shipping. In the last years however, waves of private equity (PE) money have flowed into shipping, fuelled by a financial environment where banks no longer have the lending capacity or appetite for such perceived high-risk lending.

So what does this fundamental shift in "who your lenders are" mean for shipowners in gen­eral? In today's market, banks are still willing to lend, albeit more cautiously and judiciously. So unless you are a top tier shipowner or operate in the high value sectors, you may have to look elsewhere for funding. Private equity funds on the other hand are mostly counter-cyclical and have been accumu­lating shipping debts at an rapid pace as shipping companies have turned (and continue to turn) to them to bridge the funding gap created by the scaling down of the banks' shipping portfolios.

WHAT ARE PRIVATE EQUITY FUNDS?

PE funds are collective investment schemes used for making investments in various equity or debt securities – typically seeking high investment returns over a fixed term. There are sev­eral ways in which private equity funds make investments within the shipping sector, including entering into joint ventures with shipowners, taking direct ownership stakes in vessels, acting as mezzanine lenders, or purchasing exist­ing debt from banks. Increasingly, these funds are becoming a prominent feature on the ship finance landscape.

BENEFITS OF TAKING ON A PRIVATE EQUITY PARTNER

Shipowners can realise several benefits from taking on a private equity partner. The main upside is of course a ready and available source of funding when banks are not willing to lend, but in addition shipowners may obtain better access to financial, commercial and related mar­kets by utilising the private equity funds' broad investor base. In addition, since private equity funds are less regulated than traditional banks, they are able to offer more flexible lending solutions.

SHORT-SIGHTEDNESS AND OVERSUPPLY?

Unlike traditional banks, private equity funds do not typically have any previous relationships with the shipowner, and to many private equity funds the shipping business is unchartered territory. This poses several challenges for the tradi­tional shipowners. Private equity funds often do not share the same long-term interest and goals as the shipowners. For instance, private equity funds expect a high level of return for their investment and usually within a fixed term – this may not always be possible in a highly cyclical shipping industry, where ship­owners expect their financiers to ride out the down cycles with them. The funds' views on financing strategies are generally more short term – buy in quickly when the market is on the down cycle and exit as soon as the light starts to shine. They are simply not into the business of operating ships over a long period of time, with exit strategies within three to five years of investment.

Readily available PE cash has been blamed for an over-supply of vessels in the market. This type of finance has made it easier for smaller third-tier com­panies to enter the shipping market, and is often pointed to as one of the reasons for the current supply glut of tonnage in certain sectors.

CONTROL AND CORPORATE GOVERNANCE

Private equity funds often expect to play an active role in managing their invest­ment, demanding extensive report­ing. This happens formally when they become owners/co-owners but also informally when they are still lenders. Such requirements may not sit well with many shipowners who are cautious about ceding control of their business.

There may also be fundamental conflicts inherent in PE arrangements. Many decisions are made by shipowners with the long term interest of the ves­sels and its business in mind. However, since the funds are in for the short haul, their approach to decision making (even whilst wearing their hat as lenders) may be in stark contrast to the shipowners. As a result, shipowners may have to live with the consequences of decisions made by the private equity fund long after the investors have exited. There is a concern that private equity's entry into shipping may not end well, especially if a fund is the majority-partner control­ling the board as well as demanding a say in key investment, divestment and operational decisions.

IS IT ALL BAD NEWS?

Despite initial bad press and the lin­gering suspicions surrounding the role of private equity funds in ship finance, it remains to be seen if and how such participation will change the landscape of shipping. The only certainty is this: Capital for shipping is never scarce even in the down cycle, but unless you are a top name or state-owned, you may have little choice but to seek alternative forms of financing. In a properly conceived and well executed transaction, private equity could be a useful and comparable source of financing for shipowners. "

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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