By Foluke Akinmoladun
Once a lender has completed a vessel analysis for the purposes of credit assessment, other analysis it may undertake is an analysis of the transaction itself particularly, breakeven computations, loan to value computations and transaction cash flow projections.The borrower’s guarantors and the counter parties are also examined to ensure securing the lender’s loan in case of a default.
Thus, what is a credit assessment? This is an assessment of the capacity of the borrower to repay the principal and interest on a loan. It assists the lender in making an informed decision as to how much the borrower is capable of lending and how much the lender will be willing to lend in the circumstances.
Credit assessment focuses more on the assessment of the borrower’s capacity to repay than the lender’s ability to lend; therefore, the analysis is done on the borrower and the market within which the borrower operates.
In making a credit assessment, the lender looks into several factors. These are sometimes referred to by their acronym such as the six Cs or CAMPARI.
The six Cs are –character, capacity, capital, company, conditions and collateral. CAMPARI on the other hand, stands for character, ability, margin, purpose, amount, repayment and insurance. Focus here will however be on the six Cs. To further adumbrate on the six Cs, it is important to understand the reputation, earnings, market, assets, liabilities and strategic direction of the borrower as shall be seen below.
The first C stands for character, which refers to the reputation that the ship owner has amongst his or her contemporaries, shipping agents, and within the market, he or she operates in. In addition is an assessment of the management. Here what the lender wants to know is the record of accomplishment of the management, whether there are adequate internal controls, what is the company’s strategic direction, and other information that related to the performance management of the ship owner company. Other factors lenders examine are the level of honesty, integrity, background, educational and industry knowledge of the management personnel.
The second C is capacity and relates to earning capacity of the vessel. Examining the payment history and current loans and expenses are indicators of the borrower’s capacity to repay a loan.
The earnings capacity also relates to the retained earnings of the company, which in the financial statements of the company becomes part of its equity reserves. The higher the reserve, the more buoyant the company is and the better its capacity to repay a loan applied for.
The next C is company which goes into the internal management of the vessel and its performance in the market. Here the lender seeks to know the operational risks that the company is facing and the management’s appetite for risk. Here, how management handles difficult issues such as the recent pandemic will also be important. The recent pandemic has had its toll on ship movements’ further adversely affecting freight prices so management skill for ship owners has never been more important in recent history.
The lender also wants to know the condition of the business, the market the vessel operates in, the trends in that market and how it is affected by the economy. The lender would also analyse whether the current condition of the business will either continue, improve or deteriorate. This will be examined against the capital of the vessel owner company and the investment plans both short term and long term of the borrower.
Finally, the value of the business assets and personal assets and the assets of any possible parent company is important to the lender particularly as collateral. Ultimately, the cash flow of the vessel’s operations is the main source of repayment.
However, the lender wants to be sure that they can realise their investment in the case of any default. For this reason, some lenders will not lend except to certain flagship countries that they are familiar with their laws on ship mortgage and are able to realise their investment without difficulty.
Credit assessment is an integral part of a ship finance transaction. For a proper credit assessment, risks and ways of mitigating the risk is analysed along with an analysis of the customer and the vessel. The transaction itself, in terms of ways to secure the interests of the lender is also analysed. Finally, the borrower, guarantor, charterer and off takers are analysed to ensure that a proper credit assessment is done. It is important to the lenders in a ship finance transaction, to have a proper credit assessment of the borrower. This will ensure that in granting the loan, risk is minimized and profit is maximised for shareholders, creditors and employers of the bank.
Foluke Akinmoladun is a lawyer, accountant, mediator and arbitrator. She is the Managing Solicitor of Trizon Law Chambers and can be reached at: Foluke.A@trizonlawchambers.com