Thursday, 30 June 2011

Santander looks East as demand for Spanish operating leases grows

Santander, the only bank currently arranging Spanish Operating Leases (SOLs), has told Aviation Exchange it is pitching to potential clients in the Middle East and Asia as it witnesses growing demand for the tax leases. The structures, originally developed by Caja Madrid, allow lessees to receive tax benefits through accelerated depreciation and have previously only been closed in Latin America and Europe.

Spanish flag carrier Iberia secured the first ever aviation SOL in September 2005 after going on the hunt for alternatives to Japanese Operating Leases (JOLs). Caja Madrid provided 21% equity while RBS financed 79% debt, delivering savings of 6.5% through a reduced rental stream on two Airbus A340s.

The JOLs previously favoured by Iberia tended to deliver larger savings, but according to Gregorio Herrera, Santander Global Banking & Markets, Europe, there are several additional benefits entailed within SOL structures.

"SOL is a genuine operating lease product allowing a lessee to be protected from residual value downside whilst enjoying upside," he said. "The lessee keeps residual value upside potential through fixed price purchase options, [and] early buyout options can be incorporated." The prospect of 100% financing further sweetens the deal, Herrera added, while Santander's global reach affords lessees easy access to their equity provider, no matter where they are in the world.

By contrast, JOLs are often bunched in with finance leases due to the presumption among Japanese investors that lessees will exercise their call option.

Overseas market takes off

Iberia's preference for SOLs was cemented in 2006, when the airline closed deals for another three A340s, that time drafting in ING and WestLB as debt providers. But it was Santander that took the product overseas, closing the first cross-border SOL in 2008 for two Airbus A320-family jets leased by Brazilian flag carrier TAM.

Two years later, with the economic downturn abating, an export credit-backed SOL for three of TAM's A319s won a Jane's Transport Award for innovative financing.

Bertrand Dehouck was the BNP Paribas financier who brokered that deal. He told Aviation Exchange that as global carriers returned to the black, the savvy ones started taking advantage of tax-deferral structures offered to them. "The benefit of the tax structure is provided to the airline through the equity tranche," he explained. "The debt is just priced as normal debt. What makes the deal attractive is the economics of the equity, and the fact that the airline doesn’t have to put money on the table at closing.

"However, the airline does need to be comfortable with the complex structuring and slightly different risk profile – assuming, sometimes, a greater portion of tax risk."

TAM was ideally placed to benefit from the structures due to a tax-sparing treaty already in place between the two countries. Dehouck noted: "There is a tax treaty and one would expect that it makes the economics even more compelling for the airline."

Mindful of this treaty, fellow Brazilian carrier Azul jumped on the bandwagon later in 2010 – closing its own export credit-backed SOL for six Embraer 195s – but interest in the product was already stretching beyond Latin America. In November of the same year, easyJet announced that it was financing six A319s with SOLs, mandating Santander to arrange the equity, and Credit Agricole-CIB and KfW IPEX-Bank to act as under-writers. At the time, Santander said it was only open to working with existing or target customers – a stance which it has now softened.

"We are starting conversations with some airlines in the Middle East and Asia," David Swindin, Santander Global Banking & Markets, Asia, told Aviation Exchange. He added that the bank sees "stable demand" for SOLs in Europe and Latin America, describing the latter as a "strategic region" in which to pitch the structures.

According to Dehouck, the tax-efficient leases can be implemented across a wide range of jurisdictions, though geographical location can impact on their effectiveness. A more pressing issue is whether all parties are committed to hammering out the particulars of the detailed structures. "You need to be willing to spend the time and effort to go through it," Dehouck said. "It’s a question of what kind of asset type the equity provider is deploying the equity for, its risk appetite, its client's priorities, and whether or not lessees are interested in the complex structure – because it is fairly complex."

Santander pitching selectively

Though demand for SOLs is undoubtedly rising, with Santander's willingness to provide liquidity also growing in tandem, analysts believe the product is likely to remain relatively niche within the global air finance marketplace.

In 2010 Santander closed SOLs for approximately 20 narrowbodies and regional aircraft, securing operating leases worth between USD 500m and USD 750m. Industry sources say that even with the bank's heightened appetite, negotiations are only underway with about five airlines at present. Indeed Santander itself is the first to admit that the product would not be suitable for all carriers.

"SOL is eligible for good-credit airlines [only, because] leverage is typically 80% and tenor from ten to 12 years," Herrera stressed. "Debt margins are linked to the credit worthiness of the airline and very attractive conditions can be achieved when combining SOL with export credit financing, as we have done in past transactions. The equity is real equity with a real residual value risk. Our equity yields tend to be lower than a traditional operating lessor due to the tax benefits, but are generally higher than plain vanilla debt."

The products were made more attractive by a recent change in Spanish tax law, Herrera added, which simplified Santander's leverage structure by enabling it to eliminate the head leases it had previously been forced to use.

Overall, however, the market for SOLs is expected to grow at a moderate pace, with just one arranger currently willing to provide equity and expectations low that other Spanish banks will enter the fray. As Santander has the market cornered for itself, analysts say there is no way of assessing the true global appetite for the products, though few dispute that they present an attractive, tax-efficient way of diversifying funding.

BNP Paribas summed up the product's appeal in its press release for the latest TAM deal – four A320-family aircraft which began delivering in April.

"This structure provides an optimal solution to the lessee, combining the advantages of an operating lease, competitive pricing from banking debt financing, plus a higher leverage due to the equity tranche provided by Santander," the bank said. "The SOL will enable TAM to take delivery of these four aircraft while saving a significant amount of cash – putting the airline in a more competitive business position."