Aircraft Finance

1
Why Aircraft Finance?

• Aircraft are capital-intensive, long-dated

assets
– A single new aircraft can cost from $35 million to
$150 million
– Aircraft typically have a 25 year useful life

2
Airline Industry
• Airlines are notorious for being unable to squeeze profits
• It is a cyclical business, perhaps the worst sort says
Warren Buffet
• The industry requires massive capital then earns little or
no profits
• Airlines’ net profit margin average 0.1% in the past 40
years
• Most rated airlines are less than investment grade
• Yet, they also face duopoly aircraft manufacturers,
Boeing and Airbus
• Rival aircraft makers in Canada, China and Russia are
developing very slowly

3
Airline industry (cont)

• The industry remains highly fragmented

• Consolidation is occurring on a national basis in the

U.S. and on a regional basis in Europe but M&A on a
large scale is still hampered by international
regulations

• U.S. Airways / American Airlines merger was recently

blocked by the DOJ on the grounds that it would
lessen competition in the U.S.

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Airline industry (cont)
• Add into the mix the four horsemen of the industry
which are war, terrorism, pestilence (SARS) and
recession

• Fifth rider is rising oil prices

• The industry has progressed, however

• Back in 2002 the industry could barely break even

around $20 a barrel of oil. Now it can break even at
over $100 a barrel

5
Unprecedented Demand
• Current orders for new aircraft are at unprecedented levels
• Both Boeing and Airbus estimate $104 billion worth of commercial
aircraft delivered in 2013
• $116 billion (2014), $125 billion in (2015), $128 billion
(2016), $132 billion (2017)
• On top of this, refinancing needs is an estimated at $11 billion this year
and $10 billion next year
• This is driven by aging fleets in North America, desire for more fuel
efficient aircraft, and the rise of airline passengers in developing markets
such as China and India
• Asia is arguably this decade’s growth market with 5% projected
passenger annual growth
• The region’s passenger growth, both domestic and international, is
expected to add about 380 million travelers between 2012 and 2016 to
1.2 billion according to IATA forecast in December

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Unprecedented Demand (cont)
• While there may be a component of speculative orders, there
are solid drivers besides business demand including operational
efficiency
• In an era where fuel costs over $100 a barrel, which now
represents a third of operating costs for airlines, airlines are
focusing on driving down operational costs
• This helps drives demand for new technology aircraft with more
fuel efficient engines
• For example, a Boeing 787 saves an estimate 16-19% costs on
a per available seat kilometer basis) over a B767
• The more speculative orders are longer term, mega orders for
short-haul aircraft, predominantly from lower cost carriers

7
Factors To Consider
• The record level of demand for new aircraft will
impact residual values and leasing rates for existing
aircraft
• Some industry insiders view that the 25 year average
useful life is no longer valid
• Aircraft orders placed in 2007-2010 are starting to
deliver in 2012
• For certain models it is in excess of current demand
and causes softer lease rates especially for mid-life
aircraft
• This is more pronounced for narrow body where
there is oversupply

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Aircraft Lessors

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Aircraft lessors
• Aircraft leasing companies began in the 1990’s
originally with cheap access to capital from their parent
company’s credit ratings (GECAS is the number one by
number of planes)

• Lessors offer non-investment grade airlines an option to

lease aircraft instead of having to finance them

• Lessors own an estimate 40% of the total global fleet

• This number is estimated to grow to 50% in this decade

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Top Ten Aircraft Lessors
Ranking Company US$
1. GECAS $34.1 billion
2. ILFC $26.1 billion
3. BBAM $8.7 billion
4. AerCap $7.7 billion
5. BOC Aviation $7.3 billion
6. CIT $7.2 billion
7. AWAS $6.1 billion
8. SMBC $5.9 billion
9. ACG $5.6 billion
10. Air Lease $5.6 billion
Source: Deutsche Banks for values as of 2012 year-end
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Aircraft Lessors (cont)
• Leasing aircraft offers operational benefits and frees up
capital for airlines

