Ship Finance International Limited Management Discusses Q2 2012 Results - Earnings Call Transcript

| About: Ship Finance (SFL)

Ship Finance International Limited (NYSE:SFL)

Q2 2012 Earnings Call

August 28, 2012 10:00 am ET


Ole B. Hjertaker - Chief Executive Officer and Chief Executive Officer of Ship Finance Management AS

Harald Gurvin - Principal Financial Officer


Justine Fisher - Goldman Sachs Group Inc., Research Division

Martin Korsvold - Pareto Securities AS, Research Division

Rasta Behrang

Herman Hildan - RS Platou Markets AS, Research Division


Good day, and welcome to the presentation of Q2 2012. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Ole Hjertaker. Please go ahead, sir.

Ole B. Hjertaker

Thank you, and welcome, everyone, to Ship Finance International in our second quarter conference call. With me here today, I also have the CFO, Harald Gurvin; and Senior Vice President, Magnus Valeberg.

Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates or similar expressions are intended to identify these forward-looking statements.

These statements are based on our current plans and expectations and involve risks and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include conditions in the shipping, offshore and credit markets. For further information, please refer to Ship Finance's reports and filings with the Securities and Exchange Commission.

The Board of Directors has declared a cash dividend of $0.39 per share. This represents $1.56 per share on an annualized basis or nearly 10% dividend yield based on closing price yesterday. We have now declared dividends for 34 consecutive quarters and paid out $13.75 per share or nearly $1.1 billion in aggregate dividends since 2004.

Net income for the quarter was $61 million or $0.77 per share. Included in the results was a $21.2 million net book gain relating to the Horizon Lines restructuring. So net of this book gain, adjusted earnings were $40 million or $0.50 per share.

Aggregate charter revenues recorded in the quarter, including 100% owned subsidiaries accounted for as investment in associate, was $185 million. This includes the $16.3 million of cash sweep from Frontline. The EBITDA equivalent cash flow in the quarter was $151 million or $1.91 per share. There was a full cash sweep effect of 23 out of 28 Frontline vessels and nearly full cash sweep effect on 5 vessels. The aggregate contribution was therefore $0.21 per share in the quarter.

In addition, there was also an accumulation of profit share in the quarter. The amount represented the $600,000 or $0.01 per share approximately. But due to the $50 million prepayment of future profit share that Frontline made in December 2011, we will not recognize profit share revenues in the profit and loss statement until accumulated profit share is in excess of that amount. With the profit share accumulated in this quarter, the threshold is now reduced to $48 million. And as an illustration, the average profits bid per quarter since 2004 has been more than $15 million per quarter or $0.19 per share.

We have now sold -- we recently sold the 2 older combination carriers. One vessel, Front Rider, was announced sold in June and delivered to the new owners in July this year; while another vessel, Front Climber, was announced sold last week and with delivery to new owners in September. Aggregate sales price for the 2 vessels was approximately $19 million, including approximately $1 million compensation from Frontline. Over the last 5 quarters, the number of OBOs have been reduced from 8 to 3 remaining, of which 2 are employed on long-term subcharters. The book gain from the 2 transactions is estimated to $2.6 million in aggregate and will be recorded in the third quarter.

We have previously announced the sale of the 2 remaining non-double hull vessels in the fleet. The delivery will now be earlier than previously announced, with expected delivery in the fourth quarter for the first vessel and in the first quarter of 2013 for the last vessel. Net cash effect from these sales is estimated at approximately $30 million in aggregate.

In April, we announced a restructuring of the Horizon Lines chartering deal. The vessels were built in Korea in 2006 and 2007, and had been on charter to Horizon Lines for 5 years, but the U.S. flag service they were used in was discontinued. As a U.S. domestic Jones Act container line, it could not redeploy the vessels in the international markets without significant losses, and the vessels had therefore been in lay-up for 4 to 5 months.

We received a termination compensation of $40 million of nominal value in second lien bonds plus warrants to subscribe for 9.25 million shares in the company or nearly 10% of the share capital. The bonds have been recorded in our accounts at a conservative 40% of nominal value, and the warrants have been recorded at approximately $0.13 per share, which is significantly below where the share is trading today. Due to the limited liquidity in both the bonds and the shares in Horizon Lines, we believe this is a prudent approach and hopefully there is good upside to these figures.

Before lay-up, the vessels have been dry docked at the stimulated expense of $800,000 to $1 million per vessel. And as part of the deal, we took over fuel inventories, which had a value of approximately $4 million. The break-even level on the vessels after financing and operating expenses is approximately $10,500 per day the first 18 months and $14,500 per day the next 5.5 years. The financing remains nonrecourse to Ship Finance, and there is only a limited guarantee obligation relating to the charter rate level.

While the charter market currently is soft, this was also reflected in the compensation package from Horizon Lines. We believe the market balance in the segment could create some interesting opportunities due to the age profile of vessels on the water and very limited order book.

In July, we announced the termination of 4 chartering agreements on Handysize drybulk vessels charted to the Chinese company, Hong Xiang Shipping. Hong Xiang is part of a large privately owned Chinese conglomerate, Beijing Jianlong Group. The group is active in many segments, including iron and steel production, shipbuilding and electromechanical manufacturing. We have a charter performance guarantee from the parent company in the group.

