Maritime Sources of Finance - Coursework Example

TABLE OF CONTENTS 1. Maritime sources of finance…………………………………………………………………....3 1.1 Introduction……………………………………………………………………………...........3 1.2 Islamic Finance…………………………………………………………………………..........3 1.3 Common Islamic Financing Instruments………………………………………………...........4 (A)Murabaha…………………………………………………………………………..........4 (B)Istisna’a………………………………………………………………………...……….5 (C)Ijara……………………………………………………………………………………..5 (D)Sukuk….………………………………………………………………………………..5 1.4 Current Trends……………………………………………………………………………….....6 2.0 Financing through Bonds………………………………………………………………………10 2.1 Bonds………………………………………………………………………………………......10 2.2 High Yield bonds……………………………………………………………………………....12 2.3 Norwegian Converted Bonds………………………………………………………….……….14 3.0 Conclusion…………………………………………………………………………………......15 References…………………………………………………………………………………….........16 Illustrations Figure 1: Total Sukuk Issued by Malaysia from June 2013-June 2014…………………………………..6 Figure 2: Global Uptake and growth of Islamic Finance…………………………………………………8 Figure 3: Global Sukuk issuance………………………………………………………………….............9 Figure 4: Asian Shipping Bond Value……………………………………………………………............12 Figure 5: Shipping Bond Issues in Asia…………………………………………………………………..12 Figure 6: High Yield Bonds Inflows……………………………………………………………................13 Figure 7: US High-Yield Bond Fund……………………………………………………………...............14 Figure 8: Norway’s 10Y Bond…………………………………………………………………………….15 1. Maritime sources of finance 1.1Introduction Shipping is a highly capital-intensive venture, with at least 30,000 global firms requiring by rough approximation, around $ 80 billion per annum for funding of new buildings only. This implies that shipping funding has a considerable bearing for the industry that is popular for its unpredictable earnings and technical complexity. Nevertheless, because of the nature of shipping business which is rather public-shy, methodical research on the manner in which ship-owners conduct their financing preferences as well as related governance arrangement is quite limited. Thus, after undergoing radical instabilities in the shipping market since 2008 economic meltdown, shipping firms are now emphasizing on financial liquidity in the quickly changing environment (Zeng, et al, 2008). This paper seeks to explore the various financing options available in maritime industry. 1.2 Islamic Finance Islamic finance is one the sources of maritime finance and has been growing in importance across the entire range of financing the shipping industry. Islamic Finance is also fast becoming identified as a feasible potential substitute to conventional financing. Thus shipping instruments that are Sharia-compliant appeared in the beginning of this decade and from then, there has been founding of several Sharia-compliant institutions as well as numerous international bank have followed suit and created financing arms that are Sharia-compliant (Kettell,2011). Consequent to the 2007/08 virtual economic meltdown, several banks were on the verge of collapse, with the era of prolonged economic prosperity having come to an end with a bang. The liquidity crisis was far from over, particularly for the owners within the low end of Small and Micro Enterprises bracket. This turn of events necessitated ship owners to seek other opportunities for financing. One such readily available source was Sharia Compliant finance. Although definitely not resistant to the worldwide economic meltdown, Islamic banks grew their assets by 28.6% in 2009(Ginena & Hamid, 2015).At the moment Sharia Compliant assets run into trillions of dollars making them a considerable liquidity source; both for Muslims as well as non-Muslims-who have indicated the willingness of tapping into this specific kind of financing (Askari & Krichene,2014). 1.3 Common Islamic Financing Instruments The following are some of the common Islamic financing instruments; (A)Murabaha-also known as “cost plus” financing and is the most frequently encountered structure in Islamic finance and is utilized in financing trade, providing working capital and acquiring assets. The following g procedure is used; (a)-the customer’s bank (K) identifies and inspects the asset s/he wishes to purchase such as ship that has been used before, and asks for financing from bank(M). (b)-K and M commit to a Murabaha Contract, whereby K promises to first and foremost purchase the asset from M immediately M gets ownership and secondly compensate for the asset on definite future date or dates at a certain price(also called deferred price-profit margin plus cost price)(Iqbal & Mirakhor,2014). (c)M appoints K as its agent to buy the asset from the trader (O) on the behalf of M. (d)M buys the asset (ship) under a purchasing contract with O and settles the cost price under that agreement and the asset’s title vests in M. (e)M then sells the asset (ship) to K for instant delivery (with title