In the US, borrowers often tap the capital markets when fund raising. In Europe this is less common due to the current availability of cheap bank funding on this side of the Atlantic. However, this state of affairs could quickly change.
At first blush structured finance solutions can appear complex. However, they typically provide investors with a highly rated and liquid instrument (in the form of a listed note issuance that can be traded through the clearing systems). Investors also have recourse to, and security over, a diversified portfolio of assets. All this should result in a cheaper cost of financing.
Structured finance solutions offer various benefits to airlines and other borrowers, including:
- a means of diversifying their funding sources;
- a cheaper method of raising financing and access to longer term funding and a wider investor base than may be the case with a normal bank facility; and
- a way for a borrower to exchange its future cash flows for present funding.
The potential benefits for lenders and leasing companies include:
- a means of removing exposures from their balance sheet (with the potentially favourable accounting and regulatory treatment which that brings); and
- increasing their lending capacity and maintaining relationships with their borrower clients.
Structured finance solutions lend themselves well to the aircraft, shipping and rolling stock industries due to the income-generating nature of the assets involved. However, structured finance is a technique which can be applied to a wide range of asset classes from mortgage loans to corporate loans. Ultimately it will be available for any income-producing asset which provides a cash flow to meet payments on that financing.
Structured finance solutions
The different types of structures available include the issue of EETCs (Enhanced Equipment Trust Certificates or Notes), covered bonds, CLOs (collateralised loan obligations) and securitisations (whether that be a lease, manufacturer, ticket, shipping or rolling stock securitisation).
In simple terms, an EETC is a note issuance backed by the cash flows from the rental payments made by a single airline for a portfolio of leased aircraft. This is coupled with security over the leased aircraft.
Additional features are often also included. A liquidity facility may smooth out any temporary cash flow problems. Also, the notes may be tranched to provide credit enhancement and over-collateralisation for senior noteholders.
Ultimately, though, in an EETC credit risk is being taken on the particular airline.
EETCs can also be used in the context of rolling stock and shipping financings.
For information on increased opportunities for UK airlines to access EETC funding flowing from recent changes to English insolvency law, please see our previous Bank Notes article Key features of the UK's Cape Town ratification.
A covered bond is similar to an EETC in that it involves a note issuance and the noteholders have dual recourse to both the issuing entity and the assets over which security is granted.
However, in this case the issuing entity would be a bank seeking to raise funds, as opposed to an airline. Also, the assets which the noteholders have security over would be either aircraft or shipping loans originated by the bank, rather than the aircraft.
Unlike with a securitisation, in many (but not all) jurisdictions, the assets would remain on the balance sheet of the issuing bank.
In a securitisation the entity looking to raise finance would transfer the relevant revenue generating assets to an SPV which issues the notes, and uses the notes proceeds to pay the purchase price for these assets. This transfer would be a "true sale" to ensure that the notes and the transferred assets are not exposed to an insolvency of the seller. Again, the structure would usually benefit from various forms of credit enhancement such as tranching of the notes issued.
In a lease securitisation, the leasing company would usually undertake the role of servicer of the lease portfolio and receive a fee for provision of its services. The servicer would be required to adhere to a certain standard of care in performing its rights and obligations.
Securitisations can also be dynamic vehicles with assets being removed from and added to the portfolio on an ongoing basis. So as not to prejudice the structure each new asset is likely to have to satisfy eligibility criteria. Also, on an aggregate basis concentration limits will need to be maintained so that the portfolio is not too exposed to credit risk on a particular geography, lessee or type of aircraft (to name a few examples).
It may also be possible to issue further notes on an ongoing basis to raise additional funding if the need should arise.
A CLO is simply a type of securitisation where the underlying assets are corporate loans (e.g. shipping or aircraft loans), as opposed to leases or airline ticket sales for example.
The regulatory environment both in Europe and globally has been subject to some upheaval since the financial crisis, and a settled framework is still not in place. Market participants should be aware of this when structuring transactions.
Obvious issues to highlight include risk retention requirements which some (but not all) structured finance transactions may be subject to. Risk retention requirements currently exist in both Europe and the US and require the sponsor or originator of a securitisation to retain "skin in the game" in that transaction. Unfortunately the exact requirements can differ between opposite sides of the Atlantic and existing rules may be subject to revision.