FOR MOST OF the past six years the shipping industry was holed below the waterline and sinking fast, making it a sector to avoid in debt capital markets. But recent bond issues by shipowners and operators have helped rehabilitate an industry renowned for its extreme and unpredictable economic cycles.
Container company CP Ships kicked things off last year when it raised $250 million through an offering of 10-year senior notes. In March 2003, oil tanker company General Maritime Corporation priced a private offering of $250 million in senior notes. Another tanker company, Overseas Shipholding Group (OSG), priced a $200 million senior unsecured notes offering in the same month. France’s largest container company, CMA CGM, closed a e100 million high-yield bond offering on May 15 – the first euro-denominated high-yield issue by a shipping company.
The industry needs new money to fund consolidation and to replace ageing fleets. Financially strong companies are buying up rivals and commissioning new vessels.
General Maritime is using the proceeds of its note issue to buy 19 tankers from Metrostar Management Corporation, making it the second-largest owner and operator of mid-sized tankers. CP Ships is nearing the end of a four-year, $800 million, ship replacement programme. It used its note offering to help fund its acquisition of container company Italia di Navigazione. OSG will get two new vessels in six months as part of its new building programme.
The most striking feature of shipping’s readmission to the debt capital markets is the return of high-yield bonds. So much of the shipping industry is sub-investment grade that by definition most shipping companies using the bond markets are high-yield issuers.
In the first half of 2003, the value of maritime-related high-yield transactions was over twice that for the whole of 2002. In 2000, shipping companies issued no high-yield debt at all. “The recent high-yield issues were unexpected, but the market has been strong and shipping issuers can be opportunistic,” says Craig Fuehrer, a shipping banker at JPMorgan in New York.
The high-yield markets are again beckoning shipowners. Although traditional first ship mortgage bank loans are still likely to offer cheaper funding, banks generally restrict secured lending to a maximum 70% to 80% of the value of the ship that their loans are secured on, with equity used to cover the rest. Issuing unsecured high yield enables shipowners to raise mezzanine capital or quasi-equity that can be used to fund the equity component on vessel financings. The high-yield market offers non-investment-grade shipowners access to the sort of long-term unsecured finance that banks tend only to make available to investment-grade companies.
Bridging the gap “High yield can allow a company to grow quickly provided it has sufficient operating cashflow to pay the coupon and demonstrate to bond investors adequate EBITDA/interest and debt/EBITDA coverage,” says Simon Booth, director of global shipping at Citigroup. High yield can bridge the gap in a shipowner’s capital structure created by banks’ reluctance to lend unsecured at longer tenors.
“Paying between 8% and 10% for long-term fixed-rate mezzanine finance isn’t that expensive, depending on where individual issuers have their return-on-equity thresholds,” says Booth. “Low dollar interest rates are bringing fixed coupons down, and the availability of long-term unsecured money at less than 10% breaks a psychological barrier. It will have a positive effect on shipowners’ appetite to issue high yield.” And because high yield is non-amortizing or partly amortizing, it is attractive from a cashflow standpoint.
What is impressive about the current crop of issuers is that they are tapping a market that was closed to most shipping companies following a calamitous burst of issuance in 1997 and 1998. Since 1992, 34 maritime-related high-yield deals have raised $8.1 billion. Exactly half of that was issued in 1997 and 1998. But the vast majority of those who issued in those boom years later defaulted.
“Of the high-yield deals that were done in 1997/98 all bar one went into Chapter 11 or got restructured,” says Gary Wolfe, a partner at US law firm Seward & Kissel who has represented issuers and underwriters on high-yield shipping deals.
Part of the problem was that ill-informed banks were bringing what were sometimes extremely low quality issuers to the market. Investors and issuers failed to understand each other’s markets.
“The quality of the transactions deteriorated as the market kept strengthening,” says Anthony Argyropoulos of investment bank Jefferies & Co in New York. “Banks tried to satisfy demand with as many transactions as possible and some were not well thought out.”
The unsecured money on offer from the high-yield market naturally appealed to shipowners looking for an alternative to bank finance. Several owners set up lightly capitalized special purpose vehicles that bought ships and issued high-yield debt. The high-yield offering often dominated the issuer’s capital structure, with little equity and only occasionally bank debt to keep it company.
“The shipping industry isn’t suited to this,” says Argyropoulos. “It needs a combination of bank debt and high yield, because assets are depleting over time and because the return on capital deployed in the industry as a whole is typically less than the cost of the high-yield transaction.” Ideally, no more than 20% to 40% of a shipping company’s capital structure should be high-yield credit. In 1998, the figure in some cases was approaching 100%. Many issuers saw high-yield bonds as a source of loan capital rather than as a substitute for equity to be used in combination with bank finance.
The issuers’ assets – their ships – were often old and costly to maintain. Ships lose value in a down market, when utilization rates and earnings are low. Owners that had issued high yield couldn’t raise new money needed to upgrade fleets in a down market.
