Tuesday, September 22, 2009


THE KG model has long looked to be the weakest link in the newbuilding financing fiasco. Up until recently, bankers have been afraid to add pressure, for fear of making the situation worse.

That may be changing. Klaus Stoltenberg, head of shipping and aviation at German bank NordLB, speaking at a conference in Hamburg last week, enunciated the banks' dilemma in stark terms: "Basically, we want to keep projects alive but we need adequate rewards," he said.

The KG financing scheme now seems like the kind of daft idea that could only be invented in the easy money atmosphere of a market bubble. KG houses collect money from small investors to finance a newbuilding via equity, covering about a third of the cost of construction, with the remainder financed via a mortgage underwritten by a bank. But because of a mismatch in timing common in financing new ships, the vessels are usually ordered before the KG houses collect the money. Banks make up for the gap by offering bridge loans.

Those loans are becoming very hard to justify, as the value of ships has declined in the crisis. Mr Stoltenberg offered an example of a loan for a fictional 5,300 teu container ship ordered in 2006 to be delivered in 2009. Capital required to be regulated under the Basel II regime would amount to about €481,000 ($710,000) in 2006. But if the vessel is delivered this year and cannot find employment, the capital required on a bank's books would be 25 times that much.

The reckoning due is not unlike the collapse last year in derivatives contracts based on underlying mortgage values, although the overall value, of course, of the KG market is much smaller. But similar to the situation with banks and CDOs, unsupported leverage was extracted out of an underlying deal involving private investors. And the ultimate outcome, when the dam breaks, may require a political solution.

Banks are as guilty in this cycle of virtue-less finance as the KG houses, and arguably, the small investors themselves. Yet, they are not villains for stating the reality that the business has become untenable. It's a relief that, via Mr Stoltenberg's comments, they are asserting common sense.

Certainly, drawing the line will be painful, but without the pain, a solution can never emerge. A zombie KG market is more damaging to the industry than one in which the parties begin to address their wounds


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