effectively passing to K) for the deferred price with the conditions that it is payable either by definite installments through the entire Murabaha time or in a single lump sum on the last day of that time (Harwood, 2006). (B) Istisna’a is utilized in financing key construction projects and can also be utilized in pre-delivery funding of a ship that still is under construction. Primarily, the pre delivery repayments of the contract price are financed by the bank (A) paying them to the builder of the ship. The ship’s title will pass on to A upon finishing and delivery, A then transfers the ship’s title to the customer (B) on understanding that B will settle the deferred price on similar basis as that of Murabaha via installments over a definite period. (C)Ijara and ijara wa iqtina(Lease and lease purchase)-just as in Murabaha, the owner of the ship(A)will look for financing from his/her bank(B) for acquiring the ship s/he has selected as well as inspected. With the assumption that this is not a pre delivery financing, B will buy the ship from the seller who may be A under a buy agreement and will later lease the ship to A under an Ijara agreement. (D)Sukuk Other instruments comprise of the Sukuk also known as Islamic bonds .Sukuk may be applicable where there is significant funding requirement .This investment certificate can be rated and listed with investors getting payments periodically. Over the past years, there has been rising trend of uptake of Islamic finance. Thus IF is set to position itself in a big way both in Islamic as well as conventional economies because of rising global demand for Islamic Finance. Sukuk is one aspect of IF that is swiftly developing worldwide. Malaysia has been extremely successful in the issuance of Sukuk, easily becoming the second biggest sukuk market. This has been strengthened further by Securities Commission and Bank Negara Malaysia initiatives to develop the infrastructure so as to enhance and improve the worldwide interest in their Sukuk market. Thus taking advantage of its best practices as well as meticulous structure, the Islamic Capital Market (ICM) proved its worth in 2014 and continues to perform exceptionally well. Currently, the Malaysian ICM is valued at USD 500 billion with this value anticipated to tip USD 1 trillion by 2020,with Malaysia taking the first position as issuer of Sukuk having a market share of nearly 40 percent. Figure 1: Total sukuk issued by Malaysia from June 2013 to June 2014; Source: Bloomberg The other form of Islamic financing instrument is Musharaka which has however not been broadly utilized in financing ships. This is maybe the purest type of Islamic financing method since it comprises sharing of both losses and profits by various parties in some sort of partnership (Nazim, 2014). 1.4 Current Trends One of the regions that has been experiencing a surge in the growth of Islamic financing products has been Asia, especially Malaysia, India and China. Thus South East Asia ha s undergone fast economic growth in the past few years; with particular contribution coming from shipping of exports .The shipping sector has and continues to benefit from the dynamic and innovative Islamic finance products. This has seen a growth of total fleet rise from 2002’s 58,280 to 2014’s 150,337 in South East Asia region. In addition, container ships have also increased from 2002’s mere 5,630 to 2014’s 22,069. Thus, for instance in Philippines a dozen trends are restructuring the worldwide maritime transport as well as trade in South East Asia. In addition, Philippines is a global emerging market and one of the world’s biggest producers of pineapples, sugar, rice and coconuts; all of which have to shipped out of the country. The Port of Manila lies at the centre of the country’s port system and serves as a gateway to world’s main cities. Shipbuilding is a core activity in Philippines and actually there was an increase of 40 percent in show space in 2015 Marine Annual Exhibition for international and local maritime companies. In addition, Philippines is ranked as the 4th biggest shipbuilder in the world with the government building more shipyards in the country. Investing in shipbuilding facilities requires finance and the country’s biggest Islamic bank –Al-Amanah ready for the financing needs that may arise. These developments are bound to be key factors in the uptake of Islamic finance and a core contributor to the maritime industry. Singapore is another pace setter in uptake of Islamic finance and contributor to the maritime and shipping industry going onwards. Unlike Philippines whose ports and other infrastructural and financial facilities are still developing, Singapore has a flourishing maritime and shipping, as well as Islamic Finance industry. Singapore has always been attempting to grow its port and Islamic Finance profile by proactively establishing connections with shipping correlated industries together