International Shipping Finance for the Russian Market

A thesis submitted to the Bucerius/WHU Master of Law and Business Program in partial fulfillment of the requirements for the award of the Master of Law and Business (“MLB”) Degree

Alexey Titkov July 26, 2013

13,799 words (excluding footnotes)

Supervisor 1: Mr. Thomas Schwenke

Supervisor 2: Mr. Volker Lücke

   

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Table of Contents

1. Shipping Finance ................................................................................................. 5

1.1.Traditional Shipping Finance .............................................................................. 5

1.2. The New Shipping Finance Environment ........................................................... 8

1.3. Historical Survey of the International Shipping Finance in Russia ................ 12

2. Russian Market, shipowners’ perspective ...................................................... 19

2.1 The Russian Market for International Shipping Finance .................................. 19

2.2 The key players .................................................................................................... 21

2.3 Registration from shipowners’ perspective ...................................................... 25

2.4 Russian bank or a foreign bank from the shipowners’ perspective .............. 30

3. The deals, Investors’ Perspective ..................................................................... 33

3.1 Traditional Shipping Finance, Bankers’ perspective ....................................... 33

3.1.1. The deals analysis ....................................................................................... 35

3.1.2 Registration from the bankers’ perspective ............................................ 41

3.2 Alternative finance for the Russian Market ...................................................... 43

Conclusion .................................................................................................................... 46

Bibliography .................................................................................................................. 49

 

 

 

 

 

 

 

   

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Introduction

 

The research herein focuses on the current shipping finance situation in the

Russian market, with an emphasis on the relationship between the established

domestic Russian shipowners, even if they operate through subsidiaries abroad,

and international financial institutions that provide funding to shipping

companies around the world.

The severe economic crisis multiplied existing problems in the shipping industry

that were already looming due to the industry’s position in the declining stage of

the shipping cycle. All market players, including Russian shipowners, recognize

the current situation in which banks now find themselves. It is very unlikely that a

bank or a lender will seek to increase shipping finance in its current portfolio and

some want to exit the market altogether. Russian shipowners had only just

entered the calm waters of international shipping finance when the crisis

commenced. This a significant question now to be resolved whether they will

continue to be active players within this market in the future.

The structure of the paper includes 3 chapters. The first chapter describes basic

concepts of traditional shipping finance, provides a historical overview of the

development of international shipping finance in Russia, as well as draws

attention to the unique situation in which global shipping has found itself since

the global economic crisis began to overlap with the crisis in the shipping

industry. Chapter 2 describes the structure of the Russian shipping market,

emphasizes its key players and provides their perspectives with a perspective

view from multiple sides. Chapter 3 contains the main analysis of the deals

closed between Russian shipowners and international finance providers,

represents quantitative analysis of the market, and tries to envisage future

perspectives of shipping finance in Russia within current circumstances.

This work explores whether there are any implicit competitive advantages for

Russian shipowners. This research will consist of an analysis of overall economic

health and financing activities of key Russian shipowners, such as Sovcomflot,

FESCO, PRISCO and some other more minor Russian shipowners. The paper

   

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investigates what those shipowners have in common and whether Russian

shipping companies will be active players in a newly financed environment. It

might be that they succeed in finding elements to balance the scales, therefore

tempering the overload of skepticism and austerity.

This paper aims at answering these and other questions, covering the historical

development of shipping finance in Russia, the legal issues blocking access to

international funding, and establishing risk assessment in respect of entering the

Russian market for lenders.

The novelty and challenge of this paper lies in the fact that very little prior

thorough research on the Russian shipping market has been conducted. There

have been several attempts to capture a broad overview in articles and notes,

in particular in Marine Money Journal. The latest Marine Money report on the

topic, however, dates back to 2003.

Qualitative and quantitative analyses of Russian shipping finance deals have

not previously been made. Data gathering for research has been difficult due

to the lack of specific information on the Russian region by the banks committed

to the shipping industry. The shipowners as well are either reluctant to share the

data or do not keep records or archive the information. This is the reason why

the current paper might not reflect a 100% accurate picture of the existing

deals, but rather gives an insight about their volume and characteristics.

The legal environment in Russia is also an important aspect. The research

describes from both shipowners’ and bankers’ perspectives the key aspects of

Russian jurisdiction, such as ship registration, mortgaging and applicability of

foreign court decisions in order to review what concerns these aspects may

cause and what the rationale is behind these concerns.

In summary, this paper has an ambitious goal of gathering and structuring the

existing experience of Russian shipowners by reviewing the volumes, schemes

and appealing legal structures and deals that attract international shipping

finance, identifying existing problems, elaboration of possible solutions and

forecasting of future developments in the industry, focusing on the main idea:

   

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assessing the possibility of acquiring finance in the new global finance

environment.

   

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1. Shipping finance

1.1 Traditional shipping finance

This section gives a simplified overview of shipping finance to the readers who

do not possess enough knowledge in the industry.

Ship is a unique asset. It takes a long time and a lot of money to construct one.

Shipping finance can be treated as an art of attracting money to acquire or

build a ship. Shipping is an extremely capital-intensive, cycling, and highly

volatile industry with a high leverage degree. Shipping finance is an asset-based

finance and plays outstanding role in the financial world. There are a lot of

conferences being held in different parts of the world every year shaping the

interest to the matter.

Shipping finance is a truly international sphere. And the reasons are obvious: the

ships are moving all around the world. The financing of large ocean-going ships

is undertaken by banks all over the world, by no means just for owners in their

own country. On the contrary, and certainly for larger ships and larger owners,

one is more likely to find, for example, an American bank, acting through its

London office, lending to a Greek-controlled owning company and securing

itself on a Liberian registered ship.1

The international shipping finance has two common traits. First, it is usage of the

US-dollar as a currency for operations. Second important thing is the English Law

being historically used as a dominating legal system.

The shipping trade experienced a real boom in 2003-2008, that caused the

dramatic increase in tonnage and consequently in shipping finance volumes, as

there was a need in providing funding for these capacities. The crisis dropped

the world trade and, hence, the shipping plummeted as well. The reduction in

capacities and tonnage on order reduced the estimated need in finance from

                                                                                                                         1  Harwood, S. Shipping Finance, p.1-2.  

   

   

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about 200 billion USD in 2010 to 55 billion USD in 2012. However, the ability of

banks to provide this money plummeted at a faster pace and even this money

is difficult to be found nowadays.

The world fleet capacity has been steadily rising and is expected to rise in future.

Shipping is the main transportation means of goods, providing the lowest costs

and environmental sustainability. Industry experts believe that the rates will soon

reverse to bullish and drive the industry up along the cycle.

A few words need to be said about the shipping industry cycle. There is demand

for newbuildings and the yards build ships before the excess of shipbuilding

capacity is reached. The capacity excess and speculation predetermine the

decrease in the ship prices. Overtonnaging is reached by that moment and this

fact drops the fright rates and the demand for newbuildings. The demolition

process increases and the fleet constantly shrinks till the fright rates start to

recover and raise thus demand for newbuildings and load consequently the

shipyards. Then the story repeats. The average shipping cycle lasts around 7-10

years. Now in 2013 the cycle has already being on its declining stage for 3 years,

but this time the problems started for the shipping and for the whole world even

earlier when the world trade turnover went down due to world economic crisis.

The traditional shipping finance usually describes the cooperation between a

shipowner and a finance provider, thus implies both perspectives: shipowner’s

and banker’s, as banks have always been the major funding providers of the

industry.

The shipowner is supposed to choose whether to acquire a newbuilding or a

second hand ship. The choice is dependent on many aspects, such as the

ongoing business intentions of the shipowner, the current market situation, the

time it takes to build a new ship and/or availability of second hand ship on the

market and the terms of financial support the shipowner can get.

When the option is chosen, the shipowner is supposed to attract the finance, as

very few shipowners have enough money to acquire ships using only equity

financing. The traditional sources of capital for the shipowners were Syndicated

   

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loans (40,2%) , Bilateral lending, internal equity finance, shipyard and

governmental finance (36,3%), tax lease (2%), equity funds (2,5%), bond and

public equity (5%), KG/KS markets (6%) , Non-ship mortgage loans (8%).

Banks through syndication or bilateral deals have always had far the largest

share of the shipping finance market. This can be described as banker’s

perspective. The banks have to decide about the investments in shipping

portfolio and in the precise project. The bank has to assess the shipping risk,

taking into account the industry volatility and hence the possibility of a

shipowner to gain cash flows from this ship or other ships. A Bank gives a

shipowner term sheet, the document providing the main characteristics of the

bank offer, such as loan amount, interest rate, term and repayment schedule

etc. Bank is willing to be secured if the loan cannot be repaid. Securitization is a

thing of vital importance in shipping finance. These are some types of securities:

a first statuary mortgage over the vessel, an assignment of insurances, an

assignment of earnings, a personal or parent company guarantee and a

charge over the shares of the borrower. Some deals are closed under Export

Credit Agencies’ guarantees.

The traditional shipping finance scheme represented by Figure 1.1 below:

Figure 1.1 ‘Traditional Shipping finance structure’. From ‘Shipping Finance’ by S.