At the time of redelivery, Hong Xiang had failed to pay charter hire for approximately 3 months. But as Hong Xiang had soft chartered the vessels in the market, we managed to collect significant amounts in hire from these subcharters during that period. At the end of the second quarter, approximately $4 million was recorded in trade receivables relating to these vessels, but a part of this has subsequently been recovered from the subcharters.

The original charter rate was $14,000 net to us, while the spot market is reported currently to be in the $7,000 to $8,000 range. We do not want to be specific on the amounts claimed for overdue payments and future losses in order to not compromise the legal proceedings. It is difficult to assess how long time the legal process will take, and we don't expect to have it finalized until next year at the earliest.

The companies who had the vessels on subcharter from Hong Xiang have been very cooperative in this whole process, and the vessels were immediately rechartered without idle time between the charters. The company's intention is to continue employing the 4 Handysize vessels in the short-term market until market rates recover.

We finalized the restructuring of the agreement with Frontline in 2011, and this is the second quarter we see the economic effect of this in our profit and loss statement. Frontline paid a cash compensation of $106 million to us in December 2011, which was equivalent to nearly 2 years' reduction in base rates. We use these proceeds to prepay on bank financing and have therefore reduced break-even rates for these vessels to the new reduced base rate.

While we had a net contribution per share of approximately $0.10 per share from these vessels before the restructuring, the cash sweep therefore now represents the net contribution. Based on historic charter rates provided by Clarksons, there have been very few quarters last 15 years where we wouldn't accumulate basically a full cash sweep. If Frontline generates market revenues in line with the previous base rates, like in the second quarter, the cash sweep alone would give us a positive net effect in excess of $0.20 per share per quarter or double the previous net contribution from Frontline.

The spot market in the third quarter has been reported by brokers to be lower than the second quarter, but we will not make any predictions for the remainder of the year. Frontline reports their numbers tomorrow and may be more specific on the guiding for the tanker market.

The cash sweep is based on 2 separate calculations, 1 for 23 vessels and another for 5 vessels. The threshold levels for the 5 vessels is higher than for the 23 vessels. And depending on the market, there may be a full cash sweep effect and profits placed on top for 23 of the vessels, but no contribution on the 5 vessels like we had in the first quarter. It is worth noting that the cash sweep and the profit share is based on actual performance by the vessels in the period.

We still have a significant portfolio of long-term charters, which is the backbone of our business. Most of our vessels are chartered out on a long-term basis and we still have close to 10 years weighted average charter coverage. Full details on a vessel-by-vessel basis is available by contacting us on e-mail at

We have $5.5 billion of fixed rate order backlog, which is equivalent to approximately $69 per share. The EBITDA backlog was approximately $4.4 billion or $55 per share. These numbers are after we excluded the Hong Xiang charters and include only the reduced base rate from the Frontline vessels. Expectations for cash sweep, profit share and rechartering at the end of current charters are therefore not included.

Looking at the segments where this cash flow will be generated, we see that offshore is still the largest with 46% or approximately $2.5 billion; while tankers, where the company started, now represents approximately 34% of the backlog or nearly $1.9 billion. It is worth noting that this is not only Frontline, but also include tankers chartered to other customers.

Hong Xiang represented approximately 2% of our charter backlog. So after the termination of those charters, bulkers have now been reduced to 6% of the portfolio, while containers stands at 14%.

We have a total of 15 customers and more than 40% of the portfolio is with companies with a market cap in excess of $5 billion. If we include all listed companies, the percentage is 83%. In addition, a majority of the backlog is -- in the private segment is with companies with a public rating. Of course, if we look at counterparty risk, it's worth noting that we own the assets and they all have an alternative market so the effect of the counterparty risk in theory should be limited to the excess charter hire, if any, above current market for the corresponding charter period. The rest is effectively covered then by this deal.

If we look at the average weighted charter tender, as indicated on the right side, with more than 70% of the portfolio in excess of 10 years, we only have 2% of our charter portfolio with less than 5-year charters.

We invested significant amounts in the first half of 2011 but have been very cautious the last 12 months. The main reason for this is that we've seen a downward pressure on asset prices driven by several factors, partly by the general uncertainty in the world economy, which increased after the summer last year, but also we've seen dynamics in -- particularly linked to the financing, asset financing in the shipping industry, where European banks have been very careful with their volumes to the industry linked to a general downturn in the European markets.

At the same time, we've also seen significant deliveries of newbuildings coming into the market in many segments, driven by previous ordering of vessels, and we've seen shipyards who’ve had logged significant order books in the past having reduced the backlog on newbuildings, they have decided they’ve had to focus more on attractive new orders.

What we've seen is that over the last 10 years, because of what we could call a super cycle from 2002 to 2008, where we saw significant buildup in shipbuilding capacity, these shipyards could basically build these vessels on their standard design and did not have to do much product development over this period. So when we now see that there is an increased focus on efficient vessel design, this is, as we see it, more like a pent-up demand or sort of a pent-up technological development that should have taken place over the last 15 years but has really been concentrated now over the last few years.

So what we see is that the new contracts and the vessels you now can order at the shipyards have much more fuel-efficient engines and therefore more economical to use. This is general across-the-board in the industry, but we have seen a significant impact, particularly on the container market, where the container vessels traditionally have been designed for high speed and focus on transit time, and where the focus now has been more on reduced speed and more optimal use of the vessels also in a slow-steam scenario.

