DISCLAIMER: PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS. There is no guarantee that any investment objective will be achieved or that losses will not occur. An investment in any Strategy described herein is speculative and involves a high degree of risk. Information contained herein reflects subjective viewpoints regarding the financial markets and shipping industry trends and predictions relating to both. Such viewpoints may be incorrect. No due diligence process can be an absolute guarantee against operational risk or investment losses.
Svein Engh: My background is on the banking side of the maritime industry, where I’ve spent the majority of my career. The last 14 years or so have been on the asset management side.
Particularly post-financial crisis, the banks started to pull back from lending to the maritime industry. Starting around 2012, new regulations were coming into the banking industry, and we also saw private equity and hedge funds getting into the maritime space, typically as speculative investors on the equity side. Back in those days, I had a lot of dialogue with private equity firms as well as hedge funds.
EnTrust Global was the first to call me about the lending side, as opposed to solely buying ships and the typical idea of buying low/selling high that strategy relied on. EnTrust was interested in the lending side because of the banking dislocation, which was very intriguing because they were the first fund manager that looked at the industry from a lending perspective.
Our chairman and CEO, Gregg S. Hymowitz, had the same view of the industry that I did at the time. By the end of 2015, the competitive environment had dramatically changed from before the financial crisis until that time. It had gone from being very overbanked to substantially underbanked. We had a meeting of the minds that this was a great time to start a new business focusing on lending, because of the reduced competition. That was the whole thesis of why we started the business, which is called the Blue Ocean strategy, focusing on lending. Even though we’ve always had a broader mandate, so that within the strategy we can be opportunistic/do other things, the lending side is what drives the business.
Today, I am the Senior Managing Director and Portfolio Manager of the strategy and have brought together a team of experienced maritime analysts and financiers to help execute the strategy. It is amazing to think that what started as an idea and a team of three in 2016, has now evolved into a business that has deployed over $4.6 billion involving more than 100 transactions and a continuously growing team – now with over 20 dedicated investment professionals across the team and our operating partners.
We have always taken a countercyclical approach given market dynamics specific to the multitude of sectors within the industry, such as the Container, Tanker and Dry Bulk markets, and the additional sub-sectors within each of those. Each of these sectors and sub-sectors moves cyclically. As it is difficult to predict absolute peaks and troughs within these sectors/sub-sectors, to successfully invest in this market, it is imperative to have a general sense of where any particular sector may be within its cycle.
As I mentioned, we now have a broader team of over 20 people dedicated to building and managing the portfolio. This is the only thing that Blue Ocean does and is critical to the success of the strategy. When you are focused on lending, it's all about avoiding having to take a loss. It is a cyclical industry, there's no denying it. What do you need to do to make sure that you don't get caught out? The simple answer is you need to focus on being countercyclical, which requires an experienced team of professionals who can identify various dynamics within the market. In other words, when a sector rises to high levels in terms of freight rates and asset values, you have to have the discipline to back off and look at other sectors that are in a more appealing part of their cycle.
"As long as you maintain a countercyclical approach, you should be
able to manage through the cycles no matter what happens."
If you are lending when the asset values are at the highest level, you end up putting too much debt on these assets to perform well in a downturn in the market that's bound to happen at some point in the future. This is something I've always believed in. As long as you maintain a countercyclical approach, you should be able to manage through the cycles no matter what happens, whether it goes up or down. That's something you have to be very, very disciplined about.
On the banking side, unfortunately, a number of banks don't have the same approach, because they are regulated entities, and the regulators tend to focus more on the cash flows than the underlying assets themselves – i.e., the collateral. Regulators typically prefer the banks to lend when the markets are at high levels because that's when you have the highest cash flow. However, that's also typically when you have the most amount of downside risk.
Svein: If you think about global trade, around 85%[1] is seaborne and carried on ships around the world. It's the most economical way to transport finished goods and raw materials. It's something that can't be interrupted and is a pivotal part of the worldwide economy. The industry serves as the backbone of international trade and commerce, facilitating the movement of goods, raw materials, and energy resources across the world. If you think about your daily life, almost everything that you use, touch, and so on, at some point would have been on board one of these ships, either as raw materials or as finished goods.
As I touched on earlier, the industry itself is comprised of many different sectors and sub-sectors. It includes everything from Containerships to Dry Bulk to Tankers, and from Offshore Construction & Energy Infrastructure to Cruise, among others. Again, within each sector, there are many supply and demand factors at play, many of which are specific to the shipping industry. Another interesting thing about the industry is that maritime sub-sectors are historically uncorrelated to each other and to non-maritime industries, which can create diversification benefits for skilled investors. As I mentioned before, the key to our approach is to invest countercyclically. To prudently deploy capital and identify attractive entry points, requires a knowledgeable and experienced team, given all of the dynamics that are at work.
