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The Port of Hong Kong

Past, Present and Future

Maritime Money - Hong Kong vs The World

Introduction
Good afternoon ladies and gentlemen and thank you for the opportunity to
address you on the topic of the shipping ﬁnance markets in Hong Kong as they
were, as they are now, and as we expect them to be in the future. Before I can
address the subject directly, I need to reﬂect a little on the industry itself which
gives rise to the need for the provision of ﬁnancial services. Having direct
involvement with the industry for only the past 15 months, I am reasonably well
qualiﬁed to provide my own views on the present and future, but have needed to
rely on the experiences of my colleagues to address the past which has taught us
all many a valuable, and sometimes costly, lesson. My personal observations
after such a short time in the industry convince me that Hong Kong has many
advantages over its competitors in all facets of shipping services and I will
address these as we go forward.

In November 1997, the HK Shipowners Association delegation, under the
Chairmanship of George Chao, visited Premier Li Peng in Beijing to discuss the
future of shipping in Hong Kong. Premier Li was most supportive and saw
shipping as essential to the development of finance and trade and predicted that
Hong Kong would have a bright future as an international free port and shipping
ﬁnance centre. The Minister of Commtmications, Mr Huang Zhen Dong,
expressed to the same delegation that Beijing supported the continuation of
Hong Kong as the Asian regional centre for shipping. With the entiy of China
into the WTO, these statements made 4 years ago bear even more applicability
and will help to underpin the Hong Kong industry, albeit with increasing
competition from Shanghai and other mainland port cities.

When comparing Hong Kong to the rest of the world, we should
remember that the history of international shipping in Asia and Hong Kong is
quite young compared to Europe. In 1960, Hong Kong owners barely owned 1m

dwt of ships and only since then did the regional owners acquire ocean going
tomiage for international trade.

The development of the debt and equity markets in Asia is a
comparatively new phenomenon and these markets, until recent times, lacked
the size and sophistication of the markets in the United Kingdom, mainland
Europe and the United States. The shipping markets themselves have some
fundamental structural differences, with the European markets (apart from
Greece) being more focussed on large corporate structures, and the Asian market
still being driven to a large extent by family concerns. Each of these models has
entirely different ﬁnancing structures and financial services needs.

Before we try to make comparisons, it is important to Lmderstand that
shipping ﬁnance, as is the industry which it funds, is a global product and can be
delivered from any major money centre. Given developments in communication
over the past decade, it is no longer absolutely necessary to have a physical
presence in the domicile of the borrower if a ﬁnancier is to develop his book and
provide the required facilities. There are however, downsides to the
development of relationships from this remote control approach, but
nevertheless, it still works to a certain extent. It is not a structure to which we at
Wayfoong Shipping Services subscribe, but other institutions have enjoyed
some limited success utilising this remote control approach, however I fear that
they will be unable to continue with this model in the foreseeable future.

The global ﬁnance industry is somewhat ﬁagmented and it is difficult to
obtain accurate ﬁgures as to the true extent of the ﬁnancings which have been
provided in various centres.

The current size of the global market is estimated at USD62bn (as at end
2H0l) of which around 65% is held by the German banks who have been able to
build their portfolios through the success of the KG scheme, and their need to
diversify away from geographic (ie domestic German) risk and vessel type (ie
container) risk.

Global portfolios have grown by an estimated 3.9 times over the past
decade.
Hong Kong is holding its own in the global scene with USD12.3bn in
outstanding loans to the industry (20% of global total) and a growth factor of 3.

The Past
In the mid eighties, the shipping industry was over built and over banked
with the owners blaming the banks for offering money too cheaply, the banks

blaming the yards and their governments for over capacity, and the yards
blaming the owners for placing the orders in the ﬁrst place. It is interesting to
see how history repeats itself with such monotonous regularity and with over
orderings now evident in many sectors, we can expect to hear the same plaintiff
cries of distressed owners from all over the globe.

Before the crash of the mid eighties, there were numerous banks and
ﬁnance houses engaged in ship finance in Hong Kong. Restructuring of two
major transactions in late 1986 involved 70 creditor banks and created a major
shake out in the ship ﬁnance market thus reducing loan supply quite
dramatically. Following this restructuring period, the supply of ﬁnance to the
shipping industry was leﬂ to a small group of banks with Wayfoong Shipping
Services holding a 70% market share. The Japanese banks had withdrawn
completely and the Gennans had not yet ventured into the market, preferring
their own domestic market. Borrowers came to understand the importance of the
relationship with their bankers and few have forgotten their fair-weather friends
of the 80s despite the recent temptations of highly geared and low priced ﬁnance
offerings which are evident in the market.

On a global basis, a similar scenario existed. The high point of participant
activity was probably reached in 1996 when over 200 institutions were involved
in ship ﬁnance, with this number reducing to approximately 130 now active. Of
these, the major lenders to the industry probably comprise no more than 35
banks.

