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    Abdulrahman Sharif
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    This document discusses the potential for Islamic aircraft financing structures. It notes that traditional lenders have exited aircraft financing while equity investors have become more cautious about the airline industry. However, Islamic funds total over $200 billion and represent a growing market opportunity. The document outlines some basic Islamic leasing structures and airline sukuk structures that could tap into Islamic investor funds by providing Sharia-compliant financing for airline aircraft purchases and leases. It analyzes features of potential airline sukuk deals and believes regional airline funding demand will outstrip conventional sources, making Islamic structures an attractive prospect.

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    This document discusses the potential for Islamic aircraft financing structures. It notes that traditional lenders have exited aircraft financing while equity investors have become more cautious about the airline industry. However, Islamic funds total over $200 billion and represent a growing market opportunity. The document outlines some basic Islamic leasing structures and airline sukuk structures that could tap into Islamic investor funds by providing Sharia-compliant financing for airline aircraft purchases and leases. It analyzes features of potential airline sukuk deals and believes regional airline funding demand will outstrip conventional sources, making Islamic structures an attractive prospect.

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    27 views14 pages

    Airline Sukuk by Robert Fugard

    Uploaded by

    Abdulrahman Sharif
    This document discusses the potential for Islamic aircraft financing structures. It notes that traditional lenders have exited aircraft financing while equity investors have become more cautious about the airline industry. However, Islamic funds total over $200 billion and represent a growing market opportunity. The document outlines some basic Islamic leasing structures and airline sukuk structures that could tap into Islamic investor funds by providing Sharia-compliant financing for airline aircraft purchases and leases. It analyzes features of potential airline sukuk deals and believes regional airline funding demand will outstrip conventional sources, making Islamic structures an attractive prospect.

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    © All Rights Reserved
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    of 14

    Islamic Aircraft Financing

    Structures

    Robert Fugard
    Linklaters
    Partner, Asset Finance Group
    the current environment
    • reappraisal by banks of approach to aircraft finance
    - exit of some traditional lenders
    - restriction of categories of airline credits considered

    • 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


    - 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

    2
    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

    3
    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

    4
    ‘basic’ Islamic leasing structure
    Islamic investors

    investment Investment (Modaraba)


    (85%) agreement

    Modareb

    investment (85%)
    Declaration of trust

    Sale of
    Vendor aircraft Islamic Lessor
    (Cayman SPV)

    Equity
    contribution Islamic lease Insurance &
    (initial rental) (Ijara) Maintenanc
    (15%) e Services

    Airline
    5
    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

    6
    airline sukuk structure
    • sukuk gives investors share in profits generated by investment in
    asset

    – 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)

    • problems with morabaha - based sukuks and tradeability


    – sale of debt (bay al - dayn) prohibition

    • aircraft ijara - based sukuk would fuse aircraft ijara technology and
    conventional EETC technology

    7
    airline sukuk features
    • relationship of sukuk holders to issuer is that of investor, not
    creditor

    • sukuk holders are joint owners of trust assets, being


    – 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

    8
    airline sukuk features
    • complexity dictated by investor/rating requirements
    – 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

    • likely rating agency focus on


    – level of over - collateralisation
    – bankruptcy protection
    – quality of assets
    – liquidity facility

    • possibility of credit enhancement


    – asset value guarantee
    – investment - grade put option

    9
    airline sukuk features
    • investor loan to value ratio enhancements restricted by “one class
    only” certificates
    – possible solution: morabaha - based subordinated tranche (on limited
    recourse basis)

    • level of bankruptcy protection depends on jurisdiction of airline


    – 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
    – conventional interest - bearing liquidity line not possible
    – possible solution: morabaha - based secured liquidity facility

    10
    airline sukuk features
    • ‘standard’ ingredients will include
    – 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

    • Shari’a board approval


    – structural and documentation review
    – written opinion in prospectus
    – composition of Shari’a board

    11
    airline sukuk structure
    Sukuk Holders

    investment
    (85%) Declaration of Trust

    Up-front purchase price (85%) Mortgage

    Sale of aircraft Issuer Liquidity Liquidity


    Airline (Morabaha) Facility Provider

    Deferred purchase price (15%)

    Asset
    Head Lease Value
    (Ijara)
    Guarantee

    Asset Value
    SPV Lessor Support Provider

    Sub Lease Sub Lease Sub Lease


    (Ijara) (Ijara) (Ijara)

    Airline Airline Airline


    12
    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
    – 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

    13
    Any Questions?

    14

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