Islamic Aircraft Financing
Structures
Robert Fugard
Linklaters
Partner, Asset Finance Group
the current environment
•
reappraisal by banks of approach to aircraft finance
-
•
difficulties in sourcing equity prepared to invest in the industry
-
•
as a reaction to uncertainty in the industry
as a result of changes to tax rules
restriction of tax-based leasing
-
•
exit of some traditional lenders
restriction of categories of airline credits considered
loss of traditional tax products: US, Germany and Japan
curtailing of Export Credit Agency support
-
abolition of LASU fixed rate option
increases in premia and reduction in advance rates
1
the Islamic finance market
•
Islamic funds estimated at over $200 billion
•
growing market
-
•
return of Islamic funds to region
opportunity to tap into the significant funds of Islamic investors
seeking Shari’a compliant investments
establishment of regional secondary market infrastructure in Dubai
(DIFC), Bahrain, Saudi Arabia
over 250 Islamic Finance Institutions worldwide
-
Western institutions most active in this market are HSBC Bank plc
(through HSBC Amanah Finance) and Citigroup
Local financial institutions include Arab Banking Corporation,
Dubai Islamic Bank,Abu Dhabi Islamic Bank, Kuwait Finance
House, First Islamic Investment Bank, as well as Islamic Development
Bank
2
what Islamic finance offers
•
diversification of funding sources
•
investor’s regional understanding of risk
•
conventional-style documentation
•
bankable governing law
•
ability to combine with conventional funding sources
3
‘basic’ Islamic leasing structure
Islamic investors
investment
(85%)
Investment (Modaraba)
agreement
Modareb
investment (85%)
Vendor
Sale of
aircraft
Declaration of trust
Islamic Lessor
(Cayman SPV)
Equity
contribution
(initial rental)
(15%)
Islamic lease
(Ijara)
Insurance &
Maintenanc
e Services
Airline
4
airline sukuk structure
•
sukuk defined by AAOFI’S Shari’a standards as
“Certificates of equal value representing undivided shares in
ownership of tangible assets, usufruct and services or (in the
ownership of) the assets of particular projects or special
investment activity”
•
can provide greater diversification of funding sources than ‘basic’
Islamic leasing structure
•
access to larger volumes of capital
•
potential to provide liquid investments for Islamic investors
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airline sukuk structure
•
sukuk gives investors share in profits generated by investment in
asset
–
–
•
problems with morabaha - based sukuks and tradeability
–
•
ijara - based cash flows most appropriate for sukuks
real estate ijara - based sukuks
Malaysia
$600m issue (June 2002)
IDB
$400m issue (July 2003)
Qatar
$700m issue (September 2003)
Bahrain
$250m issue (June 2004)
Saxony
€ 100m issue (August 2004)
Dubai DCA
$750m issue (proposed)
sale of debt (bay al - dayn) prohibition
aircraft ijara - based sukuk would fuse aircraft ijara technology and
conventional EETC technology
6
airline sukuk features
•
relationship of sukuk holders to issuer is that of investor, not
creditor
•
sukuk holders are joint owners of trust assets, being
–
–
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aircraft (subject to leases)
lease revenues
lease rights
•
sukuk holders exercise rights as owners through sukuk agent, who
is empowered to enforce lease rights against airline, and can be
compelled to do so by relevant proportion of sukuk holders
•
sukuk holders rights against Issuer are limited recourse to the trust
assets
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airline sukuk features
•
complexity dictated by investor/rating requirements
–
•
likely rating agency focus on
–
–
–
–
•
rating agencies (eg Standard - Poor’s, Moody’s, Fitch) apply
conventional rating criteria - Shari’a compliance not relevant - so need
to minimise reliance on performance of ijara
level of over - collateralisation
bankruptcy protection
quality of assets
liquidity facility
possibility of credit enhancement
–
–
asset value guarantee
investment - grade put option
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airline sukuk features
•
investor loan to value ratio enhancements restricted by “one class
only” certificates
–
•
level of bankruptcy protection depends on jurisdiction of airline
–
–
•
possible solution: morabaha - based subordinated tranche (on limited
recourse basis)
relative under-development of regional bankruptcy laws (compared to
s1110 US Bankruptcy Code)
repossession and deregistration risk mitigated by international route
network and external flagging
liquidity facility - classic US EETC 18 month requirement versus 42
month “Iberbond” liquidity line
–
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conventional interest - bearing liquidity line not possible
possible solution: morabaha - based secured liquidity facility
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airline sukuk features
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‘standard’ ingredients will include
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aircraft management and remarketing agreements
lessor ‘ring fenced’ from other transactions for bankruptcy remoteness
lessor established in tax neutral jurisdiction
•
listing issues - eg: Luxembourg/London/DIFC
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Shari’a board approval
–
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structural and documentation review
written opinion in prospectus
composition of Shari’a board
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airline sukuk structure
Sukuk Holders
investment
(85%)
Declaration of Trust
Up-front purchase price (85%)
Airline
Sale of aircraft
(Morabaha)
Mortgage
Liquidity
Facility
Issuer
Liquidity
Provider
Deferred purchase price (15%)
Asset
Value
Guarantee
Head Lease
(Ijara)
Asset Value
Support Provider
SPV Lessor
Sub Lease
(Ijara)
Airline
Sub Lease
(Ijara)
Airline
Sub Lease
(Ijara)
Airline
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market outlook
•
regional inflow of Islamic funds increasingly matched by greater
sophistication of regional financial intermediaries and investors
•
airlines’ requirement for funding seems likely to outstrip
conventional funding sources available to region due to
–
–
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huge aircraft orders
need for specialised appetite for regional risk
run of innovative Islamic aircraft financings (eg. by Emirates) have
helped develop ‘downstream’ Islamic aircraft financing technology,
while non-airline sukuks and airline bonds (eg. Emirates’ $500
million eurobond issue) have established investor appetite for this
asset class
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