Aircraft financing has gone thorough an evolution over the past several years. It started with mainly bank financing, then moved to equipment
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trust certificates (ETCs), then to enhanced ETCs (EETCs), and finally to aircraft ABS. Today, both EETCs and aircraft ABS are widely used.
EETCs are corporate bonds that share some of the features of struc- tured products, such as credit tranching and liquidity facilities. Aircraft ABS differ from EETCs in that they are not corporate bonds, and they are backed by leases to a number of airlines instead being tied to a sin- gle airline. The rating of aircraft ABS is based primarily on the cash flow from their pool of aircraft leases or loans and the collateral value of that aircraft, not on the rating of lessee airlines.
One of the major characteristics that set aircraft ABS apart from other forms of aircraft financing is their diversification. ETCs and EETCs finance aircraft from a single airline. An aircraft ABS is usually backed by leases from a number of different airlines, located in a num- ber of different countries and flying a variety of aircraft types. This diversification is a major attraction for investors. In essence, they are investing in a portfolio of airlines and aircraft types rather than a single airline—as in the case of an airline corporate bond. Diversification also is one of the main criteria that rating agencies look for in an aircraft securitization. The greater the diversification, the higher the credit rat- ing, all else being equal.
Aircraft Leasing
Although there are various forms of financing that might appear in an aircraft ABS deal—including operating leases, financing leases, loans or mortgages—to date, the vast majority of the collateral in aircraft deals has been operating leases. In fact, all of the largest deals have been issued by aircraft leasing companies. This does not mean that a diversi- fied finance company or an airline itself might not at some point bring a lease-backed or other aircraft ABS deal. It just means that so far, aircraft ABS have been mainly the province of leasing companies. Airlines, on the other hand, are active issuers of EETCs.
Aircraft leasing differs from general equipment leasing in that the useful life of an aircraft is much longer than most pieces of industrial or commercial equipment. In a typical equipment lease deal, cash flow from a particular lease on a particular piece of equipment only contrib- utes to the ABS deal for the life of the lease. There is no assumption that the lease will be renewed. In aircraft leasing, the equipment usually has an original useful life of 20+ years, but leases run for only around 4 to 5 years. This means that the aircraft will have to be re-leased on expira- tion of the original leases. Hence, in the rating agencies’ review, there is a great deal of focus on risks associated with re-leasing the aircraft.
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The risk of being able to put the plane back out on an attractive lease can be broken down into three components: (1) the time it takes to re-lease the craft; (2) the lease rate; and (3) the lease term. Factors that can affect releasing include the general health of the economy, the health of the airline industry, obsolescence, and type of aircraft.
Servicing
Servicing is important in many ABS sectors, but it is crucial in a lease- backed aircraft deal, especially when the craft must be remarketed when their lease terms expire before the term of the aircraft ABS. It is the ser- vicer’s responsibility to re-lease the aircraft. To fulfill that function in a timely and efficient manner, the servicer must be both well-established and well-regarded by the industry.
As Moody’s states, the servicer “should have a large and diverse presence in the global aircraft marketplace in terms of the number of aircraft controlled. Market share drives the ability of a servicer to meet aircraft market demand and deal with distressed airlines.”
The servicer is also the key to maintaining value of the aircraft, through monitoring usage of the craft by lessees. If a lessee is not main- taining an aircraft properly, it is the servicer’s responsibility to correct that situation. Because of servicers’ vital role to the securitization, the rating agencies spend a great deal of effort ascertaining how well a ser- vicer is likely to perform.
Defaults
In addition to the risk from needing to re-lease craft, rating agencies are also concerned about possible defaults. Because of protections under Section 1110 of the U.S. Bankruptcy Code, and international statutes that favor aircraft creditors, there is relatively little risk of losing an air- craft. There are, however, repossession costs, plus the loss of revenues during the time it takes to repossess and restore the aircraft to generat- ing lease income.
The rating agencies will “stress” an aircraft financing by assuming a default rate and a period of time and cost for repossessing the aircraft.
A major input into base default assumptions is the credit rating of air- line lessees. For this part of the review, the ABS rating analyst does rely on the corporate rating of the airline.
While there is little risk of not recovering the aircraft in event of a default, the rating agencies do carefully review the legal and political risks that the aircraft may be exposed to, and evaluate the ease with which the aircraft can be repossessed in the event of a default, especially if any of the lessees are in developing countries.
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Enhancement Levels
In aircraft ABS, as in every other ABS sector, the rating agencies attempt to set enhancement levels that are consistent across asset types. That is, the risk of not receiving interest or principal in a aircraft deal rated a particular credit level should be the same as in a credit card or home equity deal (or, for that matter, even for a corporate bond) of the same rating. The total enhancement ranges from 34% to 47%.
Since the early deals, there has been a change in enhancement levels.
Early deals depended largely on the sale of aircraft to meet principal payments on the bonds. Since then, aircraft ABS has relied more on lease revenue. Because lease revenue is more robust than sales revenue, the enhancement levels have declined. To understand why a “sales” deal requires more enhancement than a “lease” deal, consider the following.
If an aircraft is sold during a recession, the deal suffers that entire decline in market value. On the other hand, if a lease rate declines dur- ing a recession, the deal sustains only the loss on the re-lease rate.