OSG: The sharks start to circle

OCTOBER 24, 2012 — Multiple law firms specializing in securities class actions have announced that they are investigating potential claims against tanker giant OSG (NYSE: OSG) concerning possible violations of federal securities laws. The investigations, say most of the law firms, relate to allegations that “certain statements issued by the company between May 6, 2009 and October 22, 2012 concerning OSG’s financial performance were false and misleading.”

Meantime, OSG’s stock twitched up to $1.42 at today’s opening, still down precipitously from the $3.26 region at which they had been trading on October 19. That was followed by the October 22 announcement that caught the attention of the class action lawyers and which disclosed that the company was considering a Chapter 11 bankruptcy filing (see earlier story).

Reuters reports multiple sources as saying that OSG has hired Chilmark Partners and Proskauer Rose for financial and legal advice, respectively, on the potential Chapter 11 filing, while the lenders behind OSG’s credit line have retained Lazard and White & Case to prepare for potential restructuring talks.

Also reacting to the October 22 announcement was rating agency Standard & Poor’s.

It lowered its long-term corporate credit rating on OSG to ‘CCC-‘ from ‘CCC+’. and lowered its ratings on the company’s senior unsecured debt to ‘CCC-‘ from ‘CCC+’, the same as the corporate credit rating. It said its “3” recovery rating remains unchanged, “indicating our expectation that lenders will receive a meaningful (50 percent-70 percent) recovery in a payment default scenario.”

The ratings agency also placed its corporate credit and senior unsecured debt ratings on OSG on CreditWatch with negative implications.

“The downgrade reflects our belief that OSG is facing a high probability of very near-term default, following the company’s announcement today that it is evaluating strategic options including potentially filing Chapter 11,” said Standard & Poor’s credit analyst Funmi Afonja.

Standard & Poor’s said its downgrade of OSG also “reflects Standard & Poor’s criteria and definition for the ‘CCC’ rating category, including our definition of ‘CCC-‘, which states that a default, distressed exchange, or redemption appears to be inevitable within six months, absent unanticipated significantly favorable changes in the issuer’s circumstances.”

The ratings agency noted:

New York City-based OSG is one of the world’s leading liquid bulk shipping companies. As of June 30, 2012, the company operated a fleet of 112 vessels (67 owned, 45 chartered-in), totaling about 10.7 million deadweight tons. The company will take delivery of two vessels in 2013, bringing its total fleet to 114 vessels. Operating both internationally and domestically in the competitive shipping industry, the company has high leverage and substantial revenue exposure to volatile spot markets. Positive credit factors include a well-established market position in the ocean transportation of crude oil and petroleum products and long-standing relationships with its customers, mostly major oil companies that have solid credit quality. We categorize OSG’s business profile as “vulnerable,” its financial risk profile as “highly leveraged,” and its liquidity as “weak” under our criteria.

OSG has weak liquidity in our assessment. As of June 30, 2012, cash sources included existing unrestricted cash balances of $226.6 million. As of July 2012, the $1.5 billion revolving line of credit was fully drawn. Our liquidity assessment takes into account the lower revolver commitment of $900 million from the forward-start facility that will replace the existing revolver in February 2013. Our estimated sources of funds do not include potential asset sales because these are not assured. However, about 70 percent of the book value of OSG’s fleet is unencumbered, providing an additional potential source of liquidity.

We believe that OSG is in a liquidity crisis and the risk of default is imminent, absent unexpected new financing or relief from its lenders. OSG has a $1.5 billion revolver that will be replaced by a smaller $900 million forward-start facility in February next year. During July 2012, the company drew down an additional $343 million under the revolver, reducing availability to zero. Although we believe that a portion of that drawdown could be available as cash on the company’s balance sheet, we expect that there will very likely be a liquidity shortfall even after taking into account cash on hand. As of June 30, 2012, cash sources included existing unrestricted cash balances of $226.6 million. Our estimated sources of funds do not include potential asset sales because these are not assured. However, about 70 percent of the book value of OSG’s fleet is unencumbered, providing an additional potential source of liquidity.

We expect OSG to use its liquidity sources primarily for debt service and for capital expenditures. Roughly $63.6 million is outstanding of OSG’s $75 million 8.75 percent debentures that mature in December 2013. As of June 30, 2012, the company also had $46.5 million in remaining capital commitments for vessels scheduled for delivery in 2013.

In accordance with Standard & Poor’s liquidity methodology and assumptions, in our view, the relevant aspects of OSG’s liquidity include:

A potential deficit of cash sources relative to uses over the next three quarters; The likelihood that covenants will be breached unless there is a very credible plan to avert such a breach in a timely fashion or lenders appear likely to provide a covenant waiver or amendment; and Indications of a poor standing in credit markets, as reflected in serious stock price decline (the current share price is down by roughly 90 percent from a year ago) and wide spreads on its bonds. However, the company retains core bank relationships.

As of June 30, 2012, OSG was in compliance with and had moderate cushion on all its financial covenants. Financial covenants limit secured debt to 30 percent of assets (as of the credit agreement date) and investments in joint ventures (except liquefied natural gas joint ventures) to 30 percent of total assets. The credit agreement also requires maximum leverage (debt to total capitalization) of 0.6x, minimum net worth of no less than $1.2 billion, and minimum unencumbered tangible assets to unsecured debt of 1.5x. The company’s liquidity problems are further compounded by the fact that its financial covenants tighten at the end of the fourth quarter. We believe that there is a high likelihood of a financial covenant breach when the new covenant levels become effective. The financial covenants use a different definition of debt than Standard & Poor’s. We expect the company to continue to meet its covenant requirements.

In resolving the CreditWatch listing, we will evaluate the steps OSG takes to address its liquidity crisis, including potentially filing for voluntary Chapter 11 protection. We will also assess the impact of any potential restatements of the company’s financial statements on its operating prospects and financial viability.