2007

Synthetic or Real, It Makes No Difference

How do you finance a newbuilding that is contracted at today’s high prices for delivery in 12 to 18 months? No lender in his right mind is going to lend at a reasonable level against future delivery without a firm known income stream and no charterer is going to fix forward for that period particularly in these frothy times. The answer is to call Douglas Garnsey, Head of Corporate Risk Solutions at The Royal Bank of Scotland (“RBS”) who has structured transactions to bridge this risk by creating synthetic time charters using FFAs with Alex Gray of Clarkson Securities Limited.

Historically, borrowers knew that to leverage up a transaction they had to provide a long-term charter of say five years, at a sufficiently high rate with a first-class name attached. In entering into such a transaction, the owner not only gave up operational control of the vessel but also the upside. With FFAs, this is no longer the case. In the simplest case, these transactions were done as swaps and are hybrids of these original time charter transactions.

Under a synthetic time charter or FFA Swap, the borrower who has an existing relationship with the bank is a seller of a FFA with the bank, RBS, in this instance, as the counter party. The bank, in turn, enters into equal and opposite FFA with a strategic creditworthy counter party such as a name charterer, grain house or a trader as buyer. In fact, at delivery the vessel is trading spot with the FFAs providing a floor and a ceiling. Voila! The ship has term employment that provides visible cash flows to the bank. The FFA market is what makes this work by providing future pricing for periods of up to three years, although it is rumored that longer terms are being done off-market.

This is only an excerpt of Market Commentary – 07/26/2007

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