Chinese financial leasing – an increasingly viable alternative to bank debt for a capital intensive industry
Shipowners require vast amounts of liquidity in order to fund the CAPEX costs of acquiring new and second-hand tonnage as well as to fund their operations on a day to day basis and Chinese lease finance offers an increasingly viable alternative to the more traditional bank finance that shipowners have traditionally relied on.
Historically the shipping industry’s principal source of capital has been a combination of secured borrowing from commercial banks together with a shipowner’s own equity. After the global financial crisis of 2007/2008 however, many banks, having had their fingers badly burnt by borrower insolvencies, narrowed their exposure to the shipping industry whilst others withdrew from the market completely. Indeed, if we compare debt volumes in the period immediately prior to the crash in 2007/2008 to those we see now, it shows that commercial banks are lending roughly half the amount to the shipping industry that they were a decade ago.
But the fundamentals of the shipping industry haven’t changed and it remains as capital intensive as it always has been. Shipowners have therefore needed to look to alternative sources of capital to stay afloat.
One such alternative source of capital is Chinese lease finance, which we have seen rapidly develop from a relatively fledgling industry back in 2009 to an increasingly mainstream source of finance with some sources suggesting that in 2017 alone, more than USD 20 billion’s worth of new assets were financed by Chinese lease finance.
A schematic representation of a typical sale and leaseback structure covering both pre and post delivery scenarios is set out below, showing the basic principle that title in the vessel or in the construction contract at the pre-delivery stage is transferred to an SPV wholly owned by the leasing house (by a novation of the construction contract at the pre-delivery stage or a memorandum of agreement for sale on a post-delivery only financing). The vessel is then bareboat chartered back to the seller/lessee on “hell and high water” terms by way of a bareboat charter under which the seller/lessee pays regular instalments (often termed as the “fixed hire”) equivalent to the financed amount of the vessel over the term of the lease after delivery (normally with a “balloon” purchase option/obligation at the end of the charter period) plus an interest element (often termed as “variable hire”).
The terms of this bareboat charter also contain extensive provisions more typically seen in bank finance documents than in charters, covering topics such as LTV requirements and other financial covenants, information covenants relating to provision of audited accounts etc, as well as more typical chartering provisions relating to maintenance and operation. They will also normally contain purchase options at various stages during the charter period, sometimes exercisable upon payment of a “prepayment fee”.
As security for its obligation to pay, inter alia, the fixed and variable charterhire, the seller/lessee will typically grant the SPV/lessor the sort of security documents that we are used to seeing in the bank finance model, including, a corporate guarantee from the seller/lessee’s parent, a charge over the shares in the seller/lessee, an assignment of the vessel’s insurances, requisition compensation and earnings, an assignment of any construction contract and refund guarantees (depending on the structure and whether pre-delivery finance is being offered) and security over the accounts into which any earnings and any retention amount shall be held. If the seller/lessee intends to sub-charter the vessel on a long term basis then the leasing house may require some form of direct agreement to be entered into between the SPV/lessor and any sub-charterer in order that the SPV/lessor will be able to “step-in” to the seller/lessee’s rights under the sub-charter in the event of a seller/lessee default.
Whether the leasing house back-funds its financing of the acquisition price depends on the depth of its pockets, but most transactions will now be structured in such a way as to ensure that the SPV/lessor has full flexibility to borrow against title in the vessel and the earnings under the bareboat charter if it so wishes and for the incoming bank or syndicate of banks to piggy back off the security package granted to the SPV/lessor by way of onwards assignments etc.
The advantages of Chinese lease finance over traditional debt finance:
- As stated above, Chinese leasing houses are actively lending in a sector where traditional bank finance is increasingly hard to come by. This is especially the case with some lessors who are operating solely or mostly as financing solutions to help secure orders at affiliated yards in China.
- Bank affiliated Chinese leasing houses, though regulated by the Chinese Banking Regulatory Commission, are not subject to the same strict restrictions on liquidity reserves as apply to Western commercial banks under BASEL III and IV etc and as a result are able to offer higher leverage than commercial banks, with some leasing houses often lending between 80-100% LTV as opposed to 60% LTV being typically offered by commercial banks.
- There is generally no need to spend time arranging a syndicate as would be required under a big ticket bank financing as Chinese lessors have the appetite and capacity to execute “big” deals alone.
- Margins and fees are typically not much higher than the margins and fees applied by commercial banks.
- Both pre- and post-delivery financing packages can be arranged and whilst some lessors will only finance PRC built vessels, others may be prepared to finance good quality vessels built in other jurisdictions.
- At least until IFRS ‘16 becomes effective on 1 January 2019, a sale and leaseback can be structured in the form of an “off-balance sheet” operating lease with a purchase option at the end of the charter period.
In view of, inter alia, the above advantages, our view is that whilst traditional bank finance will continue to play an important role in financing the maritime industry (and may even increase its exposure as the markets continue to improve, in part at least by “back funding” the Chinese leasing houses), Chinese lease finance is here to stay and will likely continue to significantly increase its market share in the years to come.
For more information about Wikborg Rein’s capabilities in this sector, please contact, Jonathan Page in London, Jonathan Keats, Ronin Zong or Chelsea Chen in Shanghai and Lars-Erik Østerbø in Bergen.