Dede's Law and Business Series:

Credit assessment in debt finance for shipping transactions (1)

By Foluke Akinmoladun

There are two major ways in which ship acquisition or operations can be financed. It can be financed through borrowing or debt instruments or it can be financed through equity, equity instruments or a combination of equity and debt. There must first be a need for finance for a ship finance transaction to be initiated. In this writeup, I will be looking at credit assessment in a debt finance transaction and the details that will be required in the transaction for the lender to generate a credit assessment report for its credit authority.

There has been a slump in the availability of finance for ship operations and acquisition in recent times. A number of factors contributed to this such as, the global financial crisis, a fall in ship mortgage-backed securities value, the failure of Lehmann Brothers in September 2008, amongst others. This underlined a number of significant issues that adversely affected shipping, in particular an oversupply of ships, many of which were ordered during the preceding peak market.

Coupled with the oversupply of ships in the South Asia markets, there has been a significant decrease in the appetite of financial institutions for financing shipping activities. Despite all these, ship-owners know that some things never change; approximately 90% of all goods traded continue to be transported by sea and ships need to be overhauled and replaced, thus ship finance is constantly needed. Therefore, in providing ship finance, a lender needs to ensure that the transaction is profitable and the risks involved have been mitigated to a manageable level. For this, a credit assessment of both the borrower and the transaction is required.

Credit assessment is only one aspect of the shipping finance transaction analysis that the lender undertakes in deciding to make the loan available to the ship owner. The main analysis or “tests” that the lender undertakes for a ship finance transaction are shown below.

A risk and mitigation analysis:

This analysis assists the lender in understanding the risks involved in the transaction and the possible ways of mitigating or reducing the risk to a manageable level. Next is a customer analysis wherein the lender analyses the capacity of the borrower to repay. This is where the six Cs of credit assessment of the borrower is relevant. Third, the vessel’s capacity to trade is analyzed in the light of the vessel’s age, value, history, speed and emissions.

The issue of emissions has become particularly important with the coming on board of the Poseidon principles. The Poseidon principles was the result of 11 banks, collectively representing more than US$100 billion in assets and about 20 per cent of the global ship finance signing a global framework agreement referred to as the Poseidon Principles.

These Principles were directed towards meeting the Paris (Climate Change) Agreement’s target of below 2°C warming; and the IMO’s target of cutting greenhouse gas emissions from global shipping by 50 per cent by 2050 (compared to 2008 levels). This has added the need for emission levels of the ship to become a major item in credit assessment of a borrower.

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