• Many airlines prefer short and middle term obligations

which allow for more flexibility especially if they are
entering new markets

• Many leasing companies have stronger balance sheets

than airlines and are in a better position to obtain
financing

• Hence, leased aircraft will grow at a higher rate than

owned aircraft

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Aircraft Lessors (cont)
• Lessors face their own challenges
• Leasing companies also need to find financing
• Lease rates are generally flat but lease rates for
some aircraft are expected to be softer for
narrowbodies that are in over supply especially mid-
life aircraft
• Some mid-life aircraft lease rates are experiencing
30-40% declines
• New aircraft deliveries will impact lessors with older
technology aircraft in their portfolios

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Operating Leases
• Lessor acquires the aircraft (either from the
manufacturers or airlines) and arranges financing for it
• Airline leases the aircraft from the lessor
• If the lessor buys the aircraft from the airline and
leases it back to the airline is a sale/leaseback
transaction
• Lease terms typical 3-7 years
• Longer lease term for widebody aircraft (vs
narrowbody)
• Airline returns aircraft to lessor when the lease ends
• Lessor takes aircraft residual value risk

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Operating Leases (cont)
• Leasing Rates
– Typically equals 1% of new aircraft cost per month
– Actual lease rates are determined by market
supply and demand
• Maintenance Reserves
– Paid to lessor and available for scheduled
maintenance
• Security Deposit
– Typically equal to 2 to 3 months of lease payments
– Returned to airline at the end of the lease

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Yet, More Finance Challenges
• Airlines and lessors are faced with finding
financing when liquidity is scarcer and risk is
re-priced post financial crisis

• New investors from the East is entering the

space as traditional banks from the West pull
back on lending, especially with Basel III
constraints

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Attractive Asset Class
• Aircraft pledged as security
– Aircraft Owning Entities
• Aircraft is a hard asset
– Large operator base
– Transparent 3rd party aircraft values
– Globally recognized security procedures (Capetown
Convention)
• Loan To Value (“LTV”) Metric
– LTV is based on the average of two appraisals from third party
appraisers
– Avitas
– Airclaims

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Aircraft Values
• Base Value
– is the appraiser's opinion of the underlying economic
value of an aircraft in an open, unrestricted, stable
market environment with a reasonable balance of
supply and demand, and assumes full consideration of
its "highest and best use."
• Market Value (or Current Market Value if the
value pertains to the time of the analysis)
– is the appraiser's opinion of the most likely trading
price that may be generated for an aircraft under the
market conditions that are perceived to exist at the
time in question.

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New Sources of Financing
• China
– Several Chinese banks have created leasing arms
o Bank of China bought SALE in 2007
o ICBC Leasing Arm
o Minsheng Commercial Aviation closed its first
international deal with Air Berlin
o More Chinese banks are likely to expand into the sector
o AIG has extended the deadline to sell ILFC to August
31st to a consortium of Chinese investors

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New Sources of Financing (cont)

• Japan
– RBS Aviation Capital was acquired by Japanese
bank Sumitomo Mitsui last year, now SMBC
Aviation
– DVB sold its 60% share in TES Aviation (aircraft
engine solutions) to Development Bank of Japan
and Mitsubishi Corp.
– Jackson Square Aviation was acquired by
Mitsubishi UFJ Lease & Finance from Oaktree
Capital Group last year

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New Sources of Financing
(cont)
• PE / hedge funds have also entered the space
– Returns sought are high teens to 20’s
• New lessor start-ups
– Avolon, Greenstone Aviation, Jackson Square
Aviation, Air Lease Corporation, CIAF, and RPK and
Hong Kong Aviation Capital, some of which have been
backed by PE and hedge funds
• Most recent is Fifth Star Aviation LLC, which will
focus on mid to end of life aircraft
– Led by KKR Asset Management’s head of
transportation

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Financing Structures

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Tapping Which Markets?
• Issuers want a diversified funding source

• Existing lessors became distressed during

the downturn when they lost access to
commercial paper funding and inexpensive
sources of capital

• Aercap was rated investment grade (BBB-) by

S&P and Fitch last year

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How To Finance Aircraft
• Bank Market (~28% vs 21% last year)
– Single aircraft or small portfolio
– Pooled Aircraft Securitization
– Term Loans vs Warehouse facilities
• Export Credit (~23% vs 30% last year)
– Export-Import banks
• Capital Markets (14% vs 10% last year)
– Secured
– Unsecured
– ABS

