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GROWING GOVERNMENT INVOLVEMENT IN TRADE 83 LARGE AIRCRAFT The Export-Import Bank (Eximbank), as part of the ''commonline" agreement relating to large transport aircraft, charges a fixed rate of 12 percent plus a 0.5 percent commitment fee. However, it charges a 2 percent application fee that is paid either up front or over the first six semiannual installments. This procedure raises the effective rate to 12.5 percent. On the guarantee option, the guarantee fee is 0.5 percent with no loan application fee. However, the funding of the guaranteed paper is at market rates.8 The European export agencies only provide credit guarantees, but will support aircraft exports to the extent of 62.5 percent of the cost of the aircraft rather than 42.5 percent as in the case of the Eximbank. In consequence the U.S. has offered 62.5 percent and the Europeans have come down to 42.5 percent on recent competitive transactions. Eximbank repayment occurs only after private lenders have been repaid. The funds are provided by private institutions, but the export agencies subsidize the rate at the commonline level, which is presently 12 percent. Both the Eximbank and the European agencies will provide financing up to 85 percent if the other offers it. The basic result is that the direct financing of a sale is close to parity except for the 2 percent application fee (the normal European fee is 0.3 percent). This fee makes the financing of the U.S. export more expensive and is particularly onerous because it represents an "up front" payment from airlines that frequently are scrambling to raise the down payment on the aircraft. The market rate for the Eximbank guarantee of 85 percent of the cost is balanced against the subsidized interest rate on up to 62.5 percent financing by the Europeans with the balance of 27.5 percent at market rate. However, in cases where the Europeans go up to 85 percent with a subsidized rate, the Eximbank guarantee program is more expensive, particularly when the 0.5 percent commitment fee is included. Although the commonline agreement that relates to large transport aircraft calls for a 10-year term, both Eximbank and the European agencies are willing to guarantee a 12-year lease transaction. However, a 12-year term and the requirement of equal semiannual payments of principal damage the economics of a tax lease. The optimal time period of a tax lease is 15 to 18 years. Another competitive problem for the U.S. manufacturers relates to the practice of the European manufacturers to fund their exports in their own currencies. Under the terms of commonline agreements, the European export credit agencies may lend German marks at 9.5 percent and French francs at 11.5 percent, while U.S. dollar loans are at 12 percent. In competi
GROWING GOVERNMENT INVOLVEMENT IN TRADE 84 tions over the last several years it has become very clear that not all airlines regard these rates in the various currencies as equivalent. The U.S. Eximbank will lend only dollars but allows its guarantee to be used to raise loans in other currencies. This latter option does not match the European offers because commercial banks cannot offer to fix an interest rate 18 to 24 months in advance of aircraft delivery and, in any case, will lend only at commercial rates. The French franc rate has been highly subsidized during the entire existence of the commonline agreement. The only solution that completely neutralizes this issue is for Eximbank to offer to lend directly at commonline rates not only U.S. dollars but also German marks and French francs. United States exporters are adversely affected by Eximbank policy with respect to airlines of developing countries. The Eximbank charter requires "a reasonable assurance of repayment," which is often used to turn down loan applications from airlines of developing countries. In contrast, the European export agencies are more liberal. It should also be noted that the "commonline" agreement does not cover exports of Fokker and British Aerospace to developing countries. However, on such transactions, the commonline agreement on interest cost is adhered to on 85 to 95 percent of the transactions. Another disadvantage for U.S. manufacturers is that the Eximbank will not cover the foreign content of a U.S. export while the European export agencies will. In consequence, the U.S. exporter has to find another way to finance this portion of the aircraft cost. With growing percentage of foreign content in U.S. aircraft exports, this becomes an increasing problem and a competitive disadvantage for the U.S. manufacturers. The Eximbank and the European agencies now have an informal understanding not to provide financing commitments in one another's countries, i.e., the United Kingdom, France, West Germany, and the United States. This recent development can prevent some of the unusual transactions conducted in the past. Unfortunately, the Eximbank has been inconsistent over the years not only in its policy toward large aircraft exports but also in administering that policy. This has inhibited the ability of customers to plan their equipment purchases and related financing. In dealing with the European agencies they knew where they stood. Although Eximbank will meet foreign competition, it is often unwilling to provide financing where no competition exists. This policy limits sales to some customers, particularly to developing countries where alternative sources of funds are not available. More disturbing is the policy of Eximbank to insist on a competitive offer from a foreign manufacturer before it will agree to finance a U.S. aircraft export. This can have the effect
GROWING GOVERNMENT INVOLVEMENT IN TRADE 85 of requiring the aircraft manufacturers to induce competition when none may otherwise have existed. As can be seen, the Eximbank export support for large transports falls short of meeting foreign competitive financing. In consequence, the burden has fallen on the manufacturer to provide competitive financing. Competitive pressures in financing international sales have combined with an uncertain earnings outlook and cash flow difficulties to stimulate new forms of financing. Many carriers and their lenders have become hesitant to take on substantial long-term debt service commitments for new aircraft. Ironically, the success of an industry that has historically been a bellwether of technological innovation is increasingly dependent on innovation in financial instruments and arrangements. Some recent transactions for both domestic and international carriers have been based on an operating-lease concept in which the airline commits itself to lease aircraft for a two-or three-year lease payment term. The concept involves structuring the transaction as a tax lease with the lessor taking the investment tax credit and the accelerated depreciation. This then reduces the lease payments. The balance of the cost is raised from banks, institutional lenders, or the public market. The problem associated with such operating leases is that should the airline return the aircraft at the end of the initial lease term, the senior lenders would