Kingfisher suspension raises question for lessors & financiers, could add to India's cost pressures
Kingfisher Airlines’ suspension of operations has had a flow-on impact on the global leasing and financing sector, highlighting some of the challenges facing aircraft financiers and lessors in the Indian market and again raising concerns regarding regulatory safeguards for international investment in India.
The continued delays by the Indian Government to de-register Kingfisher-operated aircraft since it suspended operations in Oct-2012 is also expected to hurt other, still-operational, Indian carriers while also creating the impression that India is not adhering to the Cape Town Convention, of which it is a signatory.
ILFC and DVB Bank have been the most vocal about the challenges in the market, with both companies encountering ongoing and costly problems in repossessing aircraft previously operated by Kingfisher Airlines and only now making some (slow) progress on regaining access to their aircraft.
The Indian Government is allowing its international credibility to be further eroded, damaging the national airline capability
This situation presents potential challenges for other airlines in the market, with India’s airlines relying heavily on financing from foreign banks for purchase and lease of aircraft. There is as a result a real danger that this could add a further cost element to the already high-cost operating environment through increased leasing and financing costs.
Some lessors and financiers have threatened to withdraw from the market entirely, or at least attach a higher risk premium to the Indian market amid concerns they will continue to face challenges recovering their assets in the event of a default. Lessors have also been acting more cautiously in the market, with some reportedly demanding rental payments six months in advance, in reaction to recent market developments. In essence, the situation boils down to a basic principle: the absence of an accountable legal regime limits the availability of funding, creating illiquidity and hence, increased cost.
This complicated situation comes amid a backdrop of record demand for aircraft leasing globally. According to DVB Bank, aircraft leasing, which has financed 35-40% of new deliveries over the past decade, is set to increase its share at the same time as the overall size of the financing gap is increasing. DVB noted that in 2011, commercial banks funded nearly two thirds of all new aircraft deliveries in 2011 directly or indirectly. Given this global situation, and the preference by Indian carriers in the current market to lease rather than acquire their aircraft assets, India’s Civil Aviation Ministry, in a bid to prevent foreign lessors from avoiding the market, is likely to issue guidelines to airport operators and government agencies not to hold on to aircraft as security for dues of an airline.
However, considerable credibility damage has already been incurred over the past six months.
ILFC sees progress with High Court decision, but is still being ‘held hostage’
After a frustrating and vocal battle over the past six months, International Lease Finance Corporation (ILFC) on 25-Mar-2013 announced the successful removal from India of one A321 aircraft, previously operated by Kingfisher Airlines, following Delhi’s High Court decision on 15-Mar-2013, which ruled that ILFC could have access to its aircraft to ensure they can be refurbished and maintained.
IFLC said: "This first aircraft's departure demonstrates the High Court's pragmatic approach in an environment that is perceived as hostile by many foreign investors. This decision marks a first step in the right direction, and adheres to the principles denoted in the Cape Town treaty (ratified by India in 2008) and international best aviation practices. Based on media reports, this decision is in line with the policy change expected to be made by the Indian government in short order".
ILFC CEO Henri Courpron said: “This decision is a much anticipated development in ILFC’s efforts to recover our aircraft and engines. We commend India’s High Court for taking a firm stance which we hope will prompt the publication of the much awaited policy revision. It is not too late for India to reverse the current negative perception prevailing within the international finance forum. A comprehensive change in the current policy permitting ILFC’s assets to be removed from India without any restrictions will be considered a positive and much needed step towards reform. This policy is expected to bring much relief to India’s aviation sector by safeguarding Indian airlines’ continued ability to obtain needed affordable aircraft financing".
ILFC still has five A320 aircraft, previously operated by Kingfisher, in India, with Mr Courpron stating: "One of the hostages has been freed; we are worried about the others”. He similarly noted that the company was being “held hostage” by local government authorities noting that while the aircraft have been de-registered, “de-registration is only one of the steps you need to get the airplanes out of the country. There are other authorities in the country, like airports and tax authorities, who have an ax to grind against Kingfisher and we are being held hostage to this process.” He said the aircraft remained stranded by administrative hurdles and problems getting the aircraft ready to operate, noting: "We have made legal and political progress but people are not following instructions from the government. We have to stop this hostage situation."