Harwood, 2006, p.79.

   

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The second decade in the new century is a kind of unique for shipping due to

overlap between industry crisis and global economic crisis. And the time is even

more unique for shipping finance. Basically, no one doubts that the shipping will

recover in the future due to global economic growth. But the consequences of

this overlap for shipping finance cannot be determined yet, as it may never be

the same.

1.2 The new shipping finance environment

The crisis brought substantial problems to almost every industry in the world. To

some extent, shipping felt it a bit later and was outperforming the market for a

while. The high charter rates, especially in container market were holding till

autumn 2010, driving the market which was already touched by decrease in the

world trade volume. The prognoses were still positive for the shipping, but the

point of no return has already been passed. Costly container lines price wars

overlapping severe Greek crisis and Japan nuclear disaster, two main shipping

nations, dropped the market down which has not recovered by now. Currently,

shipping market, with some differentiation in sectors is still doing badly due to the

excess of tonnage, which predetermines overcapacity and diminishing the

value of shipping assets.

Container is expected first to recover as the rates seem to improve in the

nearest future. The market is waiting for giant container ships with capacity over

13000TEU. The situation is also dependent on the geographical diversification of

container lines routes. Europe-Asia routes are more affected by the crisis than

inter-Asia transportations. Dry bulk market dropped first, as the demand in

commodities by economies went down with the crisis. The decrease was

significant. There is still excess in tonnage in almost all vessel types. When the

crisis commenced, the orders with delivery in 2010 and later had already been

done. That worsened the situation, as immediate response was not possible. But

the market is showing optimism regarding the second half of 2013. The worst

prognosis is still for tanker segment: most operators showed losses in 2012 due to

almost half decline in rates in comparison to 2008 when the crisis rushed in. The

recovery is expected late 2013 or 2014.

   

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The lack of demand and decline in rates, which are slowly improving now,

predetermined the problems faced by the shipowners, but what made it worse

was the banking crisis. Every company involved in shipping activity has felt the

credit crunch on the sector. The shipping industry cannot climb up the cycle

under the same finance conditions as it happened before as the banks found

themselves in new waters.

Debt is cheaper than equity and financing of a ship before 2008 was quite

simple. It was possible to finance almost 100 % for construction and post-

construction phase of a newbuilding. Now banks are more accurate in action

and aligned with economic nature precautions they are feel more constrained

due to legislative amendments, such as new Basel III requirements. All market

players are aware of the challenges that current situation brings.

Loan financing is still possible, but much more is needed to attract finance:

transparent legal company structure, corporate governance, strong Risk

management, strong company and group level financial statements in

accordance to IFRS and of course the competitive strategy of generating cash

flows – only strongest players can count on credit facilities nowadays.

The shipping risk is too high - no more ‘tourists’ in the industry. Most banks are

reducing shipping in their portfolios or exit the segment. On the contrary, some

are trying to play with the volatile market. The terms of loans reduced and the

price paid by the shipowners for the debt increased. Loan financing is still alive,

but loans are provided currently by strong traditionally committed to the

shipping banks to the market outpacers.

One of the speakers of the Deloitte Shipping Finance Forum 2011 said: «We are

in crisis because there was too much trust and easy money and the only way

out of that crisis is too much trust and easy money».2 It is also important for the

industry that the survival shall not turn to be artificial. So far everybody

                                                                                                                         2  Deloitte Report Shipping Finance forum. The need to consolidate. Retrieved from:

http://www.deloitte.com/assets/Dcom-Netherlands/Local%20Assets/Documents/EN/Industries/Transportation/nl_en_rep_shipping_finance_forum_2011.pdf  

   

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recognizes that there will always be shipping the money will come, but all

players have to learn how to live within their means in the new conditions.

But if banks reduce their share in ship financing where the money comes from to

satisfy the current capital requirements for 2013 amounting 100 billion USD?

The first response on the situation came from the private equity in form of share

capital and subsidization. The companies need more equity. To get a loan the

banks ask for 30-40% equity in project along with acceptable debt to equity

ratio in the whole company. For example in German KGs private equity

placement increased by 34% in 2010.3 But the equity is also coming not

exclusively from shareholders, but also from investors who wish to benefit from

the situation. Buying a ship is much cheaper now and cash rich players are

willing to participate in JV expecting cash flows in the future.

The fact that buying ships is cheaper now increases the gap between small and

big shipping firms. The bigger companies can afford cheaply increase the

tonnage creating a competitive advantage for the future. And it works

regarding both newbuildings and second hand. Many companies in Germany,

around 43%, were unable to renegotiate banks and had to sell the ships. The

supply contributed to the price decline.

It is also much more difficult to get a loan for a small firm, as the risk cannot be

diversified in a one ship project due to high dependency on rates and market -

the banks are not willing to participate in such projects anymore.

Small companies have big problems. This drives the demand for mergers and

Joint ventures. The small companies cannot offer transparent and credible

structures to attract financing, alas - the bigger you are the more options you

have to finance your ships.

For companies which meet the requirement of the size and transparency,

another opportunity appears on the horizon - IPO. Publicly listed shipping

                                                                                                                         3  Axhausen M. et al in KPMG report ‘Ship financing in flux – searching for a new course’ 2012, p. 6-7.

   

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companies profited on the boom in 2005-2007. Who will manage to consolidate

now and undertake IPO will benefit from the rising market in the future.

Another capital market instrument being actively used by shipping companies

now is issuing bonds. Bonds are securitized loans with long-term investment

horizon. Unlike shareholders, bondholders are creditors. This implies lower risk

than IPO for investors and predetermines its popularity along with low interest

rates on the market.

The bad market situation, numerous insolvencies, restructurings and defaulted

charterparties created more room for gambling than ever before in traditional

shipping business and attracted players such as hedge funds trying to create

value and profit from the situation.

Another so far unknown instrument in shipping finance is private debt. There are

a lot of pension funds, money markets and other players who have money,

which they can lend in exchange for security in form of the most senior debt to

guarantee the repayment in case of insolvency. The opportunity is convenient

for shipowners as there are much less regulatory constraints than in case of bank

financing and more freedom for borrowers than in case of attracting external

equity.

There will always be shipping! This idea comes through the whole research.

Whatever problems are faced by shipping companies there is no other such an

efficient way to transport the goods. The current situation brings shipping

finance to the new, so far unknown environment and that makes it interesting to

observe the developments and adjustments of the industry.

The financing issues influence the industry markedly. The banks’ risk averse

behavior and overall reduction in significance of the bank financing reduces

the attractiveness of traditional business locations such as Germany and raises

new centers of financial power. The industry competition is reaching the new

level. German KG – shipowners need to compete with Chinese governmental

support of local shipowners on the globalized market in the future. Full of

traditions and often family owned small and mid-sized shipping companies have

   

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to compete with industry giants on capital markets. Shipping is now adjusting to

be a real globalized industry and not just an asset ownership. Shipping finance is

not the same any more.

1.3 Historical Survey of international shipping finance in Russia

The international shipping finance has just become part of Russian shipowners’

lives. Russia had hardly entered this world when situation changed again. What

will happen to positive trend achieved by Russian shipowners before the crisis? If

one wants to understand the current situation in shipping finance being faced

by Russian shipowners it is crucial to realize the historical perspective, e.g.

development, traditions, incentives and local market drivers which no doubt

had influenced and keep on influencing shipping finance in Russia.

The Soviet Union state funding program for shipping companies and shipyards

was the largest in the world. At the end of 80-s the grt of the soviet merchant

registered fleet amounted almost 26 million grt and the country was ranked 4th

in the world on this indicator. To be mentioned that ranked 1st and 2nd Liberia

and Panama respectively had registered fleet being only virtually registered due

to outflagging tendencies which were gaining in power for the western

companies since the 70-s. To this extent Soviet fleet was surpassed only by

Japanese fleet, amounting around 28 million grt. 4 The Soviet fleet was not only

registered but also controlled fleet and to this extent the Soviet Union was one of

the largest maritime nations by the moment it terminated its existence. Russia as

the Soviet successor has undisputable rich merchant shipping traditions.

After the collapse of the Soviet Union, the Russian fleet declined in the following

five years by almost 40 percent . Some part of the fleet was split of among the

former republics. Only 10 from 17 sea-going shipping companies remained in

Russia. But this was not the main driver. From the 8th place in 1994 the Russia

                                                                                                                         4  Harwood, S. Shipping Finance (3rd ed.), p.6-7.

   

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plummeted from the top ten maritime countries and the erosion process went

on. 5

The Russian companies got access to offshores when the office of Swiss firm

Riggs Walmet Group was opened in Russia in 1991 providing offshore services to

the new market. Since then the vast majority of ownership rights on Russian

based resources and production facilities left the country with no intention to

return. Shipping suffered the same problem. Not only vessels were registered

under the foreign flag but the owners themselves relocated the place of

business to offshores. Cyprus became the beloved point of destination for

Russian business.

