New horizons

The concept of using a lease structure to finance ship or aircraft development is hardly new. What is constantly evolving, though, are the various tax regimes that either facilitate or stop cold these vehicles. Amanda Greene reports.

Over the past few years there have been at most 60 shipping IPOs on various world exchanges. Most notable have been the ship listings in the Korean capital markets earlier this year – listings facilitated by an innovation introduced by Fortis Bank that drew upon private equity to help underwrite these structures.

The transactions were possible, says Harris Antoniou - head of global shipping for Fortis Bank, because ship finance in general has become less esoteric. “It is a reflection of the fact that the industry has opened up and become more popular.” More banks are involved in the industry today, he says, than ever before.

These may be difficult words to swallow about an industry that is considered staid and complex even by bankers used to the minutiae of asset-backed financing. Partly the new interest is due to global market conditions: the growing levels of liquidity are driving banks to move into new areas – such as ship finance – in order to maximise profits. But the industry itself is alluring. While the basic model remains steadfast – banks using ships and/or aircraft as collateral, oftentimes with export credit agency support – trends have emerged in recent years to tempt new players to enter and entice established hands, such as Fortis, to experiment with different forms.

LNG financing

For instance, says Godwin Chang, managing director and regional head of export finance, Asia, at SG Corporate and Investment Bank in Hong Kong, LNG financing is a trend that is gaining significant traction.

Banking interest in this energy submarket is fierce – both in the LNG project itself as well as financing of the vessels, he says. “We think export credit agencies will play an important role in LNG financing going forward.” Sinosure, for instance, is poised to become an active player in this space. “China, right now, manufactures only for domestic projects but I think eventually it will be manufacturing for export and then Sinosure will step in.”

Last year the bank signed the Oman shipping deal – a transaction that was the first shipping deal supported by KEIC (the Korean Export Import Bank) on a limited recourse basis. The 12-year term financing is combined with a lease and is the largest shipping finance with interest make-up ever provided by KEIC, he says. The borrower was Tiwi LNG Carrier & Areeji LNG, the supplier Samsung Heavy Industries.

Aircraft finance primer

Innovations are also key to the ongoing competitiveness of aircraft finance, Christian McCormick, the Paris-based CEO of Natexis Transport Finance, says. Indeed, the inherent structure of aircraft finance largely demands continual evolution of structures, he says.

Natexis Transport Finance, for instance, recently opened an office in Hong Kong to expand its coverage. Within 27 days it brought in its first mandate – an optimised lease for China, McCormick reports. But to understand the significance of this, it is important to step back and view how deals are done in this space from a larger perspective.

Typically financiers such as Natexis Transport Finance provide funding on an asset-backed basis - that is, it will look at the aircraft itself to see if it is a viable asset. Once the company is comfortable with the aircraft, then it will look at the airline's finances, which are at best a secondary consideration. That is fortunate given most airlines’ balance sheets and the number of corporate bankruptcies over the past 20 years, McCormick says. “It is one reason this industry is asset backed. An aircraft will be around longer than any airline is likely to be.”

In these deals it is, for obvious reasons, a key consideration that the company has clean title to the aircraft. “It is absolutely essential that we are able to exercise recourse to the aircraft. The structure you created must be friendly to the bankers. It also cannot be located in a jurisdiction in which the government might seize the aircraft for national security reasons.”

Some jurisdictions are “friendlier” than others, he adds. The US and France rank among the least friendly. The US, in particular, can make it difficult for a bank to extract an aircraft from a bankrupt company, despite its Chapter 11 provisions. “I have gotten aircraft out of Brazil much faster by contrast – in just two weeks compared to the several months it can take in the US.” Although, he adds, “Recent developments in Brazil, with the introduction of legislation similar to Chapter 11, have made it [more difficult] for lenders to get aircraft out.”

The way bankers address these issues is by creating a vehicle that is ubiquitous in structured finance – the special purpose vehicle, or SPV. Placing ownership in an SPV located in a friendly jurisdiction has allowed air finance to flourish, McCormick says.

There are any number of innovations that can and have been introduced to the SPV format, largely in response to tax changes around the world – the other key element to aircraft finance.

“Most airlines don’t have the greatest balance sheet and a $40m or $50m loan [the average price of a narrowbody aircraft nowadays] on an airline’s balance sheet usually does not help,” McCormick explains. “They are not looking for ownership and amortisation by introducing debt. Rather they are looking for a lease.”

Basically what air financiers do is create an investment for an outside investor – a company, for instance, that needs an expense to amortise in order to reduce a high tax bill. Called tax-leveraged leasing, it is a structure that does not touch the airline’s balance sheet and has little financial connection to the bank once the investor steps in to assume ownership. Its sole purpose is to enable the investor to buy the aircraft. Then the SPV leases it to the airline. The ownership is now within the folds of the SPV, collecting lease payments and servicing the loan of the investor who, of course, gives the bank first ranked access to the aircraft. In short everyone is happy: the investor who gets a tax break and is the official owner of the aircraft; the airline that gets the new aircraft on a lease basis; and finally, the bank, which has clean recourse to the aircraft should it become necessary to repossess.

This is the basic structure that is not likely to change, McCormick says. Outside of this structure, though, “new innovations are introduced all the time”. Or in some cases, disappear. In the US, for instance, the Internal Revenue Service in recent years has deemed these leases to be improper tax shelters. Other markets, however, have stepped up and introduced tax legislation to favour such investments.

A few years ago a Polish lease was introduced, so was a South African lease. The big development now, McCormick says, is what is called the optimised French lease, which is being used in China and was recently introduced in Turkey by Natexis. It was one of these tax innovations that led the bank to land its Hong Kong mandate.

There are a lot of theories in the industry that suggest airlines, in the future, will or should only lease aircraft. Indeed, industry statistics suggest such a shift is now underway with a slight majority of new aircraft being leased instead of owned outright by the world’s airlines. To be sure, there is a psychological factor at work – most nations prefer to own their aircraft. But as the finance industry continues to introduce tax and capital-markets innovations to facilitate lending, those preconceived notions are likely to be swept to the wayside.