Today, the diminishing availability of capital from traditional credit sources – like banks – continues to create an opportunity for alternative lenders to step in and become financing partners of choice for many shipping companies. Blue Ocean is among the market leaders in alternative financing for the maritime industry – as I mentioned, we have deployed over $4.6 billion since inception across over 100 transactions[2].
Our mandate is essentially to provide financing for anything that touches the water, and while we focus on commercial vessels such as Containerships, Dry Bulk and Tankers, we can also get involved in offshore energy – think oil rigs and wind farms and all of the infrastructure involved in transporting labour and equipment to and from the mainland – as well as things like cruise ships and ports and related maritime equipment.
The emphasis of our business is senior secured loans. These are loans that are directly sourced where we are typically the only debt provider in a customised structure secured by hard assets collateral – vessels – as protection for our loan. The dynamics of the industry allow us to generally charge above-market rates, 10-13% is what we typically charge in interest rates, in addition to obtaining fees and investor protections against pre-payments. Moreover, the collateral against which we are lending tends to be quite liquid, which is an important consideration for risk management.
As I mentioned, our mandate enables us to be opportunistic across the capital structure when working with our borrowers. We have completed junior debt, equity and secondary transactions, as attractive opportunities have presented themselves over the years. However, I should note that our equity exposure tends to be structured equity, which introduces greater cash flow predictability, and more downside protection compared to simply buying the publicly-listed stock of shipping companies and hoping the price rises. This capital structure flexibility enables us to offer comprehensive financing solutions to our partners, positioning us as a one-stop option for all of their financing needs. While only a relatively small portion of our overall strategy, these transactions have been additive to our overall return profile since inception.
"We pride ourselves on what we think distinguishes us, including our industry expertise, speed, scale, flexibility and reputation for transaction certainty."
In addition to the various sub-sectors, an additional level of complexity within this industry that I’ll mention is its ownership base. When you look at the various ship owners within the market, you’ll notice that it’s highly fragmented. While large ship owners like Maersk or MSC are what people typically think of, the vast majority are small- or medium-sized companies and are just as critical to the global supply chain. The typical borrowers utilising our platform are small- to medium-sized owners of vessels who have extensive experience managing their business through market cycles. Generally, these owners are also private companies that are multi-generational family businesses. On the other hand, we have also worked with larger public companies on complex transactions that exceeded $400 million in size, which is a scale on which few can compete in our industry. Regardless of the situation, we pride ourselves on what we think distinguishes us, including our industry expertise, speed, scale, flexibility and reputation for transaction certainty. An interesting fact about our business is that ~40% of our borrowers are repeat customers who appreciate the value-add we bring to the equation and despite our higher pricing, want to continue to partner with us to grow their businesses.
Svein: When we think about the maritime industry and the various complexities I just described, you can imagine that it comes with its own set of challenges, as well as, of course, opportunities. Currently, the maritime capital structure is influenced by several factors, one of which is the aftermath of the Global Financial Crisis.
When this occurred in 2008, it led to a sharp decline in charter rates and asset values, which caused stress in global shipping loan portfolios.
"Changes have led lenders, like banks, to view other assets more favourably,
especially considering shipping’s cyclicality, tenor, and currency dynamics."
This stress was particularly acute in European shipping loan portfolios where exposure was concentrated, leading European banks to reduce their lending activity to shipping companies. In addition, regulatory changes such as Basel III and the European Capital Requirements Directive IV, which mandate higher capital and liquidity requirements for long-term assets, have also discouraged ship finance for traditional lenders. Changes such as these have led traditional lenders, like banks, to view other assets more favourably, especially considering shipping’s cyclicality, tenor, and currency dynamics.
As a result of these dynamics, lending to small- and medium-sized shipping companies has been curtailed, creating a need for capital to refinance existing loans, enable vessel purchases, and facilitate restructurings of stressed companies, which in turn, presents an opportunity for the Blue Ocean team, which has been able to target attractive risk-adjusted returns through direct lending opportunities – most of which we directly source – with vessel owners.
Given the level of the funding gap in the maritime sector, this trend is not expected to change in the near future, and we expect that our pipeline will continue to be robust and grow.
Svein: As I mentioned, when you are focused on lending, it’s all about trying to avoid having to take a loss. With this in mind, our team adopts a countercyclical approach to investing in the maritime industry, which involves focusing on sectors that are identified as being in the lower third of their respective cycles. This strategy is based on the belief that these sectors have cash flows that are effective from the onset and that there is limited downside risk in terms of future collateral value. Our team uses various market data, including information regarding the general global flow of commodities and time series on different indices. Most importantly, and I cannot overstate this, our team’s extensive knowledge of the industry is key to assessing where each sector is in the cycle. We also consider other factors, such as where the assets will be trading and their employment profile, which also impact the loan-to-value (LTV). For instance, if a vessel has a long-term employment to a high-quality counterparty, we may be willing to offer a higher LTV.