One of the most used sources of finance for Russian shipowners in the 90s was

the Russian “interpretation” of shareholder financing. The traditional methods of

shareholder financing are loan financing by the shareholder or providing share

capital, put it different, giving money for ships, for example, German “KG-

scheme”. The expected sale of the State’s final holding of shares in some

Russian shipping companies by auction has been suggested as possible source

of funds for the companies involved.6

Another way of financing was State aid. Due to the poor conditions of the

economy and overall instability the help was not that significant. State aid is

usually aiming at purchasing newbuilding on domestic market rather than other

P&S agreements, as it helps not only shipowners but also shipyards involved. But

the situation on the shipyards was below bad level and the government was not

really able to assist significantly. The Merchant Marine Revival Program was

adopted in early 90s. The program was aiming at channeling finance together

from the state and industry, though the project was not really successful.

The government also tried to help the companies acquire traditional loan

financing from international banks and even negotiated directly with banks in

                                                                                                                         5  Ibid. 6 Powell P. Shipping finance for Russia: how to source it. Retrieved from http://www.marine-money.com/archive/shipping-finance-for-russia-how-to-source-it  

   

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Germany, Japan and some other states for financing newbuildings for Russian

shipowners.

The global shipping industry lifecycle was on its rising stage in 1990s. The numbers

of bunks with shipping banks in its portfolio increased almost twice in 1993-1995.

The assessment of the political risk in Russia was not higher than nowadays and

the first international investments came to the country. The banks providing

shipping finance dealt purely with commercial issues by making a decision

whether to give money to Russian shipowners. The rule was simple: if the

company was ready to meet the bank requirements such as interest rate,

reasonable terms and security, period of repayment etc., put it different if the

likelihood that the project would succeed was positive, the financing was

possible. But almost no company was able to meet these requirements.

In October 1994, the first international shipping finance deal which can be

traced was closed between Primorsk Shipping Company (PRISCO) and

European Bank of Reconstruction and Development (EBRD). It was a traditional

loan amounting 75 million USD with 8 year tenor. The credit facility was attracted

to finance construction of 4 tankers in Ukrainian shipyard. The equity amounted

20% of the deal. The direct borrower was PRISCO maritime Ltd. registered for this

purpose on the Isle of Man. PRISCO itself was acting as a Guarantor. Interesting

is also the fact that the loan structured in two loans. The first was bilateral 45

million USD loan provided by EBRD. The second amounting 30 million USD was

syndicated by English bank Hill Samuel Ltd. and two Dutch banks: Meer Pierson

NV and Nederlandse Scheepshypotheekbank NV (Nedship). All tankers were

owned by one-ship companies in Cyprus, where the mortgage was registered.

Another interesting fact that after registration of mortgages the vessels were

registered under bareboat charter in Russian Registry, so the vessels were

carrying Russian flag. Offshore structure of the deal was the condition of the

banks participating. No state warranties were used to guarantee the deal.7

                                                                                                                         7  Nozhnikova E., Privalov A., Good news for Russian Shipowners in Kommersant. Retrieved: http://www.kommersant.ru/doc/10496/print    

   

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To sum it up, the deal represented a classic shipping finance loan scheme but

with one exclusion - the vessels came back on bareboat charter. And this is a

very interesting fact, because the vessels purchased by Russian shipowners with

international funding afterwards remained under the flag of convenience.

PRISCO was privatized in 1992, but the deal and foreign currency operations still

required an approval of the respective Ministry, which was granted. In 1996

using the flows in legislation PRISCO was fully restructured through international

subsidiaries and almost the whole fleet was offshored.

The Russian legislation already had a law regarding ship mortgage, but the

there was no effective tool of vindication. The newborn Russian legislation

lacked confidence in terms of taxes, mortgages and other vital things for

shipping finance. It was too complicated and unclear to work with.

The 90-s had a few examples of financing by the international banks and these

deals were fully structured through international subsidiaries of Russian

shipowners. The loan pricing was slightly above the international market.

EBRD was the first and one of the main finance providers of this time period. The

then-Vice-president of EBRD Gui de Selliers commented on the deal with

PRISCO: ‘Vessels flying the Russian flag can be financed by international banks.

Commercial banks participating in this syndicate demonstrated that the

financing of the Russian shipping business is profitable even without government

guarantees’. Other clerks of the bank added that the agreement was likely to

be the first in a series of similar projects with other Russian shipowners, and that

the number of Western banks involved would increase.8

Actually it was truth and EBRD continued investing in Russian shipping. One of

the most significant projects before the default was undertaken by EBRD in

cooperation with Sakhalin Shipping Company (SASCO), by the end of 90s one of

                                                                                                                         8  Nozhnikova E., Privalov A., Good news for Russian Shipowners in Kommersant. Retrieved from: http://www.kommersant.ru/doc/10496/print.  

   

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the main Russian sea carriers. But this project turned out to be less successful

and resulted in collapse in 1997 when the company was unable to pay the loan

back. 16 ocean vessels were sold out by 2001 to cover the debt.

Almost no new ships have been built in Russia for a long period of time, and only

177 ships were built for Russian shipowners altogether between 1992-2001. The

Russian shipping industry met the next decade with almost ruined shipbuilding

and almost dying shipping. The interest rates offered by Russian banks for

shipbuilding had been falling, but the repayment terms were still so short as to

be practically unacceptable for shipowners. By contrast, foreign banks offered

credits for 7 to 9 years at roughly half of the Russian interest rate. The future of

Russian ship finance remained where it had been for a decade – offshore,

among the handful of well-known maritime bankers. 9

The break-even point was reached in early 2000s, when the government found

the first money for maritime sector after the country defaulted in 1998, e.g. the

Ministry of Transport began a small subsidizing program for interest rates on

newbuildings constructed on contracts with local shipyards. The new era was

expected.

The period between 2003-2013 was characterized with reaching the new level

of shipping finance. The amount of traced deals has increased significantly

along with global shipping boom in 2004-2007. This time turned out to be a truly

jump forward for the global shipping. On the pushing wave of the world’s

success the Russian companies closed significant amount of good deals. Some

of them will be analyzed in Chapter 3 of this research.

The decade emphasized trends of consolidation, so the Novoship merged into

Sovcomflot, the other shipowners found themselves parts of large logistic

corporations, which united shipowning with stevedoring, rail, truck and

forwarding services. The role of the government has strengthened. The new

                                                                                                                         

9  Helmer J. Russian Ship Finance report. Retrieved from: http://www.marine-money.com/archive/Russian-ship-finance-report.  

   

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century was characterized by launching in Russian state controlled

corporations, which were intended to reverse the trends of overall assets

dilution. The new era started with the names of Gazprom, Rosneft, Transneft,

Rostech, Rosnano, Rosatome. The shipping industry received Sovcomflot and

United Shipbuilding Corporations. To be mentioned some others shipping

companies are still partially owned by the state. The increasing role of the

government is now assessed as a new political risk by the western banks and

financial providers.

Another significant trend is the gaining power of the Russian banks, which

increased in several times their domestic investments after many western

financial institutions were too busy solving their own problems caused by the

world’s financial crisis. The crisis and changes in legal environment broke the rule

of thumb, that attracting money from Russian banks is too expensive and

unbeneficial in comparison to foreign financial institutions. Before that, the only

competitive advantage of the Russian banks was the readiness to act in

accordance with Russia laws and Russian Registry, while the international banks

asked for international structure of the deal.

The legal system has strongly improved and matured towards convenience of

business players involved. The Russian International Shipping Register was

created; many aspects of mortgages and taxation were also cleared up in the

legislation.

It is interesting that the improvement of Russian economic situation and the

overall climate for shipping companies goes simultaneously but with little

covariance with the development of international finance for the Russian

shipping market. No governmental undertakings or shipowners initiatives really

attracted shipping finance into the country - almost all significant examples of

successful ship financing were structured through international subsidiaries of

Russian companies to avoid the influence of Russian political and legal risks. The

analysis is provided in the respective chapters of the research.

   

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To sum it up, the history of Russian Shipping finance can be divided into 3

periods. The first period is the soviet period, characterized by the clear system of

state financing with its system benefits and disadvantages.

The second is the period from the collapse of the Union and by early 2000s. The

main trends were destructive for the industry: changes of ownerships which

often happened in an illegal or simply criminal manner, the overhead offshoring

and dilution of assets. But this period was also the birth of international shipping

finance in Russia. And even though attempts to acquire finance from

international players were not always successful that was a step forward.

In 2000s situation improved, the third period commenced. The amount of deals

with international financial institutions increased, the Russian shipowners

became able to fulfill the conditions of foreign banks. Put it different, some

Russian shipowners finally became players of the international shipping finance

market. Even though they still paid the risk premium, the finance deals turned

out to be win-win agreements for both lenders and shipowners.

Did this period end with the world’s economic crisis? The possible options are

clear. The economic crisis together with shipping industry’s life cycle crisis may

turn out to be the headstone for international shipping finance for the Russian

market or, on the contrary, the Russian shipowners will find themselves in a more

competitive position than ever before and will be able to benefit from the

current situation. Answering this question is one of the main goals of this paper

and subject to further analysis in respective chapters.