DVB: India could be 'shut out' of the market for aircraft finance
While ILFC has made some progress, DVB has so far had less success, despite a second visit to India in the week commencing 25-Mar-2013. DVB Bank, in a meeting with India’s Directorate General of Civil Aviation (DGCA), demanded the de-registration of two aircraft previously operated by Kingfisher Airlines. DVB Bank senior VP aviation finance Carsten Gerlach said: "Following discussion of all the relevant facts, the DG stated that the DGCA will make a decision on DVB's de-registration application before the court hearing scheduled for 08 April 2013".
The Delhi High Court will hear on 08-Apr-2013 DVB Bank’s lawsuit against the DGCA, according to the court’s website. India's Director General of Civil Aviation Arun Mishra in Dec-2012 said de-registration and issuance of an export certificate for the aircraft would be withheld until a court decision is reached. However, in early Mar-2013, the DG was quoted as saying that the Indian Government would seek to make it easier for lessors and financiers to repossess the aircraft, adding that he hoped to reach an amicable settlement with DVB, Kingfisher and Indian tax authorities, who took possession of two Kingfisher aircraft in a bid to recover tax dues. Mr Mishra also said: “"We are always willing to help the leasing companies. We are committed to a solution”. A meeting was scheduled for 26-Mar-2013 to discuss the issue.
Addressing the severity of the situation, DVB in Feb-2013 warned that India could be "shut out" of the market for aircraft finance if carriers such as Kingfisher failed to return aircraft they were unable to finance and the government fails to provide the conditions for suppliers to repatriate their assets.
DVB Bank CEO Wolfgang Driese said India should step up efforts to show assets can be repossessed when dues are not paid. Mr Driese warned: "If we are unable to repossess the aircraft, we will not underwrite new business in India” and this will likely send a signal to other banks to be more cautious or avoid the market. He added: "There are several countries in the world, where we are not doing any business as asset arrests prove impossible or just too time-consuming”. The lender has suspended all financing to Indian carriers because of the situation, according to DVB Bank MD aviation and rail Bertrand Grabowski.
DVB Bank in Dec-2012 also sued the DGCA and Kingfisher Airlines to have two aircraft de-registered as part of efforts to recoup its funds and regain control of its asset. DVB senior VP aviation finance Carsten Gerlach said: "Our main trouble really is with the DGCA, which should de-register the aircraft. We have now filed a writ petition at the High Court in Delhi against DGCA and also Kingfisher, strictly focused on de-registration”.
There is a host of conflicting claims on the aircraft, making resolution more complex
The DGCA must de-register the DVB-financed Airbus aircraft before the bank can sell them elsewhere, but, with airports, banks and tax authorities simultaneously seeking access to the heavily-indebted carrier’s assets, there is a battle for priority. The DGCA has reportedly argued that those aircraft were not financed by DVB alone, so de-registering them would make the DGCA answerable to other financiers, who are also trying to recover funds.
Meanwhile, Kingfisher has hit back at the tax authorities' actions to repossess the aircraft, saying it is illegal for authorities to seize aircraft that are owned by foreign lessors. "This will send a very wrong signal to any foreigner who wishes to do business in the aviation industry in India," the airline cautioned.
Mr Grabowski has accused the Indian Government of failing to adhere to rules set out in the Cape Town Convention, or to its own laws in place before that agreement. The two aircraft financed by DVB with Kingfisher were purchased before the Cape Town Convention was in place, he said. He noted that the impact on other airlines in the market is potentially quite severe, observing that other carriers in the nation face rising aircraft financing costs following the Kingfisher default on leases and Indian authorities failure to help recover the aircraft. He said: “Risk is perhaps higher than we thought. If someone is willing to do aircraft financing in India, costs will move up”.
