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CQS Rig Finance Fund Limited (RIG)

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Tuesday 20 December, 2011

CQS Rig Finance Fund Limited

CQS Rig Finance Fund Ltd : Annual Financial Report

CQS Rig Finance Fund Ltd : Annual Financial Report

CQS RIG FINANCE FUND LIMITED (the "Company")

ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 SEPTEMBER 2011

FINANCIAL HIGHLIGHTS FOR THE TWELVE MONTHS ENDED 30 SEPTEMBER 2011

  • Net Asset Value total return of 5.4%, inclusive of dividend income. 

  • Ordinary share price return of 1.6%, inclusive of dividend income. 

  • Discount of 23% to fully diluted net asset value as at 30 September 2011. 

  • A dividend of 1 penny per ordinary share in respect of the year ended 30 September 2010 was approved at the AGM of the Company on 7 April 2011. A total dividend of GBP974,100 was paid on 11 May 2011. 

  • An interim dividend of 0.55 of a penny per ordinary share in respect of the year ended 30 September 2011 was approved by the Board of Directors on the 9 September 2011. A total dividend of GBP535,755 was paid on 7 November 2011. 

  • The Company has repaid all net debts during the financial year ended 30 September 2011. 

CHAIRMAN'S STATEMENT

Introduction

I have pleasure in presenting the Company's annual report for the twelve months from 1 October 2010 to 30 September 2011.

The Company has made some significant progress over the last twelve months and I am encouraged that the Company has fully repaid its net debt. The reinstatement of regular dividend payments and the progress that the Net Asset Value ("NAV") has shown over the financial year are also encouraging and given the turbulence in Global markets the share price has also performed relatively well.

Investment Performance

The Company's performance for the year under review was positive, despite renewed concerns of a global economic slowdown and increased market volatility.

The Company's NAV increased from 27.64 pence per ordinary share on 30 September 2010 to 28.14[1] pence per ordinary share on 30 September 2011. In May 2011, the Company paid a one penny per ordinary share dividend in respect of the financial year ended 30 September 2010. The total return to shareholders (change in NAV plus dividend income) over the fiscal year was 5.4%. The price per ordinary share ended the period modestly lower, with a closing price of 22.75 pence on 30 September 2010 and a closing price of 22.125 pence on 30 September 2011, representing a return of 1.6%, inclusive of the one penny per share dividend. The ordinary shares ended the year at a 23% discount to the NAV. The Company has repaid all net borrowing through active portfolio management and proceeds generated from restructurings, asset maturities and selective asset sales. As at 30 September 2011 the Company had a net cash position of GBP2.9m.

Financing

In October 2010, the Company agreed extensions to its secured financing arrangements ("Secured Facility") with Credit Suisse Securities (Europe) Limited ("CS") and executed an extension to its unsecured loan facility ("Subordinated Facility") with RBC Cees Trustees Limited ("RBC").

I am pleased to note that, on 30 November 2010, the Company announced that in line with its objective of reducing leverage, it had repaid the principal and outstanding interest on its Subordinated Facility. The Subordinated Facility was repaid out of the proceeds of portfolio realisations. On 14 December 2010 the Company announced the repayment of all cash borrowed under its Secured Facility to CS. The Company continues to operate a Prime Brokerage Agreement with CS that allows the Company to borrow in one or more currencies against assets of the Company.

New Investment Objective and Investing Policy

At the Company's Annual General Meeting on 7 April 2011 an ordinary resolution to approve the Company's new Investment Objective and Investing Policy was approved by Shareholders.

The new investment policy and objective reflect the Investment Adviser's belief that there are now an increasing number of attractive opportunities available for the Company to invest in instruments that are unsecured and/or subordinated within individual issuers' capital structures. The related opportunities significantly widen the investable universe and thereby allow the Company to source attractive investments while also widening risk diversification and improving portfolio liquidity. Additionally, the Investment Adviser believes that investments in convertible bonds can offer an attractive combination of yield and equity participation while providing some protection from declines in equity valuations.

