Prerequisites for leasing scheme implementation

Viktor V. Chugunov - Executive Director Sudoexport State Unitary Enterprise

Recently, after the crisis suffered by domestic shipping companies and shipbuilding plants in the nineties and in the beginning of this decade, a certain revival on the shipping and shipbuilding markets began.

Major Russian shipping companies such as Sovkomflot, Novoship, PRISCO and FESCO steadily increase their tonnage by means of new building, using in full their ability of attracting long-term loans in accordance with the established world practice of ship construction financing. Leading Russian shipyards are also undergoing significant changes, which are largely related to the global shipbuilding boom.

Thus, the Admiralteyski Shipyard continues with a series of tankers for Sovkomflot аnd conducts preparatory works for handling an order for construction of ice-strengthened class tankers for Sevmorneftegaz.

The Baltiyski Shipyard proceeded with a long-term programme of constructing line ice-breakers for Rosmorport FSUE and of «Ro Pax» type ships ordered by a foreign customer.

The Northern Engineering Plant (Sevmash) proceeded with an order placed by Norwegian Company Odfjell for eight chemical tankers with deadweight of around 45 thousand tons.

The Vyborg Shipbuilding Yard has started on a long-term project of constructing 10 tankers of around 12 thousand tons deadweight for Caspian Sea, commissioned by Kazakh companies.

Two shipyards of Sea Oil and Gas Projects Group have also been working steadily: the Krasnoye Sormovo Yard is building a series of tankers of 13 thousand tons deadweight for Caspar, and Volgograd shipyard is working on an order for dry cargo ships of «river-sea» type and for hull construction, commissioned by foreign customers.

Noting the above positive trends, it can be observed nevertheless that most of them imply orders for new ships, placed by either foreign companies or major Russian shipping companies that are capable to ensure the construction and long-term (so-called ‘post-delivery’) financing.

At the same time medium-sized and small shipping companies (as most of the Russian companies are), which have a compelling need to replace ships, or to increase their number due to the cargo base actually existing to be shipped, still experience the same difficulties and problems with ordering ships which were 5 – 10 years ago.

In essence these problems can be outlined as follows:

  1. In order to provide for building new ships (usually not more than two), Russian shipping companies can:
  • make a down payment of not more than 20 to 25% of the ship’s cost (the so called «equity» of the customer) during the construction;
  • cede only the ordered ship and /or other unbound ships of the company (usually 15 – 20 years old) to the bank as mortgage security.
  1. To accept an order from a Russian company for a new ship, shipyards lay down the following preconditions:
  • advance payment of not less than 40 – 50%, or 85 – 90% of the ship’s cost during the construction period;
  • construction of not less than 2 – 3 hulls when ordering ships of a brand new design.
  1. To provide financing (loans) for construction of a new ship, Russian banks require:
  • confirmation from the shipping company of its ability to pay out not less than 30% of the ship’s cost as a down payment;
  • post-delivery ship’s mortgage in bank’s favour for the whole period of credit;
  • confirmation of ship’s guaranteed operation.

At the same time, even if meeting all the above requirements, Russian banks (except Sberbank and Vneshtorgbank), are not able to grant credits for more than 5 years, which, in combination with a relatively high value of these credits, does not warrant redemption of ships.

Comparing capabilities of the majority of Russian shipping companies with the shipyards terms and Russian bank requirements, it becomes obvious that the problems of fleet renewal and replenishment may remain unsolved for many years to come.

Yet it is these companies, capable of handling the major part of continuously increasing domestic cargo traffic, that should and can become the main customers and consumers of Russian shipbuilding industry.

But to make this scheme work it is necessary to set appropriate conditions for shipping companies and shipyards, which, at present time and with all the above listed problems, can be achieved only by using leasing schemes of ship construction and operation.

 Particulars of leasing schemes when ordering new ships

In the modern Russian economy, leasing schemes are not widely spread.

In 2003, the weight of «ships and ship repair equipment» on leasing service market in Russia amounted only to 0.53%.

Leasing companies seem to be «scared» of water transport industry as a business; whenever ship owners are accustomed to the legal and financial brackets familiar to them and their clients (i.e. bare boat charter, time charter, freight rates, etc.) and often misinterpret ships’ leasing as an ordinary rent.

