By Thomas Zimmerman, senior vice president, Mortgage Strategy Group, PaineWebber, Inc.
During the past several years, two features have exemplified the asset-backed securities market - rapid growth and securitization of increasing numbers of new asset classes. Aircraft ABS is one of those new asset classes added to ABS. While not as large as home equities or cards, aircraft ABS do have the potential to become a significant category. And they currently trade at wider spreads than do larger, traditional, on-the-run ABS sectors.
For those investors willing to learn the details of a new category, the aircraft leasing sector offers some interesting opportunities. Since the sector's first leasing deal in 1992, six major aircraft leasing firms have used securitization to fund their activities. These include companies such as GPA, GE Capital Aviation Services (GECAS), International Lease Finance Company (ILFC), and Pegasus. With airline traffic growing rapidly, and the industry turning to non-traditional ways of funding aircraft, aircraft leasing is expected to grow rapidly over the next several years.
In this article we briefly review the evolution of structured aircraft financing, including both EETCs and aircraft ABS (since airlines may use either financing technique). We also spell out some basic issues an investor must deal with when considering an aircraft ABS deal.
Aircraft leasing deals require more investor home-work than do many other ABS collateral types. Financing, accounting and taxation are complicated, and often some collateral is domiciled in foreign countries. Also, aircraft leasing deals differ from typical ABS consumer finance deals. Instead of thousands of auto loans or hundreds of thousands of credit card accounts, a typical aircraft leasing deal may involve only 20 to 100 aircraft. Hence, the characteristics of every single aircraft and its specific financing become important, as do the attributes of each lessee.
Aircraft ABS do have several distinct advantages over other asset classes. Aircraft are quite (trans)portable, unlike CMBS. Aircraft designated for a particular region or overseas country can be shifted quickly to a different location if regional economics weaken in that territory. Also, aircraft do not face the same obsolescence risk that exists in high tech areas such as computers. Many safety and communication updates can easily be in-stalled into existing aircraft, which keeps "used" craft competitive with new models. Finally, the Federal Aviation Administration mandates maintenance schedules for all aircraft, making it highly unlikely that a lessee will abuse leased equipment.
Although economic upheavals in Asia and several other emerging areas slowed the growth in world airline passenger miles during the last two years, most observers view this as only a slight interruption in a long-term secular up-trend.
As integration of world economies continues and economic growth creates more affluent consumers - air traffic is expected to keep growing. Airbus Industries Global Market Forecast predicts that over the next twenty years, passenger traffic is expected to grow at 5%, with the highest regional growth in Asia (5.8%) and Europe (5.4%).
The passenger fleet is expected to double to approximately 19,000 in 2018, from around 10,000 jets today. Freighter growth rate is expected to be even greater, at 6.3% per year. The cargo fleet is expected to grow to 3,400 by 2018, from today's 1,450.
The Financing Gap
Traditionally, airlines used outside sources to fund their growth. Their internally generated funds typically fell far short of capital spending requirements, especially during recent years. This financing gap for 1991 to 1997 averaged around $19 billion/year. Passenger miles are also expected to expand rapidly over the next decade, fueling the growing need for financing.
In the past, airlines relied on banking coffers to satisfy their financial needs. Recently, a shift has occurred to new sources of funding, including several which utilize structured financing techniques.
Enhanced ETCs (EETCs)
The 1990-1993 industry downturn caused many airlines to lose their investment grade ratings. When ratings dropped below investment grade, the airlines lost a large number of investors who could not hold non-investment-grade securities. As airline traffic and new equipment needs started to recover in the mid-1990s, many airlines still had a below-investment-grade rating, which limited their access to funding. To meet their rising equipment needs, they turned to structured finance markets so as to create investment grade securities and broaden their investor base.
The result? Development of "Enhanced" ETCs (EETCs) and lease-backed ABS. An EETC is similar to an ETC (essentially an asset-based corporate bond) except that it is (a) structured with a series of credit tranches rather than a single class, and is (b) backed by a liquidity facility. That facility is available to pay interest for an eighteen month period. The rationale is that this is the time needed to remarket the aircraft lease in the event of airline bankruptcy.
While EETCs borrow techniques from the ABS market, they differ in several respects from ABS securities. Most importantly, they lack diversity, in that EETC collateral is from a single airline. By contrast, aircraft ABS collateral includes numerous aircraft types leased to a variety of airlines.
This allows corporate buyers to diversify their exposure to the airline industry without the burden of purchasing a wide variety of individual corporate issues.
Beginning in 1992, the major aircraft leasing com-panies began to explore the use of securitization to fund their activities. The first deal was the ALPS 1992-1 issued by GPA, the large Irish aircraft leasing company.
The table below lists most of the aircraft leasing deals effected since then (both private and public issues). Total issuance from the 11 deals listed amounts to around $11.4 billion. Note that several (such as ALPS 1996-1) are a refinancing of earlier deals. It is apparent from the volumes shown in Table 1 that aircraft leasing is far from one of the larger sectors of the ABS market. However, the need for aircraft financing is expected to grow dramatically in coming years, and along with it, the need for leasing and ABS funding.
Characteristics of Typical Aircraft Leasing Deals
To date, all aircraft ABS deals have been issued by aircraft leasing companies. As with many new types of ABS sectors, the first several deals contained quite a variety of structures and provisions. As more deals have been issued, there's begun to be more standardization, although structuring is still being refined.
Aircraft ABS consist of the leases plus the aircraft. Cash flow to support the deals comes primarily from two sources: lease payments and the sale of aircraft. (In some early ALPs deals, cash flow came mainly from the sale of aircraft.) Later deals utilized lease payments as the primary source of cash flow. Lease rates can be either fixed or floating.
The number of aircraft/deal has ranged from 11-229. Depending on whether the aircraft were new or used, and on the models involved - appraised value of the average aircraft ranged from $13 million-$32 million.
Appraised values of aircraft (many of which are "used") depend on several variables, including:
Model Type Certain models are very popular with the airlines, because of factors such as their configuration, flight crew size, energy efficiency, etc. Highly-desired models have a higher probability of being remarketed sooner once their current lease expires or is terminated.
Wide-/Narrow-Body Wide-body planes (with two aisles) are used primarily for long, trans-ocean flights. Narrow-bodied planes can be used on both domestic and short international flights. Worldwide demand for used, narrow-body planes is currently greater than for wide-body planes.
Stage III By international agreement, all commercial aircraft must meet Stage III noise levels early in the 21st Century in most countries and by December 31, 1999 in the U.S. Older planes can be outfitted with "hush kits" to meet those standards, but the conversion is costly.
Attractive Asset Category
The spreads from larger, well established leasing companies are wider than those in traditional ABS sectors (such as cards and autos), and substantially wider than those in corporates. Spreads from newer, less well known leasing companies are even wider vs. alternative markets.
Aircraft ABS represent an investment in a well diver-sified group of aircraft and airline companies. We be-lieve they should appeal to ABS investors, and in particular, to corporate investors looking to diversify their portfolios.