The Company's new Investment Objective and Investing Policy expand its investable universe to include unsecured and/or subordinated debt instruments, including convertible bonds and other associated securities. Furthermore, the Investment Adviser believes that expanding the investable universe to include a wider range of financing opportunities relating to oil, natural gas and other resource sectors should also assist in increasing the opportunity to generate attractive returns in addition to widening both portfolio diversification and improving portfolio liquidity.

Full details of the new Investment Objective and Investing Policy is available on the Company's website (www.cqsrigfinance.com).

Outlook

Supported by the current and forward price of Oil, capital expenditure plans by National and International oil companies are on the rise. Utilisation rates remain solid for high specification drilling and services equipment, particularly Ultra Deep Water Units and floating production, storage and offloading (FPSO) vessels are being awarded contracts at historically-high day rates.

There is a clear preference for new high-specification equipment, a trend which was reinforced by the events at the Macondo oil field in 2010. With this in mind, further consolidation in the sector is likely as oil companies seek to renew their ageing fleets. This was evidenced by the recent acquisition of Aker Drilling by Transocean Ltd.

Financing remains a challenge for many companies as banks seek to strengthen balance sheets and core capital ratios, thus forcing companies to enter the high-yield market for financing.

As such the current market environment provides an attractive opportunity set upon which the company may grow going forward.

Dividends

At the Company's Annual General Meeting on 7 April 2011 shareholders approved the payment of a final dividend of one penny per ordinary share of no par value in respect of the financial year ended 30 September 2010, which was paid to shareholders on 11 May 2011.

On 9 September 2011 the Board of Directors announced that the Company intends to recommence regular cash distributions in the form of semi-annual dividend payments, initially targeting dividends equivalent to an annual yield of 4 per cent of the Net asset Value per Share as at the start of each financial year. On the same day the Board of Directors announced an interim dividend of 0.55 pence per ordinary share in respect of the year ended 30 September 2011. A total interim dividend of GBP535,755 was paid on 7 November 2011.  

Annual General Meeting

The Company's Annual General Meeting will be held at the offices of Kleinwort Benson (Channel Islands) Fund Services Limited on 6 March 2012.

Post Year End

In October 2011 there was positive news regarding one of Company's legacy workout positions. On 11 October 2011 Ramunia Holdings Berhad announced the completion of the acquisition of the deep producer vessel MT Laurita for USD82.5m in cash. The vessel formed the major part of the collateral for the FPS Ocean AS (formerly DP Producer AS) bonds. The resulting proceeds had a materially positive impact on the Company's NAV and share price which rose to 32.06 and 25.875 pence per share respectively as at 31 October 2011.

On 20 December 2011 the Company announced a final dividend of 0.6 pence per share in respect of the financial year ended 30 September 2011 to be approved at the AGM and if approved, paid on 11 April 2012.

Michael Salter

Chairman

20 December 2011

INVESTMENT MANAGER'S REPORT

Oil Markets

The fundamental outlook for the oil and energy sector remains robust. In its 2011 edition of the Global Energy Outlook, the International Energy Agency (IEA) restated its projection that world energy consumption will increase by 53 percent from 2008 to 2035 and noted that "given expectations that world oil prices will remain relatively high through most of the projection period, petroleum and other liquid fuels are the world's slowest growing source of energy."1

Brent Crude oil prices maintained elevated levels over the course of the year under review. The price of Brent Crude rose from a starting point of USD87, initially as a result of growing demand associated with signs of economic recovery, and were driven even higher at the end of 2010 and into 2011 as social and political unrest unfolded in several Middle Eastern and African economies. The high point was reached in April 2011 (USD124) and levels were maintained above USD100 for the majority of the remaining period to September.

