Those looking for ship finance may do well to look to Chinese leasing houses – if they manage to sustain success where other forms of financing have failed
The upswing in popularity for ship financing via Chinese leasing houses offers up both pros and cons for the dry bulk market, a topic hotly debated at the 10th Annual Capital Link Shipping, Marine Services & Offshore Forum held in London last week.
Dan Tindall, consultant at international law firm Clyde & Co, opened discussions, noting that Chinese leasing sources have become the financiers of choice for many ship operators.
“I think we see with many of the larger orders placed for fleet replacement, people’s first stop for finance is perhaps no longer the Western banks but people looking at Chinese leasing companies,” he said.
Estimates claim that traditional banks went from financing about 80% of the shipping industry in 2008 to around 60% of it in 2016. Conversely, Chinese leasing firms increased their market share to about 20% last year. A proportion of that share was attributed to an expanding base of Western shipowners.
According to estimates, Chinese leasing firms increased their market share to about 20% last year. A proportion of that share was attributed to an expanding base of Western shipowners.
Exploring the trend
This increase in activity from the West is something that Bill Guo, executive director for shipping at ICBC Leasing, is familiar with. The finance organisation, part of ICBC, one of the “Big Four” of China’s state-owned banks, offers a number of different solutions for those looking to finance their ships, including import, operating and cross-border leases, among others.
“Right now, for ICBC Leasing, 80% of business actually comes from outside China and 50% of that is the European customers,” Mr Guo said. He added that the organisation is actively promoting itself in Europe to build further business.
“All these transactions actually had very little connection with China,” he explained, adding that a ship involved in one may not even have been built in the country. This, however, is of little importance as the company is offer ship finance wherever it is needed, he said.
China’s banking regulator is throwing its weight behind Chinese ship financing too. Earlier this year, Mao Wanyuan, director of the non-banking department at China Banking Regulatory Commission, said that, with China’s shipbuilding industry undergoing a challenging transformation and consolidation period, active participation of domestic financial leasing companies has become all-the-more important to aid shipyards in winning newbuilding deals with credible counterparties and in exporting domestically-constructed vessels.
When it comes to ship finance, Chinese leasing houses have become the prime source: they’re growing, they’re popular and they offer a way to keep ships on the water. However, the downside is this relatively new source of easy financing could compound oversupply problem, as operators continue to order more vessels with Chinese funds. The market would also do well to remember what happened with another high-profile, state-backed funding initiative in shipping. Is there the potential for Chinese state-owned leasing companies to follow the path of the now disparaged German KG schemes?
The KG structure, also known as German Limited Partnership, allowed a shipowner to sell and charter back their vessel to a special purpose company created to principally own the vessel during the charter hire time frame. Whoever arranged the setup would negotiate with banks and sell the equity to German small private investors, and these individuals would use their investment to lower their individual income tax. This idea was hugely popular in Germany because of the country’s high personal income tax level, sometimes up to 70%. As well as having to deal with income tax of over 50%, Germans have to pay 9% church tax as well as a 5.5% solidarity contribution to fund Germany’s reunification.
Shipping law company Kravets & Kravets (K&K) notes that at its peak around 440,000 investors had “sunk their teeth” into KGs through the purchase of shares of single ship limited partnerships. This made them part owners (i.e. limited partners) of an individual vessel, so they were able to fully participate in the vessel’s profits while their liability was limited to the value of their share. At the same time, the tax treatment of the vessel was independent of the actual revenues. In essence, those looking to invest in the KG system, “in exchange for tax-advantaged, zero-liability ship shares”, were seeking “high guaranteed returns with no risk”.
When times were good, there was no issue with financing ships using this structure, as high charter rates ensured that the flat-rate tax was always less than a ship’s actual revenue and that ships kept their value. However, it was the shipping crisis of ten years ago that put paid to the KG model’s failsafe image.
“Today, one ship KGs have a lot more risk and a lot less return,” K&K explained. “Not surprisingly, this has led to an outflow of capital and German ship owners have had to reorient their corporate and funding models.
“Whereas prior to the shipping crisis (circa 2007), 26% of global orderbook tonnage came from German one ship KGs, post-crisis, that number has shrunk to 2%. In other words, the German one ship KG market has been utterly, almost completely annihilated – since 2008, over 180 one ship KGs have gone insolvent and been removed from the market.”
Chinese leasing companies have been eager to fill the gap left by the departure of KGs as a financing vehicle. And it’s not only in China where leasing models have come to greater prominence. Speaking on the Capital Link Forum panel, Christos Tsakonas, global head of shipping at DNB ASA, in which the Norwegian government holds a 34% share, explained that the bank has also seen “an explosion” on the leasing side, something he described as a “very welcome addition”. Other European ship leasers with part-governmental ownership have also recorded an uptick in deals. Mr Tsakonas also noted that a large number of leasing houses are “springing up every day” across Asia and are not just restricted to China.
Whether the model of providing easy financing in an already oversupplied market is necessary or even desirable remains to be seen, but the comparison of Asian leasing with the now out-of-favour KG models cannot be ignored.