AUGUST 3, 2012 — In another indicator of tough times in the tanker sector, Moody's Investors Service yesterday lowered its ratings of Overseas Shipholding Group, Inc, ("OSG"); Corporate Family and Probability of Default, each to Caa1 from B3; senior unsecured to Caa2 from Caa1, Issuer rating to Caa2 from Caa1 and Senior Unsecured Shelf to (P)Caa2 from (P)Caa1. Moody's affirmed the SGL-4 Speculative Grade Liquidity rating. The ratings agency said the outlook remains negative.
Moody's said the downgrade of the ratings reflects potential liquidity pressure as the step-down of OSG's $1.5 billion senior unsecured revolving credit on February 8, 2013 approaches. Moody's believes that the company faces a cash deficit of between $200 million and $250 million through December 31, 2013 due to ongoing weak fundamentals that prevent the generation of free cash flow.
Moody's says it believes that freight rates should modestly improve from current levels in line with the historical seasonal pattern as winter approaches. However, the challenging outlook for trading conditions across OSG's international crude and international product tanker segments because of excess capacity in the world fleet accentuates the need for it to now address the step-down of its revolving credit facility. OSG will need to either raise capital to allow it to comfortably comply with the existing terms of the forward-start facility or negotiate an increase in the committed amount of this facility and higher thresholds for financial covenants to have the needed cushion for absorbing weak earnings and cash flow generation, now likely into 2014.
Moody's believes that OSG is likely to seek to monetize its more attractive, non-core assets rather than encumber or sell some of its traditional oil tankers or product carriers since the market values of these vessels remain in the doldrums. A renegotiated credit agreement would likely raise its cost of funds, but more significantly, would require pledging of vessels as collateral. Having a significant number of unsecured vessels to pledge and certain investments to monetize provide OSG important financial flexibility and supports the Caa1 rating as it addresses its current liquidity.
The negative outlook reflects the uncertainty of OSG's ability to timely raise the capital needed to sufficiently reduce drawings on the revolver and comply with the terms of the forward-start facility. The terms of the forward start credit agreement remove the add-back for treasury stock the existing credit agreement allows when calculating the leverage (debt-to-total capitalization) ratio and minimum net worth covenants. Under Moody's forecast assumptions, compliance with the leverage covenant could be challenged as early as at year end 2012 and possibly on the minimum net worth covenant sometime in 2013 if spot tanker rates do not meaningfully improve. The negative outlook also considers the execution risk in, and uncertain timeframe for, completing the liquidity-raising initiatives the company has under way.
The Caa1 Corporate Family rating reflects the increased credit risk as the company's liquidity remains stressed while the freight rate recession continues.
"Moody's does not expect average annual tanker freight rates to meaningfully strengthen above their 2011 levels before well into 2013. Values of international tankers are also not likely to improve as deliveries from the global order book outstrip growth in ton-miles," said Moody's Senior Credit Officer, Jonathan Root. "Contributions of the company's Jones Act fleet have helped to prevent a difficult situation from being even worse and should continue to do so going forward."
OSG remains a market leader in the majority of its trades, says Moody's. Its market position and potential alternate sources of liquidity help mitigate additional downwards rating pressure. However, estimated ongoing operating losses and a continuing burn in cash through 2013 will continue to pressure the company's liquidity and prevent improvements in credit metrics. The Caa1 rating also considers that the company's 46 owned, debt-free vessels and interests in three joint ventures provide alternative sources of liquidity.
The outlook could be changed to stable if OSG can create a sustainable capital structure, by either refinancing the forward start facility, raising equity or monetizing assets, or a combination thereof. Building an adequate liquidity cushion, comprised of a significant amount of unrestricted cash and availability under the forward start facility could also support an outlook change. Sustained improvements in tanker-market fundamentals will be required in order to support an upgrade of the ratings. Sustained improvements in credit metrics, such as Debt to EBITDA of less than 6.5 times, Funds from Operations + Interest to Interest of at least 3.0 times and positive free cash flow generation that is applied to debt reduction could lead to an upgrade; however, we do not anticipate OSG achieving these metrics levels before 2014 at the earliest. Following the stabilization of an adequate liquidity profile, debt-funded fleet growth that limits improvements in credit metrics could derail any positive ratings momentum. The inability to complete liquidity raising actions by November 30, 2012 could lead to a downgrade of the ratings.