The Hindu Business Line : AIG bailout likely to impact Indian aviation

Bangalore, Sept. 18 The financial bailout of the world’s largest insurer the American Insurance Group (AIG) is expected to have its reverberations on the Indian civil aviation sector.

International Lease Financing Corporation (ILFC), AIG’s subsidiary, is currently among the world’s largest aircraft lessors. AIG’s customers include domestic aviation companies, Jet Airways, Kingfisher Airlines, Deccan Aviation and Spice Jet.

Almost the entire fleet of the private civil aviation sector is lease financed. Currently, there are about 370 aircraft in the country, of which about 35 per cent are new. Some of the leases, especially for new aircraft, were structured as cross-border sale and leasebacks, industry sources said. In this kind of structure, aviation companies purchase aircraft, sell it to a finance company and lease them back, paying fixed lease rentals at regular intervals. Such cross-border lessors are to taking advantage of double taxation treaties.

Sources said in most private sector aviation companies, deals were structured as leveraged leases. Leveraged leases imply that lease financiers, such as ILFC, raise debt for funding the assets. Each of these leases is structured through a separate special purpose vehicles (SPV), the sources said, with equity participation by both the counter parties involved. The structure allowed the SPV to raise funds on the basis of the rating of counter-party risks — which is the ability of the lessee to meet regular rental payment obligations during the life of the lease transaction.

Structure hiccups

There are, however, problems with such structures. Consulting firm KPMG’s aviation analyst and senior advisor Mr Mark Martin said, “Most of these lease transactions are structured with rental payments linked to the London Inter Bank Offered Rate (Libor).” The lease covenants therefore allowed for pass-through of any escalation in funding costs on to the lease rental.

In the initial stages of aircraft acquisition, the costs were available at spreads as low as 200 basis points over the six-month Libor. But the US government’s $85-billion bail-out package for AIG priced the spread over three-month Libor at 850 basis points, translating into an interest of about 11.5 per cent at current Libor levels. Accordingly, there are fears that if this interest is passed through to the aircraft lessees, the rentals are likely to steeply escalate from the current levels.

Impact on sector

However, Deccan Aviation Pvt Ltd Chairman, Capt G.R. Gopinath said, “We don’t see any impact now, since the lease contracts are already done deals. Some were fixed contract and some were floating linked to Libor.”

Mr Martin though preferred to remain cautious and said, “It is too premature to ascertain the impact on the aviation industry. We need to see how the situation pans out over the next few weeks.”

But there is intense speculation in the international financial markets that AIG was likely to put this subsidiary on sale. This was in view of the tight conditions for the Federal Reserve’s bailout package, since the AIG bailout loan was for 24 months.

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