First Ship Lease Trust - Back to Earth

2Q 2009 Results

First Ship Lease Trust, FSLT announced its 2Q 2009 quarter results on 21st July, 2009. Forward DPU forecast came in at 1.5 USD cents, much lower than the 3.08 USD cents ever announced. Rather then feeling disappointed, I felt reassured of my investment instead. The forecast of 1.5 USD cents DPU was arrived at by setting aside 50% of free cash flow to pay off debt, rather than distribute to shareholders. This, in itself, is more prudent and sustainable in keeping FSLT afloat.

Impact on FSLT

The following table illustrates the impact of DPU cut and the increased voluntary debt payment will have on FSLT:

Assuming 50% of operating cash flow is used to pay off debt totally, the amount of outstanding debt by 1Q 2012 (first bullet payment becomes due) is reduced by 20.62% to 395m USD. The value-to-loan ratio will have been 175%. Interestingly, the current loan-to-value ratio is 176%. Against the value-to-loan covenant of 145%, seems to me 30% is the comfortable margin the management intends to maintain.

If so, unless FSLT is slabbed with higher interest rates by the lenders, chances for further cut in DPU is unlikely.

Personal Performance

So what does the cut in DPU mean to me, as a shareholder? The following table illustrates my own valuation of FSLT on my portfolio:

From a huge paper loss when FSLT plunged way below 40 cents in March earlier this year, the share price of FSLT had recovered to paper gain for me (factoring dividend payout so far). As shown in the projected future payouts using 1.5 USD cents as a guide, my investment in FSLT will only remain barely profitable, unless the equity value improves instead of decline (factoring dividend payout) as projected.

The missing piece

Cutting the DPU and making higher loan repayment is only one critical step in the right direction. If the managment is really sincere in creating value for shareholders, more had to be done.

Firstly, once the share price recovers to a more realistic value, say 87 SGD cents (10% annualised yield), the management should seriously consider a rights issue to clear the debt and make DPU accretive acquisitions again given current down-to-earth valuation of ships. The dilutive effect will be significant, but it will go a long way for supportive shareholders who does see a future for FSLT beyond 2012.

Secondly, once the credit market resume back to 'normal' before the subprime induced credit crisis, the management should re-negotiate a more realistic and sustainble amotizing debt repayment scheme with the lenders.

Conclusion

Now that FSLT is back to earth, it should seriously consider making more earthly decisions to grow FSLT in a more sustainable and profitable fashion. Just like Tsit Wing, I hope to make good money (ROI), not merely breakeven. For now, I still see a potential in FSLT.

First Ship Lease Trust's Distribution Reinvestment Scheme (DRS)

DRS Summary

In short, DRS is a scrip dividend scheme for FSLT to make payments through issuing new shares in place of cash. FSLT had 2 strategies to reduce cash payout in terms of dividend, one is via direct reduction in distribution (from almost 100% to 75%) and second is via DRS. While a 25% cut in direct distribution conserve about USD 4m, how much DRS can conserve depends on the take up rate, up to a potential conservation of about USD 12m. To entice shareholders to take shares instead of cash, the shares are offered at a discount of about 5%.

Shares or Cash dividend?

I had an enjoyable discussion on the topic with a reader and the our correspondences (via comments on one article) can be found here. After the fruitful exchange with better insight, I summarise the key points and add a few more.

Qualitatively, if the market ultimately recover (before 2012 when the first bullet payment is due), choosing shares might seems a better option. But in current market sentiment where cash is king, many might choose cash that is immediately tangible. If the shares crash further, the cash can buy more units than those offered at a discount under DRS.

Those who should know better

Is there other hints for a better decision? The management and the sponsor should hold the key to the answer, if they don't know, who would know better? Along with the annoucement on the discounted price of the new shares under DRS, the take up rate of the key directors and sponsors are disclosed as well. If all of them subscribe 100% to new shares, I would almost do the same without much thought. In contrast, if the unamious choice is cash, I'll take cash and run fast. However, shareholders looking for a mark of confidence is still disappointed. The key directors take up 100% while the sponsor choose only to take up the 25% of the distribution in shares. 'Insiders' show their confidence, sponsors shows their reservations.

