Beginners guide to aircraft finance

Beginners guide to aircraft finance

The minimum requirement to be an airline is that you have at least one aircraft. But you do not need to own it.

Aircraft are expensive. The official (or list) price for an Airbus A318 is $75.1 million. An Airbus A380 is $256.4 million. You can always negotiate discounts but few airlines can afford to own their entire fleet outright. Airlines have paid for aircraft with share issues or corporate bonds, but most use the aircraft as an underlying security. This is why the aircraft finance – or airfinance market – is so big.

The two main users of commercial aircraft finance are airlines and leasing companies. Leasing companies are also providers of finance to airlines as well.

At its most simple, aircraft finance can be split down into:

1) Operating leasing

2) Bank debt – including export credit guaranteed deals

3) Secured Bonds – Enhanced Equipment Trust Certificates for airlines, operating leasing securitisation, export credit bonds, Pfandbriefe

4) Everything else!Islamic finance and other specialist deals

Of course, it is possible for an airline to be leasing an aircraft from a lessor who has financed it through bank debt or securitised the lease. You can also issue export credit backed bonds.

Operating leases

The simplest way to get an aircraft is to lease it from an operating leasing company. Airlines can do this by leasing an aircraft that the operating leasing company already owns or by selling an aircraft they own.

When an airline sells the aircraft it is known as a purchase and leaseback or a sale and leaseback. Some – but not all – leasing companies also place speculative orders with manufacturers.

Airlines typically make monthly or quarterly lease payments. At the end of the lease – which is typically three to five years – the airline returns the aircraft to the leasing company.

Carriers are expected to insure and maintain the aircraft during leases. Leasing companies may also charge a fee for future maintenance – known as a maintenance reserve. At the end of the lease airlines will need to return the aircraft in a set condition. The return conditions often account for a lot of the lease documents. Good leasing companies have very strong technical knowledge.

The first dedicated aircraft operating leasing companies were Ireland’s Guinness Peat Aviation (GPA) founded by Tony Ryan (who also founded Ryanair) and International Lease Finance Corporation (ILFC) founded by Steven Udvar-Hazy in the US. Both were launched in the 1970s and created what is now a billion dollar industry.

Most of GPA was sold to GE in 1993 and is now part of GE Capita Aviation Services. ILFC was acquired by insurer AIG in 1990 and later sold to AerCap in 2014. Udvar-Hazy left in 2010 to launch Air Lease Corporation.

Wet leases

Operating leases can be very short – airlines may lease an aircraft at the last minute for just one flight if one of their aircraft is broken. These last minute deals are typically structured as Aircraft Crew Maintenance and Insurance (ACMI) leases or wet leases. There are airlines that specialise in doing this.

Japanese Operating Leases

Japanese Operating Leases (JOLS) are structures where Japanese investors – often small and medium sized companies – own the aircraft. Japanese investors are typically interested in using JOLs to defer taxes as well as any return. JOLs are usually leveraged with debt.

JOLs typically have 12 year terms. They usually have a call option (JOLC) where airlines have the right to buy the aircraft at the end of the lease. There is no obligation on airlines to buy the aircraft but it is expected by the investors and airlines would need to be careful not to disappoint them if they wanted to return to this market.

Japanese investors have been an important source of aircraft finance since the 1980s. Nearly all of British Airways widebody fleet in the 1980s was financed by Japanese investors using Japanese leverage leases (JLLS) – but this tax driven product is only available for Japanese airlines.

Aircraft backed loans

Airlines (and leasing companies) also regularly borrow money from banks. Loans can be structured as simple mortgages or as finance leases (which are different to operating leases as the airline gradually pays off the lease until they own the aircraft).

It is very rare for an airline to be able to borrow the whole value of the aircraft. Airlines typically put in about 15% of the aircraft’s value with banks financing 85% .

Banks will often work together with a few other banks (known as a club deal) or syndicate larger deals to a wide range of banks. Many banks are keen to support their local airline. French banks typically win Air France deals, for example.

Bank deals can vary from a single aircraft loan or large billion dollar loans that finance whole portfolios.

Revolving loans

Just like many people have overdrafts that they do not need, airlines and leasing companies often like to have some bank debt available in an emergency. With a revolving loan facility banks arrange a facility but the borrower decides when it wants to draw it down. They pay a fee to arrange the facility and higher interest when it is actually being used. Revolving loans can be secured by aircraft.

Warehouse loans

Warehouse loans are similar to revolving loans but typically used by leasing companies to finance aircraft for a relatively short term. A leasing company may arrange a $500 million warehouse to allow it to buy aircraft before finding longer-term financing. Warehouse facilities may specify what age and type of aircraft are suitable.