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How To Finance Aircraft (cont)
• Manufacturer
– Limited Availability
– Expensive

• Tax Lease
– Limited Availability but gradually returning

• Sale & Leaseback

– Typically to Aircraft Lessors

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Typical Two Tranche
Structure
LTV to CMV
• Class A 65%
• Class B 80%
• Sample Waterfall
– Cashflow from operations after SG&A
o Pro-rata 1st and 2nd lien interest expense
o 1st Lien scheduled amortization
o Required Maintenance / Liquidity Reserve
o 100% sweep to prepay 1st Lien

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Credit Structure
• Priority Creditors (ABS, EETC)

• Secured Creditors

• Unsecured Creditors

• Subordinated Creditors (secured / unsecured)

• Equity

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Market Trends
• Banks are constrained by access to liquidity
and Basel III rules
• LTV’s from banks are 60% to 75%
– 75% to 85% pre-crisis
– Higher bank funding costs
o 3-5% over benchmark indices
o 1-3% spread pre-crisis

• Bank lenders are also requiring faster de-

leveraging and/or shorter terms

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Market Trends (cont)
• Last year aircraft lessors raised $6 billion from bond
markets
• Pricing ranges from 4% to 8/9%
• Aircastle (Ba3/BB+) raised US$500m from an upsized
seven-year unsecured trade that paid a 6.25% coupon
last November
• Enhanced Equipment Trust Certificate (EETC) is the
most common instrument for U.S. secured capital
market aircraft financings
• United Airlines 2013-1 Class A EETC (single-A rated)
priced at 4.3% on August 1st

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EETC
• Enhanced Equipment Trust Certificates (EETC’s) are
bonds that airlines issue to finance aircraft
• EETC’s are essentially structured corporate debt
• First introduced in 1994 as an extension of the
Equipment Trust Certificates (ETC’s) then being used
to finance aircraft for the U.S. airline industry
• This has historically been limited to the U.S. airlines
• With the steady growth of non-U.S. jurisdictions that
have adopted the Cape Town Convention, EETC’s are
expected to be more widely used by non-U.S. airlines

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EETC (cont)
• Investor looks to single corporate credit (the airline)
backed by an asset (the aircraft)
• Utilizes an SPV structure, debt tranching and a
liquidity facility
• Liquidity facility is typically 18 months of debt service
• A Special Purpose Vehicle (SPV) is set up to
purchase the aircraft that issues bonds to investors

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United Airlines 2013-1 EETC
• $720 million Class A (A-/A rated) 55.1% LTV
• $209 million Class B (BB+/BB+) 71% LTV
• Proceeds were used to finance 18 new Boeing 737-
900ER and 3 new Boeing 787-8
• Classes offered – two tranches of amortizing debt
offered
• Interest on Class B is paid before Class A principal
• Key asset backed features - cross default and cross
collateralized

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Doric Alpha EETC
• First U.S. dollar denominated EETC by a non-U.S.
issuer backed by aircraft on lease to Emirates airlines
• First lessor operated EETC where the owner of the
aircraft was different from the operating airline
• $462 million Class A certificates (June 2013)
– priced at 5.250% with a maturity of 9.9 years, a
weighted average life (WAL) of 5.7 years and LTV
of 50.6% $462 million Class A certificates
• $168 million Class B certificates
– priced at 6.125% with a 6.4 year maturity, WAL 3.8
and LTV of 69%.

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Asset Backed Securities
• A few pooled securitization deals but aircraft ABS
issues have yet to make a comeback

• BNP Paribas and Goldman Sachs arranged $650

million asset backed secured term loans issued by
GECAS that closed in January 2013

• Complexity and requirements of ABS are deterrants

although there is appetite for ABS paper

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Export Credit Agencies
• Huge increases in volume due to extensive support
from U.S. and European governments
• Limited to subset of new deliveries
• Financing through ECA-backed guarantees has
historically been lower than commercial debt
• New 2011 Aircraft Sector Understanding (ASU) will
increase ECA financings costs
• Intent is for ECA financing to be less attractive for
stronger airlines

