Last year was a bad one for all things airborne. Airlines ran into trouble as ticket sales and share prices plummeted when SARS flew through Asia and towards the end of the year another winged destroyer, Bird Flu, unsettled the winds in the region. Yet, despite nervousness that the airline industry was walking on air, three innovative cross-border securitizations of airline ticket sales were signed in Korea and Japan. The timing of these securitizations may seem surprising but those behind the deals insist they are built on solid ground.
The deals involved Korea's flag carrier, Korean Air (KAL) and its second biggest airline, Asiana Airlines.
In September last year, KAL signed its first international securitization, a ¥27 billion (US$242 million) deal backed by yen receivables arising from the sale in Japan of airline tickets by KAL on its routes between Japan and Korea. The KAL deal involved the largest ever airline ticket securitization and the first by an Asia-Pacific originator to tap the yen market. It was also the first time a Japanese trustee had agreed to an entrustment of airline ticket receivables. Nomura International was the arranger and joint lead manager. OZ Yen Receivables Cayman Limited issued the secured floating rate notes, which were listed on the Irish Stock Exchange. The floating rate notes, due in 2006, were supported by a credit facility from Korea Development Bank (KDB), which also acted as joint lead manager.
Three months later, Asiana Airlines completed a ¥10 billion securitization of airline ticket receivables on December 24 2003. The transaction securitized future receivables from the sale in Japan of Asiana Airline tickets on its routes between Japan and Korea. OZ Yen Receivables Cayman Limited issued the secured floating rate notes due in 2006, which were listed on the Irish Stock Exchange. The deal was completed in a record nine weeks and was Asiana's first Japanese yen securitization.
In both complex cross-border deals, Korean, Japanese, English, Irish and Cayman laws had to be considered.
Ending a busy final quarter, on December 29 the third (Asiana's second) cross-border airline ticket receivable securitization was signed. The deal was a US$60 million securitization of Asiana's US dollar ticket receivables. Irish Stock Exchange-listed entity Oz Receivables issued the series 2003-1 floating rate secured notes due in 2008.
In all three deals, international law firm Paul, Hastings, Janofsky & Walker LLP played a central role in coordinating, advising and structuring the securitizations. In the case of KAL, Paul Hastings advised Nomura International as arranger and joint lead manager and in the Asiana deal the firm advised Nikko Citigroup as joint arranger and joint lead manager and JP Morgan Chase Bank as note trustee.
In Seoul, Shin & Kim advised Citigroup and JP Morgan on Korean law. Eugene Chang lead a team from Wu Yun Kang Jeong & Han in advising KDB, the joint lead manager in all three cases, on Korean law.
In Tokyo, Anderson Mori advised the Japanese trustees on Japanese law, while Walkers acted as Cayman Island counsel and Dillon Eustace as Irish counsel to the bond issuer.
Testing new wings
Although securitizing airline tickets was unusual practice in Korea and Japan, the Paul Hastings team, led by experienced securitization practitioners Neil Campbell in Hong Kong and Norifusa Hashimoto in Tokyo, proved innovative and effective in building a workable structure that worked well for all the parties involved.
Korean securities laws are modeled on those of the US, making cross-border deals relatively straightforward. A second wave of legislation in September 1998 strengthened procedures for restructuring financial institutions and introduced structures for asset-backed securities and mutual funds. New accounting standards adopted at the end of 1998 and closely modeled on those of the International Accounting Standards Committee (IASC) have also allowed foreign investors to place greater reliance on Korean financial statements.
Asiana's yen securitization was made considerably smoother because the framework drawn up earlier for the KAL signing was adopted with only a few minor adjustments to suit the various parties to the deal.
"Completing the Asiana deal in only nine weeks was highly exceptional," says Campbell. "It was made easier because a great deal of the groundwork had already been laid in the KAL deal. We were pleased to have the opportunity to apply the same technology that we helped to pioneer for the Korean Airlines securitization to assist the teams at Nikko Citigroup, JP Morgan and Asiana to structure and complete the transaction." The KAL deal took four-and-a-half months to complete.
