Recent estimates indicate that oil companies and their subsidiaries own only about 34% of the world's tanker fleet, with independent tanker companies owning slightly in excess of 55% and title to the balance resting with various governments around the world. Accordingly, with over half of the world's tankers owned by companies other than those enterprises directly connected with the oil business, the importance to oil companies of the financing of independent tanker operators is immediately apparent.

Historically, shipping companies have obtained financing in various European companies against mortgages on the hulls of the ships, usually up to about 50% of the vessel's cost. Since the value of a ship is tied almost entirely to what it can earn in the marketplace, ship prices fluctuate violently and in sympathy with swings in the world market. If it became necessary to foreclose a mortgage in order to recapture a loan, such foreclosure proceedings would take place at one of the lowest points of the charter market, for if the market were high the vessel would probably be able to earn its debt service. While it is true that adequately capitalized independent companies can ride out the stormy cyclical swings of the industry and over a period of time pay off debt on vessels, commercial banks with demand depositors are usually not in a position to wait out the spot charter market until it swings high enough for the vessel to again become an earning asset. These peaks and valleys of the shipping business have made American lenders shy away from ship loans secured only by the mortgage on the hull of the vessel.

With the world's tanker tonnage seriously depleted by action during World War II, it became evident that a new pattern of ship financing must be developed if the world's oil was to be moved to market. The great oil companies, by and large, ever mindful of net return on investment, found that they had tremendous capital needs immediately following the war for new exploration, refineries and other direct expenditures in the oil producing and distributing business which could show a more profitable employment for capital funds than financing a whole new tanker fleet. Against this background, a financing package was developed which lent to the independent tanker operator the credit of the oil company which wished to use the vessel, without putting a liability for borrowed money in the oil company's balance sheet.

The original financing pattern developed directly following the war involved three pieces of collateral: (1) an assignment of all right, title and interest in a bareboat charter from a major oil company, the charter hire from which was sufficient to cover debt service; (2) a preferred ship mortgage on the hull of the tanker; and (3) the naming of the lender in insurance loss payable clauses on the policies covering the ship. In this fashion, the lending institution obtained a lien on an earning asset, an assignment of that asset's earnings, and an insurance policy which would pay off the loan if the asset were destroyed.

This bareboat financing soon gave way to financing against the assignment of long term time charters. Acceptance of a time charter by the financial institutions constituted a considerably greater risk for their depositors' money than financing against bareboats. This is true, since a time charter is essentially a performance contract, and, if the owner fails to perform, charter hire ceases and, accordingly, the funds to which one looks for debt service also stop.

The importance of picking good operators in time charter financing is the paramount credit consideration. In order to give lenders some protection against the errors which are inevitable in estimating the amount of net charter hire which will be available for debt service after the payment of all operating costs, we at The First National City Bank of New York compute 11 months gross earnings for every calendar year, and net against this figure 12 months estimated operating costs. While some vessels may not be off hire as much as 30 days in any one year, particularly new vessels, experience has shown that this is an equitable yardstick to use. Additionally, when loans are made against a mortgage on only one vessel, owners are usually required to obtain off hire insurance to protect the lender and himself against the cessation of charter hire occasioned by the vessel being unable to perform through some peril of the sea or other mishap.

Operating costs continue to increase, and the hazards of having these increased expenses eat up projected charter hire previously earmarked for debt service must be evaluated. Aside from the partial protection offered by allocating some arbitrary increase in operating costs in computing net charter hire, many long term charters now provide escalation on the five major items of operating expense, sometimes as an absolute amount, often as a percentage, and occasionally tied to some published index of a government agency.

After experience had been obtained with time charter financing, the next step was to finance vessels against the assignment of consecutive voyage charters. An owner with a large fast ship obviously favored the consecutive voyage instrument, but this type of charter added still other credit factors to the ship loan business. It became necessary to inquire closely into the speed of the ship, her bunker consumption, the probable trade in which she would be employed, the computation of the time charter equivalent of the consecutive voyage rate, and, since the owner is responsible for the payment of bunkers under this form of charter, the lender has to assure himself adequate arrangements exist for the obtaining of bunkers at reasonable rates throughout the life of the contract.

The problem of marine insurance is a world all of its own, and one in which lending institutions must seek expert guidance from skillful and resourceful insurance brokers.

Additionally, it is necessary to keep a constant check on the current operating costs of various types of vessels in order to be in a position quickly to evaluate an independent owner's estimate of his projected operating costs when applying for a loan. The legal problems involved in a ship loan are immense and cover everything from the citizenship of the owning company, if the vessel is to be documented under the American flag, to the enforceability of a lien in a foreign port.

The pattern of ship financing outlined above seeks effectively to isolate lending institutions from the vagaries of the charter market and provides a sound basis for the extension of credit to an industry which has not historically commanded adequate credit facilities. The development and refinement of this type lending have grown enormously over the past ten years and undoubtedly constitute the major portion of financing available to independent tanker operators. It is a pattern which enables oil companies to obtain needed tonnage without huge capital investments or the direct employment of their own credit and one which allows independent operators to contract for and build new vessels of superior efficiency to replace the rapidly aging world fleet.

While every ship loan of this kind rests basically on the same premises, no two in my experience have ever been precisely alike. Different provisions in charter parties present different risks and imponderables, amounts of equity contribution follow no set pattern, and the amount and nature of the loan documentation vary widely. In closing, it is interesting to note that the pattern which was developed in ship financing is now spreading to many forms of transportation including aircraft, automobiles, trucks, railroads and barges.