Business

Thu Jun 26 01:21:00 PDT 2008

By Umesh Desai

HONG KONG, June 26 (Reuters) – Amid the global credit crisis, more companies are looking to release cash locked up in big ticket assets like planes, ships and real estate through sale and leaseback agreements.

But this is often at the risk of increased leverage and reduced transparency.

While softening property prices have slowed the pace for deals involving real estate, the entry of new buyers such as pension funds and insurance firms will revitalise this form of corporate finance.

"We have seen quite a substantial increase in enquiries since the financial turmoil began last year," said Ole Hjertaker, Oslo-based chief financial officer of Ship Finance Management AS, which buys ships and leases them back to shipping companies.

The New York Stock Exchange-listed firm had focused a lot of its efforts in 2007 on marketing campaigns, but in the current year there was no time for pitching deals, such was the increase in demand for sale and leaseback, Hjertaker said.

In May, it executed an $850 million deal with Norwegian oilfield services group Seadrill <SDRL.OL>, the biggest ever sale and leaseback contract in the marine industry, he added.

Although Seadrill did not make any capital gain on the transaction, its shares soared on the Oslo stock exchange after it hinted the cash from the sale could be paid out as dividend.

But applications such as these are raising alarm bells.

"In a sale and leaseback transaction, if you use the money to repay debt it’s broadly neutral for the credit — you are replacing one form of financing with another," said Frederic Gits, senior director at Fitch Ratings.

"But if you are giving the money back to shareholders you are increasing the leverage of the company," he said, while warning about excessive payments towards stock-friendly items like share buybacks and dividends.

OPAQUE FINANCIALS

Gits says such transactions could also result in reduced transparency because information about the seller’s future obligations related to lease payments would not appear on the liability side of the balance sheet.

"Companies entering into sale and leaseback transactions become less transparent and more difficult to analyse," he said.

Meanwhile, financing companies are girding for more business at a time when unsecured credit is difficult to obtain.

BOC Aviation, the aircraft leasing arm of the Bank of China <601988.SS><3988.HK>, is focusing on buying from airlines that cannot finance their orders due to the global credit crunch.

The company has a $1 billion credit line from its parent bank and another $500 million in loans and cash that it is able to tap for purchases, as it anticipates growing demand for sale and leaseback deals.

"There are three catalysts for this — the credit crunch in the banking system, the record backlog of 7-½ years of orders in the aircraft industry and soaring fuel prices that are hurting airline profitability," said its chief executive Robert Martin.

The Singapore-based CEO predicts activity will peak around 2010 as manufacturers increase production to meet this backlog. Financing needs would have risen 50 percent by then, he said.

PROPERTY DEALS

The property sector, which has seen some moderation in sale and leaseback activity in the wake of falling real estate prices, is expected to see higher volumes as insurance companies such as Prudential Plc <PRU.L> bridge the gap left by debt-fuelled buyers such as private equity firms.

"Despite the relative paucity of debt funding, there is still a lot of equity available for property market investments," said Revathi Padmakumar, London-based head of real estate at KPMG Corporate Finance.

That trend will also spread to less-mature markets like Asia as professional landlords replace local developers and operators.

"Japan and Korea should see the strongest volume growth given the level of market maturity," said Brian Chinappi, managing director at RREEF, the global alternative investment business of Deutsche Bank’s asset management division.

"Growth in China will be slower because most multinational corporate owner occupation is within the industrial sector."

But sellers will have to tread carefully as rating agencies take a cautious view.

Tesco <TSCO.L>, the world’s fifth-largest retailer, is in the midst of selling some property to release billions of pounds of value from its real estate.

The amount of its portfolio that is owner-occupied, rather than leased from a landlord, dipped to 80 percent from about 83 percent a year ago. It has realised 1.4 billion pounds as part of a property sell-off worth more than 5 billion pounds.

However, Standard & Poor’s said this is hitting the retailer’s financial profile.

"Rapid new space expansion and store-premises sales and leaseback transactions inflated the group’s rent expenses and operating lease commitments," the agency said, after cutting Tesco’s rating to A from A-plus, while revising its outlook to negative from stable.

(Editing by Ian Geoghegan)

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