have considerable exposure against the residual value of the aircraft, and the equity investor would be in danger of losing the tax benefits if the aircraft could not be leased again. As a result, some mechanism must be devised that would make such a transaction, with its residual risk implications, attractive to both equity investors and senior lenders. In spite of the inadequacy of airline operating profits to pay for "new generation" aircraft, manufacturers have been under considerable pressure to get their aircraft in the hands of carriers that represent good potential for follow-on orders, particularly when the alternative would be to close down the aircraft manufacturing line. Not surprisingly, many recent transactions have involved substantial manufacturer financing. Senior lenders could probably be induced to take an asset risk in the range of 50 to 60 percent of the aircraft price, provided the manufacturer were willing to assume the responsibility of remarketing the aircraft in the event of a default by the airline. Unfortunately, banks are limited to a 25 percent asset risk on an operating lease. It might be possible to secure residual value insurance for a portion of the asset risk. However, the market for residual value insurance is thin, and the volume of the risk that can be covered in this manner is uncertain. Consequently, it is not clear that a large number of aircraft could be financed on this
GROWING GOVERNMENT INVOLVEMENT IN TRADE 86 basis, because of the problems outlined. In addition, the expense of the insurance can adversely affect the economics of the transaction. Another possible approach that might reduce the residual risk is to develop a special entity to purchase aircraft and enter into operating leases with a number of airlines. The risk would be spread over time and over a large number of borrowers since not every airline would turn back aircraft at the end of the initial lease period. The financial community, the aircraft manufacturers, and the airlines need to continue efforts to design financing packages that meet airline minimal cash flow and balance sheet requirements and that minimize the exposure of the manufacturers while assisting them in making sales. The panel recognizes that use of tax policy to improve international competitiveness is controversial, largely because it involves tax "expenditure" to encourage exports. Those exports do, however, represent business that otherwise would not exist and thus enlarge the tax base. Nevertheless, government tax policies obviously will continue to play a critical role in determining the attractiveness of such arrangements. The panel recommends consideration of additional measures that would enable aircraft manufacturers to reduce the risk in leasing aircraft to domestic and foreign customers. Many of these steps would involve removal of legal roadblocks rather than increased financial exposure for the government. Unlike banks or other financial entities that are currently or prospectively engaged in such leasing (e.g., insurance companies), aircraft firms engaging in leasing do not hold highly diversified or liquid portfolios of financial assets or have a broad customer base compared with financial institutions. Therefore, large transport and especially commuter aircraft producers face greater risk of catastrophic financial losses than more diversified lessors. The ability of U.S. aircraft producers to finance new products in the deregulated airline environment would be enhanced if restrictions that determine a "true" lease (i.e., one that allows five-year depreciation) and the claiming of the investment tax credit on the part of the lessor were liberalized. Easing restrictions would partially equalize the financial risks faced by lending institutions and aircraft producers in leasing and allow aircraft demand to be exercised. Leases of aircraft to foreign operators also have increased in recent years. However, current tax policy penalizes leases to foreign customers by restricting the eligibility for investment tax credit (ITC). Actions that would eliminate ITC for all non-U.S. aircraft operators would be counterproductive to this country's efforts to sell aircraft to non-U.S, operators. Continuing the use
GROWING GOVERNMENT INVOLVEMENT IN TRADE 87 of tax leasing to the international airline community is an important marketing tool. An additional step that would be useful in enhancing sales to developing countries would be to include aircraft as infrastructure project equipment that qualifies for Agency for International Development (AID) and World Bank funding. In view of the fact that over 60 percent of the current civil transport aircraft market is outside the United States, the availability of the investment tax credit to foreign operators will have a major and beneficial impact on the market for U.S. aircraft. Determining the net benefit or cost will require careful analysis. The importance of foreign markets for the U.S. civil aircraft manufacturing industry means that congressional proposals to deny even the current, restrictively defined investment tax credit to foreign operators could have a serious and detrimental impact on the industry. However, as noted earlier, the denial of the investment tax credit on foreign aircraft purchases could serve a useful purpose as a temporary measure to countervail unfair trade practices. The earlier admonitions with respect to the dangers of invoking retaliatory measures must be repeated. Recent changes in legislation have been enacted to improve the utility of special corporations to permit deferral of U.S. taxes on foreign sales. The rules governing the corporations (formerly called Domestic International Sales Corporations [DISCs], but now called Foreign Sales Corporations [FSCs]) have been modified to bring them into conformance with GATT. In the new legislation changes have been made that reduce the obligation for demonstrating a foreign presence for smaller firms, and they all provide for partial exemption of taxes rather than partial deferral, as formerly permitted. These changes can be of benefit to smaller enterprises in the civil aircraft industry in their efforts to expand export sales. The panel recognizes that the subject of providing government support for financing export sales of aircraft is controversial (the same could be said for other long-lived capital goods that require large expenditures, e.g., electrical generating equipment). Opponents assert that the support benefits a few large companiesâ an assertion that ignores the benefit to the 15,000 enterprises that supply materials, components, and subsystems to the major designers and assemblers of aircraft. Opponents also assert that competitive markets should be allowed to work and question why American taxpayers should be asked to support foreigners who buy U.S. aircraft. To the first the panel responds that it is unrealistic to regard the international market for aircraft as "competitive" in the classical sense employed in economics. As this report has indicated, many countriesâlarge and small, highly developed and developingâhave explicitly targeted aircraft manufacture as an