When we ordered 4 containership newbuildings in 2011, these were based on a newer design, where we, at 30% of the historical peak order price adjusted 2 years before we order the vessels, ordered these vessels at 30% lower price than previously done. At the same time, these vessels are maybe up to 30% more fuel-efficient per transportation capacity and can carry maybe 10% more cargo than the comparable vessels in the past.

Of course, this has a significant impact also on the asset value for secondhand values. And while we expect that to normalize, we believe that there will be a continued value gap between the 2 vessel types, newbuildings and secondhand values, and we have been waiting for that to crystallize also in asset pricing. At the current -- at present, we see that yards are effectively quoting prices, which is essentially marginal production costs for these assets and also reflecting the current low steel price.

At the same time, we know that China and Korea are the marginal producers of shipping assets. And there is inflation pressure, particularly on labor cost in China, that we believe will create the floor for the level they are willing to build vessels at. At the same time, here, we also see that banks who have been very careful in lending money, they've been focusing their attention and their capacity to the bigger, well-known names and the bigger, well-known systems, and the same thing goes with who's got access to capital from export credit agencies who also focus on the bigger entities. So the banks, they really want to do business these days with companies who have a public profile and who have access to different pockets of money. We believe therefore that we now see a very interesting time where the bigger companies, like Ship Finance, will have access to capital and while others will not have the ability to do significant new projects.

So while we have been very careful over the last 12 months, we now see that the market begins to look more interesting from asset price perspective. Of course, what we focus on when we do new projects, we focus on the combination of assets and charter coverage. And in this scenario and in this market environment, we believe it could also be attractive to take on some more asset exposure like we've done from time to time in the past in order to position ourselves for a potential rebound in values and charter rates and thereby create even more value for our shareholders than just locking in the charter rate together with the asset acquisition at the same time.

We will not make specific guiding on what we intend to invest and exactly when because we need that flexibility. But what we can say is that we have been very careful over the last 12 months for a reason. And we believe asset values, and particularly the asset values on the newbuildings side, have corrected down to interesting levels. and then it's more a question of timing and structuring the right deals for us before we start to deploy capital for new projects again.

If we then switch to our performance last 12 months. The normalized contribution from our projects, including vessels accounted for as investments in associates, the EBITDA was $638 million last 12 months. This is equivalent to approximately $8 per share. Net interest was $138 million or approximately $1.74 per share. But more importantly, our normalized ordinary debt installments relating to the company's projects was $364 million or more than $4.50 per share. This is excluding the significant prepayments relating to the Frontline vessels in 2011.

We had approximately $3.1 billion of net interest-bearing debt at the quarter end, and we continue our scheduled steep [ph] loan amortization. The amortization represents around 8.5 years profile to 0, and this compared to a weighted average age of the vessels of approximately 5 years. The net contribution from our projects last 12 months after this aggressive debt prepayment profile was $166 million or $2.10 per share, which again compares to the $1.46 in dividends declared for the corresponding period. Over the last 8 years, aggregate net income has been nearly $21 per share, while aggregate dividends declared have been $13.75 per share, illustrating the relative conservative profile of the company.

And with that, I will leave the word over to Mr. Harald Gurvin, our Chief Financial Officer, who will take us through the numbers for the second quarter.

Harald Gurvin

Thank you, Ole. On this slide, we have shown our pro forma illustration of cash flows for the second quarter compared to the first quarter of 2012. Please note that this is only a guideline to assess the company's performance and is not in accordance with U.S. GAAP.

For the second quarter of 2012, total charter revenues were $168.9 million or $2.13 per share compared to $172.8 million or $2.18 per share in the first quarter of 2012. On the VLCCs, Suezmaxes and chemical tankers, revenues were in line with the previous quarter. The container vessels achieved revenues of $17 million in the second quarter compared to $21.3 million in the previous quarter. The reduction is due to the termination of the Horizon Lines charters in April 2010. However, it should be noted that we, on average, receive charter hire until mid May 2012 as Horizon Lines pay charter hire upfront on a quarterly basis.

The drybulk vessels achieved revenues of $17.6 million in the second quarter compared to $16.9 million in the previous quarter. Revenues for the second quarter includes charter hire from the 4 Hong Xiang vessels. Following the cancellation of these charters in July 2012, we expect revenues from drybulk vessels to decrease slightly going forward also due to the recent sales of 2 additional OBOs.

On the offshore side, charter hire came in at $92.3 million, in line with the previous quarter. We also generated a cash sweep from Frontline of $16.3 million in the second quarter, up from $13.6 million in the first quarter, which reflects the full cash sweep on most of the vessels. Our profit share of $0.6 million also accumulated in the second quarter. But as this is netted against the $50 million of profit share prepaid by Frontline, the number is not included in the table above.

And vessel operating expenses showed a slight increase compared to the first quarter. This is due to the 5 Horizon vessels coming off bareboat charters and thus incurring OpEx, and also a full quarter of operations for the 4 drybulk vessels delivered during the first quarter. So overall, this summarizes to an EBITDA of $151.3 million for the quarter or $1.91 per share.