Tangible advantages of leasing compared to alternative ways of purchasing ships for shipping companies (own funds or bank credit) are well known.

Over the years of leasing development in Russia, practically there was no any full-fledged leasing transaction for a new cargo or any other ship. Interaction between Russian ship owners and leasing companies, as regards lease of new ships, are limited to very few examples. These separate, though positive, examples can not be considered as an acting system.

And yet, at various fora of shipping and shipbuilding community, more and more often now, leaders of Russian industry and transport express an idea of setting up a specialized ship leasing company, which would be supported by the Government.

Sectoral leasing company – efficient way of leasing schemes’ implementation.

The idea of setting a specialized (sectoral) leasing company is presently implemented under the aegis of the Federal Agency of Industry on the base of Sudoexport FSUE in the framework of the shipbuilding industry modernization programme developed by the Agency.

Concept of Sudoexport activity as a State sectoral leasing Company envisages its activity in three directions:

  1. Arranging of construction of new ships at Russian shipyards in the framework of leasing contracts with Russian shipping companies (included State-owned ones).
  2. Arranging of construction of new ships at Russian shipyards in the framework of bare boat charter contracts with foreign shipping companies.
  3. Ordering new ships at foreign shipyards in the framework of leasing contract with Russian shipping companies (if not possible to place an order in Russia).

The first of the said directions, being of higher priority, mainly applies to medium-sized and small shipping companies.

The advantage of sectoral specialized leasing company over other Russian leasing companies is its capability to combine occasional orders for one or two ships from individual shipping companies with poor financial backing, into a sufficiently large series of eight to ten ships. Enlargement of construction sequence will not only lead to optimization and cost reduction of ship building, but will enable to arrange system purchase and delivery of foreign ship equipment whose cost amounts to 50 to 60% of the ship’s price.

Presently, Sudoexport is about to complete the setting of a financing mechanism for the delivery of such kind of equipment, involving a number of Scandinavian export agencies, which creates favorable conditions for financing a substantial part of construction cost of the ship. Such system, as an independent block, will integrate into the general scheme of construction and post-delivery financing in the framework of ships’ leasing (Schemes 1 and 2), and can also be offered to shipyards for constructing ships without usage of leasing schemes.

One more project of Sudoexport as of a sectoral leasing company, is a leasing scheme (the so-called «reimbursing» leasing scheme, to be more precise) for ships renovation (Scheme 3). Such project may be claimed on the market of «river-sea» and river-going vessels.

Method of renovating 20 – 25 year-old ships has been already tried by a number of Russian companies, Volgotanker first of all, approved and currently is implemented under the survey of the Russian River Register and Russian Maritime Register of Shipping.

The main advantage of the renovation method is that it is significantly (by 4 to 5 times) less capital-consuming, compared to construction of a new ship; it upgrades ship’s technical condition, extending her lifetime by 10 to 15 years, and thereby forms her new market price, increasing it by several times, compared to an old ship.

These very benefits, considering financial limitations of shipping companies operating in this market sector, allow us to say that the project proposed may be called for in the nearest 5 to 7 years.

All the above-listed directions of activity of Sudoexport as a sectoral leasing company, require substantial and long-term financial back-up, including budgetary financing on a redemption basis.

The issue of allotting budgetary funds for partial financing of ship construction on a leasing basis is presently under discussion in governmental bodies. Its favorable decision will considerably speed up leasing incorporation and development in the industry.

Implementation of the stated approach in the activity of Sudoexport FSUE as the state leasing company will contribute to:

  1. shipyards and repair yards – enhance their production potential and have a regular flow of orders with secured financing.
  2. domestic shipping companies and ports – regularly purchase new ships without attracting long-term credits and enjoy tax and other advantages of the leasing scheme when operating these ships.
  3. the Government - efficiently create favourable conditions for the execution of domestic and foreign orders at Russian shipyards, as well as to replenish domestic fleet with new ships flying Russian flag.

Written with the assistance of S.I.Berezhkov, Director of Sudoleasing company of Sudoexport FSUE

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# 3(13), 2005