New Investors and New Growth - Is Irish Aviation Finance Booming for the Better?06 Jul 2017
As a leading market in aviation finance, Ireland has seen unprecedented growth in recent years - but is this growth sustainable and what impact will forthcoming changes have for those looking to maximise a high yield of return?
Increasing passenger numbers have seen Ireland's burgeoning aviation finance sector grow rapidly in recent years. The jurisdiction now dominates the market for this asset class, alongside Cayman and Singapore, and currently manages 50% of the world's aircraft fleet (representing €110 billion in assets).
The local expertise in managing multiple aviation finance structures has contributed significantly to the growth of the Irish economy. However, the forthcoming introduction of Basel III regulation in 2018, will undoubtedly impact the aviation sector as a whole: reducing the amount of traditional bank loans and increasing the cost of financing for airlines, so more sophisticated capital markets structures will be required.
While there have been a number of traditional ABS securitisation transactions over the years, especially in the aviation sector, arrangers have had to be more innovative with their structures to meet a diversified investor base. Recent new structures have included:
i) Aircraft backed securitisations with a Shari compliant element;
ii) Private equity investment through S110 SPV issuing profit participating notes;
iii) Export Credit Agency ("ECA") backed Sukuk issuance along with traditional ECA orphan structures (especially if the proposals that these will have a 0% risk rating for banks instead of the normal 3% leverage ratio requirement);
iv) Crowd funding websites to raise private funds;
v) Schuldschein unsecured funding market;
vi) Korean investor SPV structures;
vii) End of life Aviation funds; and
viii) European EETC structures.
Common themes at the Airline Economics Conference held in Dublin earlier this year were the significant investment by new investors in this asset class, and the high number of new aircraft deliveries that need to be financed this year. Historically a number of different investors have been seen entering this kind of space, including insurance companies in addition to numerous private equity investments from US and UK firms. Now the market is seeing a lot of Korean investors, including banks and insurance companies. Notably many Asian investors are now using Irish aviation structures to acquire dollar assets at good yields diversifying their Investment portfolios into aviation assets. Volume of capital can be a cause for concern among existing lessors involved in mid-life asset class, with just too much money chasing certain assets. This has led to inflated second hand prices as the low yields on some availability of financing is currently very cheap.
With new investors seeking good returns the question is will this pace slow down anytime soon, and what long-term effect will it have on Ireland's Aviation finance sector? Factors attracting and influencing aviation and capital markets structures to Ireland more recently include:
i) Ireland's extensive tax treaty network with specific clauses that deliver favourable withholding tax results, especially in aircraft leasing where 80% of the treaties eliminate this cash flow risk;
ii) Planning opportunities around Ireland's low corporations tax rate of 12.5%;
iii) The use of Ireland's securitisation and financing S110 structure that allows Profit Participating notes as a structuring tool when certain investor criteria are met, allowing distribute profits to be paid out as interest instead of dividends;
iv) Ireland's high level of expertise from the origins of aircraft leasing and securitisation;
v) OECD BEPS compliant jurisdiction;
vi) Ireland becoming the gateway to Europe for many US multinationals as the only native speaking country in the Eurozone, which is attracting US companies looking to set up capital markets, holding companies and subsidiary structures; and
vii) the high number of quality golf courses in the top 100 world index attracting investors for business and pleasure.
Ocorian has been involved in alternative financing structures for aviation and shipping assets over the last 15 years and foresees this funding in the secondary market increasing rapidly in 2018. As Ireland has a strong track record in setting up and administering these structures, the jurisdiction is well positioned to continue assisting with these funding structures.
Ireland's position is further bolstered by its large tax treaty network that is favourable to both Rental and Interest withholding tax exemption. Furthermore, the recent adoption of the 'Alternative A' insolvency provisions of the Aircraft Protocol to the Cape Town Convention on International Interests in Mobile Equipment (the “Cape Town Convention”) has also been beneficial. The Alternative A provision is similar to the Section 1110 of the US Bankruptcy code, and gives certainty to the rights of the creditor to repossess an Aircraft asset. This will mean a higher credit rating for these structures using Ireland compared with other jurisdictions.
The next two years promise to be busy ones for capital markets, as new structures are devised to meet the growing aircraft demand while adapting to the new regulatory environment. With such low yields of return from deposits, arrangers and financiers need to be innovative with their structures to provide a high yield of return whilst mitigating any political, or country risk which will make it all the more challenging.