DVB has around USD450 million of direct and indirect financing to Air India, IndiGo and Jet Airways, Mr Grabowski said. After Kingfisher’s defaults, two banks decided to discontinue financing to the Indian aviation market, he said without naming the lenders. “The Kingfisher story has been a kind of trauma for many banks,” Mr Grabowski said, adding: “The concern is not just for DVB, it’s an industry concern.”
Veling Ltd managing director Nirvan Veerasamy, speaking in Oct-2012 at CAPA's India Aviation Summit 2012, similarly said the long-term implications of Kingfisher Airlines' financial situation, as well as the financial problems of a number of other Indian carriers, “substantially increases the risk associated with aircraft leases” in the country, and makes other developing markets such as the Middle East, China and Southeast Asia more attractive in comparison. Veling leases two ATRs to the carrier.
Mr Veerasamy also noted that defaults, such as that of Kingfisher Airlines, could have a significant effect on the business in India. He said: “I do remember the earlier days of aircraft leasing in India when a few lessors had difficulty (repossessing) aircraft. As a result, most, if not all, lessors require a power of attorney for de-registration of an aircraft at the very beginning of a lease". He continued: “This is in effect a ‘blank cheque’ which a lessor may use when a set of specific events take place that leads to the repossession of the aircraft. Today, we have moved to another environment whereby a lessor may not be able to take back its aircraft before stepping in the shoes of a defaulter and paying that debt”. This makes the business much riskier, he added, and lessors may look to more attractive markets such as West Asia, China, and Southeast Asia.
Mr Veerasamy has also said he fears that his firm may have to bear some of the debt burden of Kingfisher Airlines Ltd. While noting that airline difficulties and defaults are part and parcel of the business of leasing aircraft, he noted that the situation in which lessors are being prevented from repossessing their aircraft on the basis that Kingfisher Airlines may have outstanding airport and other dues is the key concern. In an interview with Live Mint on the sidelines of the CAPA India conference, he said: “As a lessor with assets in India, I am of course very worried about this development. In my view, it is an extremely dangerous road to be engaged on and I would find it unacceptable that such debt is transferred to a lessor under the perception that such party will have sufficient funds to buy peace and tranquillity. Such an action would, to say the least, be totally unfair business practice”.
In the long term, Mr Veerasamy said the situation “will have a catastrophic effect on the business of aircraft leasing in India”. He explained: “Let me elaborate with a simple analogy. If I were to place my funds in a bank, the underlying fact would be that I can remove my funds from that bank at any time necessary. The same goes for assets that are placed in India. An aircraft lessor will lease its aircraft only on the knowledge that the aircraft may be removed quickly and efficiently when the need arises. In our business, such a need arises precisely when there is an airline default...Today, we have moved to an environment whereby a lessor may not be able to take back its aircraft before stepping into the shoes of a defaulter and paying that debt”.
He continued: “The long-term effect of this, for all leases in India, is that it substantially increases the risk associated with aircraft leases. As such, India as a market becomes less interesting compared to other developing markets such as Middle East, China and South-East Asia. Transaction will be priced higher and in some instance, I can see lessors demanding a repossession risk insurance, a high-cost product which will inevitably be passed on to the airline, further increasing its costs of operations.”
Airbus director of aircraft finance Nigel Taylor similarly noted that the action, or inaction, of the carrier will have a negative impact on investor confidence. “It’s not good news. I think India should react to restore investor confidence in financing aircraft to India”. Boeing Capital Markets MD Kostya Zolotusky similarly noted that cooperation is needed with Indian authorities. “What we need to do is essentially work on how India starts to apply the treaty and evolve from the past difficult resolutions of defaults and repossessions,” he said.
Meanwhile, former Air Seychelles CEO Captain David Ralph Savy commented: "It is a black mark on India's civil aviation sector, and Indian carriers are paying the price by having to pay steep rentals on aircraft leases."
An interesting sidenote to this situation, however, is that Jet Airways has reportedly received two ATR aircraft from a lessor that earlier leased the aircraft to Kingfisher Airlines, according to Live Mint. Jet Airways is reportedly leasing the aircraft at a below-market rate as the lessor is unable to take the aircraft out of the country.
