Select Committee on Environment, Transport and Regional Affairs Appendices to the Minutes of Evidence

Memorandum by H K Leggate (FUS 12)




  There are two elements to the financing problem facing the UK Shipping Industry into the 21st century. The capital intensity of the industry combined with an ageing fleet means that financing requirements are high. Access to capital is however limited due to the risk status of the sector.

  According to recent research, the industry's finance requirements over the next five years could exceed $150 billion, with newbuilding finance of $125 billion, and second hand finance of $33 billion.[65] Of this the UK requirement is expected to be $2.22 billion.

  This increased demand is combined with a fall in the number of banks providing shipping finance. The Asian crisis combined with poor market conditions particularly in container and dry bulk shipping meant that in the latter half of 1997 and 1998, various banks disposed of their shipping portfolios. This included some very well established banks such as Hambros, Long Term Credit Bank of Japan Banque Paribas' Geneva Shipping Unit all withdrawing their shipping facilities. Other commercial banks were also forced to make sizeable loss provisions in response to poor performance in the sector.

  The reticence of the remaining shipping bank sector to support the industry has lead to a tightening of credit facilities, particularly for the smaller companies, which are now turning to the capital markets to obtain the necessary finance for investment. The use of such markets is not in itself a problem. However, the investor perception of the shipping industry is such that they demand particularly high levels of return which can exacerbate cash flow problems and even lead to default.

  This memorandum examines the financing requirements for the UK industry over the next five years and analyses the options that are currently available to the shipping companies in terms of debt and equity. Finally there are recommendations to alleviate the particular problems faced by such a cyclical industry, namely, government backed loans, and an extension of the Enterprise Investment Scheme to encourage equity funding.


  The shipping industry is very capital intensive. Furthermore, the age of many vessels in the UK and indeed the world fleet suggest that investment in newbuilding is fast becoming a necessity. Table 1 shows the average age of the fleet for the various sectors of the industry in terms of number, gross tonnage and dead weight tonnage. These statistics reveal an average age of 19.8 years for the total trading fleet, and 22.3 for the total non trading fleet, with all sectors around this high average. The demand for capital is therefore increasing.
Average age of the UK fleet 31 December 1997 (100 GT and above)

UK owned
UK registered
Vessel typeNumberGT DWT NumberGT DWT

Total dry bulk15.413.8 13.612.710.7 10.8
Total other dry cargo19.3 16.816.620.7 14.114.0
Total passenger22.020.0 23.120.718.7 22.3
Total liquid21.420.2 20.623.518.0 18.1

Total trading fleet19.8 17.717.821.3 15.515.9

Total non trading fleet22.3 17.015.422.6 19.117.6

Source: Lloyd's Maritime Information Services/Chamber of Shipping.

  Recently produced estimates of these financing requirements for the world fleet, based on age and future predictions for the industry are shown in table 2.[66] For newbuild the financing is based on 80 per cent of the total purchase price, and for second-hand vessels 60 per cent in line with the industry averages.
Financing requirements 1998-2002 (World Fleet)

TypeSub type UK finance1

Newbuild (Finance @ 80 per cent $ million)
TankersCrude oil27,480.0
Gas LPG5,801.8
Dry bulk30,807.8

Total125,451.3 1,759.32
Second hand (Finance @ 60 per cent $ million)
Total33,000.0 462.79

1 Based on proportion of UK fleet to world fleet in terms of DWT.
Source: Drewry Shipping Consultants.

  The table shows that for the UK, approximately $2,222 million will be needed for vessels, $1,759 million for newbuilding and $463 million for second hand ships. Given these high financing requirements, and the nature of the industry, financing investment in vessels poses a particular problem for the industry. It should also be noted that this analysis focuses entirely on financing for ships. Companies in the industry also need to finance working capital and for the restructuring of existing capital. The following sections examines the options currently available and their relative suitability for the industry.


  The investor's opinion of the industry is typified by the credit rating agencies Standard and Poors and Moodys.

  Both see the industry as high risk because of its economic sensitivity, capital intensity and competitive structure. All these factors lead to volatility of freight rates and company cash flows.

