Friday, February 11, 2011

Safe Bulkers Inc. - Analysis Of Earnings Results For 2010 Q4

Safe Bulkers Inc. (NYSE:SB) reported $0.47 earnings per share for the quarter ended December 31st, 2010. Our forecast called for earnings per share of $0.33. Clearly our forecast missed reported earnings by a wide margin and it is important to analyze why, to avoid repeating the same mistake in the future.

The discrepancy between our forecast and actual results was because of our miscalculation of the company’s expected gain/(loss) on derivatives.

The company is using a very prudent interest rate risk management strategy. As of December 31st, 2009 it had entered into interest rate swap transactions for a notional amount of $452 million to effectively hedge its interest rate exposure on total debt of $471 million.

The weighted average swap rate as of December 31st, 2009 was 3.33%. Because the prevailing short-term LIBOR rate has been below this level for the entire year, we had expected the company to realize a net loss on interest rate swaps that expired during the year. Any gain or loss from expiring swaps is typically included on quarterly earnings either as a component of interest expense (if the swap qualifies for hedge accounting) or as a separate item (if not).

However, the company’s interest rate swaps do not qualify as effective cash flow hedges under GAAP. Safe Bulkers has to include on its quarterly earnings any unrealized gain or loss from differences in mark-to-market valuation on its outstanding interest rate swaps.

During the fourth quarter of 2010, because of an upward trend on the LIBOR term structure, the company’s unrealized gain on its outstanding interest rate swaps exceeded realized loss on the expired swaps. As a result, Safe Bulkers reported a gain on derivatives of $4.9 million, compared to a loss of $3.9 million for the previous quarter. Our forecast had mistakenly called for a loss on derivatives of $4 million.
The fact that the company’s interest rate swaps do not meet the strict GAAP hedging accounting criteria will continue to create volatility on its quarterly earnings. Despite this volatility, Safe Bulkers should be commended for a very prudent and very conservative interest risk management strategy.