In June, when the US House of Representatives voted in favour of following the Senate in closing the door on all out-bound lease transactions, the end looked imminent for the US cross-border lease. With the re-election of the Bush administration that end now looks a certainty.

The US Inland Revenue Service (IRS) has also shaped itself from a mere spectre to a veritable threat. The IRS is rumoured to be stepping up its audit of lease-in lease-out (LILO) transactions. To date, however, no LILO has prompted any litigation. Settlements have been reached, though it is unclear as to their final terms. Understandably, lessors have not been forthcoming as to the range of tax liabilities.

There is, however, some light at the end of what is a very long dark tunnel. Arrangers are beginning to bite the bullet and look to close alternative products in other jurisdictions in order to survive.

The French leveraged lease, once the also-ran product of the industry, finally may be coming into its own. According to Matthieu de Varax, partner at Simmons & Simmons in Paris, "This is a very interesting period for the French lease market. People in Europe are looking for alternatives to the US cross-border lease; moreover, there is tax capacity available in France right now so there may be opportunities."

Although there is tax capacity available, it remains limited to a number of sources. "Those that have the tax capacity have a lot of it: i.e. big players such as BNP Paribas, Calyon and Société Générale. Those with less tax capacity will, on the whole, tend to be more conservative, concentrating only on the best deals," says a Paris-based banker.
New Jersey Transit seems to be one such opportunity. In July the transit authority closed a $38.8 million French leveraged lease, which refinanced a fleet of articulated and suburban buses. Global Capital Finance acted as exclusive financial adviser on the transaction, while the equity was put up by an unnamed French institution.

The deal follows on from a transaction signed in October 2003 by the municipal transit authority, again advised by Global Capital Finance. This earlier transaction involved light rail vehicles with an appraised value of $72.5 million.
New Jersey Transit's appetite for these transactions remains undiminished. On October 14, a re-scheduled meeting of the Board of Directors of the New Jersey Transit Corporation, NJ Transit Rail Operations, Inc., NJ Transit Bus Operations, Inc., and New Jersey Transit Mercer, Inc. was held. The proposed 'Action Items' included the 'French Cross-border Lease: Diesel Locomotives'.

As yet it is unclear as to when, or if, a deal will come to market; though it is known that the transportation authority has been seeking approval from the government's Federal Transit Administration (FTA) for a $90 million French lease on 88 Alstom Comet V railcars since July 2003. Fortunately, under US legislation it would be difficult to outlaw foreign equity sources, so the French leveraged lease remains outside its reach. In this case, the French lessor, pursuant to French law, passes on the tax benefits.

New Jersey Transit remains one of many municipal-owned transportation authorities that has suffered at the hands of the rapid demise of the US leasing industry. Since the 1990s, the authority has supplemented its capital funding programmes with leasing deals, especially in the form of cross-border transactions. The authority had intended to close this $90 million French leveraged lease, involving federally funded equipment, before a letter from Senator Charles Grassley to the Transportation Secretary Norman Mineta provoked the FTA's freeze, and the transaction under board consideration is likely to concern different assets.

A tale of two markets
Whilst domestic lease structures -  most popularly the credit-bail or finance lease - require formal approval to benefit from exemption on capital gains taxes as well as accelerated amortization, its cross-border structure does not.

The unapproved lease (without seeking the tax exemption on capital gains at the end of the lease term) may have a lower net present value (NPV) benefit, but has proved a hit with a number of end users. NPV benefits range between 4 and 5%, though the reality is that there is far more demand than available capacity.
Nevertheless, the unapproved structure has been challenged by the French authorities on a number of occasions. In the approved structure the special purpose lessor is usually a groupement d'intérêt économique (GIE), though one alternative structure uses a société anonyme (SA) or société en nom collectif (SNC), which is consolidated on the balance sheet of the tax investor.

Given the consolidation requirements, coupled with a finite number of tax investors, syndication is rare. According to a Paris-based structured financier, "It is very difficult to do a syndicated deal. For a single investor it is easier to swallow, especially with either aircraft or ships."

These 'single investor' leases tend, on the whole, to be the domain of the larger French banks that have the tax capacity to close the deals. Moreover, given the conservative nature of many of the larger French players, deals may only be looked at if the bank-client relationship necessitates it.

Whilst French cross-border leveraged lease deals have tended to include French content in the past, this may no longer be the case. Certain industry sources believe that it is sufficient to have the investor as the only French connection to the transaction.

Others disagree. "Absent a tax approval and/or any French content, if you're only 'passing through' France, it's not going to make certain parties very comfortable," says Alain Gautron, partner and head or European Finance at Orrick, Herrington & Sutcliffe LLP.

In the current market, arrangers will need to be far more diligent. Whereas in the past arrangers could secure 'no action' letters in relation to their transactions, this is no longer the case. "They are now told to have a look at the old ones. We still have that grey cloud hanging over us. If it is Alstom railcars for an Asian railway system, then it's all right; but if you're building railcars in Japan, there is not going to be too much comfort," says one Paris-based source.

