Securitizations of aircraft leases have become an important source of capital for U.S. airlines as well as for U.S. and non-U.S. lessors. Such financing provides access to the U.S. and foreign capital markets, opening up a significant new source of capital for the air transportation industry. There are two basic structures for securitizing aircraft leases: the enhanced equipment trust certificate ("EETC") securitization and the portfolio securitization. This article briefly describes these two structures and then considers their development and the state of the securitization market today.
EETC Securitizations
An EETC securitization enhances the creditworthiness of traditional equipment trust certificates ("ETCs") secured by lease receivables and the leased aircraft as follows: First, the issuer of the EETCs is bankruptcy remote (and insulated from a bankruptcy of the lessee) to the satisfaction of the rating agencies. Second, the EETCs are tranched to take advantage of the expected residual value of the aircraft, i.e., the lower the advance level, the higher the rating. Third, a liquidity facility is provided to ensure the continued payment of interest on the EETCs during the remarketing period following a default by the lessee.
The term of the liquidity facility in an EETC securitization relies on the ability of a lessor to repossess an aircraft from a bankrupt lessee under section 1110, if the lessee does not elect to perform. The principal issue in doing an EETC securitization with a non-U.S. airline will be the availability of "section 1110 equivalent" repossession rights, i.e., the ability to repossess and remarket the leased aircraft in a time frame comparable to that allowed by section 1110.
The foregoing enhancements to traditional ETCs allow EETCs to have credit ratings significantly higher than the corporate credit rating of the lessee, particularly at lower advance levels. Thus, a sub-investment grade borrower can issue investment grade debt, and an investment grade borrower also can reduce its borrowing costs with the lower pricing for higher grades of debt.
Portfolio Securitization
In contrast to the EETC structure, a portfolio securitization relies on a diversified portfolio of aircraft on operating leases to a number of airlines, both in the U.S. and in other countries. Rather than enhancing a single corporate credit, the ratings of the debt securities issued in a portfolio securitization are based on the existence of a worldwide aircraft leasing market and the projected residual values of the aircraft in the portfolio. The actual levels of the ratings depend on a number of factors, including the age, initial value and diversity of the aircraft in the portfolio, the diversity (both individually and geographically) of the lessees of the aircraft and (to a much lesser extent) their credit quality, the initial level of lease rents, assumptions as to the timing and costs of defaults and remarketing and other relevant factors. Credit support in a portfolio securitization is tailored to the particular needs of the aircraft and lessees involved, e.g., coverage for potential Eurocontrol liens, major maintenance costs, compliance with noise regulations and similar factors.
An important element in portfolio securitization is the quality of the servicer of the portfolio, in monitoring the performance of the lessees and in re-leasing and selling the aircraft both at the normal expiry of leases and in the case of lease defaults. The rating agencies also may require that a back-up servicer be identified and committed to act in appropriate circumstances.
Development of Portfolio Securitizations
The first portfolio securitization was Aircraft Lease Portfolio Securitisation Limited 92-1 ("ALPS 92-1"), sponsored by GPA Group plc ("GPA"). (ALPS 92-1 was a Eurobond transaction; thus, the "s" in the spelling of the name.) Prior to ALPS 92-1, which closed in June 1992, lease securitizations had involved large portfolios of small ticket items and were more similar to mortgage and credit card receivables securitizations. ALPS 92-1 was the first securitization of "big ticket" items of leased personal property, i.e., aircraft with values from US$15 million to US$80 million.
ALPS 92-1 involved a portfolio of 14 aircraft on lease to 14 lessees in 12 countries (not including the U.S.), having an aggregate appraised value of US$521 million. (In all aircraft securitizations, the value of the aircraft is their "base" value, i.e., their value based on historical valuations and trends, assuming a balanced market without regard to temporary market conditions.) The aircraft were sold to ALPS 92-1 in "true sale" transactions, and it issued US$417 million of senior and mezzanine debt, with the senior debt divided into three classes of Eurobonds, two with bullet maturities and one amortizing. There was substantial credit support in the form of a "supermezzanine loan," available to fund shortfalls of principal and interest, with repayment of such loan subordinated to the senior debt.
Standard & Poor's carried out an extremely high level of due diligence in ALPS 92-1. Each country in which a lessee was located was completely vetted from a legal standpoint, and each lease was carefully reviewed to ensure that it met exacting legal standards. A similarly high legal standard was applied in the actual aircraft deliveries, resulting in an extended period between initial funding and the transfer of the last aircraft, with a corresponding negative arbitrage between debt service and the minimal return on temporary investments of funds.
Except for the one relatively small class of amortizing bonds, the ALPS 92-1 debt was to be paid from aircraft sales in the eighteen months before the maturity date, during which period ALPS 92-1 was in effect required to create a sinking fund by selling aircraft. If ALPS 92-1 failed to meet specified sales goals, it effectively was put into a voluntary workout, with the senior debt holders having the ability to sell aircraft at levels sufficient to pay only the senior debt.
This financial structure forced aircraft sales within a limited period and required that sales proceeds be held in low-return investments. A further risk was the possibility that the fixed remarketing period could occur during a significant recession or even a period when very few aircraft sales were being closed, as happened following the Gulf War in 1991. (ALPS 92-1 in fact refinanced its debt at the beginning of the remarketing period in 1996, through Aircraft Lease Portfolio Securitization 96-1 Limited.)
