Islamic finance in the GCC is emerging as a credible alternative source of ship finance.
Shipping companies are finding it tough to get bank financing due to strained liquidity and tight credit conditions at present.
Last month, SFS Group Public Company, a Cyprus-based non-banking financial institution and Malaysian subsidiaries of the Kuwait-based bank Kuwait Finance House had announced their partnership to set up a Global Shariah Shipping Fund, a private equity fund that aims to raise $150 million (Dh550m).
In November last year, QInvest (Qatar-based investment bank) and Fortis Bank Nederland signed a joint venture agreement and each committed $50m to the QInvest-Fortis Bank Nederland shipping fund, making it the world's first Shariah-compliant ship financing fund.
"Since Islamic finance is much more focussed on assets and lending to business and the real economy, it is inevitable that the shipping industry will be a material sector for the Islamic finance industry. Since shipping is a global business, this will not be restricted to the GCC but we will see the GCC taking a global view of the industry and participating in cross-border transactions.
"A prime example would be the new shipping fund announced by Kuwait Finance House Malaysia," Davide Barzilai, Partner, Norton Rose, the London-based global law firm, told Emirates Business.
He said Islamic finance is going through a process of being more than a minor, niché sector of the wider banking market.
The Islamic finance market is well placed to take advantage of the scarcity of capital and funds such as the Fortis Nederlands/Qinvest junior ship finance fund are examples of future sources of finance over the coming years. However, he said, even though the GCC is the hub of Islamic finance, 2009 saw little interest from regional shipping companies leveraging Islamic finance.
"Last year, we only saw minor interest in Islamic finance among the regional shipping companies.
"It might be that the shipping companies in the GCC have enough equity so they have not been in the market for finance in the way that we had seen in the past," he said. Apart from Islamic finance, he said shipping companies can also turn to the equity markets and quasi-equity markets (or structured bonds such as convertibles).
He, however, denied that the days of traditional financing are over for the shipping sector.
"I would never say that the days of traditional financing are over as this is too simplistic. It may be quiet but the fundamentals that traditional ship financing provides are still relevant and I expect will come back when availability of capital finds its new level," he said.
Globally, the ship finance sector is facing one of the worst crises in terms of getting finances.
"The ship finance sector is facing one of its darkest times. Historically, ship finance was undertaken by banks based in Hamburg, and these banks have been hit so hard that a few of them may face bankruptcy.
"Considering the massive drop in tonnage prices, the credit committees of most banks have reconsidered their lending strategy and it became a new ballgame altogether," said Jasamin Fichte, Managing Partner, Fichte & Co, a Dubai-based international commercial law firm.
She said most of the international banks have not been able to provide any finance last year and transactions were only considered for existing clients.
In the UAE, she said, while local banks were reluctant to get involved into ship finance in 2008, last year a couple of national banks had taken up ship finance and even employed qualified staff to develop on these deals. But she was not aware how many of these deals had been finalised.
"In 2008, ship finance was given but most banks structured deals as either project or corporate finance. National banks will only look at very safe clients with a good portfolio and excessive securities. And deals will take much more time, a term sheet will not be written that easily any more," she said.
Banks in the region are still reluctant to lent money, and as long as banks don't start lending the shipping business is not going to go up, she said. Barzilai also agreed that the GCC is no different from the rest of the world in terms of ship finance.
"Banks are sitting on the debts of poor performing companies and have not been quick to enforce their rights. 2009 was a year when facilities were amended and defaults waived.
"This is not just a GCC issue – this is happening throughout the world. The question remains to be seen as to whether or not there is sufficient equity within the shipping sector to keep the ship owners going over the coming year or whether we are experiencing a 'W' type of recessionary curve with the second downward part of the curve to hit the markets in 2010, he said."
He said: "It is envisaged that growth will come out of places like the GCC. So if there are positive events for 2010, I believe the GCC is well placed to take advantage of them. The wider credit crunch has meant that the [Islamic finance] sector has increased its impact in comparison with the conventional finance markets."
Banks face stormy times
Given increasingly gloomy growth forecasts, the ability of shipping companies to generate revenues sufficient to service debt obligations must come into question – presenting real risks to banks that provide financing to shipping companies, said Deloitte.
The report 'Crisis in shipping – Keeping your portfolio afloat' said: "On paper, these financial institutions may have sufficient security against shipping defaults in the form of mortgages, assignments, and pledges, and possibly guarantees from group companies or directors. But with the falling prices of certain types of ships, mortgages on assets may not cover the loans. Even more important, it takes time, effort and money to sell collateral.
"As such, banks are encountering a challenging set of circumstances when it comes to securing their shipping portfolios.
"Some shipping enterprises with sufficient reserves may be able to agree with their lenders on adjustment of ratios (such as loan to value) and/or restructuring of debt. To meet obligations, these companies also have the option of laying up part of their fleets until demand returns. This could allow for decreased operational cost."
Ship owners who have not built up reserves may not be able to survive, forcing the sale of assets to repay the lender. But in any sale of a ship, there will be the issue of competing claims. That is, when ship owners cannot meet debt obligations, they typically are not able to pay other creditors either, such as the crew, bunkers, spares, agents and insurers.
As such, the ship cannot simply be sold to another party, as many of the claims against the defaulting owner may still be enforced against the ship after it has been sold. The ship will most likely have to be sold in a judicial sale or auction – where the chances of lenders losing money can escalate significantly, the report said. Right now, banks need to prepare for the worst when it comes to their shipping portfolios.
They need to undertake business reviews to assess the viability of their shipping clients, identifying which companies are in danger of default and work to find solutions to preserve their interests.
However, in the cases where default cannot be avoided, banks must be ready to take a course of action that best protects their capital.
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