(Corrects Feb. 20 story to remove incorrect reference to sale of loans by Varde and Oakhill)
By Jonathan Saul and Maiya Keidan
LONDON, Feb 20 (Reuters) - A growing number of hedge funds are moving into shipping debt, an asset class few have invested in before, looking to buy up loans and bonds as banks cut their exposure to the troubled sector.
World economy worries and cost pressures are dampening prospects for a proper recovery in many segments of the shipping sector, which has struggled with tough markets for a decade.
Meanwhile European banks, particularly German lenders, are trying to offload distressed and performing loans to the industry which attracts high capital requirements.
The European Central Bank's banking supervisor has flagged troubled non-performing loans in 2019 as "a concern for a significant number of euro area institutions".
Hedge funds clocked up hundreds of millions of dollars in losses from investments in mainly equities when the shipping industry first turned sour a decade ago – and have made limited forays for the most part since.
Last year some equity-focused funds bet on a recovery for the global shipping industry through the stock and futures markets but many are now retrenching after heavy losses in the fourth quarter.
Debt-focused funds are hoping for more luck.
"There is more hedge fund buying interest in shipping debt than in equity now. I don't think anyone believes the (shipping) market will recover any time soon," said Basil Karatzas of New (KOSDAQ: 160550.KQ - news) York based shipping finance advisory firm Karatzas Marine Advisors & Co.
"So, if you buy equities the upside potential is limited. You can more easily make double-digit returns through credit risk investments."
Hedge funds looking at distressed loans include York Capital Management and Cross Ocean Partners, the sources said.
A spokesman for York Capital declined to comment, while Cross Ocean Partners did not respond to requests for comment.
One deal expected to generate hedge fund interest include a portfolio of distressed shipping loans that Greece's Piraeus Bank is seeking to sell, finance sources said.
A source close to the Piraeus Bank (Athens: 21535576.AT - news) deal said the portfolio of shipping loans, called Nemo, was made up of non-performing and performing loans with a nominal value of 500 million to 600 million euros. The source said a sale was expected to close in the second quarter of 2019, declining to provide any details on potential bidders.
Och-Ziff Capital Management was amongst the suitors for a 2.7 billion euro distressed portfolio of shipping loans that was sold this month by ailing German state bank NordLB, which sources said was bought by private equity firm Cerberus.
Och-Ziff did not respond to requests for comment.
NordLB plans to wind down its remaining non-performing shipping loan portfolio of nearly 4 billion euros almost completely by the end of the year, which sources said is still likely to involve some loan sell-offs and expected to generate hedge fund interest.
Germany's No.2 lender DZ Bank is also trying to offload over one billion euros of toxic shipping loans from its troubled transport financing division DVB Bank, although there have been multiple delays with the sales process, finance sources said.
Others though have opted for other types of investments, viewing toxic debt as too risky now.
"Hedge funds need to step in to shipping but it's a bit early for the distressed cycle. It's a question of timing," said Louis Gargour, chief investment officer at hedge fund firm LNG Capital (Other OTC: CGHC - news) , which has around 10 to 15 percent of its total exposure focused on bond issuances by shipping companies. (Additional reporting by George Georgiopoulos in Athens; editing by David Evans)