   

20  

2. Russian Market, shipowners’ perspective

2.1 The Russian market for international shipping finance

This section describes the size and activity of the international shipping finance

market in Russia.

Shipping finance is a truly international and globalized mechanism and has

usually no state boarders. The sole idea is the cooperation, when the shipowners

operating world-wide are aiming to acquire finance from global finance

providers. This is of course subject to some local specification, which is mostly

behavioral or state-help oriented in nature. Thus German KGs are preferably

aiming at acquiring funding from German banks, to be mentioned both

German shipowners and banks are the main players in the global shipping

industry.

However, Russia is a special case to this extent. Firstly, the market is split of to the

fleet operating internationally, which can be registered under the flag of

convenience, and the domestic fleet which is supposed to fly national flag by

law. In general this is the world used practice. In Russia this practice is more

specific, as even operating internationally Russian fleet may be subject to flag

limitations. This leads to a perception that not all Russian shipowners can get

access to international finance. Empirically, it strikes that almost all international

financing deals with Russian shipowners were structured through offshoring and

outflagging. The grounds for this and perspective of changes in the future will be

analyzed further in this paper; the fact is to be taken as an axiom now.

Secondly, as it follows from the historical survey provided in this paper, the

process of determination of the Russian shipowner community and domestic

funding providers’ community deviated from one in Europe or somewhere else

in the world. The Russian traditional shipping finance market is not limited to

international funding providers. There are also domestic banks which provide

money only to Russian shipping companies and these programs are sometimes

subsidized by the government. Russian finance market is the place where global

   

21  

finance providers and Russian finance providers meet and Russian shipowners

who have access to international finance also have an option of domestic

funding, which is different in terms and conditions.

Empirical evidence show, that only 3 Russian companies were active in raising

funds from global financial market players. These companies are Sovcomflot

(SSCF), Primorsk shipping company (PRISCO) and Far Eastern Shipping Company

(FESCO). The fleet of these companies comprises around 200 vessels with DWT

around 14 million. This numbers represent about 70% percent of Russian owned

DWT and slightly more than 10% of the vessel number in calculations based on

IHS Fairplay data for the Russian merchant fleet.

The statistic retrospect has one important clue: the Russian merchant fleet

reduces in amount of vessel numbers and grows in terms of DWT. And in Russian

reality this is not caused by the trend of overall increase of average ship size. As

it was mentioned, the Russian fleet can be virtually divided into two groups:

vessels which may be offshored to benefit the shipowner, simplistically this is the

fleet operating internationally, and vessels which are supposed to carry the

Russian flag by law.

Many of the vessels from ‘domestic’ virtual group are really old and have to be

replaced. The speed of overall fleet obsolescence in this segment is frightening.

The replacement by modern vessels is not foreseeable. Even though some

improvement in shipbuilding has been recently reached in Russia, construction

on domestic shipyards is still problematic, meanwhile constructing ships abroad

and using international finance remains a dream in this segment. This segment

of shipping, even though it is still merchant fleet, according to Art.2 of the

Russian Merchant Shipping Code (MSC), has no access to international funding

due to obvious reasons, such as company size, transparency, stable cash flows

and sometimes simply no contact to foreign financial institutions.

The situation with the fleet operating internationally is much better. Shipping

finance is characterized by internationality. Traditional shipping finance in its

global insight and as being observed in this paper, is the tool for the

international fleets, independently from the ship flag.

   

22  

The share of the ocean going or at least working internationally vessels in the

Russian fleet is around 15 million DWT and only around 350 in vessels’ numbers.

These data are very close to the numbers which show the share of the Russian

fleet owned by the companies who have access to international shipping

finance. And referring to the perception at the beginning of this section –

around 90 % share of the international operating Russian fleet (in DWT) has the

access to international funding.

2.2 The key players

Nowadays, the main players among Russian shipowners are: Sovcomflot (SCF),

Primorsk Shipping Company (PRISCO), Far Eastern Shipping Company (FESCO),

Sakhalin Shipping Company (SASCO), VBTH (Shipping division of Universal Cargo

Logistics Holding) and MSCO (Murmansk Shipping Company). First five

companies from the list were successfully acting in attracting international

financing. There is no publicly available evidence that MSCO has ever attracted

international shipping finance but this company is seemingly capable of doing

this in the future.

Sovcomflot (SCF) is the largest Russian carrier. SCF has the richest history among

all Russian shipping companies especially concerning the international

orientation as it was created by the soviet government for external operations.

SCF is 100% owned by the state. In the modern Russian history SCF was merged

with the second largest company Novoship. Together as SCF Group it is currently

far the biggest and most successful Russian shipping company and one of the

leading tanker carriers in the world, offering crude oil, refined petroleum an

liquefied gas transportation.

SCF fleet is ranked 1 in the world as Aframax tanker operator and second as

Suezmax operator. SCF is also the largest Arctic tanker shuttle operator. The fleet

comprises vessels of various types built in Russia, Japan, Sweden, Korea and

amounting 160 vessels with DWT of 12, 36 million. This is more than a half of the

whole Russia controlled fleet. More than a million DWT is currently on-order. The

   

23  

current strategy is oriented on extensive growth - the company doubled in size in

7 years.

The details of the international shipping finance experience of the leading

Russian shipowners along with the analysis of precise finance opportunities will

be scrutinized in Chapter 3 of this paper. However, it is important to mention that

SCF is a recognizable firm which has no problems attracting finance from

international providers even taking into account the current harsh global

finance situation. SCF is the most experienced Russian company in terms of

international ship financing. It is important that SCF is a ‘classic’ shipping

company, e.g. vessels are the main assets and the cash flows are generated by

freight.

PRISCO is another ‘classic’ shipping company, but it is privately owned. The

degree of ‘classicism’ is a bit lower than in SCF case, as PRISCO nowadays is a

group of companies comprising also a bank, insurance company, Far East

Mortgage Loaning Center etc. But shipping is still the main activity of the

company and vessels are the main assets.

The transportation PRISCO fleet consists of 11 tankers with total DWT about 1.2

million. As it follows from the name of the company PRISCO performs its activity

in Primorie (Far East). PRISCO was quite successful in attracting finance during

the shipping boom in 2007 and was enlarging the fleet constructing

newbuildings in Korea and Japan. During the crisis the management decided in

favor of fleet reduction strategy: in 2011PRISCO sold 6 Aframax tankers to SCF

Group.

SCF and PRISCO have much in common. These are both tanker operators. Both

companies structure their fleet operations through offshore companies, and the

vast majority of vessels carry a flag of convenience. The differences are in size

and ownership.

FESCO is a privately owned large transportation group. It has inherited its name

from the Shipping company, but now FESCO is a group comprises comprising a

lot off transportation assets including port, stevedors, rail business etc. FESCO

   

24  

was and still is the largest Russian container operator. However, container has

always been the weakest segment in Russia; the Market is represented by the

global players and the share of Russian companies is miserable. The shipping

division of the FESCO group loses in significance and constitutes slightly more

than 6% of the group turnover. Only in December 2012 the group sold around 20

vessels. The fleet is now less than 1 million DWT and the strategy is designed to

maintain the fleet size for support of the group needs.

FESCO was active in financing during the boom in 2000s but now the group is

not among ambitious players in the market in terms of attracting traditional loan

financing from international banks. The group is raising corporate loans on

different purposes, plays with assets and can afford issuing bonds on capital

markets. The corporate structure implies much more options to gain finance to

support shipping divisions in case of purchasing vessels in the future. The

company is successful in attracting multimillion loans from Russian and

international banks, e.g. in 2011 EBRD opened a 100 million credit line under

Russian state guaranties.

VBTH shipping division is a part of privately owned Universal Cargo Logistics

Holding, one of the major players on Russian logistics market. UCHL is a huge

logistics operator with port, stevedoring, rail, truck, shipping and shipbuilding

assets. The shipping division comprises three shipping companies: North-Western

Shipping Company, Volga Shipping Company and Western Shipping Company.

Volga Shipping is less interesting as it owns mostly river-class vessels. North

Western Shipping Company and Western Shipping Company comprise a huge

river-sea class fleet amounting about 150 vessels.

These shipping companies were slightly involved in international shipping

finance in 2005 and 2005 attracting funding from International Finance

Corporation, a part of World Bank providing funding to developing economies.

This is a unique and interesting experience.

As all these companies are now part of the large transportation group they

benefit from the corporate loan facilities and direct support from the holding.

   

25  

The shipping companies themselves are activly raising loan financing from

Russian banks.

FESCO as a shipping company and VBTH have much in common as they

represent large transportation holdings, FESCO and UCLH. What does it mean

being a part of a holding nowadays? It was already stated that the current

shipping finance market demands greater security, higher equity share and a

transparent corporate structure. The harsh industry conditions dictate

consolidation. Amazing, but the fact that due to Russian corporatization these

shipping companies turned out to be parts of successful transportation groups

and find themselves in better competitive position then before the crisis. The

holdings now can provide money or at least act as a guarantor to acquire new

vessels which have become cheaper due to the crisis. It doesn’t necessarily

mean they do it, e.g. FESCO currently reduces the fleet, but strategically it is

supposed to be beneficial. When it is being said that shipping shall stop being

an asset ownership model and transform to an industry, it can be noticed that

some Russian companies are already parts of logistic industry and benefit from

the logistic chain integration and corporate structure.