Quantitative Analysis

So qualitative analysis doesn't help here. How about quantitative analysis? The following is table tested the outcome if I choose shares entirely while 25% of other shareholders choose shares.


Under this scenario, my dividend entitlement for the next distribution will rise by about 7.2% to compensate me for taking shares instead of cash now. This compensation will fall to a meagre 2% if all shareholders take up distribution in shares. (Note that the actual DPU falls by 2.5%. The fall is even larger at 7.2% if all choose shares).

Over a longer period, until 1Q 2012 when the first bullet payment is due, the comparison for taking shares all the way versus taking cash all the way is illustrated:


Here, I assume the DRS only applies until 3Q 2010 when the USD 65m tranche is due for first installment (the distribution cut to 75% should be enought to service this installment) and dividend continues until 1Q 2012 when the 1st bullet payment is due. It is quite clear that taking shares might be a more worthwhile option, provided the shares are still worth something by 1Q 2012.

Benefits to FSLT

I've been talking from common shareholder's point of view. How about from FSLT? Cutting distribution to 75% generated about USD 4m and assuming all shareholders take up shares, will yield another USD 10m (the sponsor already pledge to take up 25% distribution in shares). But against the loan of some USD 500m, it might seems meagre. Noting that one of the value-to-loan covenant is 145%, a USD 10m reduction in debt will improve value-to-loan ratio by about 3.5%. But the expected reduction will be much lower since I don't think most shareholders will opt for shares.

Conclusion

I'll take up shares for now and see how other shareholders react. In the long run, I'm still confident that if the management can make use of the (slightly) better financial position to improve distribution in the future (via more distribution accretive acquitisions), it is still better to take up more shares.

First Ship Lease Trust 4Q 2008 results - Desperate measures in drastic times

4Q results at a glance

First Ship Lease Trust posted its 4Q results today, 21st January 2009. DPU for 4Q will be USD 3.08 cents but will be cut to about USD 2.45 cents from 1Q 2009 onwards. i.e. Using last done price of 46.5 SGD cents and assuming 1.5 SGD to 1 USD, the yield will be cut from current annualised 39.7% to 31.6%.

Rationale behind distribution cut

It is mentioned in the press release that the distribution cut resulted from a change in distribution policy, from a target distribution of 100% distributable cash flow to 75- 80%. The reason stated was to conserve cash to reduce debt and take advantage of any potential opportunities arising from this crisis. The following is quoted directly from the press release:

...
Beginning 1Q FY09, FSLTM will provide DPU guidance on a quarterly basis until longer term visibility returns. For 1Q FY09, FSLTM is targeting a DPU of US2.45¢, which represents about 75 to 80% of expected distributable cash flow. The retained cash will be applied to reduction in financial gearing and potentially to funding growth opportunities when they become available.


Mr Cheong Chee Tham, Chief Financial Officer of FSLTM, said: “Given FSL Trust’s secure long-term cash flows and lack of near-term refinancing needs, we believe that we are extremely well-positioned to take advantage of attractive opportunities which we expect will present themselves in the next 24 months. Our revised payout strategy will give us the needed financial flexibility to take advantage of these opportunities and will result in a more balanced yield / growth equity story for the capital markets.”
...

Rationale analysis

Reduction in financial gearing

A DPU cut from 3.08 to 2.45 cents meant a savings of 0.63 cents per quarter, or annualised 2.52 cents. With 501.27m units in the market, this implies a savings of 12.63m per year. Against, its current debt of about 515m, the 12.63m will seem quite insignificant. So it is quite difficult to see how this will actually help in "reduction in financial gearing".