In Europe, the numbers are quite dramatic with a reduction from over 100
in 1998 to just 72 currently however the nmnber of German and Dutch banks
has remained relatively stable but the majority of UK banks have withdrawn. In
the Far East, the number of active lenders has reduced from more than 50 pre
Asian currency crisis to somewhere below 40 of cmrent times

The reasons given for these withdrawals have been:
. Poor risk/reward proﬁle offered by ship ﬁnancing
.Record rate of consolidation within the international banking industry
. The heavy capital requirements of the shipping industry and the 100%
equity risk weighting

. The relative attractiveness of other areas of lending

The same factors have inﬂuenced major lending institutions to temper
their exposure to shipping fmance.

In Hong Kong we have 163 fully licensed banks of which only 36 are in
any way active in the shipping markets. Of interest to note, of the 43 Chinese
mainland and locally headquartered banks operating in Hong Kong, only 4 are
active in the shipping markets, thus highlighting the general lack of appetite for

shipping ﬁnance amongst the local banks.
Whilst the number of participants has fallen sharply, the capacity
available to the market has not fallen by anywhere near the same extent, and in
all probability has probably increased. There is a greater emphasis on quality
and size as well as age of asset and this has resulted in a major shift towards
newbuilding ﬁnancing and correspondingly higher loan limits.

The Present

With the recovery in the shipping markets in 1990/1991 there has been
some renewed enthusiasm from lenders to build their shipping books again
although there is a lack of evidence of new participants entering the market.

Ship owners have become much more sophisticated in their approach to
funding and market risk and are seeking more than a traditional stand alone
mortgage to provide their ﬁnancing needs. More and more are looking into the
syndicated loan market to ftmd expensive newbuilding projects and lenders are
supportive of this market in order to minimise risk exposures and concentrations.
This syndicated market is extremely active and over the past 10 years has
enabled USD34bn of new loans (in total) to be booked in Asia. Last year there
were 47 transactions completed at an average loan value of USD47.8m and to
date this year, there have been 31 transactions completed at an average of
USD3lm each. The high volumes in 2000 are reﬂective of the high level of
newbuild orders placed for delivery in 2002 and onwards.

The utilisation of currency and interest rate risk products is commonplace
in the majority of ﬁnancings, and owners are looking at every possible which
way to reduce their operating and ﬁnancing costs, and to bringing some
predictability to a very volatile and cyclical industry.

From a bankers perspective, Hong Kong is an ideal location from which
to run a shipping book. Placed squarely in the middle of the time zones, and
therefore able to relatively easily communicate with Europe and the US, a
structured legal system supported by a strong and proactive Admiralty Court,
availability of a large cross section of brokers, ship managers, surveyors and
insurers, and access to a deep water harbour and port infrastructure which is
hard to beat anywhere in the world. Proximity to and knowledge of the mainland
Chinese market is an added bonus, especially now that China (and Taiwan) has
gained entry to the WTO.

The number of banks currently providing shipping finance in Hong Kong
has increased dramatically during the 1990s and in addition to those stalwarts
who have always supported the market, there are many competitors for the
business available in I-long Kong itself and the Asia/Paciﬁc region.

Ship ﬁnancing is still seen by many credit “experts” as high risk business

which requires specialised lending skills and access to substantial volumes of
market information. The latter two are truisms however in our experience of the
Hong Kong and Singaporean markets over the past 10 years, the facts do not
support the high risk side of the business as in what other capital goods markets
are lenders provided with hard asset security which is readily saleable, and
easily identiﬁable cash ﬂows derived ﬁom these securities through charterhire
and similar incomes.

It is traditionally a low margin game when compared to property
ﬁnancing or working capital fmancing, and the impact of the Asian currency
crisis on bank balance sheets in the late l990s, saw many banks readdress their
lending policies and concentrate more on those higher return opportunities
which would facilitate a rebuilding of proﬁtability and balance sheet strength.
As a result, the non-specialist shipping banks withdrew from the market.

The tragic events of September 11 have put more uncertainty into a
number of the shipping markets, especially the container business, which is
reliant to a large extent on US consumer confidence, and the cruise industry
which relies to a certain amount on the airline industry which is now in absolute
chaos. We can expect to see continued volatility in these markets with reducing
proﬁt margins and possibly some failures which could expedite the pace of
consolidation within various industry sectors. The capital markets have become
stagnant since 911 with bond issues being pulled from the market and equity
issues trading way below offer price of the original ﬂoat. Fund managers are
sitting on their hands thus killing the secondary trading market, and this has a
deﬁnitive ﬂow on effect to the primary market. The high yield bond market is
virtually dead as is the equity market for new issues. As Lloyds List quote in a
recent issue, “You couldn’t ﬂoat a cork in this market”.

