Tuesday, November 06, 2018 / 12:20 PM / Fitch Ratings
A sale and leaseback of operating assets to a legally separate entity can help reduce debt and avoid lease recognition if a large minority stake is sold to a third party, Fitch Ratings says. We will treat minority dividends as lease payments and make adjustments to capitalise them if the sale creates an obligation to the minority shareholder beyond a normal discretionary dividend, provided that we have sufficient information to do so.
The traditional sale-and-leaseback transactions are less effective under IFRS 16 and Financial Accounting Standards Board's (FASB) ASC 842. Under the new accounting rules, commitments under resulting lease contracts will be capitalised, although the level of capitalised liabilities is likely to be lower than the economic value of the assets.
An alternative approach that Fitch understands may be applied is for an entity to enter into a joint venture (JV) using a similar sale-and-leaseback transaction with a special-purpose vehicle (SPV), where a large, but minority, stake, for example 49%, is sold to a third-party investor, so that the SPV remains consolidated. The proceeds of the sale can be used to reduce debt. As the SPV is consolidated, any lease commitment resulting from the lease contract between the issuer and the vehicle will be considered intra-group under accounting rules and will therefore not appear in the consolidated accounts.
The purpose of the sale-and-leaseback transaction would be negated, if the SPV was consolidated and debt to fund the assets acquisition from the issuer was located at the SPV. However, this can be avoided by keeping the SPV debt free and locating debt at a different level. This could be at an intermediate holding company of the third-party investor that acquires the minority stake, which Fitch believes would not be consolidated under applicable accounting standards. At the same time, the issuer can enter into a shareholder agreement with the third-party minority investor to commit to dividend payments from the SPV at a sufficient level to service the acquisition debt.
Although we already adjust FFO for dividends paid to minority interests, this adjustment does not sufficiently capture additional debt located at the level of an acquiring holding company. This is due to the issuer's commitment to service this debt with a combination of the contractual obligation to pay rents in the lease agreement signed with the SPV and the commitment to distribute 49% of that rent to the minority shareholder as per the binding shareholder agreement (ignoring the likely insignificant operating costs of the SPV).
In conducting its analysis, Fitch would capitalise the portion of the rents paid to the SPV and attributable to the minority interest if Fitch believes that the dividend paid by the SPV is more akin to an obligation to the minority shareholder than a normal discretionary dividend. Alternatively, Fitch could proportionally consolidate the SPV into the accounts of the issuer. This is assuming that sufficient information on the deal structure and any commitments to pay dividends from the SPV is available. We would encourage issuers and investors to ensure timely disclosure to us of such information.
Sectors where Fitch expects such structures are most likely to be used are those where sale-and-leaseback transactions have been traditionally prevalent, such as telecoms, retail and lodgings.