Bridge loans

Bridge loans are short term loans that are made in expectation that they will be refinanced – they are a bridge to the next financing.

Pre-delivery payment (PDP) loans

As well as a paying a deposit when they order aircraft, buyers are typically expected to make payments as aircraft are being built. These can account for between 10% and 20% of the aircraft’s total value. Airlines and leasing companies sometimes borrow this money. Most banks will only provide PDPs in return for the long-term financing.

Export Credit Loans

Every country wants to increase its exports. One way that countries can help is by making it easier for foreign buyers to finance imports. This is particularly important in emerging markets where finance can be less readily available.

Governments offer this support through export credit agencies that either lend to foreign importers directly or reduce the risk of them defaulting by guaranteeing loans made by banks.

Export credit agencies are often seen as lenders of last resort and they have historically been very important during industry downturns or financial crises.

Support depends on where the aircraft or components are manufactured, rather than where the company is based. Agencies can also work together. Airbus deals are typically led by one of the three European agencies. Because Rolls-Royce engines (which are made in the UK) are used on Boeing aircraft, UK Export Finance has also supported Boeing deals.

Airbus UK Export Finance, France’s Coface, Germany’s Hermes 

France’s Coface and Italy’s SACE

Boeing Export Import Bank of the United States

Bombardier Export Development Canada

Embraer Brazil’s Banco Nacional de Desenvolvimento Econômico e Social (BNDES)

Export credit agencies typically provide guarantees for Airbus and Boeing deals, with a bank or a bond raising the cash. Bombardier and Embraer deals are usually made by BNDES or Export Development Canada.

The people running export credit agencies are aware that they are lending tax payer’s money so they take risk very seriously. This means that although it is reliable – and often the cheapest source of financing – it is also usually the most time-consuming and least flexible structure for a borrower.

The approval process typically takes at least four months and deals can easily take over a year. Export credit agencies also demand more information from borrowers than banks and leasing companies.

Aviation export credit is not restricted to aircraft. Flight simulator company CAE, for example, is often supported by Export Development Canada, and spares and engines can be financed.

Because export credit financing could be used to give one manufacturer an advantage, the OECD manages negotiations between all the major commercial and business aircraft manufacturing countries and export credit loans are governed by an Aircraft Sector Understanding.

After almost a year’s negotiations, the 2011 Aircraft Sector Understanding was signed by: Australia, Brazil (even though it is not an OECD member), Canada, the European Union, Japan, Korea, New Zealand, Norway, Switzerland and the US. (Russia and China were invited to participate but chose not too.)

This Aircraft Sector Understanding governs all business jet and helicopter deals from now on.

It basically specifies that all aircraft export credit deals must have:

1) A maximum of 12 year financing

2) A maximum loan-to-value of 85%

3) Be priced based on eight risk factors

A discount is given to borrowers in countries that have ratified the Cape Town Convention (an international treaty that recognises the rights of aircraft financiers)

How export credit loans are priced

Export credit premiums are based on three things:

1) Risk-based rates/Premium rates: Based on long term loss given default and updated annually.

2) Market reflective surcharge: Based on a 90-day daily average Moody’s credit spreads index, discounted to 50% to reflect security.

3) For Direct Lending ECAs, a Liquidity Margin Benchmark: A 90-day rolling average of the lowest funding cost charged by banks to fund large aircraft transactions in USD backed by an ECA guaranty.

Risk-based rates

Export credit finance is not meant to compete with commercial lenders so almost uniquely in finance, the OECD agreed pricing is designed to penalise strong credits.

If a borrower is not rated by a recognised rating agency, the export credit agencies make an internal classification and then send their rating through to the other agencies. Agencies that have a relationship with the borrower – so may have financed their aircraft in the past or looked at supporting sales campaign – have the right to appeal if they disagree with the rating.

Classifications are valid for 12 months when sent as part of letters of offer. The letters of offer can be extended to 18 months if there is a firm commitment and commitment fees are paid.

Aircraft backed bonds

The first aircraft bonds were issued in the early 1990s. They can basically be split between bonds issued by airlines (typically enhanced equipment trust certificates or EETCs), ones issued by operating lessors and securitisations by manufacturers. Airline deals have one lessee (or obligor). Aircraft leasing securitisations can have lots of lessees – giving them diversity. Manufacturer deals can be a mixture.

Enhanced Equipment Trust Certificates (EETCs)
Railway operators issued equipment trust certificates, airlines went one better by adding some extra complexities like liquidity facilities (which mean that the senior noteholders receive interest payments for a period even if the airline has stopped paying).

The rest is coming soon…

Alasdair Whyte
By Alasdair Whyte February 20, 2017 17:14