Our countercyclical approach serves to mitigate risk in what is otherwise a very cyclical industry. Our ability to mitigate risk is further enhanced by focusing on secured loans, as these loans are typically underpinned by liquid collateral at moderate leverage which is less sensitive to demand shocks. When originating loans, we also conduct comprehensive due diligence on each borrower to mitigate idiosyncratic credit risk, focusing on the assets and the operation by the management company. Furthermore, we test LTVs on a quarterly basis to ensure that there is always positive equity in each of the loans. Ultimately, we believe that approaching capital deployment from a countercyclical perspective, as well as pursuing further risk protections through various mechanisms such as careful analysis, diligent underwriting and loan management, helps us mitigate risk for our investors.
Svein: As we’ve discussed, the maritime lending industry is highly specialised due to the unique nature of the industry itself, which includes the various factors I’ve mentioned, such as the global operation of assets, the capital-intensive nature of the industry, and the specific supply and demand dynamics of the numerous sectors, sub-sectors and ownership base within the industry. This specialisation has certainly limited the number of participants and new entrants in the maritime lending industry, as it requires a deep understanding of the industry, proprietary sourcing capabilities, and the ability to structure strong credits through robust security and covenant packages.
It goes without saying that the limited number of participants and new entrants in the industry presents both risks and benefits. On the risk side, the industry's specialised nature and the high capital requirements can create some significant barriers to entry for alternative lenders. In addition, the global operation of assets and the industry's susceptibility to macroeconomic factors and regulatory changes can also add to the complexity and risk of maritime lending. Factors such as these may restrict the flow of credit to certain industry participants.
On the benefit side, the limited competition can allow experienced maritime investors to target more favourable risk-adjusted returns. Given the supply and demand imbalance between capital required by the industry and capital available to shipowners, we often hold a degree of negotiating leverage when discussing transactions with potential borrowers, where we are often able to extract more favourable terms in terms of potential upside while focusing on downside protection.
As I mentioned, the shipping industry and its unique dynamics also generally offer uncorrelated results vs. other industries/investments that should be additive to investors, including insurance investors, from a portfolio construction perspective. Further, we feel this strategy is well-positioned to meet the needs of insurance risk carriers given the depth of the Blue Ocean team’s experience, their knowledge specifically as it relates to insurers’ risk-adjusted investment goals and the flexible, opportunistic nature of our investment strategy.
Blue Ocean is having a record year for capital deployment in 2024. We are on pace to deploy ~$1.3-$1.5 billion this year, which is above our average of ~$1 billion over the last three years (2021-2023)[3].
The business is encountering a healthy mix of repeat borrowers/counterparties expanding their relationships with us and new borrower relationships as our network continues to grow. Our ability historically to consistently execute on complex, time-sensitive transactions underscores the speed, flexibility and certainty of execution that we believe enhance our reputation with borrowers and help cement our position as a market leader in alternative financing to the maritime industry.
Svein: Two or three years after Blue Ocean’s inception in 2016, we started to get a lot of interest in the strategy from the US insurance companies. This interest came about because of the cash flow that we were generating. As I shared, we are typically able to charge substantial interest rates for our loans. In addition, these loans usually amortise/pay down over time, and when you combine the interest and the principal payments, there's often a lot of cash flow generated, which is then ultimately distributed back to investors. This is something that the insurance market found very compelling.
"Right now, roughly a third of the Blue Ocean strategy’s investor base is from
the insurance company sector – it is a significant part of the business."
Early on in our conversations, we realised that we needed to solve for capital charge requirements, including ratings. We started working jointly with two insurance companies on putting a structure in place, and since then have launched a number of vehicles structured specifically for the US insurance company market.
Everything we do is with our investors in mind, and the insurance market is no exception. Right now, roughly a third of the Blue Ocean strategy’s investor base is from the insurance company sector – it is a significant part of the business. In addition to creating insurance-specific products on the investment side, we now have an internal relationship team 100% dedicated to working with investors in that particular market, which shows that the insurance market is something we firmly believe is important to the overall growth of our investor base.
[1] Source: Clarksons Research Services, Seaborne Trade Monitor, December 2022.
[2] As of June 30, 2024. Includes committed and recycled capital.
[3] As of June 30, 2024. The pace of capital deployments is based on estimates and is subject to various factors and may change.