Barclays Capital commodities research2 notes that "the determination of key producers to defend a USD90-USD100 crude makes the downside limited, while the fundamentals create an upside potential that is far more unlimited. Naturally, the current path of least resistance for prices is still upwards and until the global market remains in a deficit, the current debt crisis can temper but not derail that momentum, unless of course, a complete policy impasse is reached."

Against this backdrop, companies continue to increase their planned capital expenditure on Exploration & Production ("E&P"). DNB Nor Markets E&P Spending survey undertaken in the summer of 2011 indicated an 11% spending increase in 2011, 8% in 2012 and 7% in 2013.

The development of resources offshore Brazil continues. At a recent conference3, Petrobras highlighted its strong production outlook. The company aims to increase oil and gas production from 2.6 million barrels per day ("mbd") in 2010 to 4.0 mbd in 2015 and 6.4 mbd in 2020. The company plans E&P spending of USD127.5bn in 2011-2015. To help achieve these targets Petrobras recently opened a tender for 21 Brazilian built 10,000ft ultra-deepwater (UDW) rigs.

After the spill at the Macondo well in the Gulf of Mexico brought worldwide attention to the offshore drilling sector last year, new drilling activity has slowly started to be sanctioned. BP has recently received approval for a new exploration plan in the Gulf of Mexico. This is BP's first approval since the Macondo incident, but the 44th exploration plan approved in total, with 30 new well permits in water depths of 500-12,000ft having been approved.

In this environment, average drilling day rates continued to trend upwards from lows in 2009. UDW day rates have recently achieved rates of USD500k per day, with the global fleet at close to 100% utilisation levels. Given the recent wave of new build orders for UDW rigs there has been speculation of oversupply. However, SEB Enskilda research notes that even taking account of availability for existing and yet to be delivered rigs, the contract coverage is still at healthy levels: 93% in 2011, 79% in 2012 and 66% in 2013.

The international jack-up market has continued its development into a two tier market over the period, evidenced by high specification units attracting much higher day-rates and utilisation levels compared with standard units. The floating production, storage and offloading (FPSO) market continues to benefit from the effects of high oil prices with over 15 contracts being awarded in 2010 and a similar number expected in 2011 following the lull of 2008/9.
Financing Markets

The high yield bond market was very active over the first part of the year under review with investors searching for yield given the current and projected outlook for interest rates and companies looking to refinance following the financing drought of prior years. Several attractive issues were launched and the Company took advantage of its cash balances to participate in these issues to broaden and diversify the overall portfolio.

The current calendar year was on course to be a record issuance year in the high yield market until August when global growth concerns and the European sovereign-debt issue caused markets to freeze once more. In the current environment it is difficult for companies to come to market without offering elevated coupon levels and in some cases strong security packages which should provide opportunities for the Company in the year ahead.

The Portfolio

The portfolio has reached the end of a transition phase as the large majority of the workout and restructuring processes have been completed and as a result positions have been cashed out. The Company has positive net cash balances and only a small minority of non-performing assets remain.

As at 30 September 2011 the portfolio was divided into three broad categories. Analysed by face value, drilling rigs are the largest category accounting for 47.8% of assets. These rigs break down into two main sub-categories, jack-up drilling rigs and semi-submersible drilling rigs. The majority of the jack-up rigs are regarded as high specification jack-ups which are targeted at particular water depths and demanding environmental conditions, such as the Norwegian Continental Shelf, setting them apart from the general jack-up market which focuses on shallow depths and is much better supplied and very competitive.

Production-focused equipment, the majority being FPSO vessels, is the second-largest category, accounting for 14.4% of assets. FPSO vessels are customised to meet the particular chemical and physical characteristics of a target oil reservoir to which they are then typically contracted for many years. While this customisation takes time and can be costly, it also makes it difficult to switch a vessel from one field to another at short notice.

