Even whilst onlookers hold their breath in anxious expectation of a coming supply gut, 2006 was another record year for newbuilding orders with an estimated $110 billion in value added to the global orderbook. Clarkson estimates that the total value of the global orderbook is now upwards of $300 billion. Considering the financing commitments required for vessels on order and the uncertainties involved in many of those vessels being built as promised and delivered on schedule, this is a number that holds sizeable implications for the ship finance community.
Yet even as the scale of financing required grows, so do the complications involved. Established yards in countries like Japan and Korea have been seeing increasing competition from innumerable new yards in China, and now yards in other developing areas such as India and Vietnam are entering the picture. European yards for the most part have been forced to specialize in higher end products to remain solvent, yet at the same time those in Eastern Europe are facing the prospect of privatization, meaning growing demands in terms of profitability and a rapidly disintegrating safety net.
Meanwhile ship finance has come more and more into the mainstream, so added to the uncertainties presented by developing yard markets are concerns about risk control in increasingly competitive lending markets, where 90% debt financing happens and even 100% is possible. Equity markets largely shy away from a market that make them wait a year and more before seeing any returns, requiring that owners provide much of their own equity to finance ship construction, but also that lenders undertake a significant amount of risk.
So what is a banker to do? The question probably has almost as many answers as there are shipping banks, but here we take a closer look at how exactly the market has shifted and what one particular bank has done to address the situation with a value-adding proposition.
Production Moves East
According to Domenik Nizet of HVB, there has been a pronounced geographic shift in the shipbuilding industry, with 80% of the shipbuilding community now being located in Asia and only 20% in Europe and the entire rest of the world. This has happened as direct and indirect labor cost differences mean that global shipyards can offer increasing cost advantages over their European counterparts while turning out vessels of similar quality.
In response to this European yards have changed their focus to smaller or more specialized ships such as cruise, where higher costs of labor can be better justified. Meanwhile, Mr. Nizet notes, there has been a paradigm shift in China, as its rapidly developing shipbuilding industry has proven itself capable of turning out worldclass ships. The trick in China, however, is finding the yards that can and will do this. Some of the biggest yards in China are state-owned and state-driven and function reliably. The concern centers more around the medium-sized yards with less established reputations. At these yards it requires a great deal more expertise to know whether the quality level and delivery dates promised are likely to be delivered.
Even as China's shipbuilding market matures and finds its place in the industry, the footprint of the global shipyard industry is expanding beyond China to countries including India, Indonesia and Vietnam, among others.
Matters are further complicated by commercial banks newly entering or rapidly growing their exposure to the shipbuilding industry simultaneous with the many changes that are taking place within the industry itself.
Meanwhile new yards are having their own troubles in obtaining the requisite financing due to ratings problems and other challenges. A resultant inability to pre-finance supplies and wages as necessary can lead to delayed vessel deliveries even for yards with the necessary technical expertise and the best of intentions. Figure 2 shows an example of the liquidity gap that developed in respect to a vessel order at one yard due to construction delays and higher than anticipated costs.
As a result of the difficulties being faced by developing yards, owners are being asked to provide more capital earlier in the building process yet given less control over how it is deployed by a yard once received, leading to serious concerns over transparency. Owners naturally look to banks for assistance with their growing pre-financing commitments, drawing the banks into the situation.
It is easy to see how an owner and a bank, in a case where both have relatively little experience with yards in a particular region, could find themselves in an unfortunate situation if they do not first obtain the appropriate technical and project advice.
HypoVereinsbank, or HVB, a member of the UniCredit Group, has identified the root of the many difficulties that arise as a lack of influence on the part of banks who provide newbuilding finance over the distribution of capital post loanapproval. A bank may disburse capital as agreed upon for the construction of a particular vessel, but a yard may then use that capital in whatever way it considers to be in its best interest. This creates challenges for banks in assessing the risk of lending against contracts with a yard without the appropriate internal knowledge and expertise.
