Bridging the Gulf

Can Islamic finance and private equity fill the funding gap in Middle East shipping? Published in Lloyd's List, 6 March 2012

It might not have been the biggest deal of recent years, but the $175m loan raised by UAE-based Stanford Marine Group in December says a lot about the current market for shipping finance in the Middle East.

The deal involved a mix of US dollar and UAE dirham funding, combined both conventional and Islamic finance and had a tenor of just five years. As such it highlighted the way local and Islamic banks are filling the gap left by weakened international rivals, but it also showed how flexible shipowners and banks are having to be to get deals done at all.

“The deal came to the market in October and anything being launched towards the end of the year was extremely difficult to close,” says Knut Mathiassen, regional head of shipping finance for the Middle East at Standard Chartered, the initial mandated lead arranger on the deal.

“There was less appetite from some of the shipping banks that have Dubai and the GCC on their radar screens. The banks that came in are all local banks, but some of them had difficulty accessing dollar funding and asked to fund the deal in dirhams. They were willing to take a lower spread for dirham funding and we and the client accommodated that. An Islamic tranche was included to access liquidity with Islamic banks.”

The deal offers some hope that new sources of funding will be able to pick up the slack created by the departure of many traditional lenders from the market. Whether they will be able to cover the entire funding gap is one of the critical questions facing the industry. As yet, the jury is still out.

“We’ve seen some interest from private equity and Islamic finance trying to fill the gap,” says Erik Muthow, a partner in the Dubai-based law firm Hadef & Partners. “Certainly they have potential and can be adapted to the shipping market, but I haven’t seen them step in to the level that would actually fill the gap.”

As Mr Muthow’s comments suggest, there are a number of potential new sources of funding. Perhaps most hope lies with local sharia-compliant banks, but others such as private equity, hedge funds, export credit agencies, sovereign wealth funds and bond issues could all play a role.

“We’ve seen an increasing number of private equity firms getting involved,” says John Haefelfinger, deputy head of ship finance at Credit Suisse. “There are also capital market transactions. Export credit agencies are something we see a lot of at the moment and we think they will be active as well in the next 12 months. Apart from that we will also see selective bond issues. Assets generating fixed income are much in demand in the market and that fits very well with bonds.”

While the industry waits to see whether these sources of finance can grow to meet the demand, the market has not yet come to a complete halt and some deals are still being done with traditional lenders, often in conjunction with local banks.

The strongest areas appear to be for offshore oil services and liquefied natural gas carriers. In contrast, few deals are being done for dry bulk or container vessels, while the tanker market is also subdued.

However, the deals being signed are being done so at far higher prices than a few years ago. Bankers say that, while the spreads on deals in 2007 were generally 100-150 basis points over the London inter-bank offered rate, these days the figure is generally 300-500bps.

In addition, the length of time banks are willing to lend money for has dropped sharply. Whereas a tenor of 10 years was previously the norm, deals now often only run for five years. These shorter tenors are partly a result of the preference of local banks for shorter-term deals. The higher costs also reflect the funding difficulties that banks find themselves in.

“We are one of the few lenders actively doing business,” says Mr Haefelfinger. “It’s not that the other banks don’t want to finance, but it’s a lack of dollar funding. The capital costs for banks have gone up. Even the best are paying a premium today.”

It is this combination of higher margins and shorter tenors that have attracted some private equity firms to the industry.

In July 2008, the UAE’s Waha Capital bought a 49% stake in GMMOS Group, the parent company of Stanford Marine. Abraaj Capital, also from the UAE, had bought a stake in the group a year earlier. Another involved in the industry is Bahrain’s Venture Capital Bank, which owns a stake in Lemissoler Maritime, a $120m venture that operates a fleet of 13 vessels.

However, most regional private equity firms have ignored the sector and, as the Stanford Marine deal shows, even those that are involved will at times want to raise external financing. The problem for many private equity houses is that the returns on offer still fail to match their usual benchmarks.

“The challenge with asset finance is that the margins are so slim,” says Chris Langdon, a partner at law firm Latham & Watkins. “If the economics of ship finance are not appealing to conventional banks, then it’s less likely that you’ll see private equity or hedge funds, which are usually chasing higher returns.”

However, there have been some signs of interest from sovereign wealth funds. Two Abu Dhabi government funds, Mubadala Development and Invest AD, control Emirates Ship Investments Co (Eships) and have helped it to gradually expand in recent years. Mubadala was also involved in the Stanford Marine deal, through its Mubadala GE Capital joint venture with US conglomerate GE.

