By Nicolai Heidenreich

Many larger industrial companies who control a sizable fleet are looking to minimize the asset exposure on their balance sheet. Off-balance sheet financing has again become very popular. In a three part series Marine Money will cover three different types of off-balance sheet financing. This first article will look at the Norwegian Limited Partnership (KS) as a structure and briefly explain what benefits the shipowner can have by entering into such an agreement. In the two next articles we will look at the KG and more straightforward capital lease structure. This will include, from an owners point of view, an in-depth comparison of the many different features of the three financing options.

Brief Description

To be considered a single purpose limited partnership (kommandittselskap (KS)) under the Norwegian Companies Act (NCA), the KS must consist of one general partner and several limited partners. The general partner (komplementaren) must hold a minimum share of 10% in the KS and has unlimited liability towards the company’s creditors. The limited partners’ obligations are limited to each partner’s share of the total committed capital, (including bank guarantee) of the KS. However the limited partner’s hold a joint liability towards the KS if one the other limited partners default on their obligations.

Of the total committed capital, 40% is restricted according to the NCA where 50% has to be paid upon formation of the KS and the rest within two years. A KS is not subject to taxes but investors residing in Norway are subject to capital gains tax currently at 28%. Deductions related to the limited partnership losses are however limited to the amount of each partner’s committed capital.

KS have been in use since the 1970s and are most commonly used for investments in commercial property and shipping. For shipping, the glory days of the KS were in the late 1980s when several loopholes in the Norwegian tax system allowed for great deductions on an individual’s tax return as a result of hyper-accelerated depreciation schedules. The tax laws have since then been changed and the latest tax reform in 1996, which addressed the taxation of shipping companies, removed all but a few tax advantages for the investors in the KS structure.

Two Types of Structures

There are generally two types of set-ups for a shipping KS. The first is generally set-up when a shipowning company is relatively small or is made up of a few private individuals. Here, to allow internal as well as external investors to make use of the commercial shipowning operation, as well as allowing the internal investors to participate in projects they choose, a KS is set-up to own the vessel, whilst the shipowning company will take a management fee for running the vessel’s commercial operation. This vessel could be without charter attached and the investors simply trust the management to turn a profit on the vessel.

The sale of stakes in a KS such of this type will not be sold beyond a limited number of people and often one or two owners will own more than 2/3rds of the capital. As a result, there will be very few investors. Although you need legal and accounting services, the set-up fees will generally be minimal. This vessel will be financed, if needed, by banks on a single ship mortgage and would obtain gearing levels thereafter. Examples of companies and investors that actively use this structure include, Thor Dahl, Mosvold, Actinor and Borgestad.

The second type of KS structure is quite different although it follows the same legal, accounting and structural set-up as the one described above in order to keep it within the framework of the KS. The differences lie in the employment of the vessel and how the stakes in the KS are sold. This type of a KS is more of a financial vehicle, and the investment carries quantifiable risk factors. As you will see in the example below describing the American Bulker KS, established in April this year, it is not very different from a sale-leaseback.

In this set-up, a KS would buy one or more vessels and charter it back, usually on a bareboat charter to the seller. Depending on the credit quality of the charterer, the arranger/underwriter of the KS can then go to a number of banks and achieve much higher gearing thereby reducing the need for equity. The arranger will, in this case, after securing the partner’s involvement, prepare a prospectus and sell the stakes to investors in their database. Investments will be made by invitation only.

There is a definite advantage by using a specialist underwriter for a shipping KS, which is to secure a liquid second-hand market of the KS stakes. There are a few specialized underwriters of a shipping KS of this type in Norway including Ness, Risan & Partners and Pareto Equity Partners.

An Attractive Investment?

With the two overall types of KS for shipping described above the type, the mindset and usually the risk tolerance of the investors entering into the KS will be different. In the first example, the investors have usually invested together with the general partner and the co-investors on numerous projects. The investor will have faith and insight into the commercial management of the vessel and as the vessel could be sold and the KS dissolved at any time, as there is no charter attached he would generally have no timeline on the investment and will continue to reinvest the capital in similar projects. This type of structure is of course more speculative as there are no guarantees for financial performance but the upside could be great as the structure allows the owners to capitalize on fluctuating vessel values.

The second type has usually a different investor profile and offers, of course, a different return profile. The general partner in this KS will usually be an investor/shipowning company that will benefit from the investment over and above the dividend payout as a result of the charter. This could be in the form of commercial or technical management, a lucrative purchase option or securing a relationship with the original owner of the vessel. This structure has a limited life and one can much easier assess the risk, as the charterer will generally be a company with a credit rating or credit history.

The one unknown risk is the residual value of the vessels but as you will see in the example, depending of course on the length of the deal, the residual value has very little effect on the IRR.

One important aspect of this type of structure is that by having a long-term charter attached, the KS can obtain a much higher gearing than if the vessel was trading the spot market which of course increases the return on the committed capital.

As the first structure we have described will differ in outcome from every transaction, it is difficult to give an example. It is very similar to a shipowner buying a ship but allowing some of his close friends to participate in the deal. This allows a shipowner to stay in business without being subjected to a large investment of equity. The second structure however is easier to describe: we have found a recent KS to show how, the seller, the general partner and the remaining limited partners can all benefit from the sale and charter back of a vessel.

