In 2015, a trade delegation from China’s Henan province visited the Baltic state of Lithuania seeking shipments of milk. Instead, they ended up involved in aircraft leasing.

Having made an investment in Henan Cargo Airlines, the Chinese were looking for dairy products to import to China using Cargolux aircraft, says Tomas Sidlauskas, chief executive officer of AviaAM China, recounting the story behind his company’s Chinese joint venture, AviaAM Financial Leasing China.

While the delegation was in town, a third party brokered an introduction to AviaAM, which wanted to discuss the establishment of a leasing portfolio. AviaAM Leasing and Henan Civil Aviation Development and Investment (HNCA) launched the joint venture (JV) leasing company in 2016.

“It’s interesting – you come to buy milk, but you buy aircraft,” says Sidlauskas. “We always had the feeling we would like to do something in China, but we really needed the partner who was capable to do that. It wasn’t pure luck, but there was a luck factor as well.

“The main idea is we are bringing the deals to the table and they are bringing the financing, because they promised to give us competitive financing from the local banks,” says Sidlauskas, adding that the project received political support because it is aligned with China’s One Belt One Road initiative.

The joint venture has already completed transactions with Russian carrier Aeroflot, with which AviaAM was already connected. “The main thing for Aeroflot is that we had a good relationship and they had a lot of brand-new aircraft. To build a portfolio quickly, it’s better to do it with well-known airlines. It’s easier to get the financing and it’s easier to prove to the JV partner that the airline is good,” says Sidlauskas.

Sidlauskas says the joint venture is now targeting deals in Commonwealth of Independent States countries, whose carriers might struggle to secure financing. “[In those countries] it’s not easy to get financing from the international society because of the credit rating of the country, but to get financing from China it’s not that hard,” says Sidlauskas, adding that while pricing was not that good for the joint venture, margins were higher compared with deals in the rest of Europe and in North America.

That joint venture now has 11 aircraft in its portfolio, with another two expected soon. 

Lagging behind

Historians of China acknowledge Henan, the province from which the delegation came, as “the cradle of Chinese civilisation”, but in recent decades Henan has fallen behind economically. Poverty remains a problem and Henan has not benefited from China’s economic rise as much as richer coastal areas.

A 2008 article in Hong Kong newspaper South China Morning Post described Henan as having a “glorious past” and “strategic geographic location”, but “lagging behind in China’s economic boom” after three decades of reform and opening up.

Now, however, the province is developing rapidly, with aviation a pillar of that growth. Could the cradle of Chinese civilisation also become a cradle of Chinese civil aviation?

Ryan Guo, managing director of Zhongyuan Aviation Leasing, a lessor based in Henan’s capital city Zhengzhou, thinks so. He says the Chinese government has identified Henan as suitable for the development of aviation and aircraft leasing.

Zhongyuan Aviation Leasing is backed by five Chinese shareholders: Zhongyuan Asset Management, Henan Province Airport, Hengyu Investment (HK), Zhengzhou Airport Economy Zone Xing Gang Investment and Henan Land Assets Management.

At the end of December, Zhongyuan Aviation Leasing closed its first deal, a $98 million 12-year sale and leaseback for Lucky Air for one Airbus A330-300 with funding from China Development Bank’s Henan branch. The deal was structured via a special purpose vehicle (Henan YuPeng Aviation Leasing) through the Henan Zhengzhou Airport Economic Zone, the first time this type of structure has been used.

Guo says the deal received strong support from the Henan government, which gave tax refunds to Zhongyuan Aviation Leasing. He says it is the first operating lease deal in China (outside of the DFTP) for which the State Administration of Foreign Exchange allowed the collection of US dollar-denominated lease rentals.

The fact the government granted tax incentives via this economic zone shows that the government supports aircraft leasing development in Henan. Only a limited number of areas in China offer these kinds of benefits, the most active of which is the Tianjin Dongjiang Free Trade Port (DFTP), where more than 1,200 aircraft have been delivered, according to a DFTP source.

Before joining Zhongyuan Aviation Leasing, Guo worked in the richer southern Chinese province of Guangdong, which boasts two economic powerhouses: Shenzhen and Guangzhou.

There, Guo headed the financial leasing division of the Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone, researching how to attract domestic and foreign leasing companies to set up special purpose vehicles (SPVs) in the zone.

In an October 2015 interview with Airfinance Journal, he discussed how Qianhai wanted to follow on from the success of other special zones in China such as the DFTP. He said that, because of its proximity to Hong Kong, Qianhai had been given permission from the Chinese central government to implement “special policies” and was being allowed to research how to introduce English law practices into Qianhai.

“Especially for the aircraft financing sector, the law is English law, so we want to do some research to introduce more English law into Qianhai,” he said at the time.

“That would not only allow the Chinese leasing companies to get more guarantee and more protection from the lease agreement, but we hope it will also give the foreign leasing companies like GECAS, ILFC or CIT more confidence to set up SPVs in China.”

However, Guo now acknowledges that some provinces have prioritised the development of aircraft leasing more than others.