Funding growth opportunities when they become they become available

As for "funding growth opportunities when they become they become available", what can 12.63m buy? The following summarised the recent acquisitions by FSLT:

1. 12th May 2008: 3x Containerships for USD 210m from Yang Ming
2. 21st April 2008: 2x Crude Oil Tankers for USD 140m from Geden Lines
3. 7th November 2007: 2x Product Tankers for USD 113m from Groda Shipping
4. 1st June 2007: 3x Product Tankers for USD 45m from James Fisher
   

With the exception of the 3 product tankers from James Fisher, the other vessels are acquired at an average price of about USD 70m. With the collapse in shipping rates, BDI from more than 10k to around 800 and container shipping rates for free, prices of ships should be under pressure (more on FSLT's loan covenant later). A check on current ship prices shows that ships are still going from a few million to tens of millions, but not many around 70m.

So if there is a fire sale, there is still a chance FSLT can acquire for a bargain.

Drastic times call for desperate measures

However, I see things differently. The change in distribution policy is just a signal for more changes in the horizon.


Loan-to-market value (LTV) covenant

FSLT had on its books vessels totalling 905.6m against about 515m of debt or 175%. The required level before a technical default is effected is 145%, implying a remaining margin of 30% or 154.5m. Its ships are under pressure for further devaluation and breaching the convenant is a real possibility. Each USD 12.63m FSLT manage to save will give it an extra margin of about 2.45%. A further cut in distribution payout ratio will not be surprising.

Equity raising via rights issue

Exceptional times call for exceptional measures. The only threat against debt-based securities like business trust such as FSLT is debt itself. There is no sign the storm will ease up in the coming quarters (or even years as many feared) and there will definitely be further consolidation as weaker players exit the market. Drastic times call for desperate measures. Each player, including FSLT, will take desperate steps to survive. If it is cash they need, they will get it somehow, anyhow. If equity raising is punitively diluting, the medicine will be swallowed, no matter how bitter. Thus I will not be surprised if FSLT go down the road of rights issue in coming quarters, to reduce debt or even fund further asset acquisitions at bargain prices.

Conclusion

The current economic crisis offers both pitfalls and opportunities. No matter what FSLT does to survive, if it survive, it should emerge much stronger and see DPU (and yield at current price) recover spectcularly.

The risk is high (to balance the returns) and seems like the only way for FSLT (and other business trusts as well) to survive is to borrow there way out of this crisis, be it loan or equity. If United States can do it, so can FSLT.

This might seems crazy, but if one look at the number of vessels being taken out of the market, either due to ship building order cancellation or shipping firms going bust, one will know that the shipping market will be in for drastic drop in ship vessel supply years down the road. But can FSLT last that long? Only time will tell.

First Ship Lease Trust - Risk Analysis

A few corrections on the DPU projections under the section "Risk versus Returns".

Rationale

The recent credit crisis, almost on a global scale, threatened to freeze up the available credit to companies. Many companies are dependent on such leverage to grow or sustain their business. Without these loans, some might not survive. The threat of the credit crisis to heavily leveraged businesses such as REITS and Shipping Trust are even higher.

The recent steep sell down in these collective group of debt based instruments is hence understandable. However, First Ship Lease Trust (FSLT) plunged the most among them, even reaching a intra week low of about 37 cents. This imply a staggering yield of 48.9% (assuming a quarterly DPU of USD 3.08 cents and exchange rate of 1.47 SGD to 1 USD). Is the associated risk for FSLT substantially higher compared to other shipping trust or REITS that the market would priced in such high yield for compensation? I will like to find out.