  Ratings are based on the following information:

    —  five years of audited financial statements;

    —  interim financial statements for the last financial year;

    —  detailed narrative descriptions of operations;

    —  detailed investigation of the company by a team of analysts.

  Companies with larger fleets tend to achieve a higher rating than those with smaller fleets. Associations with other companies, a highly rated parent company, or a highly rated charterer also affect the decision.

  Recent ratings of shipping companies in the light of bond issues have shown them to be below the investment grade, and thus carry a relatively high risk of default. A "B" rating represents a 25 pre cent risk and "BB" a 15 per cent risk. Such ratings suggest that inability to meet payments or coupon and/or principal is inevitable for some companies over the period of the bond issue. Investors therefore require high rates of return to compensate them for the high risk.

  As far as equity is concerned, again the perception is of high risk, with volatility in the freight markets leading to volatility of the share prices. Furthermore, small company shares suffer from low liquidity. Placements are often achieved in times when the market improves, but these windows of opportunity close very quickly. Some companies are however, considering initial public offerings (IPO) on NASDAQ, the over the counter equity market in the US.


  The debt versus equity debate is one which features largely in any discussion of corporate finance. Equity is the risk bearing capital of a business, due to the uncertainty of return from dividends and capital gain. Debt on the other hand cost the company less because it is perceived to be less risky since coupon payment are fixed, and there is a guaranteed maturity value. Debt becomes even cheaper due to the tax deductibility of interest payments.

  The level of debt finance or gearing of a company increases the risk to the equity shareholders, since for a highly geared company, high levels of interest must be paid before any dividend may be declared. Shipping companies tend to have high levels of gearing, which in turn makes equity investment less attractive. Also, for high levels of debt, more debt finance may be difficult to obtain because of the risk of default.

  The following brief analysis considers the characteristics of equity and two main types of debt, bank loans and bond issues, and their suitability for the industry.


  The main advantage of equity is that it is a permanent source of capital. However, the costs of a share issue are relatively high (7 per cent of funds), and there is an expectation of a high return for risk. Dividends are also paid out of after tax earnings.

Bank loans

  Debt finance is non permanent. The capital ultimately has to be repaid. With a typical bank loan, interest and capital are paid throughout the period of the loan. Interest payments are however tax deductible. The interest on bank loans tends to be lower than the coupon on bonds, and banks tend to be more sympathetic towards companies experiencing difficulties. As already stated bank credit has been recently squeezed making it more difficult for smaller companies to obtain loans.


  Bonds can have a cash flow advantage over bank loans in that there is no amortisation of principal. The issue costs are also much lower than those of shares (3 per cent of funds). However, experience of companies who have followed this route are that the coupon payments are high compared to other companies with similar ratings. Cash flow may not be able to withstand the high interests payments. Furthermore, bond holders have a low tolerance in terms of default. Most would sell defaulted bonds which could ultimately lead to winding up of the business. A few well publicised defaults could make future bond issues almost impossible for the industry.


  The shipping industry is unique in that it must suffer violent market swings which have a dramatic impact on cash flows of the business. The special problems faced by these companies are clearly not understood by the existing markets for capital, making financing increasingly difficult. At the same time the demands for finance for the industry are increasing.

  Possible solutions could be provided by:

    —  Government guarantees for loans, particularly for the smaller companies experiencing difficulties in obtaining bank finance.

    —  An extension of the Enterprise Investment Scheme which offers relief to qualifying individuals (investors) providing equity to qualifying companies for qualifying business activities. This currently is available to unquote companies, up to a maximum of £5 million for certain ship chartering and operating activities. Clearly this maximum is insufficient in the light of the requirements outlined above. Some consideration should therefore be given to expanding the limits and indeed making it available to certain smaller quoted companies.

H K Leggate

London School of Foreign Trade

Research Fellow

Centre for International Transport Management

London Guildhall University

13 December 1998

65   Ship Finance: Choices, Competition and Risk/Reward Equations' Drewry Shipping Consultants. Back

66   Ibid. Back

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