“Shipping is very capital intensive, and you need to incur new debt to get new ships,” says Argyropoulos. “A junk bond is very tough, because the covenants limit the amount of debt you can incur. It is based on cashflow, and is always looking to trap the cashflow and protect it.” If an issuer is not growing operationally, its high-yield covenants can keep it from doing so. The only way that shipping high-yield issues could work would be for the funds raised to be put to a specific use at precisely the right time – for example, to buy new tonnage to come into the market during an upturn.
So the timing of the shipping junk-bond boom, when fleets needed replacing just as the whole industry went into recession, was bad. Sure enough, many deals went sour, the bonds traded down, and in some cases they were bought back by the issuer.
Sink or swim Among issuers that defaulted were Navigator Gas, Anglo-Irish ferry company Cenargo, Enterprises Shipholding, and American Commercial Lines. Alpha Shipping, set up by Greek shipowner George Economou, raised $175 million through a high-yield issue and only managed to pay one coupon before defaulting.
Pegasus, which issued $150 million of high-yield paper in November 1997, eventually saw its debt restructured in August 2001. Another issuer, Global Ocean, went through a pre-negotiated Chapter 11 restructuring. Pegasus’s debt was restructured in August 2001.
Golden Ocean’s $300 million high-yield bond deal led to its collapse and sale to tanker company Frontline in a restructuring/ auction process. CEO Fred Cheng later said that his company should have achieved a better rating (it was CCC) and raised funds with secured rather than unsecured bonds to refinance its fleet.
The question now is whether issuers, investors, and banks can avoid making the same mistakes. There is still anxiety about whether the banks best equipped to place high-yield issues know enough about the industry.
“The top-10 shipping banks are not really in the high-yield market, where you need the big international banks,” says David Smith, an asset finance partner at law firm Allen & Overy. “The shipping banks are more specialist banks like Deutsche Schiffsbank or RBS, Nordea, and DnB.” Many of the leading banks in the volume shipping-debt market can’t work on high-yield issues themselves, so they don’t push it as an option, because it won’t bring in fees.
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But the shipping sector is too small for bulge-bracket investment banks to dedicate resources to it. The danger is that fee-chasing banks with high-yield capability but little understanding of shipping will draw in the wrong kinds of issuers, as in 1997 and 1998. “Everybody tries to jump on the bandwagon when this kind of thing starts,” says Jim Hayer, shipping projects director at Emirates National Oil Company (ENOC) in Dubai. “The investment banks will say this is great, because they are fee-driven. The banks that use their balance sheets will be worried that these deals could go wrong again.”
Of the largest investment banks, Citigroup has a credible presence in shipping as a lender, leasing arranger and M&A adviser. Citigroup was CP Ships’ bank on its 2002 bond offering and an accompanying equity offering. Jefferies & Co also stuck with the sector in the late 1990s and remains active. Other investment banks pulled out.
A way back in
US investment banks have found a potential route back into the sector. Tanker companies have led the re-entry into both equity and debt. Tankers are profitable again and have higher returns on capital than other shipping sectors. Trading in tanker shares has increased 17-fold since 1997. Buoyancy in the sector has helped banks with energy expertise learn about ships. “Since most US investment banks are strong in energy, they like to look at tanker stocks like oil-service stocks,” says Tom Jebsen, the CFO of Frontline, the world’s largest tanker company. “So although most of the US banks opted out of shipping, banks like Lehman Brothers, Jefferies, and Citigroup can still do high yield.”
By the end of this year, the high-profile defaults of five years ago should have worked themselves out of investors’ portfolios. “In a few months, we might be in the remarkable position where no high-yield shipping deals are in default,” says Allen & Overy’s Smith.
Investors today are older and warier when shipping companies go on the road. “The buy side remembers the experience of 1997 and 1998, so shipping company notes trade at a slight premium to the notes of equivalent companies in other industries,” says Jefferies’ Agryropoulos. “If you exhibit certain of the old characteristics, like being highly leveraged or having old assets, the high-yield market will be more sceptical and will price the risk accordingly. The high-yield market is strong but discerning.”
The more shipping companies that issue debt, the more investors have to work with. When a container company such as CMA CGM enters the market, as it did this year, investors can compare its prospects with those of a previous issuer such as CP Ships, a direct competitor working in an identical sector.
And investors are better served by rating agencies. “Part of the problem in 1998 was that the rating agencies didn’t understand what they were rating,” says Frontline’s Jebsen. “They rate on the basis of whether interest will be paid on time, but they don’t look at residual value risk, which is a factor in asset-based financing that rating agencies sometimes don’t appreciate.” When a new ship is financed, it has a lot of underlying value but it may be a while before it is realized. Ultimately, lenders rarely fail to recoup funds. “But from a rating point of view, a borrower can be downgraded to CCC just because it misses an interest payment,” says Jebsen.