We then move on to the profit and loss statement as reported under U.S. GAAP. As we have described in previous earnings calls, our accounting statements are slightly different than those of a traditional shipping company. As our business strategy focuses on long-term charter contracts, a large part of our activities are classified as capital leasing. As a result, a significant portion of our charter revenues are excluded from our booked operating revenues and instead booked as revenues classified as repayment of investment in finance leases, results in associates and long-term investments and interest income from associates. If you wish to gain more understanding of our accounts, we also this quarter published a separate webcast, which explains the finance lease accounting and investments in associates in more detail. This webcast can be viewed on our website,

Overall for the quarter, we reported total operating revenues according to U.S. GAAP of $84 million. Charter revenues from operating leases were down approximately $3 million compared to the previous quarter, mainly due to the cancellation of the Horizon Lines charters. Charter revenues from finance leases was slightly down, mainly due to the scheduled reduction in charter rate for 2 of the OBOs as they reach their 20-year anniversary date early in the quarter.

As mentioned, the profit share of $0.6 million accumulated in the second quarter, which has been set off against the $50 million profit share prepaid by Frontline, giving a 0 net effect in the income statement. Including the $1.4 million profit share accumulated in the first quarter, another $48 million of profit share will have to accumulate before profit share revenues are recognized in our accounts.

The cash sweep income from Frontline was $16.3 million, up from $13.6 million in the first quarter, giving an aggregate cash sweep as per 30 June of $29.9 million.

We also booked a book gain of $21.7 million relating to the termination of the Horizon Lines charters in the second quarter. As compensation for the termination of the charters, we received second lien notes in Horizon Lines, LLC with a face value of $40 million, which we conservatively have recorded at $16 million or 40 cents to the dollar.

We also received 9.25 million warrants exercisable into 10% of the common stock in the parent company, Horizon Lines Inc., which we recorded at $1.7 million at the time they were issued. It should be noted that to be conservative, we are taking an impairment of $0.5 million at quarter end relating to these warrants, bringing them down to $1.2 million in our books. The remaining gain of $4 million relates to fuel inventory on board the vessels at the time of redelivery.

So overall, and according to U.S. GAAP, the company reported net income of $61 million or $0.77 per share for the quarter.

Moving on to the balance sheet. We show $101 million of cash at the end of the quarter. In addition, we have invested $23 million in short-term tradable securities as a short-term liquidity replacement. The second lien notes in Horizon Lines are also recorded under available for sale securities at $16.5 million, which include accrued interest during the quarter.

Amount due from related parties includes a $29.9 million cash sweep accumulated during the first and second quarter. The final cash sweep is calculated on an annual basis and payable in March the following year.

Other long-term assets includes the Horizon Lines warrants at $1.2 million following the $0.5 million impairment at the end of the quarter and the $50 million investment in the 2 CMA CGM container vessels since this transaction is structured as a loan and we are mortgage securing our investment.

Stockholders' equity stands at over $1 billion, including the $159.2 million of deferred equity. The book equity ratio, including deferred equity, was 34.4% at the end of the quarter.

Then looking at our liquidity and financing status. As mentioned, the company had cash of $101 million at the end of the quarter, which excludes the $39.7 million in available-for-sale securities. On the debt side, we had approximately $3.2 billion of total long-term debt outstanding at the end of the quarter, of which $1.9 billion is consolidated long-term debt and approximately $1.3 billion is long-term debt in our subsidiaries accounted for as investments in associates. This figure includes the unsecured NOK bonds maturing in 2014, of which $73 million is net outstanding; the $125 million of convertible bonds maturing in 2016; and the $274 million net outstanding of senior notes maturing in December 2013. The convertible bonds can be repaid in shares in the company's option at maturity.

We have arranged for long-term financing for all vessels under construction, with the remaining total commitments of up to $198 million. The leverage is in excess of 75% of the contract price for each vessel with maturities between 10 and 12 years from delivery.

We have limited refinancing needs the next 4 quarters. On upcoming debt maturities, the financing relating to the 3 ultra-deepwater units acquired from Seadrill in 2008 mature during the second half of 2013. The financings were for an original total amount of $2.1 billion but was structured with a very front-loaded repayment structure, and we have already repaid over $800 million on these facilities alone. And we continue to pay down significant amounts before maturity, with an average balloon payment per rig of approximately $370 million.

It should also be noted that the rigs will have 10 years left on the charters of Seadrill at the time of maturity and are structured with put options and purchase obligation at the expiry of the charters, taking away the residual risk. While we have repaid a substantial amount of the debt, charter pre-broked evaluations have increased over the last quarters based on the strong outlook for the offshore market. The current financings are very attractive and we will address the refinancing in due course. We have a proven track record in the banking market and are confident that the rigs can be refinanced on attractive terms.

The 8.5% senior notes mature in December 2013. The original amount of the senior notes was $580 million, but the current net outstanding is only $274 million or less than half than the original amount. Our total unsecured debt now only stands at around 50% of the total debt. The senior notes can be called at par at any time and there is still more than a year left until maturity. We will address this when the time is right. And given the relatively small amount to be refinanced, we are confident that those or the senior notes can be refinanced at attractive terms.

The next slide provides some more detail on our newbuilding program and the remaining payment to the yard. Following the delivery of 4 drybulk vessels in the first quarter of 2012, we have 2 remaining drybulk vessels under construction with expected delivery in the fourth quarter of 2012 and first quarter of 2013, plus 4 container vessels scheduled for delivery in 2013. The graph shows the committed financing in the blue bars compared to the remaining shipyard installments in the yellow bars.