Creditors

The following is the list of creditors which provide FSLT with 3 loan tranches totaling 515 million USD:

1. The Bank of Tokyo-Mitsubishi UFJ Co., Ltd (“BTMU”)
   
2. Bayerische Hypo- und Vereinsbank AG (“HVB”)
3. Oversea-Chinese Banking Corporation Limited (“OCBC”)
   
4. Landesbank Hessen-Thüringen Girozentrale (“Helaba”)
   
5. Sumitomo Mitsui Banking Corporation, Singapore Branch (“SMBC”)
6. KfW

One of the greatest risk these banks can post to FSLT is for one or more of them to collapse. Their creditors could go after FSLT for immediate payment for one or more of its bullet payment facilities due on 2014. The ensuing fire sale of ships without demand for them in this market will almost result in the demise of FSLT.

The following list summarises the profile for the above creditors:


Few things to note:

1. Bank of Tokyo-Mitsubishi UFJ Co. Ltd (BTMU) and Bayerische Hypo- und Vereinsbank AG (HVB) provided the bulk of the credit facilities granted to FSLT. As far as perceived (my perception) risk is concerned, BTMU belong to one of the 3 largest banking groups in Japan and hence could pass the "too large to fail" criterion for possible bailout. But the same could not be said for HVB.
2. If the Tier-1 capital ratio can be trusted as a guide to measure the capacity of the bank to withstand reasonable loss, the HVB is obviously precarious compared to the rest.

Lessees

The following is the list of lessees of FSLT:

1. Geden Lines
2. Groder Shipping/ Rosneft
3. James Fisher
4. Berliau Laju Tanker
5. Yang Ming Marine
6. Evergreen Marine
7. Schoeller Holdings
8. Siba Ships

One of the greatest threat these shipping firms can post to FSLT is to default on their lease payments. This will force FSLT to recall the ships and look for new lessee in this slowing global economy, not an easy task.

Compared to a collapse creditor to FSLT, a defaulting lessee post less threat to FSLT. The immediate consequence is a cut in DPU.

The following list summarises the profile for the abovel lessees:


Few things to note:

1. Most of the lessees are privately owned. This resulted in insufficent financial data to ascertain their risk by retail investors like me.
2. Of those listed with readily availabe financial data. It can be seen that their credit risk is very high due to their high gearing. These are actually very large firms that should not fail in 'normal' times. But in this 'unusual' credit crunch where even banks can fail, their collapse due to insolvency is indeed material.
3. The only consolance is the midst of uncertainty is that most (except Yang Ming's 20%) of the lessees do not account for more than 15% of FSLT revenue. Though each of the lessees could post high risk by itself, collectively, the risk is mitigated by virtue of diversification.

Risk versus Returns

The above data is sufficient to show that investing in FSLT is indeed a VERY risky adventure due to the ongoing credit crisis that have yet to show signs of abating, the question now then becomes, is the returns worth taking the risk?


The above shows the hypothetical scenario of investing about $10,000 in FSLT at a unit price of 38 cents.

The following are the assumptions behind the projections in the table:

1. About 4 to 5 million USD per quarter could be diverted to pay off the recently secured tranche of 65 million USD loan for 3Q 2010 onwards. This could potentially reduce distribution income for FSLT by about a third, thus arriving at 2.05 cents USD.
2. The USD exchange rate is projected on the basis of eventual USD devaluation due to the series of capital injections and bailouts.
3. The DPU projections ignore the scrap dividend scheme that could provide funds to service part of the quarterly repayment (3Q 2010 onwards) for the 65 million USD credit facility.
   

Potential returns depending on how long FSLT can survive and whether they manage to refinance their existing loans:

Loan facilities:

1. 7 year non-amortizing USD$250 million ("Tranche A") --- repayable in full on 27th March 2014
2. 4 year non-amortizing USD$200 million ("Tranche B") --- repayable in full on 2nd April 2012
3. USD$65 million amortizing loan ("Additional facilitiy") --- linearly amortize from USD$65 million to USD$35 million from September 2010 to 2nd April 2012.

3Q 2010 - Principle recovery

Looking at the table, assuming FSLT manage to keep afloat until 3Q 2010 when the loan repayment to the 65 credit facility begin, full capital recovery (breakeven point) in terms of dividend would be collected.

