Airlines serve debt bonanza
A year after Air India made a then record-setting order for planes, Indian airlines are preparing more than US$100bn in funding required over the coming decade for one of the world’s fastest growing aviation markets.
Air India’s order for 470 planes in February 2023 was soon topped when InterGlobe Aviation, operator of IndiGo, placed an order in June for 500 new Airbus jetliners to be delivered between 2030 and 2035, marking the largest single purchase by any airline and taking its order book to nearly 1,000 aircraft yet to be delivered.
India’s newest airline, Akasa Air, also plans to add 150 planes to keep up with passenger demand.
“Based on the list price and the number of aircraft collectively ordered by Air India, IndiGo and Akasa, financing of around US$150bn would be required. A large part of that is likely to be by way of debt raised by airlines," said Anand Shah, a Mumbai-based senior partner at law firm AZB & Partners.
Airlines typically extract large discounts from manufacturers that can vary depending on the size of the order, the types of aircraft and other factors. Nonetheless, Indian carriers still face a huge funding need.
Aviation industry participants expect Indian carriers to rely increasingly on finance leases extended by banks and other lenders, under which an airline is expected to purchase the aircraft at the end of the term. This would mark a move away from historical practice as Indian airlines have largely rented aircraft on operating leases or acquired them through sale-and-leaseback arrangements.
“The India market will require billions of dollars every year and that is going to have to be split between aircraft leasing and financing,” said Pierre Briens, head of aviation for Asia-Pacific at BNP Paribas.
Lessors have taken the bulk of the Indian market for the past decade and are likely to be closer to the limits of their risk appetite, so airlines may have a need for alternate funding sources such as banks, he said.
“The conditions for financing of aircraft are easier and more attractive for airlines than they used to be, so bank financing is more relevant today and banks are likely to share more of the burden with leasing companies going forward.”
One reason is the improvement in the creditworthiness of borrowers, he said. For example, IndiGo is much larger than it was 10 years ago, and formerly state-owned Air India is now under the ownership of Tata Group, one of India’s largest conglomerates.
While the funding requirement is enormous, not all of it will come up immediately. As part of its order, Air India has already raised over US$700m for six Airbus A350-900s on finance leases from BNP Paribas, Credit Agricole, HSBC, MUFG and SMBC since last October. SMBC said in December its US$120m aircraft debt facility will partly finance the purchase of one of the planes.
Rising inflation also makes the residual value of the aircraft higher, so keeping the plane at the end of the finance lease is economically more advantageous than before, compared with returning it when the operating lease ends. The rise in interest rates has also had an impact.
Moreover, the IFRS 16 accounting standard accords the same treatment to both finance and operating leases, so one of the advantages of operating leases being previously treated as off balance sheet has disappeared, Briens said.
Last month, IndiGo signed a finance lease for four aircraft with BOC Aviation that gives the airline the option to own the planes at the end of the lease term, said an IndiGo spokesperson, who added: “As part of our efforts to diversify our financing sources, we plan to pursue more finance leases in the future.”
GIFT City solution
The finance leases for Air India’s six planes were structured through Gujarat International Finance Tec-City (GIFT City) to achieve tax savings, marking the first instance of the offshore hub being used by an Indian airline for aviation financing.
“The driver of the GIFT City structure is withholding tax on finance leases, which the Indian authorities treat as cross-border loans,” said Fergus Evans, a partner in Clifford Chance's aviation finance and leasing practice, who advised the banks on the financing.
From July last year, India increased the withholding tax rate on payments to foreign financiers, so instead of a direct finance lease between an offshore entity and an Indian airline that will carry higher withholding tax, Air India has a GIFT City-based entity that is currently exempt from the tax between the two parties.
Under Air India’s financing structure, the relevant bank lends to an offshore SPV, which is the aircraft owner, Evans said. The SPV then signs a finance lease for the aircraft with Air India's GIFT City subsidiary. That entity then subleases the aircraft to the parent airline. The finance sublease is registered as foreign indebtedness and withholding tax is payable on that.
Since the sublease is between a tax-exempt GIFT City-based entity and an Indian airline, the operator will not pay withholding tax to the entity, which in turn does not deduct the tax on payments under the lease with the SPV.
Twists and challenges
The Reserve Bank of India’s rules relating to foreign exchange controls and the country’s Insolvency and Bankruptcy Code also add to the complexity.
“Usually in a structure like this, because the credit is sitting in Air India, lenders would want the airline to guarantee the GIFT City intermediary,” Evans said. “However, this was not possible due to the RBI's aggregate limits on guarantees by Indian companies of their offshore subsidiaries.”
Lenders would welcome changes to align GIFT City with practices in other jurisdictions such as China, where airlines can provide guarantees for the obligations of their special economic zone affiliates.
Another concern is that India has not fully implemented the Cape Town Convention, a global treaty on aircraft that standardises legal remedies for default in financing agreements that are typically cross-border, among other matters.
Lessors and lenders to insolvent airline Go First have not been able to take back their aircraft as per the convention because India’s insolvency rules included aircraft leases under the moratorium.
A ministerial regulation issued last October has carved out future aircraft financing and leasing transactions from India's insolvency law moratorium to align with a part of the treaty, which gives comfort to lenders involved in new deals.
Airlines will benefit on pricing and the terms and conditions they can obtain from lenders if there is a high degree of confidence that the treaty will apply correctly.
The Indian government wants more aviation financings to be done via GIFT City and is working on changes to the regulatory framework to attract aircraft leasing businesses.
The moratorium change applies to GIFT City as well, and an independent international arbitration system is also being set up for the SEZ, said Tapan Ray, managing director and group CEO of GIFT City.
An effective, efficient, independent dispute resolution system would attract more lessors or lenders, according to AZB’s Shah. Enabling bankruptcy-remote structures and aircraft ABS capital market transactions would also drive activity to GIFT City, he said.
“GIFT City is engaging with lessors, lenders and professional service providers in India and globally to get their feedback on regulatory and tax frameworks, and accordingly proposals are submitted to respective authorities for consideration,” Ray said.