We have already paid significant amounts in cash to the yards, while we chose not to utilize all available pre-delivery financing in order to reduce the interest expenses during the construction period. This means we may have a positive cash effect relating to the newbuilding program in the quarter, when we fully utilize the available financings.

For the third and fourth quarters 2012, we have total scheduled yard installments of $45 million while we may draw up to $42 million on committed financing, giving a net cash investment of approximately $3 million.

For 2013, the scheduled yard payment totaled $179 million while we can draw up to $156 million of related financing, resulting in a net cash investment of approximately $303 million in that year. If you look at the period overall from now until the end of 2013, the overall net cash investment compared to the available financing is only $26 million.

We are in compliance with all financial covenants under our loan agreement. Free cash was $101 million compared to the minimum requirement of $25 million. Working capital was $219 million compared to the requirement of being positive. And the book equity ratio was 34% compared to the minimum requirement of 20%. And on the loan agreements, where we have minimum value covenants, we were fully in compliance at the end of the quarter.

It is worth noting that Ship Finance has been in compliance with all financing covenants for each of the 34 quarters since the company was established. Given the financial turmoil and depressed shipping markets over the last year, this gives us a very strong standing in the banking market.

Then to summarize. For the second quarter of 2012, the board has declared a quarterly cash dividend of $0.39 per share. This represents a dividend yield of 9.9% based on yesterday's closing share price. Net income for the quarter was $61 million or $0.77 per share, and aggregate EBITDA was $151 million or $1.91 per share. Our fleet renewal continues and 6 older vessels have been sold and 7 newbuildings delivered over the last year, and the weighted average age of our fleet is only 5 years. We are well positioned from continued selective growth with strong balance sheet, diversified asset portfolio and premium access to deal flow and capital.

And with that, I give the word back to the operator who will open the line for any question.

Question-and-Answer Session


[Operator Instructions] We will now take our first question from Justine Fisher of Goldman Sachs.

Justine Fisher - Goldman Sachs Group Inc., Research Division

So the first question I have is on the charts that you had showing the valuation gap between the newbuilds and the secondhand vessels. And it's an interesting -- they're interesting charts to look at because you can definitely see the divergence in the market. But the first question about those is the valuation gap could probably also be characterized as a pricing gap, and so why would you not buy the lower-priced secondhand vessels and instead buy the newbuilds. I mean, I guess, the reason may be fuel saving, but I was wondering if there was any other reason.

Ole B. Hjertaker

Well, you have a combination of fuel savings, which of course, contributes part to the value gap, but also access to financing. What we see is that typically in softer markets, basically in all industries, you have export, the credit agencies-type support on financing, which gives you in many ways better access to financing than for, say, a one-off drybulk carrier that is 5, 6, 7 years old. The banks who may look at financing that will probably give you a lower advance rate, and they even also be more expensive from a cost of capital perspective. So I think it's a combination of 2 things. It's both improved efficiency, which commands a difference in price, but also cost of capital is different. And therefore, you should see a bigger price gap between newbuildings and secondhand vessels. From our side, we look more -- we look at relative value. So we could -- I mean, we look at modern assets only. But we would be happy to buy secondhand vessels if the pricing is right and if the relative pricing is right also compared to booking a newbuilding with delivery, say, 2 years from now.

Justine Fisher - Goldman Sachs Group Inc., Research Division

Are you able to get -- or would you think that you would if you had -- for vessels coming online, would you be able to get better market time charter rates for a newbuild as opposed to let's say a 3- to 4-year-old vessels? Obviously, for a 10-year-old vessel there probably is going to be a difference, but is the charter rate diverging for new versus let's say 5-year-old vessels as the values are diverging?

Ole B. Hjertaker

Well, I mean, you have to adjust for the fuel efficiency. So if, say, if a VLCC can burn, just pick a number, 10 tonnes less per day in fuel for a newbuilding, that will of course be reflected in the charter rate you're able to command. But apart from that, as long as the vessel is modern and is otherwise in good shape, you can find charters also for secondhand vessels. But from our side, of course, what we look at is a combination of the price we pay for it, the charter rate we think we can get over the life of the vessel and also the residual value at the end of the charter. Right now, in some segments, and if you look at for big drybulk vessels, where market rates currently are below operating expense level, at least according to some brokers, you can say that there is actually a negative carry in owning the vessels for the near term, and therefore a delivery 2 years from now can actually be a benefit. If you believe that, you will have very low revenues on the vessel. So that may have an impact on the value.

Justine Fisher - Goldman Sachs Group Inc., Research Division

So that's another reason that you buy a newbuild as opposed to a secondhand vessel because it's actually a good thing if you don't have it now, but if you can buy it at a cheap price and started operating 2 years from now, then you don't have the negative carry of the interim.

Ole B. Hjertaker

Correct. Unless the secondhand value price was attractive enough so we think it's still -- so we were seeing still it's a good investment.

Justine Fisher - Goldman Sachs Group Inc., Research Division

Okay. Another question I had was just on Seadrill options. Can you refresh our memory as to when -- whether and then when Seadrill has put options or, I guess, call options to purchase some of the offshore vessels that you operate for them, that you lease to them?

