Lease securitization has the potential to plug a yawning financing gap for non-U.S. airlines. With European banks, traditionally their biggest source of capital, less inclined to lend, these carriers are increasingly looking at options for leasing aircraft, rather than purchasing them outright.
That in turn, is prompting leasing companies to test investor appetite for deals that, before the financial crisis, came with an insurance wrap and did not require them to do their homework.
In January, Goldman Sachs led the first post-crisis aircraft lease securitization, a $650.35 million deal for General Electric Capital Corp. Bankers at the firm says that there could be another five to 10 deals in the works from leasing companies that were waiting for a firm of GE’s caliber to test the waters.
Another option for financing aircraft is enhanced equipment trust certificates (EETCs), securities that are backed both by aircraft and by the credits of the owner of the aircraft. EETCs are offered under a special provision of the U.S. Bankruptcy Code, Section 1110.
Goldman also has the bragging rights for completing the first international EETC issued by a non- U.S. airline into the U.S. debt capital markets.
“There is a broad-based shift in the space,” said Greg Lee, the head of Goldman’s trade, transport and infrastructure finance group. “We are seeing a large amount of activity in EETCs in lease financing.”
Lee said that before the financial crisis, these airlines had access to cheaper and attractive financing options from European banks, in particular the German Landesbanks. Today, many of the banks that did aviation financing have left the business, and the lending capacity of the remaining banks has also decreased.
The $650.35 million AABS Limited Asset Backed Secured Term Loan is backed by lease payments and sale proceeds of a portfolio of 26 narrow body commercial aircraft manufactured by Airbus and Boeing. The portfolio was acquired by the trust issuing the notes, AABS, from General Electric Capital Corp. and is serviced by GE Capital Aviation Services (GECAS). The servicer is responsible for ongoing leasing activities, including remarketing and servicing of new leases, procuring maintenance and disposition of the aircraft, as directed by the board of AABS.
The deal consists of two tranches. A $557.01 million Series A tranche is rated ‘A’ by Fitch Ratings and ‘A+’ by Standard & Poor’s and a $93.34 million Series B tranche is rated ‘BBB’ by both Fitch and S&P.
The deal has some unusual features. Michael Millette, managing director of the structured finance business in Goldman’s finance group, said that the deal was structured as an ABS transaction but, at issuance, was a term loan.
Millette said that the deal was sold this way in order to meet GE’s timing objective. The structure also helped the issuer to attract a new investor base of institutions that preferred loans. At the same time, the structure didn’t entirely put off securities investors, he said, as the transaction was over subscribed.
Hylton Heard, a Fitch analyst who worked on the deal, said that because it was issued as a term loan, it was not a typical ABS transaction, but the agency still applied its operating lease securitization criteria to the deal. Fitch’s criteria centers on determining the amount of cash expected to be generated by a pool of assets under base-case and stress-case scenarios.
Assumed asset cash flows for each rating scenario are applied to the liability structure of the transaction to determine if they are sufficient to repay the associated debt in full in accordance with the terms of the transaction documents.
“The deal has some features that are applicable to secured term loan facilities,” said Heard. “But it’s still a loan that is backed by the operating leases and the aircraft itself.”
Compared to two transactions that the ratings agency last rated in 2007, Heard said that the AABS deal had LTV levels that are similar to and typical of what was sees in those securitization deals. The deals, Babcock & Brown Air Funding I, Series 2007-1 and Aircraft Lease Securitization Limited, Series 2007-1 were issued with LTV levels of 58% and 78.6% respectively. AABS was issued with LTC levels of 60% for the class A loans and 70% for the class B loans.
GE closed on the financing on Jan. 10, but Goldman said it completed the reoffering of the loans just over two weeks later. The initial coupons, 4.78% on the class A notes and 6.78% on the class B notes, reflected market levels at the time Goldman and other initial purchasers bought the loans. After closing, Goldman sold the debt at a yield of 4.66% for the class A loans and 6.66% for the class B loans.
The deal was initially marketed, in the early fourth quarter last year at 5% for the class A loans and 7 % for the class B loans, according to Matthew Little, a vice president at Goldman and senior banker on the trade, transport and infrastructure finance group.
What was uncertain was how comfortable the institutional investor base could get with an asset class that was mostly, pre-crisis, a monoline-wrapped structure. “So even then, when issuance was more frequent, the investor base didn’t spend a lot of time looking at the underlying specifics of the aircraft deal because they were wrapped,” said Little.
EETCs have remained an attractive form of financing for U.S carriers, both before and after the crisis. Goldman Sachs has completed more than 15 EETC transactions for U.S. air carriers since 2008.
In June 2012, Goldman led the first international EETC deal to be filed under a bankruptcy provision similar to Section 1110 of the U.S. Bankruptcy Code, which allows creditors to have full collateral rights and special treatment under the U.S. bankruptcy code that would allow them to quickly recover collateral if necessary.
The deal, Doric EETC, is backed by a lease to Emirates Airline. The issuance consisted of $433.8 million of 5.125% Class A notes with a final maturity of November 2024 and $153.7 million Class B notes at 6.5% with a maturity of May 2021.
“The unique stamp of the deal is that it was an international deal that was done without the U.S. bankruptcy provision that allows for free possession of collateral,” said Radha Tilton, a senior banker with Goldman’s trade, transport and infrastructure finance group.
The deal was possible because over the last decade an international version of Section 1110 of the U.S. Bankruptcy Code has been developed. According to the New Zealand Ministry of Finance, the Cape Town Convention enables creditors (financiers) to register international security interests and provides standard remedies in the event of default by the debtor. The Aircraft Protocol supplements and modifies the Convention to meet the particular requirements of aircraft financing. It offers creditors additional remedies, including the ability to require removal of an aircraft from the national civil aircraft register and export it.
“The UAE signed up to the Cape Town Convention, which is basically the international version of U.S. Section 1110,” said Tilton. “About 25% was sold into Europe and Asia, which is also unique because not many of these deals have been issued to foreign investors.”
The Emirates deal also allowed the airline to finance over $600 million in debt at one time that would not have been feasible to do in the European bank market, at least not in one step, according to Lee. “The combination of attractive pricing on a fixed-rate basis with the ability to do a large size at one time makes this an attractive alternative,” he said.
Lee added that one reason EETCs and aircraft ABS are attractive to investors is because the residual values in the aircraft space are relatively good compared to other asset classes. Airbus and Boeing have long backlogs that Goldman estimates to be about six years long; this supports a healthy and dynamic supply-and-demand scenario right now in the industry.
Goldman said that it expects five to 10 more deals based on aircraft lease companies that have been looking at the product, waiting for someone else to go first and are also struggling with the European bank market.
“We think that the opportunity for more aircraft ABS is pretty high,” said Little. “The fact that GE did the first one is very good; the fact that execution was very good; and the fact that trading of it post – closing has been good [all] bodes well for other issuers looking to get into the space.”