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Transportation Finance

Essential Features
Finance Lease

Finance Lease vs Operating Lease
JOL/JOLCO

Japanese Operating Lease
(with/out Call Option)
RVI

Residual Value Insurance

Transportation Finance

Transportation Finance uses the asset either as a security or as an investment. It relies on a broad range of funding tools: senior and junior debts, lease, securitization.

It is essentially a dollar denominated environment though some transactions may be structured in whole or in part in other currencies such as the EUR or the JPY.

It is key to determine who bears the “metal” risk, ie: who will get the asset on its balance sheets (and on the ground) at the end of the transaction. True lessors and operators are generally keen to bear that risk while financiers are adverse to this risk.

The more “junior” a financier is, the heavier metal risk it bears (and thus, the more sophisticated it has to be).

Typical values

A newly built regional aircraft (such as an ATR72-600): below $20m

A newly built narrowbody aircraft (such as an A320): approx. $45m

A newly built widebody aircraft (such as an A330, an A350, a B787, a B777 or an A380): ranges from $80m up to $230m

The typical senior loan advance rate ranges from 70% up to 85% of the asset value (depending on asset age and liquidity, loan currency…)

Finance Lease

A finance lease is used to finance the capital cost of the asset. The lessee takes the asset on lease from a lessor which has no economic interest in taking redelivery of the asset.

Finance leases are typically 10 or 12 years – similar to the length of a commercial loan. A title transfer mechanic allows title to be transferred to the lessee upon termination or expiry of the lease – usually a purchase option.

Total rental payments may be close to the actual cost of the asset (full payout), or a balloon payment payable on termination or expiry. Risk and reward of ownership lie with the lessee.

With IFRS 16, finance leases are treated the same as operating leases on the lessee's balance sheet: the lessee recognises (1) a lease asset representing the right to use the leased item for the duration of the lease, and (2) a lease liability representing the obligation to pay lease rentals.

Operating Lease

Under an operating lease, the asset is rented for a period of time in exchange for rental payments and returned to the lessor on termination/expiry. The lessee will never own the asset.

The lessee will agree to maintain and insure the aircraft, provide crew and operate within the guidelines in the lease. There may be many operating leases during the asset’s useful economic life.

Operating leases are usually for shorter terms (5 or 8 years, with or without options to extend). When the aircraft is returned to the lessor (redelivery), the lessee will be obliged to put the aircraft back in the same state it received it.

Rent is payable at a market rate – this rate may bear no relationship to the cost of the asset.

Finance Lease

- Lessee owns the aircraft at the end of the lease.
- Cost-effective an alternative to a commercial loan
- Longer term financing solution rather than operational need
- Cheaper than paying a market rent for the economic life of the aircraft

- Less flexibility to respond to an increase or decrease in demand
- Longer commitment to a particular aircraft type
- Risks of aircraft ownership lie with the lessee

Op Lease

- Allows lessees to adjust their fleet in times of peak or low demand.
- Reduced upfront capital cost to add aircraft to the fleet.
- Access to newer aircraft – lessee is not tied to a particular aircraft
- Access to aircraft for lessees with lower credit rating

- Lessee will never own the asset
- Rent payments paid at a market rate, may exceed actual asset cost
- Lease will contain strict maintenance and operation covenants

JOLCO (Japan Operating Lease with Call Option)

The Japanese Operating Lease with a Call Option (“JOLCO”) is a tax-oriented operating lease product, providing 100% financing at senior lending rates and with asset control remaining with the lessee.
For a long time, the JOLCO has been well-known as an optimal structure for aircraft financing, though, recently, maritime shipping containers became an emerging asset class eligible to JOLCO.
Given the current market conditions, the JOLCO structure is fully relevant as it comes to funding aircraft for market-leading operators.
The JOLCO may be structured in USD as well as in EUR or JPY as the case may be.

JOL (Japan Operating Lease)

The Japanese Operating Lease (“JOL”) is an operating lease product with asset control remaining with the lessor at lease expiry.

The JOL otherwise incorporates most of the features of a JOLCO including its relatively affordable pricing and, as the case may be, a purchase option at fair market value in favour of the Lessee.

Structure diagram

JOLCO Essentials

Lessor

A bankruptcy-remote special purpose vehicle („SPV“) incorporated in Japan: a Kabushiki Kaisha („KK“)

Lessee

Market-leading aircraft or shipping operator

Equity
Investor

Japanese Mid-cap corporate(s)

Asset

A new or used aircraft, container or ship

Type of Lease

“High water, net lease”: all costs, taxes, expenses and risks to be borne by the Lessee

Maturity

From 5 up to 12 years

Purchase Option

The Lessee has the right to purchase the aircraft at preferred price at the end of the lease.

Equity Structure

An anonymous partnership subject to the Japanese Commercial Code: a Tokumei Kumiai („TK“) or Nini-Kumiai („NK“) agreement.

Residual Value Insurance: Introduction

The Residual Value Insurance indemnifies an insured (investor or bank) against a loss that might occur if the sales proceeds of a properly maintained asset are less than the insured residual value at a specific point in time. The residual value insurance is usually set for a period of 5 to 15 years.

Residual Value Insurance: Risk analysis & Motivation

The residual value of an asset reflects its ability to generate revenues in the future through its operation (leasing) and/or its future market value (sale). Main risks include:
Economic cycle, strong correlation with GDP and real interest rates
Technical obsolescence (environment, etc.) and economic obsolescence
Asset competitiveness within its markets

Motivations:
Financial: open-balloon coverage (balance of a loan at maturity) for the lender and / or investor, better adequacy / closer match between the financing of the asset and cash flows generated from its operation.
Accounting: ‘operational lease’ accounting (off-balance-sheet treatment for the lessee and / or tax benefit) as a function of the present value of the rentals.
Asset Management: lower residual value risk for the buyer of new or recently introduced assets.

Residual Value Insurance: Asset Life vs Debt Maturity

The residual value insurance is the solution proposed by the insurance market to face the inadequacy between the duration of the financing of a given asset and its economic life.

Thanks to the residual value insurance, the loan outstanding amount at year 12 is set at 35% allowing an operator to reimburse less capital (corresponding to a reduction of the rental) and to transfer the 35 % of residual risk on a third party.

The operator at the conclusion of the 1st financing over 12 years has the possibility of refinancing its 35% RV by a subsequent loan.