Towards An In-Country Solution: Why There Is An Urgent Need To Build Aircraft Leasing And Financing Infrastructure

Gujarat recently announced changes to its stamp duty laws targeted at the aviation sector. This is amongst a host of measures that are being undertaken towards developing infrastructure for India’s aircraft leasing and financing — that is the ability to lease and finance aircraft assets using sophisticated in-country structures.

It is an area where India can try and eliminate dependence on foreign entities — in line with the atmanirbhar philosophy. With foreign exchange outflows of approximately $2.5 billion per year directly attributed to a lack of a financing infrastructure, it is an area that can no longer wait for reforms.

The Business Of Aircraft Leasing And Financing

Over the last decade, as India’s air traffic grew by leaps and bounds, aircraft emerged as a strong asset class. They delivered consistent returns and were unique in the sense the mobility of the asset was unmatched.

The number of aircraft leasing companies also grew exponentially. As did financiers that saw the value and returns in the asset class. As of 2019, 507 aircraft were leased in India and the lessor portfolio totalled approximately $20 billion.

Aircraft leasing and financing at its core is a cash-flow business. Owners place their aircraft, directly or indirectly, for use to airlines and the cash-flow is secured via monthly payments. This is not only for the use of the aircraft but also via monthly payments for other associated costs. Add to this deposits, depreciation covers and final dues, and it adds up to a very attractive proposition.

In exchange for monthly payments airlines are granted use of the aircraft which in turn is deployed towards earning revenue for the airline. And since the asset is the core to the airline, this translates to the stability of cash flows.

The cost of the asset (read: aircraft) is usually recovered during the first lease/finance term which ranges from eight to 14 years. At this stage, the asset still has more than half of its life remaining. Future placements thus became extremely attractive and accretive. Finally, the aircraft is demolished with some parts salvaged. This too is cash accretive.

They key to success is the financing of the asset. And this is where the opportunity lies.

Competitive Financing Structures And Legal Protection Are The Need Of The Hour

With aircraft being multi-million dollar assets, financing of these assets is critical. In better times, this is no challenge since the aircraft is a very mobile asset and serves as collateral. But that is enabled only with a competitive cost of capital, robust legal structure and recourse avenues.

Put simply, the money that you pay for the assets has to be offered at a competitive rate, the ability to raise debt and equity using aircraft as collateral must be high and the legal protections around the asset must be well-defined and documented. But this is much harder than it looks.

With the money secured by the underlying asset coupled with the debt servicing via the stability of cash flows, international financiers are able to raise money at rates that their Indian counterparts are unable to match.

The spread between rates offered to them versus that obtained locally range between 3 per cent and 5 per cent depending on the risk premiums, foreign exchange hedges and cost of funds.

The fact that most airlines in India have poor credit quality certainly does not help. This then is mitigated by complex structures, collateral and “comfort letters” from parent companies. But the viability of structures has to be enabled by strong legal protections and tax policies, failing which capital simply does not flow into the asset class.

Ironically, investors in India are looking for avenues to deploy cash and there is ample liquidity. But when assessed against default risk of airlines and the lack of legal protections including timelines, the risk-return profile simply doesn’t hold. Addressing this is the need of the hour.

Incremental Steps Have Been Taken But Investors Demand Much More

The lack of an in-country platform for aircraft financing and leasing was recognised and a working group was constituted by Ministry of Civil Aviation in 2017. Its mandate was to examine measures for developing this industry including the regulatory framework relating to financing and leasing of aircraft.

The idea was derived from the Cape Town Convention — the international treaty intended to standardise transactions involving movable property and provide remedies for default. It was proposed to enact a bill in order to fully implement the convention (India had only implemented the treaty in parts due to concerns over jurisdiction).

The bill named the Cape Town Convention Bill was designed to supersede certain provisions of the Insolvency and Bankruptcy Code detrimental to the aircraft financing and leasing infrastructure. But the bill is yet to be passed.

For facilitation of leasing, a city in Gujarat named GIFT-CITY was identified. This city was (and is) being positioned as preferred destination for initiation of operations in the leasing space by virtue of a competitive tax regime.

Cross industry and inter-ministerial inputs were incorporated and the proposed parameters were encapsulated in the Rupee Raftar report released in 2019. Yet, towards the end of the project, it became clear that it required comprehensive and complex coordination and changes to control measures of several entities.

The government made its intentions clear by making aircraft leasing a core agenda item in the Union budget (where the Finance Minister lays out policy priorities and funding for stated policies). Yet, there has been limited movement.

The project remains unfinished as there are still barriers that have to be scaled including the General Anti-Avoidance Rules (GAAR); framework for setting up of non-banking financial companies (NBFCs); provisions for the treatment of income from operating lease; issues related to goods and services tax (GST) and issues related to financing.

As complex as these barriers are, what exacerbates the situation is that they cannot be addressed in a piece-meal fashion and require solutions that are comprehensive and cross-functional.

Without a clear solution, investors continue to be wary and the country remains without a competitive in-country solution. As far as investors go, while the incremental steps are well received, an investor cannot commit funds on the basis of incremental steps. A full solution has to be arrived at, agreed upon and implemented.

Towards An In-Country Solution

For India’s airlines, local solutions for asset financing continue to be worked on. Yet the outcomes have not materialised due to the sheer complexity of the issue. Ironically, the Covid-19 pandemic has brought the issue of lack of financing infrastructure to the forefront.

With many of India’s airlines on the brink of collapse, the very foundations of the aviation industry have been shaken. Airlines are now sitting on large fleets with limited deployment possibilities.

Forex fluctuations are leading to increasing cash outflows while drastic declines in traffic volumes have led to diminished cash inflows. Banks are refusing to lend and rather they are rushing to lay claim on any compensation or revenue coming in. Airline balance sheets are a sea of red and credit quality stands eroded.

This leaves airlines with outstanding orders and inadequate investor confidence in a precarious position. This is because for airlines it is not only the ability to induct the orders but also the ability to finance them.

Several airlines are rethinking contractual commitments towards shrinking the fleet and conserving cash. But this equates to defaults — which will most certainly lead to an increase in the risk premiums — which then impact the entire sector as a whole. Without an in-country solution, these elements are combining to create the perfect storm.

The need to build India’s aircraft leasing and financing infrastructure has never been more urgent. Stakeholders are standing up and screaming for solutions. One only hopes they are not screaming into a storm.