December 7, 2011

Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants
Primary Credit Analyst: Funmi Afonja, New York (1) 212-438-4711; funmi_afonja@standardandpoors.com Secondary Contacts: Izabela Listowska, Frankfurt (49) 69-33-999-127; izabela_listowska@standardandpoors.com Manuel Guerena, Singapore (65) 6239-6332; manuel_guerena@standardandpoors.com Per Karlsson, Stockholm (46) 8-440-5927; per_karlsson@standardandpoors.com Jatinder Mall, Toronto (1) 416-507-2544; jatinder_mall@standardandpoors.com

Table Of Contents
What's Behind The Decline In Tanker Market Values? Most Lenders Are Reducing Their Exposure To The Industry The Struggle To Generate Liquidity And Avoid A Covenant Breach Ratings Implications For Companies At Risk Of Covenant Breach Related Research

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants
Plunging tanker values and weak rates are unleashing a litany of problems for international shipping companies and their financiers. Many ship owners have loans with collateral maintenance covenants that require the amount they've borrowed against a vessel to remain within a specified range of its fair market value. Thanks to prolonged weak rates for ship owners, tanker values are dropping, and many companies are on the brink of breaching those covenants. Where breaches occur, ship owners may have to pay part of a loan early. And if covenant cushions merely shrink, shippers' access to bank lines may decrease also, damaging their liquidity and financial risk profiles. We think that companies will continue to struggle until there is a meaningful and sustained increase in tanker shipping rates--and we don't expect that before the end of 2013. (Watch the related CreditMatters TV segment titled, "Plunging Asset Values And Weak Rates Threaten Global Shippers' Financial Covenants," dated Dec. 7, 2011.) The damage to individual shipping companies will vary. In many cases, the shipping industry's financial distress is forcing lenders to agree to covenant waivers and amendments--or risk loan defaults. But banks are also tightening the lid on already limited debt financing, with many scaling back their ship loan portfolios. This has contributed to our decision over the past 12 months to downgrade five of the 10 international tanker companies we follow. Over the next 12 months, we could take more negative ratings actions if market conditions do not improve. Overview Falling tanker values are putting shipping companies at risk of breaching their loan covenants and possibly defaulting. This is causing mounting cash flow and liquidity problems. We don't expect that tanker values will improve until rates recover. We have already downgraded five operators this year, and more could face a similar fate.

What's Behind The Decline In Tanker Market Values?

The market value of tankers has dropped over the past 12 months, with the largest tankers (very large crude carriers, or VLCCs) suffering the biggest losses. As an example, the average price of a 5-year-old VLCC is down by about 65% from the July 2008 peak of $165 million. Many factors figure into a vessel's market value, including its replacement cost (largely a function of steel prices) and earnings potential over its useful life. A ship's earnings potential is determined by voyage revenues (a function of tanker rates) less voyage expenses (such as fuel and port charges) and vessel expenses (including crew costs and management fees). But the industry tends to view shipping rates as a proxy for a ship's market value, since when they fall a vessel's revenue and earnings potential does too. That leaves buyers unwilling to pay as much for ships--the opposite of what happens when rates are rising.

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants

Chart 1

Collateral maintenance covenants in credit agreements may require that the fair market value of a vessel that serves as collateral for a loan not fall below a certain level, or not fall below a multiple of the loan balance. The idea is to protect the lender in the event of a loan default--by making sure that the proceeds from the sale of a vessel would be sufficient to cover the outstanding loan principal. Currently, asset values are falling faster than loans balances, leading to many loan-to-value ratios well above 100%. What this means is that in a loan default, proceeds from the sale of vessels would not be sufficient to cover the outstanding loan principal.

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants

Chart 2

Most Lenders Are Reducing Their Exposure To The Industry

To avoid losses from companies that might otherwise default on loans, lenders are amending credit agreements by adding clauses that permanently reduce lines of credit and require borrowers to pledge more unencumbered vessels as collateral. They are also implementing cash flow sweeps (where the creditor imposes a mandatory debt paydown above scheduled amortization when the borrower's cash balance exceeds a defined threshold) to force debt repayments. European banks (HSH Nordbank, DnB NOR, BNP Paribas, Credit Agricole CIB), many of which are embroiled in the European sovereign debt crisis and are big players in the ship financing market, are feeling mounting pressure to curtail financing for new ships and to further shrink existing loans to the sector. For example, HSH Nordbank, in a deal with the European Commission agreed to cut its balance sheet by 40%, relative to 2008

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants

levels, by the end of 2014. Banks are also seizing ships--or arresting them, in industry terminology--and forcing asset sales to cut their loan losses. For example, earlier this year, the Royal Bank of Scotland arrested a tanker owned by Ocean Tankers Holdings (not rated) because of outstanding loan payments. By contrast, Asia-based state regulated agencies, such as the Export-Import Bank of China, the Export-Import Bank of Korea, and the Japan Bank for International Cooperation, have continued to provide financing to existing borrowers and are still investing in new ship financing, in part because shipbuilding is important to their economies. Still, these agencies provide only a small fraction of the financing the industry needs and thus can't fix the credit problems of most shippers. Media reports suggest that Chinese shipping companies could be building as many as 80 very large crude carrier tankers over the next few years, as part of the government's goal to transport about half of oil imports on Chinese-owned ships. If the reports are true and China builds new vessels (a process that will take several years), we believe this will alter the seaborne international crude oil trade significantly. Non-Chinese international tanker operators will suffer sustained capacity overhang that will cause crude oil tanker rates to crash and asset values to take a deeper nosedive.

