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

restriction of tax-based leasing

exit of some traditional lenders

restriction of categories of airline credits considered
as a reaction to uncertainty in the industry
as a result of changes to tax rules

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

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 Sharia 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

what Islamic finance offers

diversification of funding sources

investors regional understanding of risk

conventional-style documentation

bankable governing law

ability to combine with conventional funding sources

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

airline sukuk structure

sukuk defined by AAOFIS Sharia 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

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

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

airline sukuk features

complexity dictated by investor/rating requirements

likely rating agency focus on

rating agencies (eg Standard - Poors, Moodys, Fitch) apply

conventional rating criteria - Sharia 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

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

conventional interest - bearing liquidity line not possible

possible solution: morabaha - based secured liquidity facility

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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

Sharia board approval

structural and documentation review

written opinion in prospectus
composition of Sharia 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

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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Any Questions?

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