"Guangdong province has a lot of economic support and they also have a lot of different kinds of businesses like insurance and banking, investment banks – so much support. Maybe for the aircraft leasing industry it’s not very important, not very big business in the whole economic plan,” he says. Guo adds that one of the biggest challenges for Qianhai was that Guangdong, unlike Henan, was not granted permission from the central government to allow lessors to collect foreign exchange rentals in US dollars.

Move to Hong Kong

An attractive leasing structure in the Henan Zhengzhou Airport Economic Zone and strong government support may still not be quite enough to keep lessors in Henan. Zhongyuan Aviation Leasing is planning to move much of its operations down to the Chinese special administrative region of Hong Kong, where lessors enjoy preferential tax rates. ICBC Financial Leasing closed the first leasing transaction to take advantage of the recently passed bill to lower the effective tax for lessors in the city.

Guo, who said in June 2017 that his company was considering a move to Hong Kong to internationalise its business and take advantage of the tax reforms. He visited Hong Kong with his shareholders in March to explore a potential listing on the city’s stock exchange. Guo hopes to make the move by the end of 2018, pending approval internally and from Zhongyuan’s local government shareholders.

“We will keep some people in Zhengzhou, but I guess most of the team will move to Hong Kong or we will recruit new people at Hong Kong. The operation team, especially the financial team, most of them will be based in Hong Kong,” says Guo.

He is also considering having a second office in neighbouring Shenzhen, because of cheaper rents there.

“It’s up to how big an office we rent. Not only our company, but my shareholders have other business like distressed asset management and a shares investment company. This office will include all these businesses,” says Guo.

“After the shareholders become a listed company in Hong Kong, then maybe later we will become an independent department to IPO independently.”

Despite concerns about low lease rate factors in China and an influx of new lessors crowding the market, Guo is optimistic about the future of aircraft leasing in China. 

“I think the market is becoming more and more rational,” he says, explaining that the biggest leasing companies have less interest in doing sale-and-leaseback transactions these days. 

Guo adds that despite competition from new lessor entrants, these newbies generally cannot get their shareholders to support leasing aircraft with “very lower lease rates compared to big leasing companies”.

He adds: “Maybe 100 or 200 aircraft will deliver in one year, but for so many leasing companies they compete with just this piece of the market, so it needs time. I guess one year or two years later the lease rate will go up gradually.”

Guo thinks big leasing companies will have to change their business models to explore more services besides pure aircraft leasing, such as aircraft part outs.

While Zhongyuan Aviation Leasing will continue to work with local government to arrange innovative deal structures and develop Henan’s aviation industry, Guo – who has experience at other Chinese lessors CCB Leasing and CDB Leasing (now CDB Aviation) – acknowledges the need to remain true to a tried-and-tested aircraft leasing business model.

“I guess we will just have the same business model as other leasing companies: sale and leaseback and place orders,” he says. “We have to finish one thing, step by step.”

From Luxembourg to Zhengzhou

Luxembourg cargo carrier Cargolux Airlines has been flying to Zhengzhou Xinzheng airport (CGO) since 2014 and has 34 flights in and out a week. 

Richard Forson, Cargolux’s chief executive officer, describes Zhengzhou airport as a “powerful hub”.

He says: “We’ve seen a significant increase in tonnage from our side and last year we transported a total of 147,000 actual tonnes out of CGO, and it seems to be attracting a lot of attention of many other carriers as well that want to operate into CGO.

“Obviously, Shanghai is congested, Beijing is congested, so we’ve been pretty pleased with the success we’ve had of CGO as a traditional point in China. It’s also allowed us to expand our footprint.”

Henan Civil Aviation Development and Investment (HNCA), the same company that owns part of AviaAM China, owns a 35% stake in Cargolux. The two companies are setting up an airline called Henan Cargo Airlines, in which Cargolux will hold 25% (the maximum allowed under Chinese foreign investment rules) and HNCA 75%. 

Forson is still considering options for Henan Cargo Airlines’ fleet, which will start with three-to-five aircraft.

“One option is to source from our fleet. The other is to go into the market and see what is available. We are a Boeing 747 operator, so having 747s there we are able to provide them with immediate maintenance support,” he says.

“The big thing – once we really scan the market to see what’s available – is to what extent we can transfer aircraft from our fleet, although, at the same time, I don’t want to see any reduction in our fleet. One has to balance it out; if I had to transfer out of my fleet, I would seek alternative replacements to come back into Cargolux’s fleet.”

Asked whether he would utilise the same Henan Zhengzhou Airport Economic Zone structure as Lucky Air did via Zhongyuan Aviation Leasing, Forson says it is something Cargolux has examined. “Obviously, if we were to decide to lease aircraft in from a lessor we would investigate what benefits there would be in the zone surrounding the airport,” he says.

“I know there are other free zones that quite a number of transactions have been done through. For Henan Cargo Airlines, it would definitely be one of the alternatives we would look at in sourcing the aircraft.”

Forson says strong support for aviation in Henan comes not only from the provincial government but the Communist Party’s central committee.

He adds: “It forms an integral part of what they call the Air Silk Road, which is part of the One Belt One Road strategy that President Xi has mentioned on many occasions.”