Seismic data companies represent 16.5% of the portfolio. Seismic technology is applied to solve problems and reduce uncertainties across the entire range of exploration, development, and production operations. Surveys are used to characterize and model reservoirs, to plan and execute enhanced-oil-recovery strategies, and to monitor fluid movement in reservoirs as they are developed and produced.

The remaining 21.3% of portfolio assets are invested in related equipment such as support-service vessels, offshore-construction vessels and accommodation units.

Exposure by Collateral Type

Collateral Type30 September 2011
(% of Total Market Value)
Accommodation Vessel7.9%
Barge/Service Vessel4.3%
Elevating Support Vessel2.8%
FPSO14.4%
Jackup10.7%
Seismic Vessel16.5%
Transport Vessel1.2%
UDW Driller37.1%
Other5.1%
Total100.0%

Seniority Analysis

Capital Structure30 September 2011
(% of Total Market Value)
1st Lien41.8%
2nd Lien17.7%
Unsecured22.1%
Equity1.1%
Convertable17.3%
Total100.0%

Positions by Category

As at 30 September 2011, the Company's portfolio, excluding interest rate swaps and foreign exchange forwards, may be categorised as either performing, performing under the terms of a restructure or non-performing as shown in the table below.

Name / IssuerClassificationValue (GBP'000s)
Aker Drilling ASPerforming1,807.1
Berlian Laju Tanker Tbk PtPerforming284.2
Boa Deep C ASPerforming654.7
DDI Holding ASPerforming2,525.8
Floatel IntlPerforming1,732.6
Galp EnergiaPerforming29.8
GCM Corp.Performing2,625.4
Master Marine ASPerforming165.9
North Atlantic Drilling LimitedPerforming35.9
Norwegian Energy Co.Performing523.5
Ocean Rig UDW Inc.Performing1,051.8
OceanTeam Shipping ASAPerforming381.8
ParpublicaPerforming671.2
Petroleum Geo-Services ASAPerforming2,473.9
Polarcus LimitedPerforming1,485.4
Rds Ultra-deepwater limitedPerforming664.1
Rubicon Offshore HoldingPerforming2,751.1
SeadrillPerforming2,064.6
Sevan Drilling ASAPerforming42.2
Troll DrillingPerforming632.5
Vantage DrillingPerforming410.5
FPS Ocean ASIn default654.5
Marine Subsea ASIn default6.2
MPF LimitedIn default0.1
Nexus 1 Pte LimitedIn default2.3
Petroprod LimitedIn default0
Petrorig Iii Pte LimitedIn default288.5
Remedial CaymanIn default29.2
Viking Drilling ASAIn default0

Outlook

The challenge for the coming year is to complete the transition into a diversified portfolio of performing investments, taking advantage of opportunities provided by the requirement to finance energy-related infrastructure and the persisting relative scarcity of bank financing.

¹ Source: International Energy Agency - Oil Market Report 2011
2 Source: Barclays Capital Commodities Research, Oil Sketches, 25 October 2011
3 Source: Pareto Securities Oil & Offshore Conference, 31 August 2011 - 1 September 2011

All market data sourced from Bloomberg and CQS.

CQS Cayman Limited Partnership

Statement of Comprehensive Income
For the year ended 30 September 2011

30 Sept 201130 Sept 2010
GBPGBP
Operating profit2,580,77219,673,126
Operating expenses
Other operating expenses(850,448)(738,823)
Finance costs(269,683)(2,543,039)
Total operating expenses(1,120,131)(3,281,862)
Net profit1,460,64116,391,264
Total comprehensive profit for the year1,460,64116,391,264
Profit per Ordinary Share
Basic and Diluted1.50p16.83p

There are no recognised gains or losses in the financial period other than those dealt with in the statement of comprehensive income and accordingly no statement of total recognised gains and losses has been presented.

All items in the above statement are derived from continuing operations.

All income is attributable to the ordinary shareholders of the Company.