According to Marin Gdanski, partner at Norton Rose in Paris, Western European transport operators are particularly keen to look at cross-border deals. "French legislation entitles investors with tax capacity to seek a ruling from the French tax authorities. This entitles them to pool their capacity into a single tax transparent lessor entity, which purchases the asset and grants a lease with purchase option to the lessee, so long as a number of conditions are met relating to the purchase price of the asset. The general benefit of the transaction to the French economy (particularly for employment) and the retrocession of at least two-thirds of the NPV tax advantage so realised to the lessee in the form of reduced rentals and/or reduction in the purchase option price."

Adds Gdankski: "Although the French tax administration has been less keen than in the past to provide such rulings, it remains possible for banks that are willing to do such transactions on a single-investor basis to do so, albeit at a lower NPV, and several transactions are currently being considered on such a basis."

Given the lessons learnt in the US lease market, however, few US lessees are willing to take unnecessary risks, and this will dampen appetite for the structure. Those left exposed to transaction costs by US legislation are unlikely to want a similar experience at the hands of the French state.

Domestic leases
While unapproved structures may be inherently risky, approved structures are beset by limitations and restrictions. Furthermore, approval is very difficult to obtain.

According to Gautron, "For many, all the effort into getting approval for these deals is worth it. The approval gives certainty. There isn't any question of: 'How certain are the benefits in my deal?', or, 'Is my deal going to be challenged?'"

In addition, for those patient enough to endure the provisions, the rewards are great. Once approval is secured, the NPV benefit generated can reach over 20%. The legislation also decrees that two-thirds of the benefit must be passed on to the lessee.

Benefits are in effect generated in a two-part process. First through accelerated depreciation, whereby the value of an asset such as a vessel can be written off by around 40% of its current market value in the first year. Second, through an exemption from tax on the capital gain made by the lessor at the end of the lease term when the lessee purchases the asset: this provides the majority of any benefit.

Restrictions and limitations - of which there are many - act as a natural regulator of deal volume. Assets must be both new and movable, and must be depreciated over terms of eight years or more. But the most important provision is that the transaction must have some social or an economic benefit to France. On the one hand there is a certain amount of conjecture as what this may encompass; on the other, there are grave concerns as to whether the provision is compliant with EU law.

Nevertheless, approved structures have retained their popularity, especially in relation to aircraft and ships. Air France recently mandated Calyon as sole arranger to arrange a French tax lease on one Boeing 777-300ER. The aircraft is expected to be delivered before the year-end and is the third aircraft from its order for 16 Boeing 777-300ER placed in October 2000.

Although the French tax lease has been a preferred method of financing aircraft for Air France this is its first deal since 2002. With three further 777-300ERs due to be delivered to Air France before the end of the year, repeat deals are expected to follow.

Ships also lend themselves particularly well to this French structure: a combination of the right numbers and right depreciation characteristics. Typical ship deals are structured so that a 5.5-year lease term from the delivery date includes a put/call option, so that the lessee has the opportunity to buy the asset outright. With a dramatic reduction in purchase cost, through a sizeable NPV benefit, the shipping entity can opt for more expensive specifications.

The French group CMA-CGM remains a major beneficiary of these deals, with a Eu580 million French tax lease rumoured to have closed in September. It is likely that the transaction comprises eight Series-8 containerships, which the French group ordered from Hyundai Heavy Industries. However, there have been questions from certain quarters as to whether there is enough tax capacity in the French market to close these kinds of deals. The containerships are slated for operation on the French Asia Line between the Far East and Northern Europe, and will come on line at the rate of one vessel per month from March 2006.

The deal comes hot on the heels of last year's French tax leases on four container ships. Société Générale acted as arranger on the transactions.

A further opportunity for French investors is structuring transactions in French overseas territories. Under French law, substantial tax write-offs are granted. The Metropolitan France Tax Exemption Law known as Loi Giradin authorizes a significant reduction of investment costs in certain business sectors through the intervention of Metropolitan France resident taxpayers.

Given the immediate write-off, rather than accelerated depreciation over time, NPV benefits generated can be higher. As with the domestic French tax lease, the deal has to be signed off by the authorities - though a change in interest rates will not affect the deal.

The latest overseas territory deal to come to market is the tax lease financing of process plants and associated infrastructures for two major mining projects in New Caledonia. The transaction is set to become the largest-ever overseas French tax lease. The deal concerns a nickel mine in the province worth several hundred million euros and is expected to take tax capacity either late this year or in 2005.

Calyon is also keen to promote similar overseas structures and has arranged a deal for Air Tahiti in conjunction with BNP Paribas. The FLL finances one ATR 42-500 and one ATR 72-500. Air Tahiti Nui closed a similar lease deal in 2002, financing two widebody A340-300s.

The future?
Although the deal volume for the French leveraged lease is not expected to increase dramatically over the next twelve months, there are signs that new products may come to market.

According to de Varax, "One of the products being explored is the financing of equipment for renewable energy, such as wind farms. These assets can be depreciated over 12 months; however, the scheme will expire at the end of 2006 so there is a window now."

Although the product is at a very early stage, its application is said to be both domestic and cross-border. Though given its tight window, the structure will have limited applicability. Even so, it is rumoured that one of the larger French banks has closed two transactions, but details remain sketchy.

Nevertheless, the French leveraged lease market remains what it has been for many years: a market dominated by the few. There will continue to be opportunities for foreign players, either through certain innovative or established structures, but on a select basis. Moreover, any notion that the French lease will somehow replace the US lease or even the German leveraged lease (GLL) is fanciful: the capacity just isn't there.