Hubris, then denial. Singapore-listed shipping trusts had the misfortune of entering the market at the peak of cycle - with the added hubris of aggressive leveraged growth until 2H 2008. This was compounded by a highly unsustainable model of excessive distribution payouts. In the meantime, the cycle turned against the trusts as industry fundamentals deteriorated and credit markets became inaccessible. The trusts have largely spent the past year mired in denial on matters including counterparty health or availability of financing.

Grasping for salvation. But the real consequences of the past 24 months could not be avoided forever. The best reflection of the dawning of reality is in the steady decline in distribution payouts over the past two quarters. Guidance for 3Q09, if given, is even lower. The sector has started using cash earnings to prepay debt or part-finance committed acquisitions. The distribution model of 100% or even 70% of cash earnings payout is clearly broken. Unfortunately, starting to retain cash today is not a panacea (in our opinion) for some of the challenges facing the sector: loan-to-value covenants, large committed order books, and counterparty risks.

Unwinding leveraged plays. We are more negative on the trusts than the shipping industry as a whole, as we believe these small, highly leveraged asset owners will be the worst-off during this down-cycle. Rickmers Maritime, the most at-risk trust, must address some key challenges in the next year. The market, in our view, is treating RMT as the canary in the coal mine - that is, what happens to RMT will drive what happens to the sector. As such, the next few months are likely to be a period of extreme, newsdriven volatility. A capsizing boat may submerge the entire sector. We downgrade the sector from NEUTRAL to UNDERWEIGHT.

Prefer FSLT. We prefer FSL Trust (BUY, FV: S$0.76) to Pacific Shipping Trust (HOLD, US$0.27) for its diversified portfolio vis-à-vis PST's 100% container focus. We expect FSLT to secure LTV covenant waivers (with conditions/pricing still uncertain). PST did everything right when it came to payout and gearing, but it is still hurting as it goes through rate renegotiations with charterer CSAV. In a separate report out today, we maintain our SELL rating on RMT but reduce our fair value estimate to S$0.16 from S$0.39 as we adjust our valuation approach to reflect the likelihood and consequences of distress. We believe RMT's unit-holders are caught in a game of "heads I lose, tails you win", whatever the final resolution.