Statement of Financial Position
As at 30 September 2011

30 Sept 201130 Sept 2010
GBPGBP
Assets
Non-current assets
Financial instruments designated at fair value through profit or loss18,478,24729,689,306
Current assets
Financial instruments designated at fair value through profit or loss5,581,8469,165,053
Cash and cash equivalents2,861,937-
Forward foreign exchange contracts181,061-
Receivable for securities sold862,702-
Other assets58,36733,512
9,545,9139,198,565
Total assets28,024,16038,887,871
Equity and liabilities
Equity

Other reserve 

89,472,52990,982,384

Accumulated losses 

(62,596,143)(64,056,784)
26,876,38626,925,600
Current liabilities
Interest-bearing borrowings-5,015,056
Short-term borrowings-3,807,588
Payable for securities purchased362,738321,047
Forward foreign exchange contracts27,266-
Derivative financial liabilities59,188-
Distributions payable535,755-
Other liabilities and payables162,8272,818,580
Total liabilities 1,147,77411,962,271
Total equity and liabilities28,024,16038,887,871
Net Asset Value per Share27.59p27.64p

Statement of Changes in Equity
For the year ended 30 September 2011

Share
Capital
Other
Reserve
Accumulated LossesTotal
GBP GBPGBPGBP
Balance at 1 October 2010-90,982,384(64,056,784)26,925,600
Net profit for the year--1,460,6411,460,641
Total recognised income and expense plus equity brought forward-90,982,384(62,596,143)28,386,241
Dividends to shareholders-(1,509,855)-(1,509,855)
Balance at 30 September 2011-89,472,529(62,596,143)26,876,386

For the year ended 30 September 2010

Share
Capital
Other
Reserve
Accumulated LossesTotal
GBP GBPGBPGBP
Balance at 1 October 2009-90,982,384(80,448,048)10,534,336
Net profit for the year--16,391,26416,391,264
Total recognised income and expense plus equity brought forward-90,982,384(64,056,784)26,925,600
Balance at 30 September 2010-90,982,384(64,056,784)26,925,600

Statement of Cash Flows
For the year ended 30 September 2011

30 Sept 201130 Sept 2010
GBPGBP
Net cash inflow from operating activities13,398,85633,351,273
Financing activities
Short-term borrowings(3,852,575)-
       Interest expense paid(710,686)(2,482,312)
(Decrease) in interest-bearing  borrowings(4,999,558)(31,844,944)
Dividends paid to Shareholders(974,100)-
Cash (outflows) from financing activities(10,536,919)(34,327,256)
Net increase /(decrease) in cash 2,861,937(975,983)
Reconciliation of net cash flow to movement in net cash
Net increase/(decrease) in cash and cash equivalents2,861,937(975,983)
Cash and cash equivalents at 1 October 2010-975,983
Cash and cash equivalents at 30 September 20112,861,937-

The notes (which are made available in the Annual Report and Accounts on the Company's website) form an integral part of the financial statements.

Enquiries
Debra Moullin
Kleinwort Benson (Channel Islands) Fund Services Limited
Telephone 01481 752455

James Steel /  Richard Johnson
NOMAD and Broker
Arbuthnot Securities Limited
Telephone 020 7012 2000

The Annual Report and Accounts for the year ended 30 September 2011 will be posted to shareholders shortly and in accordance with AIM Rule 26, a copy of the audited Annual Report and Accounts will be available to view and download from the Company's website at www.cqsrigfinance.com

The notice of the Company's Annual General Meeting will be posted to Shareholders separately and will be held at the offices of Kleinwort Benson (Channel Islands) Fund Services Limited on 6 March 2012.

[1] including 2011 interim dividend of 0.55p (ex div date of 12 October 2011)




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(i) the releases contained herein are protected by copyright and other applicable laws; and
(ii) they are solely responsible for the content, accuracy and originality of the
information contained therein.

Source: CQS Rig Finance Fund Ltd via Thomson Reuters ONE

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