Pooled aircraft securitizations grew significantly in 2000. Volume nearly tripled both in terms of dollar amount issued and number of deals completed. The year witnessed new issuers, innovations on existing structures and an overall solidification of pooled aircraft operating lease transactions in the securitization market. The maturation of this asset class is evidenced by the breadth of new issuers who, for the first time, are accessing the capital markets to both expand and diversify their aircraft portfolios. The market's increased understanding of pooled aircraft securitizations has led to a widening of collateral pools which currently range from fleets comprised exclusively of freighter aircraft to fleets of highly liquid narrowbodies. Structural innovations in 2000 included the use of multiple servicers, multiple sellers and incorporating the costs of refurbishing aircraft into the transaction.

The growth in issuance is also attributable to the relatively stable performance of existing pooled aircraft securitizations. Although lease rates have softened and some of the emerging market airlines have suffered as a result of downturns in their local and regional economies, most of the existing deals have performed as expected.

Volume/participant growth

Pooled aircraft securitization issuance in 2000 consisted of seven transactions totaling approximately $6.2 billion ($5.5 billion consisted of 144A offerings). Six of the seven offerings were 144A transactions sponsored by various operating lease companies with the remainder being a reinsurance structure sponsored by a manufacturer. Four of the transactions involved first time issuers (three of the four were in the 144A market). Volume in 2000 was greater than both 1998 and 1999 combined both in terms of volume and number of issuances.

In the 144A market, two of the first time issuers involved smaller, unrated companies that serviced and retained some equity participation in a portion or all of their entire securitized portfolio. The emergence of these issuers displays the market's increased willingness to use securitization as a tool for financing fleet expansions and renewals for companies that wouldn't otherwise have cost-efficient access to the capital markets. Saab, an additional new market participant, succeeded in utilizing a reinsurance structure to shift releasing risk on a pool consisting entirely of turboprops. The Saab transaction involved utilizing an approach similar to that of the larger pooled aircraft securitizations while accounting for the additional risks of lessee concentrations and risk of obsolescence in the turboprop market.

Repeat issuers in 2000 demonstrated the ability to use the structural foundation they first introduced. MSAF returned to the ABS market for the first time since 1998 and used the existing vehicle to nearly doubled its existing portfolios and refinance a portion of the notes in 2000. AerFi, through its AerCo vehicle had a similar offering and at the same time took on the role of servicing its own portfolio - a break from its original structure. In both instances, adding aircraft actually improved the quality of the fleets both in terms of lessee diversity and limiting exposure to less liquid aircraft. Pegasus also issued its third stand-alone offering in 2000 bringing to market a fleet consisting on younger, more liquid aircraft than in years past.

Historical perspective

First issued in 1996, the Airplanes transaction ("APT") introduced the concept of leasing an aircraft through the end of its useful life rather than requiring it to be sold following the end of a lease period. The APT transaction initially contained 229 airplanes in its pool. The fleet consisted both of old and new technology aircraft and aircraft types ranging from passenger-configured to freighter-configured to turboprops. Aircraft could be easily moved around the world as aircraft would be held in bankruptcy remote subsidiaries and the filing of mortgages was not required. The credit quality of the initial lessees was mixed with the overwhelming majority being non-investment grade entities.

In 1998 Morgan Stanley brought their own Morgan Stanley Air Finance ("MSAF") deal to market. Rather than a whole portfolio securitization, MSAF consisted of 30 passenger configured, mostly stage III aircraft with a mix of narrow and widebody. ILFC, one of the leading aircraft operating lease companies, was brought in as a third-party servicer. AerFi, GECAS and Pegasus followed with similar transactions in 1998 and 1999. The weighted average fleet age in these transactions ranged from seven to eleven years, lessee concentrations were limited and the credit quality of the lessees was mixed with the expectation of downward migration as the aircraft aged.

