Nov 28 -
Summary analysis -- Ship Finance International Ltd. --------------- 28-Nov-2012
CREDIT RATING: BB/Negative/-- Country: Bermuda
Primary SIC: Deep Sea Foreign
Mult. CUSIP6: 824689
Credit Rating History:
Local currency Foreign currency
05-Dec-2006 BB/-- BB/--
05-Dec-2003 BB-/-- BB-/--
The rating on Bermuda-registered Ship Finance International Ltd. (Ship Finance) reflects Standard & Poor's Ratings Services' view of the company's dependence on the shipping industry, which we believe has speculative-grade characteristics, and its concentrated exposure to credit risk on its charter-party portfolio. The rating also reflects our view that Ship Finance's financial risk profile is "aggressive", with credit measures that are currently weak for the rating.
We consider these risks to be partly balanced by Ship Finance'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 one-half of the company's revenues; and a large, albeit aging, fleet. In addition, Ship Finance owns one of the largest oil tanker fleets in the world. It also owns a small fleet of dry bulk ships, container vessels, and car sea carriers, along with offshore ultra-deep-water drilling rigs and supply vessels. Ship Finance is a financing company and leases its vessels to operating companies largely on long-term charter contracts.
S&P base-case operating scenario
We believe that conditions for global shipping operators will remain difficult in the near term. In general, the industry is already plagued by ship oversupply and will likely also face lower trade volumes as a result of a slowing global economy. A flood of new ships hitting the water over the past several quarters is cutting fleet utilization rates and eating into vessel values and charter rates, the latter of which are continuing at historical lows. Order books for newbuilds are still relatively large, albeit easing; as a result, we expect new vessel deliveries to continue outpacing the slowing growth in demand, at least over the next few quarters, which will continue to impede recovery in charter rates.
Overall, we view Ship Finance's contract profile as well protected, but not fully insulated, from the prolonged industry downturn. As such, the company agreed to amend its long-term chartering agreements with Frontline Ltd. (not rated), its second-largest counterparty, which will reduce the income generated by these agreements by a maximum of $66 million annually in 2012-2015, after which time the charter rates will revert to previous levels. We note that Ship Finance received a $106 million compensation payment from Frontline for the temporary reduction in charter rates and also has a cash sweep mechanism for 100% of the reduced amounts. Furthermore, over the past few months, Ship Finance has taken redelivery of five containerships and four drybulk vessels before final maturity of the charters, due to financial restructuring or nonpayment of its counterparties. We understand that the company has rechartered these vessels at rates below and contract durations shorter than the ones in previous contracts, which will hamper its earnings potential.
Ship Finance is likely to retain a concentration of credit risk on Seadrill Ltd. (not rated) and Frontline, which we think will continue to account for about 50% and about 30%, respectively, of Ship Finance's total charter income. In our view, structural credit enhancements in Ship Finance's contracts with Seadrill benefit from heavily front-loaded charter payment profiles, and subcharters to the oil majors ExxonMobil Corp. (AAA/Stable/A-1+), Statoil ASA (AA-/Stable/A-1+), and Petroleo Brasileiro S.A. - Petrobras (BBB/Stable/--) partly offset the concentration risk.
As of June 30, 2012, the fixed-rate charter backlog from Ship Finance's core fleet of 68 vessels and rigs totaled about $5.5 billion. The average remaining charter term was about 10.5 years if weighted by charter revenue. In our base-case operating scenario, we estimate that Ship Finance will earn fixed-rate charter revenues (including those reported by Ship Finance's fully owned but unconsolidated subsidiaries) of about $640 million in 2012. These revenues, we expect, will then decrease to about $620 million in 2013, largely on account of gradually declining contracted rates for ultra-deep-water drilling rigs. Aside from profit-sharing and cash-sweep incomes, as well as certain administration expenses, we understand that revenues and operating costs are mostly fixed under long-term contracts, which provides a high degree of earnings predictability, in our view. Based on these assumptions, we forecast that Ship Finance will generate annual EBITDA (including that reported by Ship Finance's fully owned but unconsolidated subsidiaries) of about $530 million in 2012 and $510 million in 2013, absent any contributions of profit-sharing income.
