0. Islamic Aircraft Financing Structures
Robert Fugard
Linklaters
Partner, Asset Finance Group

1. 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
Modareb
Islamic Lessor
(Cayman SPV)
Airline
Sale of aircraft
Declaration of trust
Islamic lease
(Ijara)
investment (85%)
Equity contribution (initial rental) (15%)
Investment (Modaraba)
agreement
Vendor
Insurance & Maintenance Services

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
Airline
Sale of aircraft (Morabaha)
Issuer
Liquidity Facility
Liquidity
Provider
Deferred purchase price (15%)
Asset Value Guarantee
Head Lease
(Ijara)
Asset Value
Support Provider
SPV Lessor
Sub Lease
(Ijara)
Sub Lease
(Ijara)
Sub Lease
(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