1Q 2012 - 45.9% returns

Before April 2012 when the 2nd bullet payment of USD$200 million ("Tranche B") is due, accumulated dividend will provide a profit of 45.9%. Over a period from Oct 2008 to Apr 2012, i.e. about 3 years, dividend return translates to about 13.4% compounded returns.

1Q 2014 - Double returns

Assuming the credit crisis is over by April 2012 AND assuming FSL manages to refinance the USD$200 milliion loan at reasonable cost that does not affect the DPU much, then before March 2014 when the bullet payments are due, accumulated dividend will already double. Over a period from Oct 2008 to Feb 2014, i.e. about 5 years, dividend return translates to about 15% compounded returns.

All 3 milestones assumes FSLT shares becomes worthless at each juncture, when the payments are due.

My Action

The ensuing credit crunch post material threat to all leveraged businesses in my portfolio. I have no faith they could survive this credit storm. After some consideration, I decided to consolidate my leveraged businesses into few counters. I sold off Surface Mount Technology and recently acquired Cambridge Industrial Trust (both at a significant loss) and averaged into FSLT. Thus only two significant leveraged businesses in my portfolio remains, Multi-Chem and FSLT.

Going forward, I will not pump more cash into leveraged businesses. There should be more great businesses going at further discount as this financial crisis dragged on. There is not better time than now to acquire as many good businesses at attractive prices. Fire sale do not occur everyday. The only problem I face is insufficient cash to invest. So patience is still the key.

Conclusion

While the crisis brood fear and anxiety amongst the market. It is also during such times that opportunities began to appear. Looking back 10 years from now. I believe I will not regret investing now.

First Ship Lease Trust - Some updates

Issue on technical default on one of their debt covenants by PT Berlian Laju Tanker (BLT).

I chanced on Musicwhiz's article about the recent First Ship Lease Trust (FSLT)'s
AGM. According to him, someone queried the management on the technical default on one of their debt covenants by PT Berlian Laju Tanker (BLT). If this issue could affect the least payments by BLT, FSLT's DPU could be jeopardized. Hence, I am not pleased to note that there is not official announcements on this matter.

I decided to do a bit of investigation on my part. First on FSLT, no recent announcement on this issue. Next, I turn my attention to BLT, from their company website, the closest match I could find was a clarification on the notice of of breach for company bonds :

15 April 2008 - CLARIFICATION ON THE NEWS IN THE PUBLIC REGARDING THE LETTER OF
NOTICE FROM IDR BONDS TRUSTEE
The Board of Directors of PT Berlian Laju Tanker Tbk wishes to clarify various news circulating in the public regarding the Company’s breach of the financial ratios following the issuance of the notice of breach for the Company’s IDR Bonds from PT Bank Niaga Tbk (the “Trustee”) dated 17 March 2008

Source:

• BLT's website
• BLT's detailed clarification

To me, my main concern is how FSLT is going to be affected by this. I went on to email them. To my pleasant surprise, they replied my mail. (I tried emailing Food Empire and Multichem before on other issues, no repies)

My question to FSLT (in red) and their replies (in blue) can be summarized as follows:
Given the issue on technical default, how will it affect its lease payments?

To date, BLT have not defaulted any of their lease payments and have been a prompt payer. FSLT have been proactive in risk management, both pre and post acquisition. After acquisition, they will monitor the lessee's financials periodically and get in touch with them if necessary.

Given that BLT contributed 21% in revenue to FSLT, will the recent purchase of crude carriers be able offset the lost in revenue from BLT if the latter default on their payments?

Post acquisition, BLT now account of 17% of FSLT's revenue while newly added Geden contribute 18%.

As far as this issue is concerned, I can say I am pretty pleased with FSLT's reply and their promptness. My mail was sent on Thu, 24 Apr 2008 23:19:11 +0800, their reply was received on Fri, 25 Apr 2008 07:14:21 -0500.

