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

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

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

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

‘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

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

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

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 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

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

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

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

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