with nurturing a macroeconomic environment that is sound. The nation’s port is world-class in addition to being a crucial transshipment hub as well as Asia-Pacific gateway. Recently Atlantic Navigation which is a Singapore-listed firm and has operations in India and GCC entered into a contact with a Singaporean-based bank for an Islamic financing facility to further its shipping activities. The country is also considering looking into offering greater certainty and clarity in the tax and regulatory treatment to accelerate Sukuk issuance as well as other Islamic capital market products (Oshodi, 2014).All these trends point to a very vibrant and rising uptake of Islamic Finance products as well as growth and development of maritime and shipping industry. Figure 2: Global uptake and growth of Islamic finance assets and Impact of slowing growth on Industry size Source: Bloomberg Western companies have also started using Sukuk as a potential source of finance for financing their shipping businesses. For instance, Bank of Tokyo,-Mitsubishi UFJ, Societe Generale, a Japanese and French bank respectively are working on Sukuk issues, with Goldman Sachs working out on a $500m issue. Regardless of recent strong growth in Islamic financial products, room for expansion still exists both in comparatively unbanked Muslim nations and the West. As portrayed by orders placed for Britain’s issue, sovereign sukuk demand is quite strong. South Africa and Hong Kong have already issued dollar-denominated Sukuk with strong interest being shown by South Korea, Russia, Luxembourg, Philippines and Australia. Figure 3: Global Sukuk Issuance Source: IFIS; Moody’s So far, 2014 saw issuance of sovereign Sukuk by such countries as South Africa, Senegal and Maldives as well as the UK, which goes to highlight the main role of governments in fronting the development of Islamic Finance as a source of finance for businesses involved in maritime and shipping industry. With this kind of trend, it is apparent that sovereign issues are going to assist Islamic Finance and shipping and maritime industry to a greater extent as well as development of Islamic capital markets where there are none (Parker, 2014). 2. Financing though Bonds 2.1Bonds Historically, bonds were scarcely seen as a characteristic source of shipping finance. Thus, bond issues by shipping firms were irregular and usually sold in reasonably small tranches to proficient bigger bank debt instruments. Nevertheless, this scenario has dramatically changed since 2009.For instance, total issues of shipping bonds in 2011 rose to an astounding 90 percent to $ 7.97 billion from 2010’s $ 4.12 billion ,an amount that has surpassed an historical high of $ 7.8 billion reported in 2009 (Talley,2013). Bonds naturally, have never been the best way of financing mainstream shipping since commodity vessels face the full wrath of market exposure. In cases where vessels have been deployed under long term contracts, particularly with energy or bankable companies, the outlook is more promising because of earnings visibility, and as such companies have been accessing the bond market from time to time. For instance, Teekay, NYK Line, Seaspan and Navios Maritime Acquisition have issued bonds in the past on the above promises whereas Jones Act together with logistics firms can rely on the ‘service’ nature of their operations to guarantee coupon payments (Parker, 2014). Other examples of shipping companies in the niche market having frequent sprints to the bonds include Norwegian Cruise Line, Tidewater and Horneback as well as Navios South American Logistics. For instance, Navios Maritime Acquisition in October 2013 issued bonds worth $610 guaranteed by 1st priority ship mortgages having an interest rate of 8.125 percent with a B/B3 rating .In addition; the company issued additional $50 million in March 2014 on similar terns as October issuing (Parker, 2014). The bond market therefore has been quite active recently especially for established companies ,for instance Rickmers Group issued in the European market a $200 million multi-currency bond on May 2014 at competitive terms with Rickmers Maritime Trust issuing around bonds worth around $80 million in Singapore at 8.45 percent maturing at 2017.In America, Scorpio Tankers even with their spectacularly effective equity raisings did not refuse to give in to the temptation of raising 50 million dollars in senior unsecured notes at 6.75 percent having a 2020 maturity (Parker,2014). Provided the status of conventional lenders in shipping, the bond market will most likely continue being an active avenue for ship-owners to get capital. So long as investor demand for yield products hold strong in the 5-10 percent range and interest rates remain down, at the trade-off of low collateral or credit, there will always be a lot of activity from ship-owners already established, together with moderately newcomers in their continuing pursuit