Another Abu Dhabi fund, International Petroleum Investment Corp, has a stake in Dubai’s Gulf Energy Maritime alongside Oman Oil Co and Dubai’s Emirates National Oil Co. Bahrain’s Mumtalakat, meanwhile, has shares in two firms based in Kuwait, United Arab Shipping Co and Arab Maritime Petroleum Transport Co.

Despite all the new entrants to the market, however, it is bank financing that remains the most important element for shipowners trying to expand their fleets or refinance existing debt. At times, Islamic finance can be combined with conventional finance, as happened in the Stanford Marine deal. In others, sharia-compliant facilities account for all the funds raised.

In June 2011, for example, the National Shipping Company of Saudi Arabia signed a SR822.6m ($220m) financing deal for two vessels being built by Hyundai Mipo. The deal was structured as a Murabaha agreement, with finance provided by Saudi Arabia’s SABB and National Commercial Bank. The funding covers 80% of the vessels’ cost, with NSCSA providing the rest.

Whether conventional or Islamic finance is used, having a strong relationship with their bank is increasingly critical for shipowners, who can find it hard to persuade new banks to offer loans. Banks are only willing to lend to new clients under tough conditions and they now often ask for loans to be part of a wider banking relationship.

“Any shipping bank today that is open for business is absolutely giving priority to existing clients first,” adds Mr Mathiassen. “We will look to bring new clients on board, but very selectively.”

Meanwhile, shipowners that have loans in place can find it hard to keep up with the covenants on the debt, and some are asking for the terms to be eased. Many banks insisted in the past that a debt could not account for more than 80% of the value of a ship. With market values dropping by 50%-60%, according to a leading European bank, that creates a problem for shipowners and banks alike.

“Shipowners are struggling with low rates and with lending requirements that might be difficult to comply with in the current market,” says Mr Muthow. “The lucky ones will have lenders that understand this and will ride out the storm with them. It’s certainly not been an easy time for shipowners and operators, but it hasn’t been easy for banks either.”

Close links to oil-rich governments also undoubtedly also help when it comes to raising finance – particularly at a time when oil prices are so high – as does having long-term charters in place.

Among the biggest deals secured in recent years have been by Qatar Gas Transport Company (Nakilat), which has raised $6.8bn since 2006 to buy 25 LNG vessels. The funding was put together in a series of tranches from a wide range of local, regional and international sources. Nakilat is in an unusually strong position.

Its chairman is Abdullah Bin Hamad Al-Attiyah, Qatar’s Minister of Energy & Industry, and the entire LNG fleet is chartered to government projects under 25-year deals.

Another major market participant has been United Arab Shipping Co, whose shareholders include several other Gulf governments alongside Bahrain. Over the past two years, it has put finance in place for nine vessels it ordered from

Samsung Heavy Industries in June 2008 at a cost of some $1.5bn. The money has been raised from the likes of Kuwait’s Gulf Bank, Société Générale and South Korean export credit agency KSure.

Few shipowners find themselves in such a strong position, however, and for the rest of the industry the signs are that it will continue to be tough to raise new finance for some time to come. The regional economy may be benefitting from high oil prices and rising levels of government spending, but these are unlikely to be enough to rescue the industry any time soon.

Oliver Ebner, senior manager for project and structured finance at National Bank of Abu Dhabi, says the evidence to date suggests that the appetite among Islamic banks and other new funding sources will not be enough to fill the gap left by traditional lenders.

“A number of European banks are stepping out of the market,” he says. “We’re facing a gap. Will it be filled by Islamic banks and private equity? No, the volume is just not there. Do we see enough bond issues and export credit financing? No, not enough. Only the very best companies have access to the bond market.”

According to Mr Ebner, more local banks may be convinced to come into the market if the pricing is high enough, but he expects the market to remain tight in the short term. If this happens, some shipowners may be forced into asset sales or to cancel more orders for new vessels. Some may yet default on their loans. While trying to ride out the storm, co-operation between market participants may be the only option.

“I’m sure that banks will come back, but not in the short term,” says Mr Haefelfinger. “Sooner or later there will be competition in shipping again. The pricing levels will reduce, the market values of ships will change, some banks will find it an attractive market to enter again.

“It needs patience by the banks. You have certain debts in the industry that are not covered any more and somebody needs to take losses. The question is who will take the hit: the banks, the shipowners, the shipyards? It’s just a question of sharing.”