SASCO is state owned shipping company with some private minority

shareholders each holding no more than 2% shares. The fleet comprises 18

cargo vessels which are mostly used for cabotage transportation and thus carry

Russian flag. SASCO was active in attracting international shipping finance in

late 90s, even though this experience was not successful. The situation was

shortly described in the historical survey in Chapter 1 of this research. In the

modern history there is now publicly available evidence that the company was

using shipping finance schemes.

MSCO is an interesting shipping company, mostly because its operation activity

lays within the Arctic region. MSCO performs 80% of the Northern Sea Route

(NSR) transportation. The fleet comprises the fleet of MSCO itself and one of

Northern Shipping Company. It amounts around 1 million DWT and is

represented by bulkers and tankers as well by huge number of supply and

special purpose vessels. The whole fleet is using the Russian flag. The government

   

26  

holds now slightly above 25% shares in the company and plans to sell it in the

nearest future. There is no publicly available evidence that this company has

ever used international funding.

These two companies are not active in international ship finance. But they are

mentioned in this research firstly because these companies use the Russian flag

and because they are potentially capable in attracting financing in the future.

There are some single results of international financing for other Russian

shipowners, such as providing loans by KfW bank to shipping companies in the

fishing segment, but they do not affect the picture. Basically only three Russian

companies are engaged in traditional shipping finance schemes. They are SCF,

FESCO and PRISCO.

2.3 Registration from the shipowner’s perspective

Who can afford offshoring in Russia? Everything in this world shall have an

economic rationale behind it and stay alone with the respective legislation. First

of all, it is important for the shipowner to determine the shipping activity. If this

activity is international in its nature, say, chartering ships to international

commodity providers, offshoring can be a solution and sometimes it happens

not only in terms of outflaging but also in relocation of the business. But what if

shipping activity is bound to the Russian flag or to shipowner’s incorporation

under the laws of the Russian Federation by law?

The Russian Merchant Shipping Code has no restrictions in terms of the

nationality of the shipowner. The definition of the shipowner is given in the

article 8 of the MSC and reflects the idea that a shipowner is a person lawfully

using the ship and not necessarily owning it. This rule of law has some limitations

which are not widely applicable and relate for example to the nuclear

merchant fleet. But the restrictions arise from the other point, namely using the

Russian flag, as this is the entrance ticket to a variety of shipping activities in

Russian inland waterways and territorial waters.

   

27  

Art. 15 of the MSC stipulates which shipowners possess the right to use the

Russian flag. These are Russian citizens, legal entities incorporated under the law

of the Russian Federation, Russian Federation as a state, its federal states and

municipalities. In addition, the ships can be registered under the Russian flag in

accordance with a bareboat charter.

The activities allowed to the ships under the Russian flag exclusively are

numerous. First of all Art. 4 p. 1 of the MSC states that cabotage shall be

performed only by the ships under the Russian flag. In June 2011 Federal Bill �141

added some shipping activities in the inland waterways and territorial waters

which can be exclusively performed by the ships under the Russian flag. These

are: ass icebreaking forwarding navigation, rescue, towing and lifting,

hydrographic operations etc.

Art.4 p.3 stipulates that in accordance with international treaties signed by

Russian Federation and in cases established by the Russian government

cabotage and the operations listed above may be performed by the vessels

under the foreign flag. But it is quite difficult in practice. To make it clear, for

cabotage to be performed by the foreign ship the following legal facts are

significant: there shall be no Russian vessel capable of doing that, the vessel

shall comply with many safety prescriptions, operations shall not be threatening

the Russian national security etc. The permission for foreign cabotage shall be

authorized by the Federal Agency of Maritime and River Transport. Put it

different, the rule of law is protective and almost prohibitive if the authorities do

not want it to happen.

Other shipping activities requiring Russian flag include almost all activities in the

Russian inland waterways. Even for foreign pleasure boats a few years ago it

was quite difficult to get access to Russian inland waterways, but the legislation

has been recently smoothened in that direction.

There is one big block of activities requiring the Russian flag which is to be

emphasized. And this is all about Arctic and Northern Sea Route (NSR). This is a

new region for navigation and the future of Russian shipping. The huge part of

Russian is situated above the polar circle and Russia treats Arctic as a point of

   

28  

exclusive influence. Without going in depth of the public law and arguing about

political importance of dominating in this region it is to be mentioned that

Russian ships are supposed to carry Russian flag of operating in Arctic. The

Russian government is now actively developing the legislation for using NSR,

intentionally striving to reserve the share for Russian shipowners with vessels

carrying the Russian flag. The legislation implies a lot of benefits for shipowners in

case they operate vessels under the Russian flag in this region. In the future

when the navigation turns out to be more active this is supposed to boom the

Russian maritime significance and the amount of Russian ships in the world.

Arctic has the greatest reserves of oil and gas in the world and the hunting

game has just commenced.

This is why the MSCO was mentioned in this research among the leading Russian

shipowners. The company now performs 80% of the whole navigation along the

NSR. The government is planning now to sale its last share of slightly above 25%

and the shipping company will soon turn out to be private. Recently the

company has sold its non-core asset Northern River Shipping Company, before

that in 2003 MSCO had transferred the nuclear icebreaking fleet to the

governmental structures. All these factors make the company more core-

oriented, transparent and open for international cooperation. The whole fleet

carries the Russian flag and is quite old. The age of some vessels is above 30

years. The company is supposed to finance newbuildings or at least purchase

modern vessels in the nearest future. The significance of this company may

force the government to subsidize it more or less directly, if of course it is not

intended to make the NSR and Russian Arctic the part of SCF monopoly or

create a new shipping giant on this purpose.

But why Arctic legislation is subject to be emphasized in the research devoted to

shipping finance. The precise successful deals of international ship financing will

be scrutinized further, but there were only two transactions in the last decade

when the fleet bought on international loans was supposed to carry the Russian

flag, and in both cases this was predetermined by the intended usage of vessels

in Arctic. Both transactions were closed by SCF. Maybe MSCO will be the next

company to succeed in this? Undoubtedly a lot depends on the financial health

   

29  

of the enterprise, the management, future cash flows and other economic and

financial data which can scare the potential investors, but the competitive

advantage of companies operating in the region is great and gaining in

significance.

Currently, the main purpose for shipowners by choosing Russian registration of

vessels is the idea of performing cabotage transportations but it might be

replaced by Arctic transportation in 5-10 years.

The shipowners who are not involved in the activities limiting navigation to the

vessels under the Russian flag are supposed to choose between Russian flag

and foreign flag. Is it really that unbeneficial to register fleet in Russia for

standard operations?

Empirical evidence shows that if the shipowners have a chance to go for the

flag of convenience they do it. As it was already mentioned before, to some

extent it is predetermined by investors’ will and the grounds for that will be

analyzed further in the research. But is it the only cause?

At the early 90s the Russian shipowners got an opportunity to use the flag of

convenience. And since then almost every vessel which could use the flag of

convenience by law was registered in Liberia, Panama, Cyprus and other world

most used registries. The law system of a newly born Russia was not able to

regulate the process. The national shipbuilding was almost ruined in the first five

years since the collapse of the Soviet Union. The shipping companies which

were struggling for survival were economically unable to register foreign

constructed vessels in Russia due to many reasons, e.g. they were supposed to

pay VAT on import.

The situation remained unchanged up to the 2006. From the end of 90s the

government started developing the legislation about the Russian International

Ship Registry (RISR). At the end of 2005 the Federal Bill � 168-FZ of 20.12.2005 ‘On

Amendments to Certain Legislative Acts of the Russian Federation in connection

with the creation of the Russian International Ship Registry’ came into force. The

Norwegian International Ship Registry was used as sample. RISR is also called the

   

30  

‘second register’. The main benefits in comparison to the main register were:

property tax exemption; income tax equaled to 0%; VAT equaled to 0%; a vessel

was no more subject to transportation tax; ship registration time limited to 7

days.

The new era was supposed to commence. But the feedback was close to

nothing.

The legislative changes made by the State initially proved to be unattractive to

shipowners and did not cause the return of ships back under the Russian flag. In

particular, the registration of ships in RISR implied much more bureaucracy in

comparison to the registration in ‘convenient’ registries, especially in case of

authorizing the call signal. The overall taxation benefits were insufficient,

especially in terms of vessel’s import, as tax exemption was supposed to be

annulled in case the ship was deregistered from RISR within 10 years. The law

also prohibited the usage of vessels registered in RISR for cabotage

transportation. In addition the shipowners were supposed to pay the unified

social tax for seafarers. The new Registry was uncompetitive.

Up to 2011 situation remained unchanged. The economic stability, the

strengthening of the Russian banking and local legislative amendments didn’t

force the shipowners to bring the fleet back under the Russian flag. In 2011 the

influence of crisis on Russian shipping industry became more significant and the

government responded with the Federal Bill � 305-FZ of 11.07.2011 "On

Amendments to Certain Legislative Acts of the Russian Federation in connection

with the implementation of the measures of state support of shipbuilding and

navigation." This legislative initiative touched many spheres improving the

competitiveness of the national shipping industry.

