Shipping Trusts – OCBC

Sharp sell-off across sector

Pessimism rules the seas. We attended Marine Money’s Asia conference earlier this week where the mood of both speakers and participants was overwhelmingly pessimistic. Conversation was focused on two key themes:
1) consequences of the current credit crisis on ship and trade finance; and
2) unfavorable industry outlooks, especially for the container and dry bulk sub-sectors.

Sharp sell-off across trusts. First Ship Lease Trust (FSLT); Pacific Shipping Trust (PST); and Rickmers Maritime (RMT) were all in attendance. ince our last sector report dated Sept 10, the shipping trusts have seen a sharp sell-off in share prices (FSLT down 61%, RMT down 58%, and PST down 37%). We attribute the decline to both transient fears: today’s abnormal credit conditions which have paralyzed equity markets; and to more enduring concerns: the trusts’ extensive use of leverage and overall industry concerns.

Beware the fine print. FSLT announced last week that its lenders had invoked the market disruption clause (MDC) as the reference rate on the loans, the US$ LIBOR, did not accurately reflect the lenders’ actual cost of funds. With increased interest costs, FSLT reduced its DPU guidance for 4Q08 by 1%. PST and RMT told us that some version of the MDC also exists in their loan documents but it has not been invoked as of now. The MDC is a standard clause in almost all loan documents. In our view, the next bit of fine print to watch is loan-to-value.

Multiple layers of risks. There is a very real risk of a large depreciation in underlying asset and rental values. Falling asset values can breach a loanto- market value covenant, triggering a technical default (and potentially distressed sales). We note that PST is the only shipping trust without a version of this clause in its loan documents. Meanwhile, counterparty risk is also becoming more of a concern – a charterer default or rate renegotiation could stress cash flows, endangering distributions or debt repayments. Committed capex is another possible stressor.

The recent sell-off is an overcorrection (in our view) but market logic is trumping everything else at present and we believe we could see further value destruction. We maintain our BUY ratings on PST and RMT, and our HOLD rating on FSLT but place all our fair value estimates under review as we work in latest developments. We believe the trusts will continue to be barraged by negative news flow on the shipping industry.