Diversity of fleet composition

Beginning in the fourth quarter of 1999 with the Aerforeighter issuance, the securitization market began absorbing varied fleet compositions. The Aerofreighter fleet consisted of 14 DC-8 freighter aircraft with an average age of approximately 30 years. Then, in the second quarter of 2000, Triton Aviation Finance issued notes backed by a fleet of aircraft that included 737- 200As that did not meet noise regulations in Europe or the United States. While these pool compositions are clear breaks from the fleet makeup first seen in MSAF (relatively young aircraft with a near even mix of narrowbodies and widebodies) the market also saw a shift in the definition of a "traditional fleet." AerCo, ACG and EAST offered slightly older but more liquid aircraft than previously seen in MSAF. These newer transactions focused on having a greater concentration of "high user base/ in production" narrowbody aircraft rather than offering a more diversified fleet having a smaller user base or more volatile lease rates.

Originator as servicer

In 2000 the market began recognizing the value added by many of the smaller players servicing their own fleets. While these originators may not have the global reach of the larger operators, the willingness to operate a less volatile fleet and take an active interest in their securitization based on the residual interest ownership mitigates most of that risk. These originators are also typically willing to adhere to tighter servicing standards than their competitors acting in a third party capacity.

Another first in 2000 was the use of multiple servicers. In the Triton transaction, Triton and ILFC split up the servicing based on where each of their expertise. We expect to see this structure used in other transactions.

Structural modifications

The ability to extend the useful life of a particular aircraft can add value to a transaction. For example, reconfiguring an aircraft for cargo or bringing it into compliance with noise restrictions can prevent an aircraft from being grounded. The risk is who bears the cost of reconfiguration or compliance. The transaction could be required to pay such expenses, but there are no guarantees that cash would be available at the time it will be needed to cover such expenses. Triton addressed this by providing a hush kit reserve fund. Such fund raised the value of the aircraft from the onset and built in the flexibility to modify an aircraft when it could no longer produce revenue in its current configuration.

Operating lease trends

The emergence of new issuers and the seasoning of existing portfolios revealed some underlying industry trends. To date, actual defaults are lower than predicted, and the amount of time that aircraft are on the ground has been relatively stable, with less liquid aircraft and widebodies taking a longer time to remarket as expected. Lease rates, however, began to decline beginning in 1999. This is attributable to two factors, according to market sources. First, the Asia crisis of 1998 led to a decline in lease rates particularly for widebodies as demand dropped off significantly in that region. Lease rates have also declined on some of the Boeing classic products such as the 737-300 due to increased supply and the tight pricing the of the newer versions of such aircraft. Interest rates also play a role. As interest rates rise and fall, aircraft lease rates, particularly on the newer aircraft have tended to move in the same direction.

In general for the operating lease industry, the one overriding theme has been consolidation. Primarily, the midsize companies have been joining forces to expand markets, achieve better financing and diversify their existing fleets. There have also been some larger mergers such as PK Finance joining with GECAS and AWAS joining with Morgan Stanley. We expect these mergers will increase the number of securitization issuances over time. As for the overall impact on market performance by individual players, it is still too early to make predictions.

The outlook

In 2001 we expect to see between five and seven pooled aircraft securitizations totaling $6-8 billion, a slight increase from 2000's $6.2 billion. The majority of these issuances are likely to be from existing market participants in the operating lease sector. In addition, we are likely to see an additional reinsurance transaction and the monetization of such existing lease transactions. Potential new issuers could include banks seeking to securitize their portfolio of aircraft loans, engine lessors or aircraft manufacturers.

With respect to structural innovations, the precedent set in prior years brings in the possibility of pools comprised exclusively of freighter aircraft, pools involving a limited number of lessees and/or transactions that focus exclusively on engine leasing.

As for performance of existing transactions, if lease rates continue to soften securitized pools with maturing leases may have to renew or release at lower rates. Further, other factors such as reduced demand for aircraft fleet by operators, the introduction of newer, more competitive technology aircraft by Boeing and Airbus, and consolidation among airlines could put pressure on aircraft lease rates and appraised values. These events could create cash flow shortfalls in some existing transactions, causing payments to the subordinated tranches to be locked out. Such pressure may be partly offset by the reduced interest expenses on the related securities in a lower interest rate environment.

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