FSLT has secured a two-year waiver for its LTV covenant and reaffirms quarterly payout of 1.5 US cents from 3Q09 onwards. Maintain HOLD with fair price of S$0.64 in view of its loans due for balloon payment in 2012 and 2014.

First Ship lease Trust (FSLT)’s lenders have given a two-year waiver on the trust’s loan-to-value (LTV) covenant by reducing the minimum coverage ratio from 145% to 100%. This waiver period will extend until end 2Q11. Over the two-year waiver period, FSLT will make quarterly repayments of US$8.0m.

We believe this is a positive development for FSLT as the waiver eliminates the risk of a breach of its LTV covenant given the fall in ship values.

Besides quarterly loan repayments, FSLT has also been making voluntary prepayment of US$4.0m and US$8.0m in 1Q09 and 2Q09 respectively using cash retained as a result of lower distributions (1Q09: 74%; 2Q09: 50%).

With the reduction in FSLT’s LTV covenant ratio and the amortisation of its loans, the shipping trust reaffirms quarterly DPU guidance of 1.5 US cents from 3Q09 onwards, which implies an annualised yield of 14%.

While FSLT has begun to repay part of its loans, it still has a total outstanding loan balance of about US$400m due for balloon payment in 2012 and 2014.

As part of the arrangement with its lenders, FLST has agreed to bear a higher interest margin of 1.7% over the three-month US dollar LIBOR on the outstanding loan of US$501m (previous margin was 1-1.2%). As such, there will an additional interest expense of US$0.7m per quarter during the waiver period. That said, this has no impact on FSLT’s DPU guidance of 1.5 US cents per quarter.

While FSLT’s lessees have been making lease rental payments promptly, we do not rule out the risk of default by its charterers.

Although FSLT did not apply the distribution reinvestment scheme (DRS) for 2Q09, the scheme has a dilutive effect on its DPU and yields. In view of an increase in the cost of borrowings arising from the higher interest margin, we lower our earnings forecasts by 3-18% for 2009-11. However, we maintain DPU forecasts of 7.9 US cents and 6.9 US cents for 2009 and 2010 respectively, based on a distribution payout ratio of 50%.

We reiterate our HOLD recommendation on FSLT and maintain our fair price of S$0.64 based on 0.8x 2010 P/B of the container shipping sector. We suggest an entry price of S$0.52.