Ole B. Hjertaker

Yes, the next options Seadrill has to purchase a deepwater drilling rig is in October 2014 for the West Polaris. They had the opportunity to call that or purchase that rig, but they had to call that 2 weeks ago and they haven't done that. So next call option is then in October 2014. Then we have one rig in West Hercules, which they have a call option in November 2014, and then West Taurus in February 2015. And then with -- and then they have purchase options, say, with on average 2-year intervals from those purchase option dates. We are happy to send the exact schedule to you. It was also disclosed actually in the 2009 20-F on Page 84 and 85. There's a detailed breakdown on a rig-by-rig basis with both combination of the charter rates in the different periods and also the purchase option dates and the purchase option and the prices.

Justine Fisher - Goldman Sachs Group Inc., Research Division

Okay, I'll definitely go and look at that. So is it -- I mean, and maybe it's too early to say, but have you guys had any discussions with them about what they might do in '14? I mean, if rig values are up, they could purchase the rigs and then resell them if they wanted to. I don't know if that's something they would even want to do, but have you guys have any discussions with them as to what they might choose to do with those options?

Ole B. Hjertaker

No, we have not discussed that specifically. I mean, they, as it's their option, we wouldn't expect them to communicate that to us until it’s time -- until they decided to call. But it's 2 years from now, so many things may change until then and we cannot make any projections or estimates of what they may or may not do. These rigs have been on very high charter rates. But now as we have amortized down so much of the debt, the charter rates also comes down based on the schedule. So from Seadrill's perspective, I'm sure they also look at the very attractive net cash flow that's coming out from these rigs. So they pay the bareboat charter hire to us, then of course, you have to add on operating expenses, but they have recently concluded charters on these rigs at levels way over that. So there's also a nice cash flow contribution for them.

Justine Fisher - Goldman Sachs Group Inc., Research Division

Okay. And then the last question I have is on the bond maturity next year. Can you talk about the various options that you guys are thinking of as far as replacing this bond? And you don't have to say, obviously, exactly what you're going to do, but are you considering secured financing to replace this bond or the Norwegian bond market, the U.S. unsecured market? And then how do you view those various options for refinancing?

Ole B. Hjertaker

Well, we have access to different, call it, sources of capital. We have around $3.1 billion in the secured bank debt market. We are present in the European convertible bond market. We have a Scandinavian bond outstanding. So -- and of course, we also have the U.S. market. So I believe we have various access to financing. We have call option. We can call the bond on 30 days’ notice at par, so we have a lot of flexibility. We still have 15 to 16 months until the maturity of that bond. And given the relative size, it's less than $300 million, I believe the size of our company and not least the strong support we have from our big shareholder, Mr. John Fredriksen, who owns 40% of the company, and his standing in the capital markets, I think, we are quite comfortable with our ability to refinance that before or at maturity at an attractive rate. But I cannot give you any guiding as to exact when or how we’ll do that. That we will do on what we could call on opportunistic basis, where we will look at our various options and choose the one we believe is the most attractive for the company.


We will now take our next question from Martin Korsvold from Pareto Securities.

Martin Korsvold - Pareto Securities AS, Research Division

I'm just wondering if you could give us an update on the container spinoff you were talking about potentially in the last quarter report. I don't see it mentioned in this quarter's report.

Ole B. Hjertaker

Yes, we mentioned the container segment in the last quarterly report as we saw that as potentially interesting segment. And what we have done after that is that we have structured it so that we have the ability to spin it off if and when we believe timing is right and we believe it will benefit our shareholders in the long term. Part of the reason for setting that up and making that -- in setting up the structure is that we believe it could be interesting from a consolidation perspective. We see several entities and structures in the container market, both the listed companies, but also on the private side and portfolios controlled by the banks, where there could be potential for asset consolidation. And having that ability to do that not only in, call it, Ship Finance, a parent company, but also on a segment specific setup for the containers, we believe, is a benefit. So it's something we have. We have it, you could say, structurally ready. We can do it if and when we believe timing is right. But we want to do that in connection with the transaction or with the structure where we can illustrate and show the market that there is -- it will be accretive to Ship Finance's shareholders. So we will get back to that when timing is right, and we wish to do something specific.

Martin Korsvold - Pareto Securities AS, Research Division

Okay. And second question on the covenants. Good to see that you're in compliance with the minimum value clauses. And I'm wondering, given that, especially in drybulk vessels and tankers, we have a situation where ship book values are quite a bit above what the actual transaction value seems to be, could you give us some idea of how this might affect liquidity going forward if values on tankers and drybulk were to come down to more sort of real levels?

Ole B. Hjertaker

Yes, of course, it's difficult to guess what the market may be in the future. I think it's a good thing we don't have any value covenants relating to drybulk vessels. So we don't have any issues there, irrespective of where the market may go. On the tanker side, we had already -- as of June 30, we have paid down the loans to a scrap value for the vessels. So if we had to scrap all the vessels, the scrap value, we're in the region of $580 per lightweight tonne. As we continue to pay down the debt fairly quickly on those vessels, we're paying down more than $80 million per year just relating to the assets on charter to Frontline, at year end, we will be down to low 500s in scrap exposure on the assets. So what we can say is that if you looked at the graph in the presentations on tanker values, we saw an extreme peak, of course, in 2007, 2008 on asset values. At that time, we did not lever up the vessels, so we had relatively conservative financing at the time. And after that, of course, first, values crashed down 50% almost overnight in 2009. We did not have any issues with minimum value clauses then. And then we've seen also a significant drop in value over the last 12 months, and we still haven't had any issues on the minimum value side. So we are, of course, prudently following this closely and believe we have structures in place, and not least the fact that we paid down so much on our financings means that even if value should slip downwards, we can still maintain a nice buffer.