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ECA (cont)
• Public agencies that provide government-backed loans,
guarantees, financial support and insurance to private
corporations from their domestic country for important
industries
• Most industrialized nations have at least one ECA
• Key agencies involved with aircraft financing include U.S.’
Export-Import Bank (guarantees Boeing aircraft), France’s
Coface, Germany’s Eules Hermes and the UK’s Export
Credits Guarantee Department (they guarantee Airbus
aircraft)
• The ECA’s have recognized the importance of aircraft
manufacturing to their economies so have supported the
export of their aircraft

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ECA (cont)
• Export Credit financing stepped in during the 2008
financial crisis when many banks pull backed lending
• The 2011 ASU addresses most of the issues that
prompted its adoption by the Organisation for Economic
Co-operation and Development (OECD).
• Airlines in the USA and parts of Europe which did not
qualify for export credit because of a so-called "home
market" or "home country" rule, complained loudly
• Strong rivals such as Emirates were gaining an unfair
advantage - many called it a subsidy - because those
carriers were not in a "home" country and so could
access cheaper export credit.

37
ECA (cont)
• The new ASU directs each export credit agency to
classify its buyers/borrowers into one of eight risk
categories, based on their senior unsecured credit
ratings
• ECAs may cover up to 85% of the net price for higher
risk airlines, but the cover for stronger airlines is
limited to 80%
• The ASU also uses a carrot-stick approach to
encourage nations to adopt the Convention on
International Interests in Mobile Equipment and its
related Aircraft Protocol (Cape Town Convention)

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ECA (cont)
• This law creates an international registry of security
interests in aircraft and spells out creditor rights,
thereby eliminating much of the uncertainty about
how creditors might fare in a local jurisdiction after an
air carrier's default or insolvency.
• The airlines of any country that adopts the Cape
Town Convention, making it the law of their own land,
qualify for a discount of up to 10% on their export
credit premium.

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Tax Leases
• Specialist equity gradually returning e.g. Japan and
France
• Governments encourage companies to update their
equipment through tax breaks.
• Companies that buy equipment get tax breaks
usually through depreciation allowances.
• This can be a problem for airlines who rarely make
enough profits to benefit from these allowances.
• Airlines can sell these benefits to companies that
have large tax bills by selling the aircraft and then
leasing it back.

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JOLCO
• Japanese tax leases began with Japanese leverage
leases (JLL) in mid 1980’s.
• A JLL requires an SPV to acquire the aircraft, and at
least 20% of the equity must be held by Japanese
nationals.
• Under a JLL, the airlines receives tax deductions in
its home country, and the Japanese investors are
exempt from taxation on their investment.
• JLL became only available for Japanese airlines due
to tax changes, and Japanese operating leases with
a call option (JOLCO) emerged for foreign airlines

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JOLCO (cont)
• A JOLCO is a Japanese operating lease with a fixed-
price purchase option, where the Japanese lessor
purchases the aircraft using a combination of debt
and equity funding and leases it to the airline.
• Debt funding has typically been banks
• Lessor is a special purpose vehicle, is typically
formed or used to act as the owner and lessor of the
Aircraft.
• The lease has to be classified as an operating lease
in Japan in order to have the tax benefits for this
structure

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JOLCO (cont)
• Lessor’s parent (Japanese equity investor) typically
will provide Lessee with a comfort letter or guarantee
backing Lessor’s performance in the transaction over
the term.
• Equity Investors are either privately-held companies
seeking tax benefits, or investor participations which
are arranged and underwritten by these transactions.

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JOLCO (cont)
• British Airways launched the first EETC that used
JOLCO tax equity this year
• The $721.610 million Class A Certificates priced at
4.625% and were rated (Baa1/A/A).
– 11.0-year tenor
– 7.9-year weighted average life (WAL)
– 55.2% initial/max LTV
• The $205.372 million Class B Certificates priced at
5.625% and were rated (Ba1/BBB/BBB-).
– 7.0-year tenor,
– 4.2-year WAL
– 70.6% initial/max LTV

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Case Study
• Please break into two teams and draw an
SPV diagram
• Please come up with a sample waterfall

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Case Study (Answer)
• Lease waterfall (priority of payments from
lease revenue):
– SG&A
– Hedge payments
– Pro-rata 1st and 2nd lien interest expense
– 1st lien scheduled amortization
– Required maintenance / liquidity reserve
– 100% sweep of excess cash flow to prepay 1st lien