The Struggle To Generate Liquidity And Avoid A Covenant Breach

Ship owners facing a potential covenant breach typically need to raise a substantial amount of cash to pay down their loans and bring them in line with covenants. Usually, cuts in operating expenses hardly make a dent in that figure, because the high fixed-cost nature of shipping limits the amount of expenses they can cut. In theory, companies that own unencumbered vessels can raise cash by doing sale-leaseback agreements (ship owner sells vessel and leases it back at a fixed rate over a set period). Or, they can sell or scrap vessels. In the current environment, though, owners that want to sell or sell and lease back vessels are having increasing difficulty finding buyers and lenders. And the few buyers in the market are demanding deep discounts, forcing sellers with limited bargaining power to record shortfalls relative to the book value of their vessels. Owners that choose to scrap vessels have so far benefited from high steel prices. However, global economic turmoil doesn't guarantee that steel prices will stay high. To help avoid covenant violations, owners could adopt more moderate financial policies, such as cutting dividends and avoiding share buybacks. With the exception of Teekay Corp. (BB-/Stable/--), none of the tanker operators we rate have repurchased shares since 2010. If a potential breach isn't imminent and the company is public, it may have time to raise capital through an equity offering. Embattled tanker operators can also turn to private equity or hedge funds for equity infusions or to issue debt hybrids, such as convertible preferred and pay-in-kind notes, though they typically have to pay high interest rates to place those. They could also issue warrants to purchase sizable amounts of equity in their companies at a greatly reduced strike price to lure investors. Several of the international tanker operators we rate, including Navios Maritime Acquisition Corp. (B/Stable/--), Overseas Shipholding Group Inc. (B/Watch Neg/--) and General Maritime Corp. (D/--) have used some combination of these strategies to raise capital and improve liquidity. But these options are becoming increasingly difficult to arrange, because of global economic turmoil, strained capital markets, and geopolitical uncertainty. That said, some companies we rate have negotiated multiple covenant amendments over the past 12 months. The nature of these usually depends in part on a company's original credit agreement. Some agreements have a cure provision or grace period that allows the borrower to remedy a breach through an equity sponsor's equity infusion or via a pledge of more vessels as collateral, for example. For companies with agreements that don't include a cure

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants

provision or grace period, a breach could be tantamount to a loan default.

Chart 3

Ratings Implications For Companies At Risk Of Covenant Breach

We may lower a company's corporate credit rating even if it successfully amends its financial covenants. This is because many companies in this predicament also suffer from severely constrained liquidity, highly leveraged financial risk profiles, and limited financial flexibility. In addition to covenants tied to vessels' fair market values, most credit agreements contain covenants that limit debt leverage and require minimum fixed charge coverage or interest coverage levels, for example. While a covenant amendment may stave off the imminent breach of a credit agreement, it doesn't resolve the underlying credit quality issues. Moreover, companies often try to resolve a potential covenant breach in tandem with solving a severe liquidity crisis. To do so, they may look to restructure their debt or contemplate filing for bankruptcy (leading to a 'D' rating). We could lower the corporate credit rating to 'SD' if a company reaches an agreement to restructure its debt in a manner that we would classify as a selective default (see "Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings," published Dec. 23, 2010), and lower our issue-level rating on the restructured debt to 'D'. We could lower the recovery ratings (debt instrument-specific estimates of post-default recovery for creditors) on

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants

rated debt issues if our simulated default scenario leads us to believe that lenders will recover lower principal and pre-petition interest due to falling asset values. In evaluating the recovery prospects associated with the underlying assets, we typically use a discrete asset valuation methodology because most vessel financings have a security interest over specific vessels, giving lenders a strong incentive to seek recovery upon default by repossessing and disposing of their respective collateral. We only assign recovery ratings to companies with speculative-grade corporate credit rating. Our recovery ratings when viewed together with the company's corporate credit rating can help investors evaluate a debt instrument's risk/reward characteristics and estimate their expected return. General Maritime ('D') is one of several international shippers we rate that has defaulted. If the world economy stays weak long enough, more shippers eventually could find that there are too few life preservers to go around.
Table 1