Lasco & Klaveness

Team Up

American Bulker KS was set-up in April this year by Oslo-based project finance specialists Ness, Risan & Partners (NRP), a firm started by former employees of Fearnley Finans. The deal originated with LASCO’s appointment of American Marine Advisors, AMA, in the spring of last year to look at alternatives for the 26 vessel strong fleet controlled by their subsidiary Pacific Coast and its vessel owning subsidiary Trans-Pacific Shipping. Lasco is the Portland, Oregon based shipping division of the Schnitzer family.

Together AMA and Lasco agreed that the drybulk panamax business was very much commodity based and that there would always be new entrants to erode possibilities of long-term profits while their fleet of handysize bulkers should be able to sustain a higher rate of profitability due to Lasco’s strong customer relationships and the synergies that were in place to cover Lasco’s own chartering needs. Looking therefore to free up capital to potentially invest further in handysize bulkers at a low-point in the cycle, AMA investigated several ways to sell Lasco’s 7 panamax vessels.

After investigating a number of options for six months, AMA approached NRP to see if the Norwegian KS market would be available. The KS suited Lasco, as an operating lease allows the company to keep the vessels on their balance sheet without the accompanying debt. AMA and NRP then brought in the Klaveness Group of Norway, with the view to set up an arrangement whereby Klaveness would become the main investor in the KS and the vessels would be managed by Klaveness’ Baumarine panamax dry-bulk pool.

Deal Structure

To facilitate the desired transaction NRP set up a KS whereby, Pacific Coast sold five panamax vessels (2 built in 1990 and 3 in 1994) into the KS for a combined sum of $67 million en bloc for the five vessels with a 10-year charter back to the seller for a combined $28,000 per day. The other two were sold to a Rickmers controlled KG (see box below). At the end of the charter Lasco has an option to purchase the vessels for a combined sum of $32 million and the charter can only be broken with the agreement of Lasco. By locking in the vessels for ten years Lasco will have ten years to make a profit on the bareboat charter. Klaveness agreed to become general partner and came up with 20% of the equity required in exchange for guaranteed commercial and technical management of at least two of the vessels. AMA, in an usual role for the sellers’ advisors, went-in and negotiated with the banks on behalf of Lasco and the KS: They felt that they could better represent the strengths of the charterer and thereby obtain higher leverage. Nordea (ex-CBK) which has a strong relationship with AMA agreed together with Privatbanken to provide the KS with loan facilities totalling $57 million split between a senior and junior tranche. Details of the loan agreements can be found in Guts of the Deal (on the next page). DnB New York were also involved by providing letter of credit on behalf of Lasco as they recently refinanced one of Pacific Coast’s revolvers. NRP then went out and sold the remaining 80% to investors based upon the Lasco and residual value risk.

Straight Forward Investment

For potential investors, as can be seen on the cash flow model (on the next page), the IRR calculation was quite simple. With an assumed residual value of $19 million, the vessels will then be 17 and 21 years respectively, the project yields an IRR of slightly above 20% over ten years, a good investment indeed. The IRR calculation however does not take into account the $7.5 million in committed but unpaid capital which the KS investors pro-rata to their investment must provide. As different investors calculate the costs of this arrangement at different rates, this is a common practice by arrangers of a KS. This portion of unpaid capital is very common in a KS structure and is in place to increase the gearing of the project.

The risk factors involved are, as already mentioned, the payment abilities of Pacific Coast as well as the residual value assumption. In this particular deal both are limited. The covenants in place include a $10 million bank guarantee or pledged cash provided by the seller which is payable on demand in the event of payment default with a 30 day grace period. In addition if either the minimum tangible net worth of the charterers should fall below $80 million, total debt to total capitalization exceeds 60% or minimum EBITDA coverage falls below 2 times, the charterers will be required to hold $30 million in cash equivalents within the company. All covenants and guarantees will be reduced pro-rate with the bareboat charter.

The residual value risk is also similarly conservative. The estimated combined scrap value of the vessels are between $10-$11 million using ten year average scrap prices and as three of the vessels will have at least 8 years trading life left, a $19 million assumption should make investors feel secure. In addition the benefit of a ten-year life of the investment also reduced the importance of the residual risk, as even with a residual value of $12.5 million the IRR on paid-in equity is 18%.

A deal that works for all

This deal is successful for all parties. Lasco have achieved their goal of off-loading their balance sheet and freeing up nearly $80 million (including the KG deal) which can now be put into more effective use. Klaveness, have added commercial management of five more vessels to their Baumarine pool — as Lasco opted to include the last three — in addition to the upside of its direct investment in the KS. The investors should see a relatively secure investment turning a profit of nearly 20%.

This type of structure, whereby the KS, through a long-term charter, is able to obtain around 85% financing, is very attractive especially in today’s interest rate environment and will very likely be used in similar transactions going forward. The KS market in Norway is still very popular as this deal was oversubscribed in a matter of days and this is certainly a window of opportunity for shipowners looking to loosen up their balance sheet by keeping commercial control of their vessels.