The most significant changes were adopted in terms of the ship registration in

RISR. The most important amendments were the following.

The bill significantly extended the list of the vessels which can be registered in

RISR. The most important is the allowance of usage RISR registered ship for

cabotage transportation.

   

31  

The RISR appeared in the Code for Inland Waterways Transportations in Russia:

the vessels constructed by Russian shipbuilders since 1 January 2010 and used

for transportation between inland waterways ports of Russia may be now

registered in RISR and benefit from tax exemptions.

Additionally some more significant amendments were done: 10-years clause for

registration was eliminated; the obligatory pension fund contributions are set at

0% rate up to year 2027; the labor legislation allows the fix-term labor contracts

with seafarers who work on vessels registered in RISR; import custom duties on

spare parts were eliminated in case of repair by Russian shipyards in Special

economic zone.

"Vnesheconombank" (VEB) was empowered with the authority to implement

the warranty support of Russian shipping, acting as Export Credit Agency.

To be mentioned that this bank is acting now as an interim borrower for Russian

shipping companies. In 2011 it raised a foreign loan and redirected it to SCF - an

interesting example of governmental support in crisis.

The Bill is treated as a really efficient attempt to increase the number of vessels

under the Russian flag and support the whole industry. The efficiency of this

novation is to be judged by time. The initiative supports the shipping sector, but

it is definitely incapable to bring the international operating fleet under the

Russian flag.

It is important to be mentioned that SCF is a state-owned company and the

increase in Russian flag ratio can be achieved by issuing a resolution. But this is

not done on purpose, as SCF benefits from nice international environment and

international financial support. The government realizes the necessity of

integration processes and Russia has made one more step to comfortable

‘equilibrium’ between flag of convenience and national registry.

2.4 Russian bank or a foreign bank from the shipowners’ perspective

When the crisis rushed in in 2008 the government adopted Government

Resolution of the Russian Federation � 383 ‘On approval of rules for granting

   

32  

subsidies to the Russian transport companies and shipping companies for

reimbursement of the cost of interest on loans received from Russian credit

institutions in 2008-2010 for the purchase of commercial vessels constructed at

Russian shipyards’.

While the international banks were less and less willing to finance shipping this

law turned the vector of funding preferences among Russian shipowners. The

legislative initiative was quite successful and helped not only international

oriented companies, but also purely domestic shipping companies. It also

contributed to the improvement of the situation on Russian shipyards struggling

with the crisis.

The Russian shipowners always have a unique option. They can apply for

international funding or take credit in a domestic bank. The crisis in Russia was

on average less severe than in western world. Russia still has incredibly low debt

to GDP ratio and can afford subsiding selective industries. The crisis forced many

international institutions to reduce financial activities in Russia and the space

was filled by domestic investments provided - state controlled banks. The Russian

banks multiplied their share in financing Russian economy in all sectors.

The situation predetermined the alignment of the conditions which can be

offered to shipping companies by the international and Russian banks. This does

not mean that they are absolutely the same now, but the gap is much smaller.

The average loan term in Russian used to be 5 years at 10% interest rate and

minimum 30% equity. There were many problems slowing the development of

shipping finance culture, such as significant legislative barriers in case of

financing newbuildings abroad and vessel’s evaluation for mortgaging.

The overall developing and strengthening of the banking sector predetermined

the smoothening of the financing conditions, while the crisis harshened the

conditions for international funding. The Russian banks found themselves to be

much more competitive than ever before. In addition the shipping companies

don’t have to pay political risk premium and Russian banks have no concerns

about working with Russian register.

   

33  

To make an example in 2009 MSCO attracted loan financing from Sberbank, the

leading Russian financial institution. The deal was split in two loans. The first credit

facility amounting 32 million USD with 7 years tenor and variable interest rate

max 10,5 % was granted for the purchase of second hand vessel. The second

loan amounted 25 million USD with a 10 years tenor and the same interest rate

was granted to refinance the credit facility from another Russian bank VTB. The

loan was securitized by Russian mortgages of 3 vessels with the value amounting

33 million USD.

In 2011 Sberbank signed with an agreement of cooperation with SCF, the same

year Gazprombank opened financing to Ltd. "VF Tanker-Invest " (100% subsidiary

of UCHL) in the amount of 138 million U.S. dollars for the construction of 10

tankers etc.

The credits granted to Russian companies by the foreign companies were close

in terms but with a slightly lower interest rate. Along with the economic

development the interest rate offered by Russian and foreign banks may equal

in 5-7 years.

The growing role of Russian bank financing is important for the whole shipping

industry. Gaining experience in working with international registers and

improving conditions of loan granting Russian finance providers can enter soon

the world shipping finance market to fill the space, which appeared due to the

fact that many international banks reduce the share of shipping in their

portfolios or leave the market. This would be beneficial for the shipping future in

Russia.

   

34  

3. The deals, Investors’ perspective

3.1 Traditional shipping finance: Bankers’ perspective

The bank crisis changed the rules of the game in global shipping finance.

George Weltman, in his article in Marine Money Journal (April 2013) writes: ‘How

do you measure success these days? For the banking industry over the last five

years the simple measure has to be survivability.’ The sector relying on

governmental support has sustained the first crisis strike, but now banks find

themselves in the new economic and legal environment.

Even though shipping is risky investment, traditionally shipping banks show

commitment to the sector. But many banks do not invest in shipping any more:

‘tourists’ have left or are leaving the industry. Loan financing is still the main

source of shipping finance. The overall volume of portfolios on the global market

is still huge, while the structure of participant has changed. Banks are bargaining

among each other and with external players selling and buying shipping

portfolios. City Group for example bought shipping loans portfolio from Societe

Generale amounting 1.2 billion USD. City is one of the banks which increased its

overall shipping portfolio since the crisis commenced and was very active in

2012, while HSH Nordbank, which is truly traditional shipping bank, has reduced

its portfolio since 2008 more than twice and is against generating new business,

preferring quality to volume.

The bottom of credit crunch in shipping is not really met. The amount of runoffs

on portfolios is constantly increasing and has reached 13.4 % in 2012. This year

set one more negative record - in the amount of banks which are not willing

making new loans in 2013.10 The real process of revaluation has just begun.

Percentage of banks who took write-offs has reached 80% in 2012 in comparison

to around 7% in 2007. The industry will undergo big restructuring process, which

has just commenced. The loans are for sale with discounts amounting up to 20%.

18 banks purchased loans from other banks. The banker’s willingness to

                                                                                                                         10  Houston C. No surprises. Marine Money, April/May 2013, p.28.

   

35  

refinance their clients is declining: almost 60 % of banks advice to prepare that

there will be no refinance. 11

Banks that decided to stay in business possess enough liquidity for transparent

strong players. There are still enough deals closed on the global market. More

banks are asking now for ECA-securitization. Governmental help and good bank

refinancing are contributing to financial sustainability of banks.

Regulators helped to save the banking sector; partially it was achieved through

additional constraints and legislative innovations. Basel III has been introduced.

The idea of Basel is to strengthen global capital and liquidity rules to improve the

banking sector’s ability to sustain shocks, financial and economic stress. Basel III

is founded on three pillows: minimum capital requirements plus newly

introduced liquidity requirements; supervisory review which now includes risk

management and capital planning plus disclosure and market discipline.12

What does it mean for the shipowners?

The banks impose more constraints in forms of covenants and securitization is

coming on the new level. Corporate ratings are gaining in significance, credit

maturities reduce from 12-15 years to 8-9, while the credit facilities become

more costly. The loans turn smaller and the equity share in new transactions

amounts 30-40%. IFRS becomes inevitable for companies willing to attract bank

financing. Banks are looking for borrowers which can withstand the crisis better.

One of the most significant changes for shipowners is increase in loan pricing.

And the trend is confidently expected to continue. The expected average

spread is around 333 basis points with the lowest level of 200 basis points.

Interesting but the price is driven not only by banks higher cost of capital along

with increased risk premium, but also the laws of free market economics: the

limited supply of bank finance drives up its equilibrium price.13

There is one more very important trend in bank financing. The banks became

much more selective regarding shipping sectors. The strategies usually mean

                                                                                                                         11    Lawrence J. Mortgages and portfolio sales. Marine Money, April/May 2013, p.32.  12  Soanes H. Basel III– what treasury did not tell you. Marine Money, April/May 2013, p.50  13  Houston C. No surprises. Marine Money, April/May 2013, p.28.  

   

36  

reluctance in tanker and bulk financing, neutrality in container and focus on gas

and off-shore. Off-shore implies now the best reliability and profitability. Hence,

this is a much more desirable investment for lenders and off-shore vessels are the

easiest to finance. Off-shoring has become a huge and independent part of

shipping finance. It is also predictable that off-shoring will split from shipping in

bank portfolios.

3.1.1 The deals analysis

Shipping financing came to Russia in its traditional form of bank loans in 1994.