Rated International Tanker Operators, Strongest To Weakest

As of Nov. 23, 2011 Company name MISC Bhd.* Stena AB BW Group Ltd. Ship Finance International Ltd. Teekay Corp. First Ship Lease Trust Ltd. Navios Maritime Acquisition Corp. Overseas Shipholding Group Inc. PT Berlian Laju Tanker Tbk General Maritime Corp. Rating BBB+/Negative/-BB+/Negative/-BB/Stable/-BB/Stable/-BB-/Stable/-BB-/Negative/-B/Stable/-B/Watch Neg/-B-/Negative/-D/-Business risk profile Satisfactory Satisfactory Fair Fair Satisfactory Weak Weak Weak Weak Vulnerable Financial risk profile Significant Aggressive Aggressive Aggressive Highly leveraged Aggressive Highly leveraged Highly leveraged Highly leveraged Highly leveraged Liqudity assessment Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Weak Weak Standard & Poor's analyst Manuel Guerena Per Karlsson Manuel Guerena Izabela Listowska Jatinder Mall Manuel Guerena Izabela Listowska Funmi Afonja Manuel Guerena Funmi Afonja

1 2 3 4 5 6 7 8 9 10

*MISC Bhd.s rating reflects application of Standard & Poor's criteria for rating stand-alone credit profiles within our group methodology. We assess MISC's stand-alone credit profile to be 'bb+'. Stena AB is not a pure-play tanker company; it is a conglomerate with interests in shipping, offshore drilling, ferry operations, real estate, and other investments. Ship Finance international Ltd. and First Ship Lease Trust Ltd., though not tanker operators, own tanker fleets that they lease to operating companies. They are therefore exposed, albeit indirectly, to the underlying issues in the industry.

Table 2

Peer Comparison--Shipping Companies

Ship Finance Overseas PT Berlian General BW Group International Teekay First Ship Shipholding Laju Tanker Maritime MISC Bhd. Stena AB Ltd. Ltd. Corp. Lease Trust Group Inc. Tbk. Corp. BBB+/Negative/-- BB+/Negative/-- BB/Stable/-BB/Stable/-- BB-/Stable/-- BB-/Negative/-- B/Watch Neg/-- B-/Negative/-D/--/-Sept. 30, 2011 June 30, 2011 June 30, 2011 June 30, 2011 June 30, 2011 Sept. 30, 2011 Sept. 30, 2011 Sept. 30, 2011 Sept. 30, 2011

Rating as of Dec. 5, 2011 Rolling 12 months ended (Mil. $) Revenues EBITDA

3,769.5 562.8

4,078.7 1,058.7

1,108.7 451.6

774.6 685.3

1,932.3 657.9

105.3 82.2

1,023.8 121.1

648.7 198.1

382.9 52.3

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants

Table 2

Peer Comparison--Shipping Companies (cont.)

Net income from continuing operations Funds from operations (FFO) Capital expenditures Free operating cash flow Discretionary cash flow Cash and short-term investments Debt Equity Adjusted ratios EBITDA margin (%) Operating margin (%) EBITDA interest coverage (x) EBIT interest coverage (x) Return on capital (%) FFO/debt (%) Free operating cash flow/debt (%) Debt/EBITDA (x) Total debt/debt plus equity (%) 14.9 5.0 2.7 26.0 13.4 2.8 40.7 21.3 4.8 88.5 68.5 4.2 34.0 10.8 3.7 78.1 22.6 3.6 11.8 (6.4) 0.7 30.5 9.4 1.1 13.6 (13.8) 0.5 430.6 398.1 142.4 138.7 (226.2) (3.3) (198.2) 24.2 (260.0)

787.3

1,060.9

388.3

553.1

396.7

56.1

43.5

16.2

(26.4)

1,497.4 (919.0)

2,047.8 (980.0)

164.7 204.9

357.6 207.3

596.5 (233.4)

94.7 (33.8)

598.9 (561.8)

280.7 (320.0)

148.2 (186.9)

(1,461.6) 469.8

(1,024.4) 158.5

144.0 176.0

90.2 88.5

(513.8) 497.5

(56.5) 28.5

(615.4) 182.1

(320.0) 194.7

(187.8) 37.9

4,644.5 7,543.6

8,912.6 4,673.5

2,032.1 3,183.0

3,646.9 857.9

5,152.5 3,335.5

481.5 342.8

3,449.6 1,603.6

2,276.5 1,018.5

1,345.3 305.7

1.6 2.7 17.0 (19.8)

1.9 5.8 11.9 (11.0)

3.3 5.1 19.1 10.1

3.6 13.0 15.2 5.7

1.3 2.7 7.7 (4.5)

1.0 2.7 11.7 (7.0)

(0.2) (0.8) 1.3 (16.3)

0.4 2.4 0.7 (14.1)

(0.1) (0.5) (2.0) (13.9)

8.3 38.1

8.4 65.6

4.5 39.0

5.3 81.0

7.8 60.7

5.9 58.4

28.5 68.3

11.5 69.1

25.7 81.5

Navios Maritime Acquisition Corp. does not release its financial statements publicly.

Related Research
Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings, Dec. 23, 2010 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009

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Declining Asset Values Are Putting International Shipping Companies At Risk Of Breaching Loan Covenants 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

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