The global economies are slowing and many are in recessionary phase
which hopefully will be short lived. My crystal ball is broken so I do not wish to
make any hard and fast predictions of an economic nature, but in seeking
guidance from several well respected economists, I now have several totally
different views on which to make judgements on business opportunities. The
only certainty is that we can continue to see change and nothing is carved in
stone. The ability to adapt to changing market circumstances and to take
advantage of opportunities as they arise will differentiate the owners and
ﬁnanciers of today and the survivors of the future.

Since the Asian currency crisis, there has been a reluctance in the retail

investment markets to invest in equities and properties for fear of capital loss.
This is especially true in the Hong Kong market where negative equity in real
estate investments has limited the borrowing power of investors to access and
trade within the equity markets. Many small investors prefer to stay in safe cash
and as a result, the liquidity of the better capitalised banks has never been
stronger. This provides opporttmities to lend, although there are dangers with
maturity mismatches for the ship ﬁnanciers as long term assets (10 year shipping
loans) are funded from short term deposits. This makes life very interesting for
the risk and liquidity managers within the banking system as these mismatches
are hard to cover and provide some sleepless nights for the portfolio managers
and traders.

The Future

The HK SAR Govermnent in recent statements following the Chief
Executives Policy Address of October 10”‘ has restated its commitment to the
shipping industry albeit in somewhat less than speciﬁc tenns. The Financial
Secretary has stated that the government will continue to build on the synergy
between the port and shipping industries to strengthen Hong Kong’s position as
a world class port and an international shipping centre. Efforts will be focussed
to enhance our strengths by streamlining the procedures to attract shipping
business to Hong Kong and promoting the attractiveness of Hong Kong as a
can-do port and can-do shipping centre. The growth in the Hong Kong Shipping
Register to 13mn GT reﬂects the success of such policies in the past and their
ongoing applicability.

In the finance sector, looking forward, it seems unlikely that the number
of banks that are active in the market will increase. With shipping investments
getting larger and more specialised, there are considerable barriers of entry to
new palticipants.The new Basle regulations are causing a number of banks
difﬁculties in evaluating their shipping portfolios particularly on the basis of the
low returns which are historically available on ship ﬁnance projects. The
selection of credit through both intemal and external rating processes will focus
banks on the returns which they are able to achieve and the level of capital
which must be provided to generate these returns. In this scenario, the concept
of the one stop shop becomes much more important if acceptable returns for
bank shareholders are to be available.

Some of the traditional ship ﬁnance banks are no longer able to compete
effectively for traditional ﬁnance business as they have limited mechanisms to
enhance their yields through the provision of non-fimds services such as
Payment & Cash Management business, risk hedging products, basic business
banking, and investment banking activities.

Whether or not banks are prepared to maintain specialised ship ﬁnance
operations which require a different set of skills to other corporate lending
businesses, remains to be seen. It is my opinion that banks in Hong Kong will
continue to do so, as shipping, and related industries, is such an integral part of
the local economy. With the opening up of the mainland Chinese market, new
opportunities will emerge and these will require specialist funding.

There will always be a place for a traditional ship lender where the
corporatisation of the industry occurs at a slower pace than in other areas.
Access to the bond and equity markets is available, and facilities are regularly
structured in the sophisticated Hong Kong market, however these markets are
not the playground of the family owned shipping company which wishes to limit
the amount of information given to the market on its own operations and where
proﬁtability is cyclical and unsustainable over the longer term. As we progress
in time, and the patriarchs of these family concerns pass control of their
companies to the next generation, there will undoubtedly occur mergers and
acquisitions which will take these companies to the next stage of development,
or see them disappear from the industry completely. As the structure of the
shipowners changes, so must the focus of the ship ﬁnancier and thus we can be
sure that change will be the driving force over the next few years.

Hong Kong lacks some competitiveness in the tax effective structured
market where large transactions are being booked under UK and Dutch tax lease
structures which provide accelerated rates of depreciation for shipowners. Given
the tax regime in Hong Kong, it is unlikely that we will be able to offer similar
facilities in the foreseeable future and therefore we will be precluded ﬁom a
market which has provided in excess of USD1bn in UK taxed based structures
over the past 12 months.

On the positive side, Hong Kong has the resources in terms of systems
and expertise to deliver the next generation fmancing products and innovative
ﬁnancing structures which will be required to meet the needs of the professional
ship owner. The securitisation of receivables cash ﬂows and charterhire income
is just one method which can offer attractively priced ftmding.

The investment community has had a traditional love hate relationship
with the shipping sector where lack of good analytical resources, single digit
returns, poorly performed stocks, and distressed bond issues has limited
investment appetites. This will not change in the near future and thus underpins
the need for access to shipping ﬁnance through traditional sources, an area
where Hong Kong can proudly hold its head on high.