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Case Study (Answer)
• Asset sales waterfall (priority of payments
from asset sales):
– Debt associated with the aircraft
– 60% / 40% split between equity and 1st and 2nd
liens

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Case Study (Answer)
Sponsor

Proceeds Assets

SPV 1
Transferor

Proceeds Assets

SPV 2
Issuer

Proceeds Debt

Investor

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Case Study (Answer)
• SPV is a special purpose vehicle
– Tax-exempt trust
– Bankruptcy remote
– Non-recourse debt
• ABS or asset-backed securities is created by
the process of securitization where assets are
pooled into a SPV and debt sliced into
different tranches are sold to investors

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Case Study (Answer)
• Securitization is primary a U.S. market
• It began in the 1980’s with the securitization
of auto loans and credit card receivables.
• Most suitable assets for securitization are a)
cash flow generating and b) contractual.

50
Credit Risks

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Credit Risk
• Main credit risks with aircraft finance

• Lessee and Borrower Credit Risk

– Aircraft are operated by airlines.
– Mitigants are diversity (i.e. pooled aircraft)
– Credit enhancement in the form of equity,
mezzanine debt and / or cash reserve
– Excess cashflow may be swept to repay debt

52
Credit Risk (cont)
• Asset Risk
– New and liquid models
– Pooled aircraft diversity
o Concentration limits and/or eligibility requirements by airframe
type

• Equity and /or Mezzanine Credit Enhancement

• Maintenance Program
• Maintenance Reserves
• Periodic re-appraisal of aircraft
– LTV tests impacting debt payments

53
Credit Risk (cont)
• Servicer Risk
– Commercial jet aircraft are servicing intensive
assets.
– Back-up servicer in an event of default
– Servicer needs to be assessed in the areas of
lease management, re-marketing and re-leasing
capability
• Repossession Risk
– Aircraft are deployed in a number of countries
each with specific creditor rights

54
Credit Risk (cont)
• CAPE town jurisdiction
– International treaty signed in 2001 that set
standards for mobile assets including aircraft
– Created international standards for security
interests, leases and defaults
• Restrictions on aircraft registered in OFAC
countries and countries with weak creditor
protections
• Regional and/or jurisdictional concentration
limits

55
Credit Risk (cont)
• Event Risk such as terrorism attacks, virus
outbreaks, geo-political tensions and war
– Reduces air travel thereby impacting lease rates,
collateral values and collateral liquidity
– Mitigants include servicer with demonstrated
historical ability to successfully re-market aircraft,
geographic diversity of airline obligors, loans and
triple net leases with limited pre-payment and
early termination provisions, and insurance
policies

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Credit Risk (cont)
• Interest Rate Risk
– Loan and lease payments may be fixed or floating
rate. The liability may be fixed or floating rate. It
creates interest rate risk between the asset and
the liability.
– If the asset does not match the liability, typically
there are borrower hedging requirements in
relation to the amount and tenor of fixed rate
payment streams funded by floating rate debt.

57
Case Study
• Please break into two teams and come up
with a few mitigants for the credit risks we just
discussed

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Case Study (Answers)
• Portfolio Concentration Limits
– Max aircraft to lessee ratio
– Min number of aircraft
– Lessee concentration limits
• Certain airlines
• Single lessee limit
• Top 5 lessors limit
– Region concentration
• Max emerging countries
• Min developing countries
• Max undesignated countries

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Case Study (Answers)
• Portfolio Concentration Limits
– Min narrowbody aircraft
– Max undesirable plane types
– Max aircraft off-lease
– Prohibited countries
• Annual re-appraisals
• LTV tests
• Min Liquidity Reserve
• Change of Servicer trigger
• Debt Covenants
– Debt to Ebitda
– Interest Coverage

60
Opportunities

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Where Are The Opportunities
• Mezzanine Debt
– There’s a gap between senior financing and equity
• Aircraft lessors (re-)financing needs
– Existing bank facilities
o Warehouse and acquisition facilities that typically have 5-7
year maturities (ex AWAS)
– Portfolio clean-up (ex GECAS)
– Aircraft purchases, both scheduled and
opportunistic
– Start-up lessors need debt (re)-financing (ex Avolon)

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