The first 75 million USD deal was closed by PRISCO; details of this new for Russian

market instrument were given in the historical survey. Since then the key players

of the Russian shipping market use international funding provided by global

financial institutions.

The empirical analysis shows that only 3 Russian shipowners were really successful

in attracting international funding. These are SCF, PRISCO and FESCO. The

graphs below represent selective indicators of the deals closed by these

companies within previous 10 years. As the access to information about deals is

limited the research doesn’t argue that the information fully accurate, however

it definitely reflects the market situation. The data about the precise deals were

gathered from Marine Money deal database and all publicly available printed

and electronic sources.

Figure 3.1

0

1

2

3

4

5

6

7

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Number of deals traced in 2003-2012

   

37  

The total volume of international ship financing deals closed with Russian

shipowners is relatively small in comparison to the global market. However it is

important to pay attention that these deals were closed by three shipowners,

and to be precise 11 of them were closed by SCF. All traditional ship financing

transactions after the world economic crisis were closed exclusively by SCF.

Figure 3.2

Figures 3.1 and 3.2 represent the development of the Russian market activity.

Russian shipowners were successful in raising international funds while the market

was bullish in 2003-2008. The volume of single deals sometimes exceeded 600

million USD and these were win-win deals for both shipowners and banks. There is

no publicly available information that at least one of the loans wasn’t repaid or

was restructured.

What does this gap in 2008-2011mean? The data used by graph formation

includes only traditional ship financing transactions with international banks. This

doesn’t mean that financial activity of the market was low. Firstly, a large share

of the market was taken by the Russian banks, as it was already discussed in

Chapter II. Secondly, the shipowners were actively using alternative financing.

PRISCO was the first to go to internationals capital markets in 2007 by issuing

bonds in Norway. SCF was very successful in bond financing in 2011 when the

demand exceeded the supply and additional emission was undertaken. The

deal was later awarded by Marine Money Journal. FESCO also issued senior

secured notes in 2013. Additionally the information in the graphs doesn’t reflect

0

500

1000

1500

2000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

The total volume of loans raised 2003-2012 (USD mln)

   

38  

Secured 25%

Unsecured 75%

Deals secured under ECA warranties 2008-2013

Secured 20%

Unsecured 80%

Deals secured under ECA warranties 2003-2008

corporate loans, which were actively used for example by FESCO, as it is a large

transportation group with only 6% of its activity within shipping.

The graphs below represent the comparative analysis of the deals closed before

and after 2008.

Bilateral64%

Syndication36%

Deal structure 2003-2008

Bilateral25%

Syndication75%

Deal structure 2008-2013

Figure 3.3

Figure 3.4

Figure 3.5

10.5

8

0

2

4

6

8

10

12

Average maturity 2003-2008 Average maturity 2008-2013

Loan maturities (years)

   

39  

Figure 3.3 represents the deal structure. The comparison reflects the global

trend. The banks are willing to participate in syndicates nowadays aiming to

diversify possible risks.

Figure 3.4 represents the percentage of deals secured by ECAs. But this indicator

has some geographical specification. Secured were loans for ship constructions

in Finnalnd and Poland by Finnerva and KUKA respectively. This transactions

implied construction of relatively small supply vessels with low capital intensity.

There is no data about ECA warranties in Korea and China, where the

overwhelming tonnage is being built. The amount of risks secured by ECA

warranties in terms of money volumes or tonnage constructed drops in this case

to irrelevant figures. Accuracy of this analysis is subject to consistency of publicly

accessible information.

Figure 3.5 shows another significant global trend caused by the crisis, namely the

reduction of maturity terms, which equally affects the Russian companies.

Figure 3.6

Figure 3.6 provides the activity of international banks on the Russian market and

includes both bilateral and syndicated deals. There are more banks that were

participating only once than represented by this graph and there is no publicly

accessible information about all participants of the syndicate regarding some

deals. However the graph definitely reflects the current situation with banks

being active on the Russian market.

0 1 2 3 4 5 6 7 8

The activity of banks in deal numbers 2003-2013

   

40  

Figure 3.7

Figure 3.7 reflects an important feature of international shipping finance market

in Russia. The vast majority of deals were closed to finance or refinance

newbuildings. In terms of money volumes or vessels’ numbers the difference is

even more significant. Second hand S&P agreements are seldom subject to

international funds and financed by domestic funding providers.

The vast majority of vessels constructed - tankers (>70%) followed by LNG-carriers

(>15%). LNG is still considered by investors as a good project, but since the crisis

commenced it was quite difficult to raise credit facilities for tanker construction.

In 2013 SCF deal was given by Marine Money ‘Editor’s Choice Award’. ‘Bear in

mind that this isn’t LNG, the loan is secured by tanker fleet, which has substantial

spot exposure in a depressed market which provides little if any income.’14

Russian shipowners in the international finance market usually have already

signed charters for planned newbuildings. The vessels are chartered by leading

companies on different projects and have contract term exceeding the loan

maturity, granting future cash flows.

                                                                                                                         14 Marine Money Febr/march 2013. Execution with a high degree of difficulty – SCF Re-Financing. P.62

Newbuildings 75%

Second hand 12%

Refinancing 13%

Financing purposes

   

41  

As we already mentioned above, data regarding ‘before and after crisis

analysis’ reflects the global market development. This is also relevant for the

tendency regarding loan pricing. As the information to the loan pricing is always

confidential, it was very difficult to collect sufficient data to form a graph. But it is

clear that that the loans are more costly now. The accessible sources provide

some pricings for year 2005, which was the most successful in terms of deals’

numbers and loan volumes - an average of 4-5% interest rate (LIBOR (2005)

+1,5% (150 basis points)). The rate reflected the average pricing that year on the

global market. The political risk premium if any was not very high for the Russian

shipping companies.

As it was stated in the first section of this chapter, nowadays the average spread

on the global market is striving to 333 basis points. Unfortunately there is no

evidence regarding prices of recent SCF loans, but they are hardly significantly

above market average.

The absence of significant differences in prices for Russian and foreign

shipowners is achieved due to a couple of reasons. Firstly, financially Russia is

quite strong now and SCF, as a sole Russian shipping company which has

recently been active in attracting international finance is 100% state-owned. To

show what it means for financial providers this paper refers to Standard&Poors

credit analysis: ‘the ratings on Sovcomflot reflect our opinion that there is a high

likelihood that the government of the Russian Federation would provide timely

and sufficient extraordinary support to Sovcomflot in the event of financial

distress’.15 This fact reduces the economic risks of investors.

Secondly, to reduce the pure political risk, which is often bound to Russian by

investors, almost all the deals are structured through foreign subsidiaries, ships

are registered and owned in Liberia or Cyprus, where they are subject to first

statuary mortgage in favor of banks. The section below of observes this

phenomenon more closely.

                                                                                                                         15 Standard&Poors. Global Credit Portal. Ratings. Retrieved from: http://www.scf-group.com/data/pdf/Sovcomflot-E.pdf

   

42  

3.1.2 Registration from the banker’s perspective.

The registration topic was already touched in this paper from the shipowners’

perspective. It is obvious that the will to attract international finance, which is

usually less costly, forces the shipowners to structure the transactions through

common shipping jurisdictions and registries. The percentage of deals structured

through offshores is shown by Figure 3.9.

Offshore registration

88%

Russian Registration

12%

% of offshore deals in 2003-2013

 

Figure 3.9

To be more precise, there were only two deals within the last 10 years structured

in a way that implied vessels’ registration in the Russian Registry.

The first deal was closed in Hamburg by SCF in 2006 with three banks: HSH

Nordbank as lead arranger, ING Bank as advisor and Norddeutche Landesbank

Girocentrale as co-lender. The 15 year-loan totalling $434 million USD was raised

to finance 3 ice-classed shuttle tankers and 3 product carriers.

Vessels built at Samsung, Korea, were ordered in late 2005 with delivery 2007-

2009 and were chartered by Naryanmarneftegas, a strategic JV between

ConocoPhilips and Lukoil. The ships were supposed to use NSR for transporting oil

in European destinations. Product tankers were constructed in St. Petersburg

(Admiralty Shipyard) with delivery 2007-2008.

The second export credit facility amounting $160 million USD was signed in 2012

between SCF and syndicate of ING, Finnish Export Credit and Finnerva.

Financing implied construction of two 2 ice-breaking OSVs under long term

   

43  

charter to Exxon Neftegas working in the ‘Sakhalin-1’ project. Both vessels were

built at Arctech Helsinki Shipyard, JV of United shipbuilding Corporation (Russia)

and STX (Finland).

The fact that the conditions of these deals outperformed the market shows, that

the Russian flag is definitely not a significant issue. Unfortunately, there is no

information about the structure of these deals, but there is almost no doubt that

the deal was guaranteed by the SCF shipowning entity existing under foreign

law and the deal was subject to foreign jurisdiction and arbitration.

What can be treated as barriers to working with Russian law and Registration?

There are two major prejudices.

The first is that the Russian mortgage system is a very strong one. However, Mr.