The Cape Town Convention, its purpose and its remedies
The well-publicised disputes of ILFC and DVB Bank are being seen as an important test of The Cape Town Convention, which was designed to make it more attractive for lessor to invest by establishing a register of interests and duplicating repossession rights available in the US when airlines default on lease payments.
The Convention on International Interests in Mobile Equipment and an associated Protocol to the Convention on Matters Specific to Aircraft Equipment were adopted in Nov-2001 by an initial 53 countries and was intended to standardise transactions involving movable property like aircraft and aircraft engines. The Convention and related protocol came into effect in Mar-2006. India acceded to the Cape Town Convention in 2008.
As noted by the Aviation Capital Working Group, central to the purpose of the Cape Town Convention is the enhancement and harmonisation of private laws in respect of the financing, lease and sale of mobile equipment. The Cape Town Convention is intended to give parties involved in such transactions greater confidence and predictability, principally through the establishment of a uniform set of rules guiding the constitution, protection, prioritisation, and enforcement of certain rights in aircraft and aircraft engines.
It alters the rules governing aircraft sales, leases and financing on a jurisdiction-by-jurisdiction basis by establishing a new international framework and providing for the creation of an International Registry to be supervised by ICAO. The intent of the Convention is to establish primacy as regards matters within its scope relating to the creation, enforcement, perfection and priority of interests in aircraft.
The Cape Town Convention provides for the establishment of an International Registry for aircraft objects. The Convention creates international standards for registration of ownership, leases and sale contracts and provides legal remedies for default in financing agreements, including repossession and the effects of bankruptcy laws. In essence, it was developed out of a pressing need to streamline differing national laws to protect investments in movable properties which pass through different jurisdictions.
AAI recognises the potential damage to lessors
Airports Authority of India (AAI) chairman V P Agrawal last month also admitted that the Kingfisher aircraft situation was affecting the interests of lessors and violated the Cape Town Convention, stating: "I do agree that this is a problem as far as the Convention is concerned”. He however said AAI would release the de-registered leased aircraft of Kingfisher Airlines to lessors only after receiving permission from India's Civil Aviation Ministry. He said: “Being signatory to the Cape Town Convention, we will release the de-registered leased planes of Kingfisher Airlines (KFA)", noting "The Ministry is yet to take a call on releasing the aircraft to the leasing companies and the matter is under consideration".
Mr Agrawal also said the Service Tax Department and other government departments “had asked us not to release the planes, but we would release them in the larger interest of the aviation sector". Director General of Civil Aviation (DGCA) Arun Mishra, meanwhile, at that time reportedly said that the Ministry may issue a guidance to release the aircraft, according to a report from Economic Times on 15-Mar-2013.
Meanwhile, there have been suggestions that the Indian Tax Office could introduce additional charges to lessors in order to reclaim some of the taxes owed by Kingfisher. ILFC is meanwhile accumulating monthly losses on re-renting the aircraft because it cannot commit to leasing the single-aisle aircraft to another customer. ILFC does not know when it may get the aircraft back, and negotiations with local authorities continue, Mr Courpron said on 26-Mar-2013.
More than just an aviation issue, as India's reputation is further stained
These intrusions further add to the complexity of aircraft leasing in India. Every international administrative process is already generally much more complex in India. The World Bank's "Ease of doing business index" in 2012 ranked India 132nd in the world, behind such countries as Bangladesh, Botswana and Honduras, which surely places this issue in centre stage for India's leadership.
For a country eager to encourage FDI in order to expand its economy, each additional piece of well-publicised commercial drama pushes back India's hopes of accelerating growth and migrating to becoming a world power. In this case the stain on the national reputation is the greater for being – apparently – a clear breach of India's international treaty obligations under the Cape Town Convention.
For domestic companies operating in the Indian market and forced to compete with some of the world's most efficient airlines, the current dispute between lessors and the government could have a real and lasting impact on their bottom line. Already burdened by a host of uniquely unfriendly national and state taxes, India's airlines hardly need the unnecessary added burden of having to pay more for financing their aircraft.
This has become more than an aviation issue for India. It is becoming yet another beacon, a lighthouse flashing a warning to vessels to keep away.