These factors are balanced by the company’s business risk profile, which we view as “fair”.
The business risk profile 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 fleet of dry bulk and container vessels, along with offshore
ultra-deepwater drilling rigs and supply vessels. Ship Finance is to a large extent a financing
company and leases its vessels to operating companies on long-term charter contracts.
SP base-case operating scenario
We believe that conditions for global shipping operators will remain weak in 2012. 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 as low as those during the industry downturn in late 2008. Order
books for newbuilds are still significant; as a result, we expect new vessel deliveries to
continue outpacing the slowing growth in demand, at least over the near term.
We view Ship Finance’s contract structure as largely protected from the prolonged industry
downturn. However, 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. 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+), Husky Energy Inc. (BBB+/Stable/–), and
Petroleo Brasileiro S.A. – Petrobras (BBB/Stable/–) partly offset the concentration
risk.
As of Dec. 31, 2011, the fixed-rate charter backlog from Ship Finance’s current core fleet
of 65 vessels and rigs totaled about $6.2 billion. The average remaining charter term was about
11 years if weighted by charter revenue. In our base-case operating scenario–following the
restructuring of chartering agreements with Frontline–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 $660 million in 2012. These revenues, we expect, will then
decrease to about $640 million in 2013, largely on account of gradually declining contracted
rates for ultra-deepwater drilling rigs. Aside from profit-share income and certain
administration expenses, we understand that revenues and operating costs are mainly fixed under
long-term contracts, which provide 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 $570 million in
2012 and $540 million in 2013, absent any contributions of profit share income.
SP base-case cash flow and capital-structure scenario
In December 2011, Ship Finance made a $156 million one-time debt repayment, of which $106
million represented non-refundable cash compensation from Frontline to Ship Finance for
charter-rate reduction. And as we had expected, this benefited Ship Finance’s credit measures.
As of Dec. 31, 2011, the company’s ratio of adjusted funds from operations (FFO) to debt
improved to 16.7%, up from 15.6% in the 12 months to Sept. 30, 2011.
In 2012, when we expect the reduced income under the amended charters with Frontline will
start to impede operating cash flows, Ship Finance’s credit measures will weaken,
notwithstanding gradually reducing debt. In our base-case scenario, in 2012 we estimate that the
ratios of adjusted FFO to debt and adjusted debt to EBITDA will deteriorate to about 13% and
5.5x, respectively, 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.
Liquidity
We assess Ship Finance’s liquidity as “adequate” under our criteria. For moreinformation,
see “Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers”, published
on Sept. 28, 2011, on RatingsDirect on the Global Credit Portal. We consider Ship Finance’s
liquidity profile to be sufficiently supported by the company’s policy of maintaining an ample
cash balance, its stable contracted cash flows, its strategy of prefinancing vessels on order,
and what we consider to be proactive treasury management.
Our base-case liquidity assessment 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 about 1.3x in 2012.
– Liquidity sources will continue to exceed uses, even if EBITDA declines by 15% in 2012.
– We understand that the company’s bank covenants require it to hold at least $25 million
in cash, cash equivalents, or available in 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 $449 million high-yield notes (of which now $274
million is net outstanding) 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 better. On Dec. 31, 2011, 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 Dec. 31, 2011, Ship Finance had about $95 million of unrestricted cash and about $23
million of available for sale securities. Furthermore, our base-case operating scenario
estimates that Ship Finance will generate about $420 million-$430 million of operating cash flow
(after cash interest costs) in 2012. This includes cash flows from fully owned, but
unconsolidated subsidiaries. In 2012, debt repayment obligations total about $350 million, and
capital-expenditure commitments for ordered vessels due for delivery in 2012-2013 amount to $103
million, for which the company obtained committed funding of $127 million, resulting in a
positive cash contribution of $24 million. We understand that Ship Finance’s remaining
capital-spending commitments due 2013 total $173 million, for which committed funding of $138
million has been arranged.
We note that Ship Finance has bulk refinancing needs, with $1.38 billion in bank loans
related to drilling rigs and a $274 million bond maturing 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 well ahead of their maturities.
Recovery analysis
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.
Outlook
The negative outlook reflects our view that, given the anticipated ongoingweak trading
conditions, Ship Finance might not be able to maintain its rating-commensurate financial
profile. In our view, a downgrade would primarily stem from a prolonged downturn in the shipping
industry, absent prospects for recovery in 2013. 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.
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 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, May 27, 2009
– Standard Poor’s Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008
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