Kuznik, in 2006 HSH Nordbank Global Head of Shipping, did not see any

problems: “We are familiar with the challenges of this flag, and the bank has

experience financing vessels of other companies flying flags of the ex-Soviet

Union Republics” and added on the matter: ‘the most important item is the

security of the project’s cash flow stream – it provides our security’16.

Russia has implemented the International Convention on Maritime Liens and

Mortgages, concluded in Geneva, 1993 without any reservations. Modern

Russian law recognizes all the maritime tools, including mortgages over the

vessel under construction. The comparative analysis does not show that there

are pure legislative flows in Russian law, hindering the usage of this tool.

The second prejudice is related to the overall reliability of the Russian system.

Artificially increased political risk assessment drives this prejudice. Meanwhile

Russia is a party to the New York Convention on the Recognition and

Enforcement of Foreign Arbitral Awards Done, 1958 and other major documents

relating to the matter. The Constitution of Russian Federation grants the

international treaties precedence over national legislation.

                                                                                                                         16HSH Nordbank talks tactics, Press release. Retrieved: http://www.conconnect.com/Workingpapers/JanesHSHfromhardcopy.pdf

   

44  

Undoubtedly, Russian legislation still has minor flaws but they do not render

finance deals impossible as was shown in practice by SCF. However, being

possible does not mean being comfortable. The problem extends beyond the

legal scope. The legislation has significantly improved since the RISR was

launched, but the influence of the Russian law on the international shipping

finance in the Russian Market is insignificant. Both banks and shipowners prefer

using the ‘convenient’ Registries, as it is always less time consuming and at the

end of the day less costly. The usage of Russian law and not the law itself is

inconvenient for the global market.

3.2 Alternative Finance for the Russian Market

An overview of alternative finance sources was presented in Chapter 1 of this

paper. This section is aimed at delivering precise examples of experiences of

Russian shipowners. Bonds have gained in popularity in shipping since 2003.

When the crisis commenced bonds turned out to be the first answer of the

shipping community to the credit crunch in the banking sector. The most

favorable destinations for debt placement are now Norway, US and Korea.

All three Russian shipping companies observed in the section above, namely

SCF, FESCO and PRISCO, have already used this capital market tool.

PRISCO was the first in 2007, entering the Norway Capital market, which is

facilitated by Nordea. SCF issued $800 million USD corporate bonds in 2011. The

deal was prepared by Deutsche Bank, JP Morgan and VTB Capital.17 Marine

Money Journal published an article regarding the matter: ‘The Russians are

coming, the Russians are coming – Public Debt Award Europe’. 18 The initial

amount was upraised from upwards of $500 million USD due to the high

demand, with the bonds priced at par to yield 5.375%. The article claims that it

was a very positive deal and SCF success was no surprise due to overall stability

of the company.

                                                                                                                         17 Marine Money Journal. Internet deal deal database, 2013 18 Marine Money Journal. Internet deal deal database, 2011  

   

45  

FESCO has issued senior secured notes and raised $800 million USD in 2013. $500

million USD volume were priced at a yield of 8% with maturity in 2018 and $300

million USD to mature in 2020, priced at 8.75%. The pricing represents the global

pricing level.

As was discussed in this paper previously, the crisis revealed the need for

consolidation. The size and credibility offered another capital market tool – the

IPO. Financial reporting and risk management along with corporate

transparency become subject to strict regulations in case the company wanted

to go public. Many shipping companies do not match these requirements. The

amount of IPOs was thus reduced since 2008. To compare there were 17 IPOs in

2007, only two 2008, none in 2009, 5 public offers in each of 2010 and 2011, and

only two in 2012. Shipping companies are different from other companies that

are being publicly traded as in the shipping industry it is very easy to estimate

the value of the assets. This predetermines huge risks on capital markets for

shipowners.

The Russian Government has already several times to announce the public

offering of Sovcomflot (SCF). Initially it was supposed to happen in 2011, but due

to the weak tanker market the placement was rescheduled. The IPO is officially

planned for 2013 in New York with an initial offer of 25% of shares. The

government plans to place 50% shares public, sell 25% to a strong investor, and

keep a 25% share. SCF is a financially stable company, but an IPO can

potentially damage its credit ratings, as the ratings are driven by governmental

support. In addition the government intends to leave SCF only 20% of the capital

gained through IPO. This is now a bargaining point between SCF management

and the government. This fact can also worsen investors’ expectations and drop

the market value. Despite the fact that SCF is a strong company, an IPO is

always a risky move, especially for a state-owned company. Of note, FESCO

and UCLH are also considering going public in the future.

With access to capital and appetite for risk, hedge funds and private firms have

become a new and interesting counterpart for the bankers.19 These investors

                                                                                                                         19  Weltman G. Brave new world? Marine Money, April/May 2013, Vol.29, Issue 3, p.2-4.  

   

46  

show significant interest in shipping, as ordering new ships now is a good idea as

it is less costly and may create significant value in the future. If banks do not

want to finance shipping then here comes private equity as a white knight.

Some Russian shipowners could also potentially benefit from the situation by

launching joint ventures, especially in the oil and offshore sectors.

It is interesting to note that alternative financing became an issue in the global

shipping only a few years ago, but Russian shipowners feel themselves more

comfortable using these sources than raising traditional loans.

This is due to the Russian regional specifically and historical developments which

have predetermined the fact that some Russian shipowners found themselves

parts of large logistics corporations, such as FESCO and UCHL, or became

global players due to governmental support, such as SCF. And while the global

market pushes shipowners worldwide to consolidate and forces governments to

save the industry, some Russian shipowners have in fact already benefited from

the situation.

   

47  

Conclusion

The shipping industry is badly struggling with the recent crisis, but very few

experts doubt that it will climb from the bottom. A famous Norwegian shipowner

and businessman Erling Dekke Naess once said: ‘God must have been a

shipowner. He placed the raw materials far from where they are needed and

covered two thirds of the earth with water’.

However, the prognoses for the shipping finance are that it will not return to its

former glory. A great deal of research and analytical publications provide in-

depth analysis of the current perspectives for global shipping finance. In 2013,

Marine Money, the most respected shipping finance magazine in the world,

titled their April/May volume ‘Brave new world?’. The main idea in respect of the

current prognosis is that the world of finance has changed on a long term basis

and may never be the same again.

Thanks to regulatory intervention, the banking sector has sustained the crisis. The

banks have always been the primary financing source for the shipping. But the

current situation challenged this perception. Fewer and fewer banks are willing

to continue investing in shipping. However, traditional shipping loans are still the

main financing source, despite the fact that conditions for granting loans have

significantly changed and are now tougher than ever before. Traditional loan

financing starting from the construction is no longer easily accessible. The

shipping companies are supposed to find more equity and be ready to

experience reductions in credit maturities. The credit facilities are only available

to the best players now.

Small companies, for example those using the KG model, are increasingly no

longer found to be sufficient by the banks to provide funding. Some banks

however continue to provide credit to these traditional models, which allowed

Germany to become a marine giant, but the trend is clearly set towards lending

to transparent large corporate structures which are able to provide greater

security. A ship as an individual asset is always attractive to lenders to act as

security, but one asset entities cannot provide as competitive a credit rating

and risk assessment as a group of assets can, which is always better off in terms

   

48  

of securitization. Consolidation trends and mergers are foreseeable on the

market.

The question must be asked, what does this mean for Russian companies?

Surprisingly, for the Russian market it turns out to be somewhat advantageous

due to several reasons. Firstly, Russian companies have always fulfilled stricter

rules of the game. The Russian bank term sheet for shipping companies has

always contained much stricter provisions than are necessary for foreign lending

institutions. No matter how odd it might sound, the crisis in fact reduced this gap

between Russian and foreign players. The conditions of loan grants by Russian

and foreign banks are harmonizing due to reverse movements: the smoothening

in Russia and harshening in the world. And taking into account the overall

better economic conditions in Russia throughout the crisis (Russian debt to GDP

ratio is constantly below 10%) the Russian companies can also benefit from the

reduction of risk assessment by the banks.

Secondly, international ship financing has always been available only to the

best Russian players operating international fleets. To some extent, the crisis has

only slightly changed the situation for the Russian shipowners. SCF is now able to

outperform the global tanker financing market. Two other Russian companies,

FESCO and PRISCO, have not participating in bank financing following the crisis,

but are able to do so. Certain other Russian companies also can enter the

market for international finance in the future.

The same trend is observable for alternative finance. Alternative financing is

gaining in significance and dictating new trends to the whole industry. Shipping

has always been a form of asset ownership but is now fundamentally

transforming its perception of an industry, and the challenges are now

apparent. The stage of mergers is foreseeable in the future. The corporate

structure and governmental support helped many Russian shipowners to be

ready for the crisis. Russian shipowners were active in alternative fund raising

and in comparison to other global players the degree of access to alternative

finance rather than to traditional finance is higher for Russian shipowners.

   

49  

In shipping finance the future belongs to firms that are capable of catching up

with new business models. Russian shipowners first surfed the Wave of success in

financing in 2003-2005 and have the chance to do this once more when this

market ultimately recovers.

   

50  

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