Hashimoto adds that in the KAL deal the firm had "addressed for the first time complex Japan law issues, including whether the entrustment of future sales proceeds held in KAL collection accounts and ticket receivables of KAL would constitute a 'true sale'. Because we had already come up with legally and commercially workable structural solutions to these Japan law issues made it much easier to complete the Asiana transaction."
In the KAL deal, however, a real challenge lay in persuading the Japanese trustees who had to be "convinced about the deal as it was one of the first in Japan", Campbell explains. "This was new territory for them. There were complex negotiations with the Japanese trustees, particularly in relation to the accounting treatment of the receipt of money from the receivables and the subsequent payments to the holders of the investor beneficial certificate and seller beneficial certificate the Irish SPV, Tokyo branch, and KAL or Asiana, respectively. Again, this was easier in the Asiana transaction."
According to Chang of Wu Yun Kang Jeong & Han although the basic tax structures and trust structure used for KAL and Asiana were similar, "as Asiana does not have as strong a corporate rating as Korean Air, direct sale receivables (those not generated through the Bank Settlement Plan (BSP) see box: Understanding BSP) were not included as it was felt that the basis for direct sale receivables is not as strong as those generated through BSP."
The crowded skies
The steady traffic between Japan and Korea owing to the countries' geographical closeness and strong business links, made the securitization of airline ticket sales feasible. Campbell insists that the parties involved had a "sense of security because the Japan routes are more dependable and solid and far less volatile than routes between other Asian centres. There is a great deal of trade between Korea and Japan, it is one of the most profitable routes for both KAL and Asiana".
KDB was likewise confident, according to Chang. "We felt this is as strong a route as we can find anywhere," he says, adding that his firm foresees a potential increase in ticket receivables securitizations in Korea in the future.
The securitizations involved KAL and Asiana entrusting all future receivables owed to the airlines by the International Air Transport Association (IATA) to the Japanese trustee. Receivables come from the sale of KAL or Asiana tickets by IATA agents (BSP receivables), and therefore consist of a regular payment by IATA to the airlines, or from travel agents (who may or may not be IATA agents) or directly from KAL or Asiana though their branches in Japan. The funds are deposited into accounts at local bank branches in Japan. The deals are structured like conventional Japanese cross-border securitizations and use two special purpose vehicles in these transactions, one in Ireland and one in the Cayman Islands.
KAL and Asiana's cross-border securitizations received backing from the state-owned KDB, which acted as joint lead manager and provided a credit facility to the issuer to support payments on the notes. KDB has promised to make up any shortfall on interest payments investors are getting, effectively giving investors the comfort of a quasi-sovereign guarantee.
Chang notes: "This is the first case in which KDB acted not only as a credit provider but as an arranger for offshore bond offerings. As KDB's sole counsel, we had to keep the delicate balance between the credit provider's interest and the arranger's interest."
Taxing issues
As with all major cross-border securitizations resolving complex tax issues and developing workable structures was crucial. "Things that worked in one jurisdiction didn't work in the other," says Campbell. "It wasn't easy organizing the tax structures for the KAL deal making sure they fitted with Japan and Korean tax laws and ensuring that tax expenses were minimized." He praises the work of PricewaterhouseCoopers in Japan for helping to resolve many of these issues.
"The transaction structure had to satisfy both Korean and Japanese legal and tax frameworks. Using a Japanese SPV would have presented a withholding tax problem for securities sold to Japanese investors and, depending on the type of SPV, high minimum capitalization costs," says Campbell.
For both Korean and Japanese tax purposes, the transaction is viewed as a financing, despite the legal structure, he says. This also raised withholding tax issues on a deemed interest component. Using the Tokyo branch of an Irish SPV minimized this risk.
Getting the green light from IATA
KAL was the first Korean originator to issue asset-backed securities in yen. The KAL deal was the biggest ticket receivables deal ever completed and the first to securitize receivables from IATA's billing and payment unit the global system that handles air ticket purchases.
The deals involved lengthy negotiations with IATA in Japan and in Canada (where the Association is incorporated), in relation to the form of consent it would give to the entrustment of the BSP receivables. In the case of KAL and Asiana, the BSP receivables consist of a deposit of money into accounts at local bank branches throughout Japan that are swept into the account with Korea Exchange Bank (KEB) on a regular basis. The new structure requires IATA and KEB to remit money directly into an account in the name of the Japanese trustee.
