Vessel sale and leaseback

How are vessel sale and leasebacks structured?

The owner sells a vessel, often a newbuilding at delivery or a modern second-hand ship, to a leasing company for a price close to its market value, and charters it back on a bareboat basis, crewing and running it as before. Hire is set to repay most of the price with interest over the term, often with a floating rate element. The owner usually has options to buy the vessel back at set prices after a few years, and an obligation or option to buy it back at the end for a final amount. Japanese operating leases with call options follow a similar pattern with different tax features.

Is the transfer a sale under IFRS 15?

IFRS 16 requires the seller-lessee to apply IFRS 15 to decide whether the buyer obtains control of the vessel. Under IFRS 15, if the seller has an obligation to repurchase the asset, or a right to repurchase it that is substantive, the buyer does not obtain control, so there is no sale. A repurchase obligation at the end of the charter, or purchase options at fixed prices the owner is likely to exercise, therefore turn most of these deals into financing. Only where the owner has no repurchase right, or the right is not substantive, and the leaseback does not cover substantially all of the vessel's remaining life, is the transfer a sale. See IFRS 16 sale and leaseback.

Vessel sale and leaseback that fails as a sale

An owner sells a vessel carried at US$ 30 million for 32 million and bareboat charters it back for 10 years at 3.6 million a year, with an obligation to buy it back for 8 million at the end. Because of the repurchase obligation, there is no sale. The vessel stays at 30 million and continues to be depreciated, and the 32 million is a financial liability. The effective interest rate that discounts the hire and the repurchase price to 32 million is 5.40%.

By the end of year 10, the liability has fallen to 8.00 million, the repurchase price, which is paid to settle it, and the owner keeps the vessel. No gain on sale is recognised, and the charter hire never appears as a lease cost: it is split each year into interest expense and repayment of the liability. The 2 million by which the price exceeded carrying amount is simply part of the borrowing. See the effective interest method.

What if the owner exercises a purchase option early?

The owner pays the option price, the liability is derecognised, and any difference between the price and the liability's carrying amount, together with fees, is recognised in profit or loss. Refinancings where the same lessor amends the hire or extends the term are modifications of the financial liability under IFRS 9: if the terms change substantially, the old liability is derecognised and a new one recognised; otherwise the amortised cost is recalculated and the difference recognised in profit or loss. See IFRS 9 modifications.

What happens in a true sale?

When an owner sells a vessel with no repurchase rights and charters it back for a shorter period, the transfer is a sale. The owner derecognises the vessel, recognises a right-of-use asset at the proportion of the previous carrying amount that relates to the right of use it keeps, a lease liability, and a gain only on the rights transferred to the buyer. A time charter back, rather than a bareboat charter, also includes the buyer's crewing service, which is not part of the lease. The mechanics are the same as for aircraft; see aircraft sale and leaseback.

How do these deals affect covenants and disclosures?

Failed sale and leasebacks are borrowings: they count in net debt and in covenant tests such as leverage and value-to-loan ratios, and the owner discloses the liabilities, their maturity and the vessels that secure them. Lessors often hold back part of the price as a security deposit, which the owner recognises as a financial asset. Because legal title has passed to the lessor, the vessels are disclosed as pledged, even though they remain on the owner's balance sheet.

How does the lessor account, and how does US GAAP differ?

When the transfer is not a sale, the leasing company recognises a financial asset, a loan to the owner, not a vessel, and earns interest income. Under US GAAP, ASC 842 reaches a similar answer: a repurchase option or obligation generally prevents sale accounting, except a fair value option over an asset readily available in the market, so most of these deals are failed sales, accounted for as financing. See shipping accounting.

This guide is general information. It is not tax or legal advice for your situation.