S&P base-case cash flow and capital-structure scenario
We expect that the reduced income under the amended charters with Frontline and vessels re-employed at lower-than-previous rates will continue impeding Ship Finance's operating cash flows and therefore also its credit measures, notwithstanding gradually reducing debt. In our base-case scenario, in 2012 we estimate that the ratio of adjusted funds from operations (FFO) to debt will deteriorate to about 13% from about 16% in 2011, and hence below the 15% we consider appropriate for the 'BB' rating. Under our base case, we forecast that Ship Finance's credit measures will rebound to a rating-commensurate level by 2013. This is based on our assumption that Ship Finance will earn a cash sweep income of at least $40 million, in addition to a full performance under its long-time charters. Our base case also assumes that the company will make no sizable capital investments beyond the current new building program and, therefore use its discretionary cash flows predominantly for debt reduction.
We currently assess Ship Finance's liquidity as "adequate" underpinned by the company's policy of maintaining an ample cash balance, its largely stable contracted cash flows, and its strategy of prefinancing vessels on order. We note however that Ship Finance has bulk refinancing needs, with $1.1 billion in bank loans related to drilling rigs and a $274 million bond maturing at various dates in the second half of 2013. Based on its favorable track record, we anticipate that Ship Finance's management will arrange funding for the debt instruments within the timeframe that allows the company to retain its "adequate" liquidity profile, under our criteria. We understand that about $1.1 billion bank loans related to drilling rigs are significantly overcollateralized given the front-loaded debt repayment schedule.
Our base-case liquidity assessment as of June 30, 2012, for the upcoming 12 months reflects the following factors and assumptions:
-- We expect the company's liquidity sources (including operating cash flows, surplus cash balances, and committed bank financing for newbuilds) to exceed liquidity uses (capital spending, mandatory debt repayments, and dividends) by at least 1.2x.
-- Liquidity sources will continue to exceed uses, even if EBITDA declines by 15%.
-- We understand that the company's bank covenants require it to hold at least $25 million in cash, cash equivalents, or available under long-term committed facilities at the end of each quarter and to adhere to certain minimum value clauses. Other covenants in Ship Finance's corporate senior secured bank facilities and high-yield notes include restrictions on payments, investments, and the incurrence of new debt. The covenants include requirements for the company to maintain an equity-to-asset ratio of at least 20% at the end of each quarter and consolidated current assets minus consolidated current liabilities of $0 or more. On June 30, 2012, the company was in compliance with all covenants.
-- The company appears to have sound relationships with its lenders and a satisfactory standing in credit markets.
-- We consider Ship Finance's liquidity management to be generally prudent.
As of June 30, 2012, Ship Finance had about $101 million of unrestricted cash and about $40 million of securities available for sale. Furthermore, our base-case operating scenario estimates that Ship Finance will generate about $400 million of operating cash flow (after cash interest costs) in 2012 and in 2013. This includes cash flows from fully owned, but unconsolidated subsidiaries. Also in October 2012, Ship Finance issued equity of $89 million and placed a bond of NOK 600 million (equivalent of about $105 million), which will boost the company's cash position at year end.
As of June 30, 2012, short-term debt repayment obligations totaled about $385 million, and capital-expenditure commitments for ordered vessels due for delivery in 2012-2013 amounted to $224 million, for which the company had obtained committed funding of $198 million, resulting in a required cash contribution of only $26 million.
Ship Finance's senior unsecured debt is rated 'B+', two notches lower than the corporate credit rating. This is a result of the contractual subordination of the company's notes to the unrated senior secured bank facilities. The notes contain a change-of-control clause, which could trigger early repayment if the company were sold. We note that all of Ship Finance's vessel-owning subsidiaries have issued supplemental indentures with joint and several guarantees in favor of the senior unsecured debt.
The negative outlook reflects our view that, given the anticipated ongoing weak trading conditions, Ship Finance might not be able to improve and sustain its credit measures commensurate with the rating. In our view, a downgrade would primarily stem from a prolonged downturn in the shipping industry, absent prospects for recovery in 2013. Moreover, negative rating pressure could arise if the credit profiles of Ship Finance's counterparties deteriorated further, thereby 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. We also consider that a timely renewal of debt maturing in 2013 is critical to maintain the current rating.
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 about 15% by 2013, thanks to the full performance of long-term charters and moderate contribution of cash-sweep income. However, we might consider lowering the rating if we see clear signs that credit measures are unlikely to turn around by 2013. Unexpected delays by Ship Finance in obtaining the extension of debt instruments, which we currently expect by end of the first quarter 2013, could also adversely affect our rating.
Conversely, we could revise the outlook to stable if we observed a gradual market recovery and if we considered the company's credit measures to be sustainably in line with the rating: for example, a ratio of adjusted FFO to debt of about 15%.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012