Martin Korsvold - Pareto Securities AS, Research Division

Okay, good. Lastly for me. On the dividends, you're paying $0.39 this quarter, whereas your cash sweep from the tankers is $0.21. And the way the market looks now, it doesn't look like there's going to be much cash sweep at least in the second half of this year. Do you feel confident that you'll be able to maintain the $0.39 dividend going forward even without any cash sweep from Frontline in the second half?

Ole B. Hjertaker

Well, I think as a general observation, I mean, the board does not communicate future dividends. So the board decides the dividends on a quarter-by-quarter basis. Also the board, when they set the dividend, they do not look at immediate -- necessarily the earnings in that specific quarter. I think the board has a more long-term approach when they look at dividend levels. And so -- and there is no link in the report from the board between the cash sweep from Frontline and the exact, the dividend payout. So we cannot comment on future dividends. And you can also say that we can -- nor can we predict what the tanker market will be over the next few quarters. There is another prominent shipowner whose market observation is that the market may go up, go down or remain stable. And while that is amusing, I think it's equally important to -- it's more the uncertainty here that is interesting to observe. And also that the volatility in many ways is a friend because the cash sweep is based on the revenues for these vessels over the year. What we've seen both in the first quarter and the second quarter is a buildup not only of cash sweep, but also on the profit split on top. And that would effectively serve as a buffer if the market should be lower later in the year. So we believe that there will be a cash sweep accumulating from a lower level than the -- if you adjust for subcharters and the buffer that's built up than the actual cash sweep levels nominal on a vessel-by-vessel basis.


We will now take our next question from Rasta Behrang from Jefferies.

Rasta Behrang

If I'm not mistaken, Seadrill guarantees a significant portion of debt related to your ultra-deep water rigs. And given that you're nearing refinancing of these term loans, I just wanted to make sure that the guarantees would be rolled over to new credit facilities.

Ole B. Hjertaker

By guarantees, you mean Seadrill's guarantee on the charter?

Rasta Behrang

I assumed -- if I'm not mistaken, they are also guaranteed the debt related to these rigs, right?

Ole B. Hjertaker

Well, no, no, the structure there is that we have the vessels on bareboat charters to subsidiaries of Seadrill. And then Seadrill is guaranteeing the performance of the bareboat charters until the end of the charter period. So Seadrill does not guarantee specifically the bank financing, and they never have. But what the banks, of course, look at when they see this, first of all, they look at the loan exposure that is due to be refinanced. And at maturity, the loan exposure is around $360 million per rig or half of what the loan use was back in 2008. At the same time, we see that market values for -- the charter fair market values for these rigs, if the banks were to have to take them as collateral, is basically almost the same as they were back in 2008. So there's a huge difference between loan amount and charter fair values, so leverage is relatively low. Then you have 100% guarantee from Seadrill for the performance of the charters, and the charters have 10 years maturity after the end of the financing period. And then on top of that, the banks also look at the guarantee that Ship Finance has contributed, which is around $80 million, I believe, for one rig -- sorry, it's already reduced to $70 million for one of the rigs and it's $100 million per rig for the 2 others, so $270 million. So the combination of this, we believe, makes a very interesting structure for the banks to look at. And I believe given what's happened over the last few years in this, call it, in the financial turmoils we've seen over the last 4 years, I believe we have demonstrated to the banks and to the market that we are able to manage our portfolio in a very prudent way. We have no issues with the banks. And we believe, at least that's what we hear from many of the banks, that we are a favored client. Of course, we will have to wait and see until we actually finance these what the terms will be, but we are confident that the terms will be very attractive in the market.

Rasta Behrang

And do you expect to refinance these credit facilities in the third quarter or in the fourth quarter of this year?

Ole B. Hjertaker

Well, we will not give a specific guiding on that, the maturities in the second half of 2013. So obviously, we will do that ahead of that. There is no call premium relating to that refinancing, so we can do that refinancing at par when we wish to. At the same time, we also have very attractive terms on the existing financing. So it's also attractive for us to keep that as long as possible. But of course, as we will be prudent and conservative in terms of the timing for when we do this as, I think, we've also demonstrated in the past when we have refinanced assets, and we believe that will be completed well before maturity of these loans.


[Operator Instructions] We will now take our next question from Herman Hildan from RS Platou Markets.

Herman Hildan - RS Platou Markets AS, Research Division

Just have a quick question. I mean, you discussed a lot about the Seadrill rigs, et cetera. And I believe you have about just short of $0.5 billion of equity or call it cash tied up in those assets. My question is if Seadrill were to, for example, pose options maybe even earlier and drop it down to an MLP, you would -- would you just call it equal return figures, so for example, eco-design newbuildings or other deals that you see in the market? Just to get an idea of, I guess, where deals in the market are at the moment.

