S&P Lowers Ship Finance Outlook
Standard & Poors today [Dec.21] lowered its outlook for Bermuda’s Ship Finance International Ltd. after the Hamilton company agreed to amend its long-term chartering agreements with locally-based oil tanker operator Frontline Ltd.
S&P said the move will reduce income from Frontline as of 2012, in exchange for a one-time $106 million cash payment.
“In our base-case operating scenario, Ship Finance’s credit measures will weaken below our rating guidelines in 2012, when the amended charter agreements take effect,” said the international ratings agency.
“We are revising our outlook on Ship Finance to negative from stable and affirming our ‘BB’ rating on the company.
“The negative outlook reflects our view that unless the shipping industry starts to recover in 2013, Ship Finance might not be able to achieve a turnaround of its credit measures, leading to a downgrade.”
S&P’s ratings service added: “We understand that the revision of the agreements with Frontline will occur simultaneously with a proposed recapitalization of Frontline, which experienced financial difficulties following an extended period of weak shipping markets.
“The recapitalization is subject to final bank financing approvals. If it goes ahead, Ship Finance will receive restructuring compensation of $106 million in cash from Frontline comprising the release of $56 million in restricted cash that currently serves as security for its charter payments with Ship Finance and $50 million as early payment of a profit split. In addition to the $106 million cash payment from Frontline, Ship Finance will use $50 million of its own cash to prepay its bank loans related to the vessels with Frontline.
“We believe that conditions for European shipping operators will remain weak. The industry is already plagued by ship oversupply and will likely also face lower trade volumes as a result of the slowing global economy. A flood of new ships hitting the water over the past several quarters is cutting fleet utilization rates and eating into charter rates that are as low as during the industry downturn in late 2008. Order books for newbuilds are still significant, so we expect new vessel deliveries to continue outpacing slowing growth in demand, at least in the near term.”
S&P said Ship Finance’s credit measures will benefit from the $156 million one-time debt repayment scheduled to take place before the end of 2011 although this is still subject to Frontline obtaining bank financing approvals.
“Consequently, we calculate that Ship Finance’s ratio of adjusted funds from operations [FFO] to debt will improve to 16%-17% as of December 31, 2011, from 15.6% in the 12 months to September 30, 2011,” said the ratings agency. “In 2012, when the reduced income under the amended charters with Frontline starts impeding operating cash flows, Ship Finance’s credit measures will weaken, notwithstanding gradually reducing debt.
“In our base-case scenario, we estimate that the ratios of adjusted FFO to debt and adjusted debt to EBITDA will deteriorate to about 13% and 5.5x, respectively, in 2012, which are below our guidelines for the rating. In our view, the weakened credit measures will leave limited headroom for any further adverse operating developments.”
S&P said the rating on Ship Finance reflects its view of the company’s dependence on the shipping industry which its analysts consider to have “speculative-grade” characteristics.
“The rating also reflects Ship Finance’s concentrated exposure to credit risk in its charter-party portfolio and our expectation of the company’s aggressive financial risk profile,” said S&P. “These factors are balanced by the company’s business risk profile, which we view as fair and which is underpinned by long-term, fixed-rate, contract-based revenue and cost structures, credit enhancement for about a half of the company’s revenues, and its large, albeit ageing fleet.
“Ship Finance is to a large extent a financing company and leases its vessels to operating companies on long-term charter contracts. On September 30, 2011, pro forma the restructuring of chartering agreements with Frontline, the fixed-rate charter backlog from Ship Finance’s current core fleet of 61 vessels and rigs was about $6.5 billion.”
The negative outlook reflects S&P’s view that, given the anticipated ongoing weak trading conditions, Ship Finance might not be able to maintain its rating-commensurate financial profile.
“We believe a downgrade would primarily stem from a prolonged downturn in the shipping industry, absent prospects for a recovery in 2013,” said the ratings agency. “Moreover, rating pressure could arise if the credit profiles of Ship Finance’s counterparties deteriorated further, increasing the risk of delayed payments or nonpayment under the charter agreements, or if debt reduced slower than we expect, on account of sizable vessel acquisitions.
“As we estimate in our base-case operating scenario, the ratio of adjusted FFO to debt will deteriorate to about 13% in 2012, before improving to the rating-commensurate level of 15% by 2013 thanks to the full performance of long-term charters and moderate contribution of profit share income. However, we might consider lowering the rating if we see clear signs that credit measures are unlikely to turn around by 2013.”
S&P said it could revise the outlook to stable if analysts observe a gradual market recovery and if the ratings agency considers the company’s credit measures to be sustainably in line with the rating, for example, a ratio of adjusted FFO to debt of 15%.
