Tax law changes have put paid to cheap deals
Until the final quarter of last year, potential aircraft purchasers could take advantage of major rivalry in the aircraft finance markets between finance houses and banks in different jurisdictions offering airlines attractive tax-based finance structures. These made financing aircraft through pure debt vehicles seem like child's play.
Financiers in Germany and Japan knew this relatively easy success would not last forever. The inherent nature of these tax-based financings allowed wealthy individuals and corporations to invest in finance structures and dodge or delay their taxes. The deals were constructed in such a way that investors and lessees alike would benefit. Increasingly, national treasuries around the world realised the only losses. Governments then clamped down on what was largely a wholesale export of tax benefits out of their economies.
Since the middle of last year, Japan's National Tax Authority protested that it was missing financial benefits from the Japanese leveraged lease (JLL), which had dominated aircraft finance for around 10 years. The JLL had two elements: debt, typically sourced by a Japanese bank, and equity, typically at least 20%, but sometimes reaching 35%, sourced by Japanese corporate investors.
Until its equivalent in Germany, the German-leveraged lease (GLL) emerged in the mid-1990s, the JLL thrived by amassing between $4 billion and $5 billion a year from financing commercial aircraft.
The JLL came to an end in September, conveniently in line with a collective collapse of the Japanese banking market. The GLL was also stopped in its tracks at the same time when the Social Democratic administration of Gerhard Schroeder was elected in Germany, with promises of radical tax policies that included killing off the GLL. German bankers estimate that between $4 and $6 billion-worth of GLL aircraft deals were signed last year. 25% higher than the previous year. Whatever the exact figure, it is clear a large vacuum has been created by the loss of one of the most attractive aircraft finance options.
Changes in Germany
But just as airlines thought there was little scope to benefit from these complicated, yet attractive, finance structures again, Germany's new government announced in early March that financiers and lawyers could have a two-day window to take advantage once again of the GLL market.
Perhaps the German Ministry of Finance did not realise the volume of activity that would ensue. But in the space of 48h, between 50 and 100 purchase agreements were signed between German KGs (special purpose finance leasing companies) and airlines. With all these agreements in place, financiers can sign new GLLs up to the end of 2000.
Bankers and lawyers worked around the clock in the 48h period, says a GLL banker in Munich. "No one could believe the Ministry of Finance would allow this. So, everyone took advantage."
Most agreements are largely between European and US airlines with good credit signing for aircraft which recently entered service or will be delivered before the end of next year. German investors' sources will range from investment funds sustained by investors including corporate institutions and famous tennis players.
Financier confidence in Germany was scuppered by drafts proposed by the Ministry of Finance which planned to extend the period of time an aircraft could be depreciated in a GLL. The proposed draft also focuses on the tax benefits investors can derive from ploughing money into such structures. These measures could destroy any economic appeal to airlines.
One aircraft finance lawyer in Frankfurt suggests the series of events may not take shape so logically. With the departure of Oskar Lafontaine from the government, the Ministry of Finance in Germany has more urgent issues to deal with. But this lack of government clarity is again sufficient to stun a finance market into inactivity, underlining the idiosyncrasies of aircraft finance culture.
The same threat of government intervention has been hanging over US aircraft financiers for at least the past two years. "We just keep on doing deals and we'll suffer the consequences of any government action if and when it becomes real," explains a tax lawyer in New York. The US Internal Revenue Service has been secretly looking into whether finance structures, for assets like aircraft, contravene boundaries.
These government-proposed drafts can sometimes take years, however, before a firm ruling is issued. In the meantime, it is up to finance packagers, equity investors, legal counsel and airline clients to decide whether chances should be taken. Risks are largely taken by airlines on the basis that if government legislation is imposed retroactively, they will need to pay additional finance costs. That is the risk when governments do not prepare a clear framework.
It seems likely that no government with a cash-rich investor base will allow anything like the leveraged leasing markets of the 1990s ever to exist again. But some marginal jurisdictions are still making a play for tax-based aircraft financing.
Both Sweden and France have a limited amount of banks or companies with the ability to invest in aircraft finance. This so-called tax capacity will not be sufficient to cater for many deals and, accordingly, investors can be selective about the types of airline credits and asset types to go for.
An Air New Zealand-subsidiary, Mount Cook Airline, is being suggested by Paris-based financiers as one of the few non-French ornon-Francophone airline which might be able to tap the French leveraged lease market to finance seven ATR 72s. This is probably only possible because of the high French content in the aircraft, which will generate a favourable ruling by the French Government.
Swedish leveraged leases are also scarce in volume. But because of the complex tax regulations involved, Swedish financiers have called on the Swedish Ministry of Finance to clarify the situation. One lawyer in the ministry will be examining the tax-based financing regulations this month. The only reason he has not done this so far is because of pressure to examine other issues, he says.
Leverage leases out
Most leveraged lease markets have always been tailored to the more successful airlines, with investors more comfortable with good-quality names. But as the options shrink and governments continue to put the final nails in the coffin of leveraged leasing, the airline users will have to go elsewhere.
Although it is virtually impossible to indicate precisely what percentage of the market leveraged leasing covered, most financiers estimate that around 30% of all new aircraft were financed in this way for much of the 1990s.
Source: Flight International