The second ALPS transaction, Aircraft Lease Portfolio Securitization 94-1 Limited ("ALPS 94-1"), was the first SEC registered securitization of a portfolio of aircraft on operating leases. The legal structure was the same as in ALPS 92-1, but with a larger portfolio of 27 aircraft on lease to 22 lessees in 14 countries. The aircraft had an appraised base value of US$998,151,000, and ALPS 94-1 issued senior and mezzanine debt in the amount of US$853,700,000. GE Capital Aviation Services ("GECAS"), which had become the manager of all aircraft owned by GPA and its subsidiaries, acted as servicer of the aircraft (without any backup servicer, as had been required in ALPS 92-1). Pembroke Capital, an Irish aircraft leasing company, acted as administrative agent for ALPS 94-1.
The ALPS 94-1 financial structure involved three multi-tranched classes of investment grade senior debt. Instead of bullet maturities, the debt was partially amortizing, with each class of debt having an expected repayment of any remaining principal based on the assumption that the aircraft would be sold at the terminations of their leases, using the sales proceeds to repay the debt. These expected maturity dates were "soft," i.e., a failure to repay principal on such dates would not be a default, which would only occur if all principal were not paid by a more distant final maturity date. If any class of debt were not paid within one year after its expected maturity, however, the interest rate on that class would increase, to motivate ALPS 94-1 to sell rather than lease aircraft. A failure to pay interest currently on the senior debt would be a default.
The principal advantage of the foregoing structure is the flexibility it provides to ALPS 94-1 in disposing of aircraft to generate sales proceeds to repay the debt. ALPS 94-1 is not forced to sell aircraft in a temporary down market, and it has time to ride out a non-market. If the delay in sales is too extended, the burden is borne by the most junior class of debt (which is effectively the equity). In that situation, there should be enough cash flow to pay the increased interest on the senior debt, but the deferred payments of principal would reduce the residual available to the junior debt.
In the largest portfolio securitization to date, two separate issuers, Airplanes Trust Delaware and Airplanes Limited Jersey, issued notes held by a single pass-through trust ("Airplanes Group"), that in turn issued senior and mezzanine debt in the aggregate amount of US$4,048.000,000. (The two issuers were needed to deal with both U.S. registered and non-U.S. aircraft.) A total of 229 aircraft on lease to 83 lessees in 40 countries were involved, with the aircraft having a total appraised value of approximately US$4.5 billion. The proceeds were used to refinance substantially all of the bank and other secured debt of GPA.
In Airplanes Group, the rating agencies allowed the transfer of bankruptcy remote, special purpose companies holding the aircraft, as opposed to requiring individual aircraft transfers to meet rigorous true sale and other rating agency legal standards. This solved a major problem – the negative arbitrage between the funding of the securitization and the delivery of the aircraft portfolio. While the individual special purpose companies would still be subject to extensive due diligence, this could be done prior to closing, allowing a simultaneous funding and delivery of a major portion of the aircraft portfolio.
The financial structure of Airplanes Groups also allowed refinancing as a means of repaying the debt. This reflected a greater acceptance by the rating agencies of the likelihood of continued cash flows from re-leasing of the aircraft, as opposed to their placing complete reliance on sales proceeds for repayment of the debt.
In 1997, an operating lease company other than GPA is reported to have successfully closed a portfolio securitization. There are also appear to be a number of other transactions being considered. However, the relative paucity of portfolio securitizations, in contrast to the large volume of EETC transactions, indicates the greater difficulty involved in completing such transactions. A single entity owning a portfolio with the right mix of aircraft is required, and there needs to be enough marginal benefit in the reduction of borrowing costs to warrant the time and expense involved in doing the transaction. However, the tools are there and the market can expect to see more portfolio securitizations in the future.
EETC Securitizations
Following the success of ALPS 92-1, American bankers began to consider how the principles of portfolio securitization might be applied to an individual airline. The answer was the EETC structure, first closed by Northwest Airlines in 1994. As described above, the rating agencies concluded that the underlying corporate credit of a single airline could be enhanced through a combination of the ability to repossess and remarket the leased aircraft within a limited eighteen month period during which interest would continue to be paid by a liquidity facility. This was combined with tranched debt, to achieve ratings for all of the EETC classes of debt that were higher than that of the airline.
Other EETC transactions quickly followed the Northwest Airlines transaction, and it was reported in late 1997 that at least eight transactions had been closed by major U.S. airlines involving over 90 aircraft and US$3.3 billion in debt. A number of EETC transactions involving national airlines and regional carriers also have been done. More sophisticated financial structures have been used, including the pooling in of pass-through trust structures of leveraged lease debt with multiple owner participants. Most transactions have been closed as Rule 144A offerings, some with registration rights, but there have been both a few SEC registered public offerings as well as some purely private offerings of EETCs.
The year 1997 saw both general acceptance of the EETC structure as well as some innovations in the structure. One operating lessor was able to securitize operating leases of aircraft with an SEC registered U.S. airline, but without any involvement on the part of the airline. America West in a public offering included some aircraft subject to Japanese leveraged leases. In late 1997, it was reported that an Asian airline was doing an EETC transaction, but that transaction apparently has not yet closed.
Summary
Securitizations of aircraft leases have achieved widespread acceptance as a means of financing for both airlines and lessors. For individual airlines that can make the necessary securities disclosures as well as lessors with groups of aircraft on lease to airlines that have sufficient publicly available financial information, EETCs will continue to provide a source of capital. Non-U.S. airlines also can be expected to undertake EETC securitizations as the legal issue of "section 1110 equivalence" is successfully addressed in other jurisdictions. More lessors can be expected to undertake portfolio securitizations as a means of accessing new sources of capital as the capital markets become more accustomed to the concept of the worldwide market for leased aircraft.
Reprinted with permission from Guide to Capital Markets.