A New Breed of Risk Taker
Against this backdrop, many yards in Eastern Europe are seeking privatization as governments strive to meet EU requirements. This despite the fact that many of these yards with the exception of those in East Germany, are also facing bankruptcy. As such it is imperative to find investors with a belief in the industry and an ability to identify yards with potential for development and profitability and those without. Unfortunately many potential investors are not well versed in the shipyard industry and lack the necessary expertise. Many financing banks, by contrast, have a better understanding of the industry and are more comfortable assessing the risk, leading these banks to be more and more the risk takers.
When a contract is cancelled by a yard, even if the appropriate refunds are provided, both bank and shipowner lose business. The shipowner clearly cannot earn money from a vessel that does not exist, while the banker loses the pre-delivery loan from his portfolio as well as the potential for a post-delivery facility. So while refundment guarantees are well and good as collateral and can help mitigate risk, the reality is that for both the shipowner and the bank a good deal means a timely delivery of a quality vessel.
Creating Value
This is a positive development for those banks that know what they're doing as competitive pressure on margins translates to pressure on returns. It is important for lenders to find a way to add value beyond margins, ideally through bringing something new to the table and achieving something together with the customer that is worth more than simply lower margins. Standing with the shipowner and recommending yards is one way for banks to do this in the realm of shipbuilding finance. By connecting banks, investors, owners and yards with its shipyard consulting services, HVB achieves just that under the leadership of Head of Global Shipping Ingmar Loges and Relationship Manager Domenik Nizet.
The bank has created a unique selling product – USP – that does not compete with classification societies, brokers or researchers, but is rather a new product based on the expertise of those who spend their time visiting and assessing shipyards and as such can really understand what is going on in many far-away and exotic locales, as well as right next-door. HVB developed this product by chance when a customer was having substantial problems at a yard. The firm sought to help and ultimately assisted the customer in getting the ship out – a little late, but still in a good market. At that point they realized the need for bankers with access to up-to-date and thorough information on a rapidly changing global shipyard industry.
HVB's product has matured into a standard yard due diligence procedure that includes a 100% partnership with technical consultant Bohn, Domazet & Associates GMBH. Together the firms offer "competent support and sound advice" in accurate evaluation, risk reduction, coordinating the various business aspects and optimizing solutions. They "help to orchestrate the complex relationship among banks, shipowners, public authorities, and investors".
The partners are keenly aware of the influence of productivity on cost as well as the influence of yard liquidity on the timely delivery of a vessel. This allows for "the evaluation of the technological and organizational competence of a yard even before shipbuilding orders have been placed." If problems do arise in the process, or had already arisen when the firms' services were engaged, HVB emphasizes the difference between typical and exceptional delivery problems; i.e. whether the problem was endemic to the yard, or if the yard's capabilities had simply been waylaid by extenuating circumstances and it retains the ability to complete the project.
Key to the success of these efforts is the creation of transparency in the target yard and the development of transparent liquidity management. This allows the bank to anticipate liquidity issues and sometimes even solve them before they become problems, such as by assisting a yard in winning state financing for their general operations, allowing an owner's payments made for a particular vessel to go toward that vessel and the yard to continue to function properly as a whole.
Figure 3 shows an example of a series of vessel orders that had run into timely delivery problems. HVB was engaged as problems surfaced with vessel 001, then for 002 installed a pilot project management team to oversee the shipyard. By vessels 003 and 004 a qualified project management team was set up, the result being that all deadlines concerning the delivery of the new vessels were met, and, in some cases, the vessels were even ready to sail ahead of schedule.
The shipyard consulting service has become so broad-based as to win a mandate to advise the Croatian government on the restructuring of its shipbuilding industry. The position of UniCredit as HVB's parent means that the firm has a large group with capabilities including investment banking that will be important in the privatization part of the project, while HVB's technical expertise, industry knowledge and contact base provide a requisite foundation from which to offer sound advice and determine which yards are and which yards aren't prepared to make the jump to the next level.
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