of alternative source of financing. Thus, the era of two hundred -base point spreads having high leverage is gone, and latest trends need fresh techniques, be it in the form of bond investors for new shipping lending or private equity investors seeking equity (Karatzas Marine, 2014). In Asia things have been looking rosier and 2010 saw a surge in the total shipping bond issued by 90 percent to $7.97 billion in 2011 from 2010’s $4.12 billion .This figure has easily exceeded the historical high of $7.81 billion set in 2009 (Grammenos, 2013).China also emerged for the first time ever, as the biggest issuer of shipping bond. In addition, the local market has continued to act as a core source of capital for Korean Shipping firms with the top 4 shipping firms raising $ 125 million additional bonds in 2011 compared to 2010.After a hiatus of one year, Japanese shipping firms have re-emerged as core bond issuers (Stopford, 2013). Figure 4: Asian shipping bond value (Figures in $ million) 8,500 8000 7,500 7700 6,500 5,500 4500 4000 3500 2500 2009 2010 2011 Figure 5: Shipping Bond Issues in Asia Source: Bloomberg (2.2)High yield bonds A high yield bond can be described as non-amortising debt security, usually issued by a company below investment grade( a firm with a credit rating below BBB).The term “high yield” implies the higher level of return demanded by an investor for his investment in the high default risk /low rated company. Typically, majority of shipping companies are high risk firms whose rating is mostly below investment (Alizadeh & Nomikos, 2009). The following are the main features of a high yield bond; foremost it has a fixed coupon or interest rate, requires no principal repayments till maturity which is normally 6-10 years, can be secured by a pledge over the assets of the issuer or a mortgage or most likely unsecured, has a covenant structure which is incurrence based-implying that the issuer might incur extra debt, it has no maintenance covenants like loan to value or value maintenance (Lorange, 2009). There is a trend amongst some shipping industry analysts to dismiss high yield bonds as unattractive or unavailable, mostly citing the misdemeanors of shipping companies’ early experimentation with these debts when in the late 1990s, almost all shipping firms defaulted (Ram, 2010).However, things have changed and today’s high yield bonds are an aspect of the capital structure of several maritime companies comprising of such firms as Stena, OSG, Navios, Teekay, Hornbeck and Gulfmark. The charts below show the recent monthly/yearly high yield amount raised as well as the number of issues; Figure 6: High Yield Bonds Inflows Source: NYSE Area Figure 7: US High-Yield Bond Fund Flows Source: Lipper 2.3 Norwegian Covered Bonds In June 2007, the Norwegian covered bond regulation was adopted. It came due to lengthy reviews and study sponsored by Norway government in addition to an immense support from the financial industry. The legislation is an up to date and modern one that offers investors strong fortification from the poling cover. In addition, this act is keenly matching similar EU regulation and directives with the Norwegian bonds being viewed as the best in category of Europe’s covered bonds (Stopford, 2009).Trading Norwegian covered bonds are typically listed and local issues listed on Oslo Bars might be traded on the exchange, however more frequently they are traded off the exchange and then afterwards reported to as well as publicized by Oslo Bors. On the other hand, international issues might be listed anywhere, normally in a global financial center. This is the avenue that has been exploited by majority of shipping companies and everyone involved in maritime business. (Grammenos, 2013).The petroleum and shipping sector’s high profitability has provided these firms with an enticement to heavily invest with the conventional industry experiencing a reducing tendency in investments over the past couple of years .Norway’s government bond 10Y reduced slightly to 1.35% in April from 1.41% in March 2015. Figure 8: Norway’s 10Y Bond Source: Bloomberg 3.0Conclusion The shipping sector operates in an extremely dynamic environment full of high risk and even loss of entire capital invested. Traditionally, shipping firms have depended on bank loans to fund their operations as well as the acquisition of ships. However, since the 2008 economic meltdown and the tightening of credit environment, especially in Europe, shipping firms have been forced to source funding elsewhere. Nevertheless, recently things have been looking up and investors in shipping business need not worry anymore since there are far much better alternatives to bank loans. These include Islamic finance, corporate bonds and a wide array of several financing instruments. It is therefore upon the shipping firm to choose the best appropriate financing method to fund its operations. List of references Read More