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NIKOLAOS NOULEZAS

Advising an owner of methods of raising finance for the purchase of two five-year oldPanamax dry bulk carriers.

Will there be any difference of funding for a well established shipowner with a currentfleet of over 20 similar vessels and a small independent owner with only two suchvessels in the present climate?

Shipping Finance and Credit Institutions

Shipping is a capital intensive industry where vast amounts are required to back upacquisitions. Financial institutions, in order to preserve liquidity at high levels andachieve minimization of credit risk through diversification, often consolidate. Groups

of maybe 5 banks syndicate and with one of them operating as the arranger, issue(syndicated) loans divided into smaller packets.

The shipping industry has always been considered as a risk-laden business thereforefinanciers insist on securities. Primarily it was also considered as the protection of thefinancial institution, but it is also an instrument for making owners more careful andprudent.

A loan agreement is the important link between the financial institution and theborrower (ship-owner). Sometimes it is quite difficult to come into an agreementsatisfactory to both loan officer and borrower. The reason is because both partieshave different points of view and opposite interests. In general, an owner would like

to see from the side of the bank the following:

A minimum equity contribution, so in case the project goes right, he will makea very high return on the invested amount.

A minimum collateral recourse to himself, which minimizes total losses if theproject goes wrong.

A maximum loan period to match the life of the asset, moratoriums, balloonand bullet terms.

Cheap finance in terms of interest and other related fees. Fast response time, advices and other financial products from the bank and,

last but not least, minimal documentation and covenants.

On the other hand the banker would like to get:

A substantial equity contribution.

Maximum collateral and recourse to beneficial owners.

A minimum loan period, especially in the case of second-hand vessels. Expensive finance. Large time intervals between decisions and proposals. Provision of any kind of financial product and service. Maximum documentation to cover against every eventuality.

All this are valid, under the assumption that the borrower has the expected credibilityand proven ability and capability to run the business, and off course that the project issensible.

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Many banks in the past years tried to categorize, standardize and homogenize theiroffers and requirements. Most of the efforts were actually a set of criteria foraccepting the project as potential proposal, and a set of criteria-biases for theborrower and the company. The process may have not been as successful as it wassupposed to be by minimizing the workload of the banker, but it established somemarket standards. As a result, almost every bank publishes a respectable bookletregarding its credit offers and policy.

Banks credit policies are not the same, neither is their stance against credit risk.Some banks, while defending their shareholders best interests, are moreconservative then others.

Credit policy is the entirety of regulations, of organizational and economical nature,that administer a credit institution for the achievement of the greater possiblefinancial outcome, for both private and social benefit.

In the same way, loan practices may vary for a number of reasons.

Sources of finance

Corporations can raise capital in two principal ways: by issuing equity or by issuingdebt. Issuing equity involves issuing common or preferred stocks. But, issuing debtoffers much greater diversity.

As a result, the various potential finance options for our customer (shipowner) are:

EQUITY:a) Owner equity ( finance provided by owner from own funds and

retained earnings) b) Limited Partnership ( funds provided by partners)c) Ship Fund ( shares in company bought privately by individuals or listed onstock exchange) d) Public Offering ( shares sold by subscription on publicstock exchange)

MEZZANINE FINANCE: Debt with high interest rate and possibly equityrights

SENIOR DEBT: a) Bond Issue (security issued in the capital markets)b) Commercial Bank Loan (loan provided by bank. Large loans may besyndicated between several banks) c) Private Placement (debt financearranged privately with pension fund, insurance company etc).

LEASE: Finance Lease & Operating Lease (long term tax effective financebased on sale of ship to company which uses depreciation benefits. May beleveraged.)

Finance is an industry and as such, has to adapt and evolve following the marketover all. This is why new methods of financing or raising capital make theirappearance every now and then. Among traditional financial instruments areclassified loans, subsidies or credits, equities and stock markets. Neverthelessnewer, innovative methods have been developed, like mezzanine finance, offshorecompanies, securitization, venture capital and maritime joint ventures.

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As mentioned, the raising of equity is among the options available, but these marketsare also highly regulated and have much greater disclosure requirements and aremore complex and expensive to arrange.

In absolute numbers, the most important source of finance is debt. Indebtedcompanies promise to make regular interest payments in addition to repaying theprincipal the initial capital borrowed. Notwithstanding, should the value of thecompanys assets become less than the value of the debt, stockholders have theright to default if they are willing to hand over the corporation to lenders. For theadministration of such handovers there is a bankruptcy court.

Conventional first mortgage remains the dominant source available to shipowners,considering the size of the shipowner with currently two owned vessels, it appearsthat this type of debt would be the most appropriate for his business plan.

Criteria review and classification

In the same time we need to mention that there is no set way for financing a ship,either new-building or second-hand, and often more than one type of finance that issuitable. In any case, the borrower needs to pay attention to the level andpredictability of future cash flow as well as cost minimization.

Ship financing appraisal, is a profound task that encounters the uncertainty of theshipping industry and the individuality of each venture. All cases are different andneed to be examined individually.

There are however fixed criteria in the credit policies that aim to classify shippingcompanies according to their credit ability and others to be applied on specific

ventures, all aiming to make the investment evaluation feasible. Same applies offcourse to our specific customer (shipowner) who wishes to finance two five-year oldPanamax dry bulkers.

It follows that the better rated clients have greater opportunities in obtaining finance,and the widest choice of financing options. In our example, the larger shippingcompany with a fleet of 20 similar vessels has most probably the scale to tap thewhole range of financing, taking as granted a sound credit analysis andfundamentals.

Consequently, the finance options for the shipowner with currently only two dry bulkvessels would be very different from those available to the larger company

mentioned with a fleet of 20 similar dry bulk vessels, considering the high volatility inthe freight market as well as the fiercer competition between the dedicated shippingbanks which creates a greater pressure on banks return and a consolidationregarding willing shipping banks resulting from further consolidation in the bankingindustry.

A further factor which will most probably not allow the smaller shipowner to obtainsame financing options and range as the well established company in our example isthe impact from the Basel Accord, known as Basel II, under the consideration thatthe larger company obtains also a much better credit-rating.

Nikolaos Noulezas13.02.2009