"Another complication was that IATA, which was the obligor, is incorporated in Canada and we had to perfect the entrustment of the receivables in Quebec. It was the first time a securitization was done against receivables generated through IATA," says Campbell. Japanese law requires that perfection of an entrustment or assignment be effected in the jurisdiction of the obligor. Because IATA is incorporated in Quebec, it was necessary to make certain public filings in Montreal to complete the perfection process.
Chang notes IATA took some convincing with respect to certain aspects of the deal. He says that IATA "did not want to change the way they have been doing business as a result of this securitization, not just with Asiana but with other airlines".
Regarding KDB concerns, Chang says that "the securitized receivables were limited to those originated through IATA's BSP systems. However, as the focus of Asiana's future marketing is in internet ticket sales, KDB was concerned a long term shift of ticket sales from BSP sales to direct internet sales might arise."
Riding the turbulence
Falling ticket sales across Asia in 2003, and worldwide in recent years owing to terrorism threats, have hit the airline industry hard.
Some observers have questioned the timing of the securitization of airline ticket sales given the turbulent times the airline industry is experiencing. A World Health Organization warning that Bird Flu "had the potential to kill more than the 774 people who died from SARS" and had "become contagious among humans", did not help the situation. In late January 2004, shares of Korean Air and other Asian carriers fell on concerns that the widening Bird Flu epidemic would undermine levels of air travel in the region as SARS did. Korean Air, Asia's fifth-largest carrier, fell 4.3%. All Nippon Airways, Asia's second-largest airline, fell 1.7%, while South Korea's second-largest carrier, Asiana Airlines, fell 4.9%. At least one Asian carrier, Cathay Pacific Airways, publicly expressed concern about Bird Flu and said it was monitoring the situation. It too had seen its shares fall in January. Eight Asian countries have reported cases of the disease.
But, advisers on the securitization deals cite the strength of the routes between Korea and Japan in comparison to other routes in Asia. "The airlines are not so worried about Bird Flu and are optimistic about ticket sales," Campbell insists. "Most airlines have bounced back after SARS and the numbers of travellers is up." While agreeing that the "airline business is volatile", Campbell says SARS and Bird Flu had less of an impact on the Japan-Korea routes, compared to other centres in Asia, and that KAL was less affected than other Asian airlines because it has a significant cargo business to support it during a drop in passenger numbers. Having recently returned from 18th Geneva Forum on Aircraft Finance and Commercial Aviation organized by the International Centre For Business Information (ICBI) in February, Campbell says airlines at the meeting had not appeared concerned about Bird Flu and that "dips in passenger traffic are not unusual".
He did not consider airline ticket receivables particularly high risk, "especially given the three year final maturity of both the KAL and Asiana deals and the fact that both deals had the support of a credit facility from KDB".
In recent years Korea has witnessed a relative boom in securitizations, owing in part to a liberalization of the country's securities laws in 1998, although last year financial troubles experienced by credit card companies scared away many investors, both domestic and international. In comparison to credit card receivables in Korea airline tickets may seem considerably more secure 2003 saw the nose-diving of profits in the credit card industry following the introduction by the Korean Ministry of Finance and Economy and the Fair Trade Commission of limits on cash advance services and card loans, and slashed interest rates on cash advance services, installment purchases, and overdue loans. This curbed both the growth potential and high profitability of the credit card firms by limiting the profitable services of the card firms and lowering interest rates. The changes left many card companies facing a liquidity crunch and some banks were forced absorb their subsidiary credit card companies.
It is still remarkable, however, that despite the fall in airline travel, especially in Asia, and some nervousness in the Korean securities market following the credit card difficulties last year, KAL and Asiana were able to convince the Japanese trustees that ticket sales are a reliable marketable instrument and that repayments, even if only for three years, would be maintained. Apart from occasional dips from air pockets, bad weather and airborne threats, it seems busy regular flights between Korea and Japan are still considered a safe bet. All eyes are on the skies.