Ole B. Hjertaker

Well, all deals are different. And the rigs we have with Seadrill have already been paid down. We have paid down significant amounts of debt. So the exposure is very comfortable to the asset itself. And of course, Seadrill is a very strong company, and we are, of course, very happy to have that in our portfolio. We also have been very happy to have the differentiation in our portfolio in a volatile, call it, traditional market for traditional shipping assets. The offshore market has held up very favorably. The purchase options they have are on specific dates, and the next purchase option for the West Polaris, which is the first, is on October 11, 2014. So they do not have call options on a running basis. So it would be very hypothetical to discuss what they want to do and not want to do. I'm sure they also have a lot of other assets that they could potentially look at, including in the MLP setup that they are discussing with the market. But it’s -- this is not something we are a party to. But at least, we expect to have the cash flow from these assets at least for the next 2 years. And in the meantime, both we and Seadrill also is enjoying very significant cash flows from these assets. So we have -- we assume that they believe that the current setup is attractive also for Seadrill.

Herman Hildan - RS Platou Markets AS, Research Division

Yes, okay. So let me kind of rephrase my question slightly. Then if you look at, for example, eco-design containerships, you see of the larger sizes you have a bunker consumption maybe 50, 60 tonnes lower than the old design like you have bunker price that's $36,000, $40,000 a day, which is what the current time charter rate is. Now as you briefly also mentioned earlier, you see the funding market drying up and for those, call it, more private players without the access to financing. The question is how much of this eco efficiency do you believe that Ship Finance will be able to, call it, take advantage of? And what kind of returns are you aiming at for eco newbuilds if you were to do a back-to-back newbuilding with a charter?

Ole B. Hjertaker

Yes, Herman, apologies for not replying properly to your second part of your question. We think that there are definitely very interesting investment opportunities for asset -- for newbuildings also. This has also something to do with when you time which transaction. So for instance, when we did the container ship transaction last year, which we negotiated effectively back-to-back at the same time as we negotiate with the shipyard, we negotiated the charter with Hamburg Süd. Of course, at that time, the container operator, they also of course, have a feeling for what asset prices are and what newbuilding prices are. And therefore that will, in a way, have an impact also on the charter rate they're willing to pay. From time to time, like we did with 2 Suezmax tankers we ordered in 2006, we may also order vessels on our own account if we believe timing and pricing and terms are right. And by doing that, we may be able to capture more of the upside if we believe that they could be affirming -- that newbuilding prices could increase due to underlying factors such as raw material, labor or other factors. And by ordering such asset ourselves, we may be able to capture more of the upside if at the time of chartering out the vessels there would either be a longer lead time or a higher price for the container line themselves. So generally, I would say that in terms of return on equity -- or, sorry, return on equity, percentage wise, you will definitely see a higher return for, say, for a newbuilding or for a new type asset. But when you look at returns, you also have to look at the asset-adjusted returns, so -- or risk-adjusted returns. So from a risk-adjusted return, we believe, of course, that the Seadrill rigs are very, very attractive now and sort of new projects and particularly if we look at more, call it, speculative positions, should command a significantly higher return. We have done deals last year where we've seen equity returns well north of 20%. And of course, what we try to do when we make -- when we structure a transaction is to try to get as much as possible of that -- of the return for ourselves.

Herman Hildan - RS Platou Markets AS, Research Division

Also just as a last question. I mean, obviously, you have a pretty interesting position in the shipping markets with the banks, call it, drawing out or going after the industry, at least lending out. And you obviously have big CapEx programs ahead. Do you see, call it, more interest from banks in terms of, call it, cooperating or coming in between as a buffer capital between shipping companies and the banks, given your, call it, experience in the industry?

Ole B. Hjertaker

I mean, that could be the case. That's what we did effectively when we structured the 2 13,800-teu vessel to CMA CGM last year, which was effectively structured, where our capital we invested was structured as a secured junior loan. So it's something we definitely can do if the terms are right. What we see on the banking side, I mean, we work with around 30 banks. And we've seen that over the years, over the cycles, some banks come, some banks leave the market. But we have a good chord of a number of banks. We have been there over the long run and we have seen down cycles before and managed well through, also through down cycles. We also see some new banks who are -- who had not significant exposure to the market, who are attracted to a segment where you've seen significant reduction in asset prices and where they now can effectively lend money to strong entities, to assets at almost historical low values, at least in recent history, at good margins. So you can say also from the bank's perspective, for those who are active or willing to deploy capital, this is also a phenomenal time to do much better risk-adjusted business than they did back in 2006, 2007 and into 2008. So we can also see some interest on that side. But generally, I would say what we see from the banks is that if you go back 4, 5 years, anyone with a shipping project could go to banks and get funding. Now the banks are much more selective. They're focused on their core clients, and of course, they also focus on clients who have access to other pockets of money be it equity, be it the bond market, be it the convertible market or other pockets of money, because no bank want to be called out as the lender of last resort, that’s to say the one who has to carry the burden if the client cannot pay up.


[Operator Instructions] As there are currently no further questions in the queue, I would like to turn the call back over to our speakers for any additional or closing remarks.

Ole B. Hjertaker

Thank you, everyone. Then I would like to thank you for participating in our second quarter conference call and wish everyone a nice day.


That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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