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Airline sukuk by robert fugard


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Airline sukuk by robert fugard

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