It's taken sometime for aircraft-related securitization to become a regular feature of the European ABS market, but with banks cutting down their lending to the industry, the time may be right for Europeans to build on the handful of aircraft-lease backed deals seen in the last few years. That, at least, is the forecast from Standard & Poor's in its latest report on the European structured finance market.
Irene Ho-Moore, a director in S&P's structured finance group in London certainly feels that leasing companies, manufacturers and airlines will have little choice but to increasingly look towards ABS as a substitute for bank finance. "An increasing number of banks are looking at the profitability of their lending books and are less willing to provide the same level of funding to airlines," she said.
"As certain funding routes, such as Japanese leveraged leases, have been phased out, securitization is fast becoming the favored option, especially among medium-sized leasing companies, as it satisfies the need to transfer portfolio risk."
You only need to look at banks' increasing focus on return on capital to see the way the market is headed, Ho-Moore said. "It is a fact that banks want to exit the market. This is a reflection of banks over all. They are asking whether they are being smart in the way they lend. Return on capital is becoming even more important - just look at the amount of CLO deals that have been launched in the last 18 to 24 months. This reflects their desire for a more efficient use of capital."
Thomas Khill, who has headed previous aircraft securitizations for U.S. investment bank Morgan Stanley Dean Witter, agrees with S&P's basic premise. "On the overall view that the capital markets will play a major role in aircraft finance, that is categorically true," he said. "Securitization will play a major role in this, although depending on the companies involved - i.e., an actual airline or an aircraft manufacturer - these will be structured differently and marketed to different people."
According to U.S. giant Boeing, its revenues are set to rise by 5% per annum over the next five years, as a result of increased air traffic that will necessitate the construction of between 8000 and 9000 new aircraft. If banks are wary of new lending and also want to clear old loans from their books then aircraft securitization should be set for a major boom.
It may take time for a proliferation of deals to take place in Europe, however. "At the moment there is no need as airlines are stable and able to borrow at rates they find acceptable," said Ho-Moore. "But there are two or three banks who are actively marketing these new capital markets solutions to airlines. I expect to see at least a couple of international transactions issued this year."
So far, the majority of aircraft deals have been originated in the U.S., although Europe has dipped a toe in the water. Most spectacularly, Morgan Stanley lead-managed a $4 billion deal for Ireland-based aircraft leasing firm, GPA, in 1996, that rescued the company from impending bankruptcy and came after several previous ABS deals from the firm.
More recently, the American bank structured the first European enhanced equipment trust certificates (EETC), in a transaction for Iberia, Spain's national airline, in September last year. The E190 million ($174 million) deal - called Iberbond 1999 and sold to Deutsche Bank - was split into three tranches and enabled Iberia to finance the leases of six aircraft.
Khill believes that the success of the deal could see more European airlines venture into the market. "Iberia were ahead of the game because they recognized that, although they could fund a few new aircraft from bank loans, securitization was the way to fully meet their needs," he said. "We're currently talking with other airlines who have seen the success of that deal and are looking at funding options."
Such deals can be trickier than more traditional asset classes. "Aircraft deals differ from mortgage deals, for example, where you can rely on a known income stream," explains Ho-Moore. "With aircraft, and other sectors like shipping, you are relying on the servicer to take the asset, sell or lease it, and then make the right decision on who to sell it to and for how much."
EETCs have been the most common place form of securitization in the aircraft-backed market worldwide. They require extra credit enhancement to ensure that the transactions get a higher rating than the airline's own corporate rating, which are often held down by the industry's inherent volatility. A higher rating is possible because, along with the extra credit enhancement, bondholders are protected by the underlying collateral, in this case the aircraft.
In Iberia's case, due to the Spanish legal system being less stringent in terms of the repossession process than other countries, an extended 42-month liquidity facility was structured into Iberbond to cover any interest payments in case of a lengthy repossession period.