Shipping Trust - Comparing First Ship Lease Trust (FSL) and Pacific Shipping Trust (PST)

What is a shipping trust?

Shipping trust a company that make money by acquiring ships and leasing out to shipping operators. They stay in business by leasing ships at a higher rate of return than the interest rate on the debt they incur to purchase the ships. Most of the profit derived are distributed as dividend to the shareholders.

For more information, see the following overview on Shipping Trusts.

How does shipping trust stay in business?

Shipping trust have to make sure the rate of return on lease exceeds the interest rate on the loan incurred. Normally, shipping trust have access to credit facilities that offer competitive interest rates.

How dividend calcuated?

Distribution (DPU) to shareholders are paid out of operating cash flow instead of accounting profits (for typical companies). This means that are arrived at:

DPU = Revenue from lease - All Management, trust fees & other trust expenses + Depreciation.

Depreciation is an accounting item that accounts for the slow depreciation of ships over their useful life. However, this does not impact the cash flow.

Case Study 1 - First Ship Lease (FSL)

	2Q	3Q	4Q	Projected
Revenue	12.672	12.819	15.224	22.377
Depreciation	(9.161)	(9.052)	(10.360)	(15.735)
Mangement Fees	(0.507)	(0.513)	(0.609)	(0.895)
Trustee Fees	(0.025)	(0.024)	(0.028)	(0.042)
Other trust expenses	(0.276)	(0.327)	(0.443)	(0.938)
Finance Income	0.098	0.169	0.182	-
Finance Expense	(0.472)	(0.928)	(2.048)	12.614
NPBT	2.329	2.144	1.918	4.766
Income Tax	0.022	0.030	0.036	0.067
NPAT	2.307	2.114	1.882	1.882
Added non-cash items and other adjustments	9.220	9.036	10.218	15.94
Units	500	500	500	500
DPU (USD cents)	2.30	2.23	2.42	3.56
Total Assets	527.236	516.874	629.234	919.234
Total Liabilities	47.049	48.653	169.824	459.824
Equity	480.187	468.221	459.410	459.410
Liabilities to Equity Ratio	0.0980	0.1039	0.3697	1.0009
Implied Interest Rate on Lease (Quarterly), IRL	2.40%	2.48%	2.42%	2.43%
Implied Interest Rate on Debt (Quarterly), IRD	1.00%	1.91%	1.21%	1.37%
Net Interest Spread (IRL - IRD)	1.40%	0.57%	1.21%	1.06%
IRL on Assets less IRD on Debt	12.20	11.89	13.18	16.07
NTA (SGD)	1.35	1.32	1.30	1.30
Change in NTA over previous quarter		-2.49%	-1.88%
DPU (SGD cents)	3.25	3.14	3.41	5.02
DPU w.r.t. NTA	2.40%	2.38%	2.63%	3.88%

The above shows the past 3 quarters of FSL. FSL was debt free prior to listing on SGX and started to acquire ships solely from debt. Its policy is to acquire ships until its debt-to-equity ratio is 1.

As of last quarter, 3Q, its debt-to-equity ratio is 0.3697. It recently announced that it had secured another USD 200m credit facilities, bringing total undrawn financial capacity to 290m.

Once fully drawn down, FSL will have about 900m in shipping assets, giving it a projected DPU of about 5 SGD cents per quarter.

Sustainability of Distributions, DPUs

1. The implied interest rate on lease, IRL (revenue/assets) over the quarters are quite consistent; quite so for the implied interest rate on debt, IRD (finance expense/debt) too.
2. The difference between lease returns and cost of debt, (IRL x assets - IRD x debt) is comparable with revenue every quarter. Deducting trust fess & other expenses and adding back depreciation, the remainder is the distribution units for shareholders.
   

Taken together, this means that, so long as lease returns exceed cost of debt by sufficient margin (Net Interest Spread), about 1%, the DPU should be sustainable over several years at least. (Lease terms are normally about 10 years).

