Aircraft finance is reliant on both debt and equity markets for the raising of capital. The debt component consists largely of two markets: the public and the private. The public debt markets relate, primarily, to securities issued in the form of enhanced equipment trust certificates (EETCs), which are securities issued by individual airlines to finance the aircraft in their fleets, and to asset-backed securities (ABS) issued by operating lessors to finance their aircraft portfolios with multiple airlines on either a collateralized lease or collateralized debt basis (CLOs and CDOs, respectively). These publicly traded debt obligations are issued as securities, usually with a rating, and are typically acquired by institutional investors (insurance companies, pension funds, etc.). The private debt markets, on the other hand, while also financing airline fleets and lessor portfolios, are typically financed by commercial banks as loans (not securities). This private market also features other investors who acquire aircraft-secured debt on a private placement basis, in transactions that avoid registration under the securities laws. This Article will examine the evolution of the private sector of the debt market, looking at the time period this author has been engaged in the aircraft finance markets.
As an initial observation, aircraft finance is a form of asset-based financing, relying on a type of collateral – aircraft – the value of which has historically performed within anticipated ranges. The usefulness of collateral, of course, is dependent on the ability of the financier to access it, and realize upon its value, in a default situation. In light of U.S. bankruptcy laws, primarily Section 1110 of the U.S. Bankruptcy Code, there has been the well-founded view that the inherent value in aircraft collateral taken with a U.S. airline can be realized upon when that airline debtor cannot repay its aircraft-secured loans. Accordingly, financiers have looked favorably on aircraft finance in the United States as a tempting, relatively safe, market in which to participate.
When I started practicing law in 1983, aircraft finance in the United States was dominated by three pockets of debt providers: U.S. money center banks, Japanese banks and insurance companies. The likes of Citibank, Chase Manhattan, Bankers Trust and Chemical Bank dominated the commercial bank markets. These banks would be in the forefront of extending credit to airline borrowers; it should be noted that in those years the operating lessors were a much smaller part of the market, and were dominated by GECAS and ILFC, neither of which required third-party financing. The Japanese banks of this era likewise took a prominent position in the financing of commercial aircraft in the United States. The likes of Mitsubishi Trust (MTBC), Sumitomo Trust, Yasuda Bank and Sumitomo Bank were very active. These banks were known to lend at low margins and for very long tenors. Finally, the insurance companies taking part in this market were a rather disparate source of financing. They bought aircraft-secured debt as private placement of securities. The primary leaders of this sector included Teachers, Prudential, John Hancock and MetLife, but the sector also included a very large variety of smaller insurance companies with names like The Woodmen.
In the early-mid '90s, the landscape changed. U.S. money center banks lost interest in lending, focusing more on fee income. The Japanese banks were largely priced out of this market because their cost of funding sky-rocketed with the turmoil in the Asian markets. This turmoil resulted in what was called the "Japanese premium" – a premium which was the added cost to Japanese banks to fund their deals. As for the insurance companies, they bowed out of this market completely due to newly-enacted requirements that their investments needed to be rated by a nationally recognized rating agency. Into this vacuum poured the European banks.
The European banks were a rather diverse lot. There were the German banks, dominated by the "landesbanks" (state-owned banks), which included Schleswig-Holstein, Bayerische, NordLB, Hamburgische, Helaba, WestLB, Sachsen, Bremer, Berliner, Rheinland-Pfalz and Saar. In addition to these landesbanks, German commercial banks also took part, including Deutsche Bank, Commerzbank, Dresdner, DVB, KfW and HVB. In France, market participants included Société Générale, Paribas, Crédit Lyonnais, Credit Agricole and Natexis. There were Dutch banks participating such as ING, ABN AMRO, NIB, Fortis, Rabobank and MeesPierson. There were also English banks such as Halifax, Royal Bank of Scotland, Bank of Scotland, NatWest, Barclays and Alliance & Leicester participating in this sector. Finally, there were banks from Italy (Intesa), Switzerland (Credit Suisse) and Austria (Erste).
By reason of this plethora of participants and the resulting competition for business, airlines (and, increasingly, operating lessors) were able to drive margins down from these banks. As well, there was some consolidation of banks during this period, with the following institutions being merger partners: Halifax and Bank of Scotland, Landesbank Schleswig-Holstein and Hamburgische Landesbank (resulting in HSH Nordbank) and Crédit Lyonnais and Credit Agricole (resulting in CACIB), among others.
The next shake-out of the bank market in the aircraft finance sector took place in the aftermath of the Lehman Brothers-triggered market meltdown of 2007/2008. This development resulted in the loss to the market of a large number of the European banks. No longer were any English or Dutch banks participating in the market, and a number of the French and German banks withdrew from this market as well. Particularly hit hard were the German landesbanks, which were major investors in (housing) mortgage-backed securities – a market that suffered catastrophic losses. Many of these banks were forced to drop out of the aircraft finance market as a quid pro quo to taking state aid for a government bail-out (the German states directed a number of these landesbanks to restrict their activities to local markets). Also, their funding costs sky-rocketed and they were priced out of the market (sound familiar?).
In the immediate aftermath of Lehman, then, just a handful of French banks and German banks remained committed to the aircraft finance sector. The French banks included BNP, CACIB and Natixis (and, to a lesser extent, CIC) and the German banks included DVB, NordLB, Heleba, KfW and Deutsche Bank. With fewer bank participants, margins did improve for these banks (although, in many instances, these better margins were necessary to cover increased funding costs). In addition, many of the banks that were compelled to exit the aircraft finance sector post-Lehman were forced to sell their aircraft finance portfolios, while others of the exiting banks simply managed down their portfolios (writing no new business).
The Lehman debacle is now almost a decade behind us. Since the resulting shake-out of the bank market triggered by that event, the number of participants in this market has increased substantially. In addition to the post-Lehman "survivors" named above, Citibank and Wells Fargo Bank, U.S. "money center" banks, are playing an increasing role as well as DekaBank (German), ING (Dutch), CBA (Australian) and Sabadell (Spanish). Also making a significant foray into this market are Japanese banks (welcome back!) such as DBJ, Norinchukin, MUFG and Tokyo Star. There is also an expectation that other Asian banks, from China, Taiwan and Korea, will soon be increasing their participation in the aircraft finance sector. Finally, we are seeing increasing participation by certain segments of the U.S. insurance company market, such as New York Life and Mass Mutual, which have figured out a way to get a satisfactory rating on privately structured transactions.
The conclusion I would draw from this ever-evolving market for private debt in the U.S. aircraft finance sector is this: aircraft finance has historically been a rather safe investment. This relatively low risk lending environment naturally draws in investors. The ebb and flow of market participants, then, is not the result of losses in this sector, but rather macroeconomic developments well beyond the aircraft finance market. Stay tuned!