New world of ship sale and leaseback
Recognising this growth and appetite for ship leasing transactions, the world’s largest international shipping association, BIMCO, set its sights on developing the industry’s first ship sale and leaseback standardised term sheet. The sale and leaseback term sheet ‘SHIPLEASE’ was released last month and will be rolled out to support shipowners, leasing companies, financial brokers and lawyers when negotiating and drawing up sale and leaseback agreements.
But what is ship leasing and why is it such a strong trend in shipping? We explore this growing market and look at what is in store for market players in these new and challenging times.
What is ship leasing?
In the context of shipping, a lessor (as legal owner/leasing company) will give to a lessee (the operator/shipping company) in consideration of regular lease/hire payments, full possession and operational control of the ship for an agreed period. There are different types of ship leasing transactions with the most common types of leasing structures being: the operating lease, and the finance lease. These structures and terms are also significant from an accounting treatment perspective.
Operating leases are typically used for short to mid-term charter of the ship and at the end of such term, the ship is returned to the lessor. The lease can usually be terminated at the lessee’s discretion and it will (subject to the applicable accounting treatment) generally not appear on its balance sheet. On the contrary, finance leases are more commonly used for long term finance of ships. Here, the lessor acts as the financier and has little involvement with the ship other than owning it. The principle is based on the premise that the lessee should enjoy the benefits, and be subject to the risks, of ownership of a vessel because during the term of the lease, it will have possession and operational control of the ship. Finance leases will contain a ‘hell or high water’ clause meaning the lessee cannot in any circumstances terminate the lease or be excused from paying hire. If the lease is terminated early, the lessee must compensate the lessor.
What has made ship leasing so fashionable?
Ship lease structures offer shipping companies an alternative source of capital, which is helpful in times of economic difficulty and when traditional debt finance from banks and financial institutions is limited. As banks become more regulated and risk averse, shipowners are seeking alternative structures that give them cash liquidity, flexibility and returns.
A sale and leaseback transaction illustrates the key benefits of ship leasing for both a lessor and lessee by factoring in the fiscal and operational needs of both. This structure allows the owner of the ship to sell and lease it back (as lessee) without incurring a huge debt on its financial statements. The buyer (as lessor) can in some circumstances benefit from the ability to depreciate the value of the ship against its tax liabilities, and subsequently share part of this benefit with the lessee through discounted hire payments. There are other benefits, such as freeing up working capital of a shipping company to enable investment in other areas whilst also managing the financials of its business through agreeing longer term repayment structures but also more equal hire payments to follow income streams.
Another point worth mentioning is the fact that the lessor will always be the owner of the ship and so in the event of non-payment of hire or any other breach of contract, the lessor would be able to terminate the bareboat charter and take back possession of its ship, albeit this is not always entirely straightforward.
Chinese leasing companies
The reasons for the expansions of the global ship leasing market are varied, but what is clear is that the market has experienced exponential growth in the last five years. Much has been led by Chinese leasing transactions, which today, are a prime source of finance, accounting for over 10% of global ship finance. Their interest has since shifted out of the newbuild market and leasing companies have been robustly entering the second-hand market. Even with today’s uncertain outlook in shipping amid the global pandemic, Chinese leasing houses continue to conclude new deals this year. There were news reports of CSSC Shipping, the financial leasing unit of China State Shipbuilding Corporation (CSSC) announcing plans to issue two bonds worth a total of $800 million due in 2025 and 2030 and to use the net proceeds primarily to develop its leasing business and refinance its existing indebtedness. Bocomm Leasing also made the headlines with a $650 million contract signed with Shell for a dozen dual-fuel long range tankers; whilr still exercising some caution in these times, their lending remains robust having expanded by 25% from 2018, to $15.8 billion in 2019.
Japanese and South Korean financial institutions are also active players in this business area. In June 2020, the Hong Kong government published an attractive ship leasing tax incentive in order to compete with tax-friendly schemes in Singapore and other jurisdictions by offering profit tax concessions for qualifying ship lessors and ship-leasing managers. The incentive applies to Hong Kong-based managers using separate Hong Kong-incorporated special purpose companies to own and lease ships for use outside Hong Kong waters based on operating or finance leases entered into with either affiliated or third-party lessees. The ship-leasing company must have an adequate number of full-time employees in Hong Kong (in any event, not less than two) and an adequate annual operating expenditure in Hong Kong (in any event, not less than approx. $1 million), whereas the figures for a ship leasing management company are respectively one and $128,000. The conditions are said to be in general less onerous than those of Singapore and has been designed to help promote Hong Kong as the preferred jurisdiction for ship-leasing activities.
Standardising the market
BIMCO has been quick to recognise the growth across Asia and has been working closely with experts, from shipowners, leasing companies and law firms, to develop ‘SHIPLEASE’, a standardised term sheet for ship sale and lease back transactions. It was recognised by senior director Wilson Liu at Minsheng Financial Leasing that with so many transactions being concluded in Asia and an influx of newcomers in the market, having an industry standard would be a useful starting point for all. Even though lessors will often have developed their own standard forms (in addition to lease terms, which are largely developed from those of BIMCO Barecon), it will be a useful crib sheet and a potential template for other transactions.
The term sheet itself sets out indicative terms and conditions for a ship sale and leaseback transaction and while primarily developed for second-hand ships, it can be adapted for newbuilds or refits. The structure of the term sheet follows a charter party and includes the customary BIMCO box layout for the main terms, agreed variables (Part II), standard provisions (Part III) and Annexes for more detailed provisions. Many of the provisions have been considered in light of industry wide consultation to help ensure they better reflect current market practice. These include provisions such as hire, which shall be paid on a ‘hell or high water’ basis, a purchase option, the lessor’s right to mortgage the vessel and to onward assign the bareboat charter by way of security to any financier subject to provision of a letter of quiet enjoyment to the charterer. From a ‘bankability’ perspective, such provisions are also useful to include at the outset.
By utilising its standard term sheets for bilateral and syndicated term loan facilities as a starting point guide, BIMCO is continuing its focus on ship financing documentation and hopes ‘SHIPLEASE’ will be seen as a ‘one size fits all’ form which parties can adapt to fit their needs.
Some commentators have speculated that ship finance will shift even further towards Asia at the expense of Europe and the U.S., but that the Covid-19 crisis will provide an important stress test for Chinese leasing. A number of shipowners have increasingly turned to Chinese leasing houses for capital but if these lessees decline to exercise their purchase options at the end of the charter period, Chinese lessors could end up owning a very large number of vessels, including those that operate in more challenged sectors such as offshore.
It would be fair to say that leaseback deals are becoming subject to more stringent screening, amid heightened market volatility, lack of liquidity and concerns about insufficient project cash flows, but shipowners continue to need access to capital and they want to operate vessels and trade as owners. What remains for sure is that the ship sale and leaseback market is no longer an alternative, but a key source of finance.
Lianjun Li is a partner and leading lawyer of the transportation and commercial litigation department in Reed Smith’s Hong Kong office. Jaye Bhogal is an associate in the asset finance team of the Transportation Industry Group of Reed Smith, specialising in the shipping and offshore sectors.
Source: Baltic Exchange