With record levels of PDPs financed in 2013, why wait to discover more about how it's being done today?
In line with the sharp increase in current order levels for new aircraft, the volume of PDP financing transactions has increased considerably in recent years.
Increased liquidity in the aviation financing market demonstrates that aviation financiers are now increasingly recognising the advantages of PDP financing; the lending commitment is short and the yields are typically higher to reflect the nature of the 'security' available.
Lessors are offering PDP financing as a 'bridge' to secure sale and leasebacks. We are also seeing an emergence of PDP financing from the debt capital markets with the completion of several deals in 2012 and 2013.
The recent increase in PDP financing has been helped in large part by the development of new structures and documentation which:
(i) provide more certainty with regard to the rights and obligations a financier acquires on a 'step-in'; and
(ii) help mitigate the insolvency clawback risk inherent in these types of financings.
What are PDPs?
Pre-delivery payments are the staged partial payments of the aircraft price made by the customer to the aircraft manufacturer pursuant to an aircraft purchase agreement in advance of delivery of the aircraft.
They can account for as much as 30% of the final aircraft price and are used by the manufacturer to provide the working capital needed to fund the aircraft production.
Until recently, PDP financings were more commonly used in respect of A320s, B-737s, A330s and B-777s. Financiers took the view that the market for these aircraft types was more liquid and hence there would be less risk on a financier step-in. We are now seeing PDP finance for A350s, B-787s, A380s, the B-737 Max and A320 NEOs; in some cases with scheduled deliveries up to 24 months out.
Usually around 75% of an aircraft's PDPs are financed with the balance paid directly by the customer. This percentage of financed PDPs can be higher depending on the aircraft type, how close the delivery slots are or if the airline risk is particularly low.
The financier will finance the PDPs by making a loan to the aircraft purchaser (subject to structuring) with interest payable throughout the loan term and principal due at aircraft delivery.
Much of the commercial discussion on PDP financing will focus on pricing; at what price is the manufacturer willing to sell the aircraft to the financier (or its permitted transferee) if there is a customer default and a subsequent step-in by the financier? In most circumstances, this price will not be the same as the price available to the airline in its purchase agreement. A number of variables will feed into the equation, such as, for example, the number of aircraft which are the subject of PDP financing and, where the PDP financier is also a lessor, the terms of its own purchase agreement with the manufacturer.
Managing the clawback risk
PDP financing structures have recently evolved to try to mitigate the risk of insolvency clawback as much as possible.
Insolvency clawback is where a liquidator of an insolvent company can require reimbursement of certain categories of payments made by that company within a period prior to its insolvency. Pre-delivery payments made under an aircraft purchase agreement could, in some jurisdictions, be 'clawed back' by an airline's liquidator as part of its insolvency proceedings.
Assuming there is no PDP financing, when an airline customer goes into default and its liquidator successfully claws back from the manufacturer all or a portion of the PDPs paid on an aircraft, the manufacturer can remarket that aircraft and obtain new PDPs from the new buyer to recoup any PDPs which have been clawed back.
Assuming there is a PDP financing, when an airline customer goes into default, the financier can step in as a new buyer of the financed aircraft. At delivery, the manufacturer gives the financier the benefit of all the PDPs on that aircraft (both financed and non-financed). So, if the defaulting airline's liquidator successfully claws back from the manufacturer any PDPs paid on an aircraft, the manufacturer no longer has those PDPs as they were already accounted for at aircraft delivery. Similarly, it no longer has an aircraft to remarket in order to recoup the PDPs that have been clawed back. In effect, the manufacturer will not have received full payment for the aircraft.
Manufacturers have been passing this clawback risk onto PDP financiers by including a clawback indemnity in the PDP financing documentation. However, given the reluctance of financiers to provide such an indemnity, new bankruptcy remote financing structures (such as ones which provide for a Day One novation of the purchase agreement to a new SPC) have been developed to try to minimise the clawback risk.
Don't be left behind
The new generation of PDP financing is upon us. It remains a complex and challenging financing tool which, if on offer to an airline or leasing customer, can make the difference between winning the business and being left out in the cold….