Major Risk Factors (to shareholders)

1. DPU are paid out in USD, whereas the trust units are in SGD. Numerically, there is no doubt the DPU can be sustained and grow as projected, but the actual yield in SGD may decline if USD continue to depreciate in short term.
   
2. Shipping vessels are depreciating assets, typically over 30 years. The existing ships will slowly depreciate from the assets in the balance sheet. Note the declining NTA (in red) above.
   

Case Study 2 - Pacific Shipping Trust, PST

	1Q	2Q	3Q	4Q
Revenue	8.514	8.609	8.703	8.703
Depreciation	3.219	3.219	3.219	2.421
Finance Expense	2.263	1.811	4.562	4.183
NPAT	2.700	5.523	0.589	1.649
Total Assets	267.747	266.595	262.224	259.722
Total Liabilities	120.915	116.745	115.357	114.880
Equity	146.832	149.850	146.867	144.842
Liabilities to Equity Ratio	0.823492	0.779079	0.785452	0.79314
Implied Interest Rate on Lease, IRL (Quarterly)	3.18%	3.23%	3.32%	3.35%
Implied Interest Rate on Debt , IRD (Quarterly)	1.87%	1.55%	3.95%	3.64%
Net Interest Spread (IRL - IRD)	1.31%	1.68%	-0.64%	-0.29%
Units	337	337	337	337
NTA (SGD)	0.614342	0.626969	0.614488	0.606015
Change in NTA over previous quarter		2.06%	-1.99%	-1.38%
DPU (SGD cents)	1.4664	1.4664	1.5087	1.5228
DPU w.r.t. NTA	2.39%	2.34%	2.46%	2.51%

PST is in a more mature state than FSL. Its debt-to-equity ratio are nearly 0.8, compared to FSL's 0.37. Similarly to FSL, PST's NTA are dropping nearly every quarter, although much slower.

One note of caution, though, its Net Interest Spread, IRL - IRD is negative in 3Q and 4Q. This means there might be a possibility PST is having difficulty getting debt at a cheaper rate than it can get from leasing ships. Not a good sign for distribution sustainability.


Conclusion

Another shipping trust, Rickmers Maritime, does not have sufficient reporting quarters to be compared here. But just by looking at FSL and PST, it shows up the inherent risk in shipping trust's business model:

They make money by leveraging between the returns on ship lease and the cost of borrowing. This is similar to banks giving lower rates on deposits and lending these out on higher interest rate. The margin, though meagre, is normally sufficient to support their profits.

However, for shipping trust, this business model built on leveraging can quickly collapse if the interest rate increase and lease rates fail to keep up. Though they normally go into hedging to minimize the risk, the danger still exists.

I bought First Ship Lease Trust on 6th Nov 2007

Business Overview

First Ship Lease Trust (“FSL Trust”) is a provider of leasing services on a bareboat charter basis to the international shipping industry. Basically, FSL Trust purchases vessels and lease them out to shipping operators.

Reasons for purchase

1) FSL Trust have stable long term lease contracts of at least 7 years. This provides a stable flow of distributable income. In other words, the dividend yield (in terms of USD) is sustainable of at least 7 years.

2) By leasing ships to operators, the trust do not have to care about ship operating cost (fuel, bunkering etc), technical, maintance issues.

3) Even at a conservative yield calculation of 2.23 USD cents per quarter, the yield is effectively 11.08% at my purchase price of 80.5 USD cents. Assuming the yield is sustainable, this is considered at very high yield!

Valuation

Assuming my required rate of return is 10% (compared to 11.08%), I will say I bought FSL Trust at just slightly below fair value.

Risk

On the surface, a stable dividend yield exceeding 10% is incredible. However, the dividend is paid in USD (converted to SGD when paid out). This results in a FOREX risk that yield might plunge in the future if USD depreciates further.