In 2011, financing markets began to inch toward pre-crunch availability levels; however, as the production schedules for each of the major aircraft manufacturers increase to produce more energy-efficient equipment, there will be even more demand for such financing. Against the backdrop of high demand, financiers and airlines must now prepare to adapt to the new finance regulatory regimes of Basel III and the 2011 Aircraft Sector Understanding ("ASU"). While it is not anticipated that either new regime will limit the availability of credit again, it is expected that both will make aircraft financing more expensive.
Basel III
Basel III will become effective in 2013. Announced as a reaction to the credit crunch, the new capital and liquidity standards of Basel III are designed to ensure (and require) a higher level of capital within the banking system. Aircraft finance transactions, under Basel II, have generally required very low levels of capital because they are asset-based financings and, as such, are fully secured by the aircraft and operating lease rental stream. In the past, the financiers' ability to lend has been largely dependent on the appraised value of the aircraft and the resulting loan-to-value ratio. As many other asset-based financings landed in default (in part because the quality of the assets turned out to be much less than was anticipated by the financiers), secured aircraft and engine financings, including securitizations, were unfairly painted with the same black brush (even though the appraised value of the aircraft assets did not change for the worse). Rather than relying upon the financiers and appraisers to accurately assess the credit-quality of the aviation asset, Basel III takes a blunt instrument to the art of aircraft finance.
Under Basel III, the new leverage ratio will require a 3 percent capital requirement, regardless of the quality of the asset. This means that lenders participating in aircraft finance transactions will have to put in more capital in front of "good quality" aviation assets, based on nominal amounts, even if the same have been independently appraised by a third-party appraiser at a much higher level. Additionally, under Basel III, the new liquidity coverage ratios will require banks to own greater levels of liquid assets. The new net stable funding ratio ("NSFR") requires that the available stable funding ("ASF") ratio must equal or exceed the required stable funding ("RSF") ratio. This means that long-term lending will likely become more expensive because funding will have to be matched. If lenders cannot match long-term loans with long-term funding, they will need to stock up with cash or near cash, which is expensive and inefficient. As a result, it is likely that, once Basel III is effective, financiers will be less willing to do 12-year long-term aircraft finance loans and, instead, will do short-term financings.
2011 OECD Aircraft Sector Understanding
During the credit crunch, the export credit loan market helped fill the gap when commercial financing for aircraft transactions was restricted by many lenders due to balance sheet and liquidity concerns. Export-credit agency ("ECA") supported financings1 reached record levels and included access to the capital markets via ECA bonds. Amid complaints from commercial lenders that could not compete with the lower-priced ECA financings, the Organisation for Economic Co-operation and Development ("OECD") signed on February 25, 2011 a new OECD Aircraft Sector Understanding (the "ASU"). The "soft law" of the ASU will, subject to certain transition and grandfathering rules, govern the way ECA financings are structured for the export of aircraft manufactured in the United States, Europe, Brazil, and Canada.
The new ASU rules keep in place the current guarantee and direct loan structures but make the provision of such guarantees and direct loans more expensive. Minimum premiums to be charged by the export credit agencies (which vary by risk classification) have been raised across the board and will be reset annually. Risk classification for buyers of aircraft will be determined by participants prior to entry into force of ASU, and the OECD Secretariat is to maintain the list. The classification will be valid for a maximum period of 12 months. The risk-based rate will be reset based on the four-year moving average of annual Moody's Loss Given Default for first-lien bank loans.
Under the 2007 ASU, the premium to be charged depended upon whether the aircraft being financed were large aircraft (Category 1) or other aircraft (Category 2). Category 1 aircraft charged premiums in the range of 4.0 percent–7.5 percent. The new ASU has no such bifurcation, and it increased the premium range to 7.72 percent–14.74 percent. In addition, less support is available for healthy credits. Previously, maximum official support was 85 percent of country-sourced content. The ASU now provides only 80 percent coverage for credit ratings of BBB and up. In this way, the ASU addresses concerns from commercial financiers that the ECAs were "crowding" the market for good credits while retaining a "level playing field" for the major aircraft manufacturers. A single set of rules will apply to all OECD countries plus Brazil.
Because of the extensive transition and grandfathering rules of the new ASU, the full effect of the 2011 requirements will not be felt for years. The ASU requires a mandatory review of its terms and provisions in 2015, but many predict that several factors will force renegotiation of the 2011 ASU sooner rather than later (and, after all, the 2007 ASU was in effect for only three years prior to being renegotiated). One of these factors is the failure of the ASU to address whether the highly anticipated Bombardier "C Series" aircraft should be made explicitly subject to the "Home Country Rule." The "Home Country Rule" is an informal understanding among the ECAs supporting the export of aircraft manufactured by Boeing and Airbus2 that these agencies will not provide financing for aircraft located and primarily utilized in their own or in each other's countries or in Spain3 (such countries are commonly referred to in ECA documentation as the "Large Aircraft Countries"). To the extent Canada's ECA, the Export Development Corporation, makes financing for the Bombardier "C Series" aircraft available in the Large Aircraft Countries, the OECD parties may seek a renegotiation of the 2011 ASU. Additionally, Russia and China participated in the 2011 ASU negotiations but only as observers. It remains to be seen whether these countries will join the ASU. With both of these countries currently developing aircraft manufacturing programs,4 the additional competition may also serve to bring all parties back to the negotiating table.
Footnotes
1. The ECA financings during the credit crunch included both traditional finance lease structures, with an ECA guarantee issued to the participating lenders, as well as direct ECA-funded financing structures.
2. These ECAs include, with respect to Boeing, the Export-Import Bank of the United States, and with respect to Airbus, Export Credits Guarantee Department (UK), Compagnie Française d'Assurance pour le Commerce Extérieur ("COFACE") (France), and Euler Hermes (Germany).
3. Spain is included due to the many Airbus manufacturing plants located in Spain.
4. The Sukhoi Superjet has already premiered at the August 2011 Moscow Air Show, and the Chinese Comac aircraft is due to come into service in the next few years.
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