Shipping Trusts – OCBC

Relentless stream of negative news flow

Grim industry outlook. Lloyd’s List reports that spot ocean freight rates for some container cargoes have fallen to zero on the Asia-Europe trades, after stripping out surcharges. Asian countries such as South Korea, Taiwan and Japan have seen 25-45% YoY declines in exports according to the most recent monthly data1 . Last week, Drewry Shipping Consultants revised its estimate for 2008 global container traffic growth to 152.8m TEUs, up 7.2% YoY. It is projecting a marginal 2.8% YoY expansion for 2009. In contrast, it projects that the global container fleet will increase by 12.7% this year. The consulting firm said that the demand-supply imbalance is still far too large, despite liner efforts to remove tonnage. Four small container operators went out of business in 2008 and Drewry said that further casualties “are a real possibility”.

Ship values are falling. At the same time, reports of falling asset values continue streaming in. According to Fairplay, both bulker and tanker ship values reached new lows last week. Tankers have seen a 25-40% decline in vessel value. A five-year-old VLCC2 recorded a value of just over US$100m last week, much lower than its US$163m peak price in August. The dry bulk sector has seen even more extreme declines of 65-70% from last year’s peaks. Five-year-old Capesize values have collapsed from US$154m in July to just US$44m last week.

Lenders are the wild card. The biggest threat to the shipping trust sector is the loan-to-market value (LTV) covenant. The preceding data shows that a breach of the required LTV level, which triggers a technical default, is a real possibility. Pacific Shipping Trust is the only trust without LTV covenants on its loan books. The biggest unknown, in our view, is whether and how lenders choose to call out such a breach. One optimistic viewpoint is that lenders will “forgive” or relax LTV requirements for owners with ships on longer-term fixed charters such as shipping trusts, but this could just be wishful thinking.

We are staying cautious. Trying to predict how lenders will react, which ultimately depends on their risk appetite and capacity, is a dangerous guessing game in our opinion. The high trailing yields seem tempting but external events such as an LTV breach could reduce or eliminate distributions. We retain our NEUTRAL rating on the sector. The trusts release 4Q08 results in the next couple of weeks. While quarterly cash earnings tend to be fairly stable, managers’ articulation of the trusts’ strategy and outlook for 2009 could be worth noting.