Like investors, rating agencies now understand the industry better. “People have become much more aware of the importance of operating and using ships rather than seeking to trade on the value of ships,” says Struan Robertson, a partner at law firm Stephenson Harwood.
Last August, NIB Capital closed the first public synthetic securitization of shipping loans with its Latitude deal. Sean Boland at joint arranger and joint lead manager Merrill Lynch says: “The number of investors familiar with the shipping industry is a lot smaller than the broader ABS investor base. Those who aren’t familiar need educating and that means longer marketing than usual. We saw a wide variety of investors including banks, funds, and insurance companies on Latitude.”
Structuring a deal such as Latitude shows how banks are taking shipping’s volatility into account on capital markets transactions. “It was crucial that we got across to investors how the credit events and loss mechanism were defined to reduce that volatility on Latitude,” says Boland. “Because of the cashflow nature of the shipping industry, short term loan arrears are a common occurrence. That’s not a risk we wanted to pass on to the investors, so on Latitude a failure to pay has to be continuous for six months.”
But the key change is the quality of the current issuers. They are larger, both in market capitalization and fleet size. Teekay Shipping, which transports more than 10% of seaborne oil, has a market cap of $1.7 billion. OSG’s is nearly $800 million and General Maritime’s $370 million. They often also have a dominant share of their chosen markets. Teekay has more than half of the shuttle tanker market, for example. Crucially, they are listed. General Maritime, Teekay, and OSG are all listed in either New York or London. Denmark’s oldest shipping company, TORM, listed on Nasdaq this year.
Investors benefit from the increased transparency. Issuers get used to the SEC filings that are part of every high-yield bond issue. “With all these companies listed in New York, you get a larger shipping universe for people to follow and analyze,” says Jebsen at Frontline, whose ordinary shares began trading in New York in August 2001. “When only one or two companies were listed, nobody had time to follow shipping.” With more shipping companies developing a name among investors, there are more opportunities to use bond or lease financing. “You will see more people utilizing leases or high yield, because you need a name to do that,” says Jebsen. “If you haven’t got a name, you go to the banks.”
For the new breed of issuer, high yield is just one of a broader range of options. They have access to cash and additional credit lines. They weigh the pros and cons of high yield more carefully and limit its role in capital structure, keeping it between 20% to 40%.
Frontline, for example, is well known for going to the debt markets to raise money, but has recently turned its attention to the German leasing market. Preparing the necessary documentation is less onerous than in a US high-yield prospectus, financing is cheaper, and covenants are less restrictive than in high-yield deals. OSG has also been active in German tax-lease deals this year.
But as consolidation continues, bank loans and leases will not support the larger companies’ financing needs. “We’re not currently thinking about going back to the high-yield market, but we could next year,” says Jebsen. “If we did a big acquisition we’d probably need to. As shipping companies consolidate they outgrow the bank market because commercial banks won’t take more than a $100 million or $200 million risk on any one company.”
So while high-yield issuance is important and, under the right circumstances, attractive, there will not be a second mad rush for it.
Despite the high-profile defaults, there have always been a select few shipping issuers that showed the market what could be achieved. Teekay pioneered maritime high yield when it went to the market in 1993, followed by Greek tanker company Eletson, and OMI. “All those bonds have been paid back at par,” says Jefferies’ Argyropoulos. “They have worked well.”
Citigroup’s Booth says: “Teekay and Stena, who are repeat issuers, have kept the flag flying. They’ve done the rest of the industry a favour by proving that there are quality shipping companies that are there for the long term.”
The performance of shipping bonds in secondary markets suggests that shipping has got onto a better course. Teekay issued $250 million of debt in 2001 followed by a $100 million tack-on. “The yield on these bonds now is about 7.3% and they are priced at 109.5, so they’ve obviously done well,” points out Argyropoulos.
General Maritime’s $250 million March issue to fund its acquisition of the Metrostar fleet was priced at 98.5 to yield 10.25%. In July, the bond price on General Maritime was 109 with a yield of 8.6%. OSG’s March senior notes traded at 104 in early July.
Although high yield is off-limits to some shipping companies, it is back open to those with the right credentials. More sophisticated investors want to see issuers with solid trading histories, larger fleets, and a more industrial approach. “I didn’t think bonds and ships would never mix again,” says Argyropoulos. “But the type of issuers we saw in 1997/98 wouldn’t be able to access today’s market.”
Citigroup’s Booth says: “Investors want a much higher quality of issuer to come to the market than some of those that accessed the market in the 1990s. The issuers you see now are well-established operators who will be around for a long time and will reissue in this market, using it as part of their long-term capital base. They are quality issuers that can reaccess the market on a regular basis.” As such, they are responsible for a fundamental transformation in the fortunes of shipping companies in the debt markets.
