This note summarises the 2011 ASU rules that relate to asset-backed financings of new civil aircraft. It also notes some key differences between those rules and their July 2007 predecessor (the 2007 ASU).
Effective date 1 February 2011
Signed on 25 February, the 2011 ASU takes effect as from 1 February 2011 – though subject to some grandfathering to the 2007 ASU and great grandfathering to the 1986 Large Aircraft Sector Understanding (LASU).
Grandfathering to 2007 ASU
This is allowed on two bases. The main features of the second basis are discussed under the next heading. The first basis is if the aircraft was subject to a firm contract on or before 31 December 2010 and is physically delivered on or before:
- 31 December 2012 – for 2007 ASU category 1 aircraft
- 31 December 2013 – for 2007 ASU category 2 and 3 aircraft
A 20 basis point per annum commitment fee is then payable on top of the applicable minimum premium.
Grandfathering to the 2007 ASU and great grandfathering to the LASU
Each participating state also has a quota of specific aircraft for which official support on either 2007 ASU or LASU terms is possible. The quotas are:
- 69, 2007 ASU category 1 aircraft
- 92, 2007 ASU category 2 aircraft
Broadly, each quota aircraft must:
- Have been subject to a firm contract on or before 31 December 2010 (for the 2007 ASU) or 30 April 2007 (for the LASU)
- Have appeared on “transition lists” held by the OECD before 1 February 2011
Great grandfathering to the LASU (but with a minimum premium rate of 3 per cent) for quota aircraft is only allowed if the delivery date of the aircraft was scheduled to be on or before 31 December 2010. An extra 20 basis point per annum commitment fee is payable if 2007 ASU grandfathering takes place for a quota aircraft. The extra commitment fee is 35 basis points per annum where the parties select LASU terms.
All civil aircraft in one category
The 2007 ASU categories 1-3 have gone. Except as part of the grandfathering and great grandfathering rules, the 2011 rules generally apply in the same way to all new, civil aircraft.
Simplified, single risk rating for each buyer/borrower
All buyers/borrowers1 are given a single risk rating category on an OECD list. The ratings are based on the buyer/borrower’s senior unsecured credit rating by an external ratings agency. Unlike the 2007 ASU system, each buyer/borrower’s risk category applies to official support for any new civil aircraft. Ratings are to revised annually, but can be revised in the interim if, say, an airline’s credit rating is downgraded. Once applicable to a transaction, a rating’s validity can be extended by up to 18 months.
The eight risk bands are set out in the table2 below.
Minimum down payments and maximum official support
For risk category 1 buyers/borrowers these are 20 per cent and 80 per cent respectively of the net price of the aircraft. For risk category 2-8 buyers/borrowers the equivalent percentages are 15 per cent and 85 per cent. Under the 2007 ASU, risk category 1 entities could enjoy 85 per cent support.
This is normally 12 years. The 2011 rules do allow 15-year finance for any new aircraft, but only exceptionally and with a 35 per cent surcharge on the minimum premium rate. The 2007 ASU permitted 15-year financings of category 2 aircraft and shorter,10-year, terms for those in category 3.
Mismatch and SOAR loans discouraged
As under the 2007 ASU, the maximum tenor cannot be stretched using commercial debt that shares pari passu the security granted for official support. So any SOAR or mismatch debt must be subordinated.
Increased minimum premium rates
Minimum premium rates have been increased to align the cost of official support with that of commercial debt. In many cases they have doubled. The table below shows the minimum premium rates in force as of 1 February 2011 for a 12-year asset-backed transaction.
Each minimum premium rate has two main elements. These are a risk based rate (RBR) and a market reflective surcharge (MRS).
Risk based rate
The RBR is set annually using a four-year moving average of Moody’s Loss Given Default for first lien senior secured bank loans. The 1 February 2011 rates are set out in the table below.
Market reflective surcharge
The MRS to be added to the RBR is calculated using a blend coefficient varying from 0.7 to 0.35 (depending on the buyer/borrower’s ASU risk category) and a 90-day moving average of Moody’s Median Credit Spreads (MCS) with an average life of seven years. (Each MCS is discounted by 50 per cent. This is because the raw MCS figures are for unsecured exposure rather than asset-backed transactions. Any negative figure produced by this discounting is not deducted from the premium.)
The MRS is calculated quarterly and is only applied when positive and in excess of 25 basis points.
Minimum premium rates are only available for asset-backed financings. To be asset-backed a financing must include:
- First priority security on or in connection with the aircraft and engines – the words “in connection with” here were not in the 2007 ASU. They may well include a share charge over an SPC owner, e.g. where security over the aircraft from the owner is impractical
- For lease structures, assignment and/or a first priority security in connection with the lease payments
- Cross default and cross collateralization of all aircraft and engines owned legally and beneficially by the same parties under the financing, whenever possible under applicable law
- The risk mitigants (if any) required under the rules summarised in the next section – none are required where the buyer/borrower is rated BB or above
Under the 2011 rules there are A risk mitigants (basically those that appeared in the 2007 ASU) and a new set of B risk mitigants. The table below shows which, if any, combinations of A and B risk mitigants correspond to each risk category.
A risk mitigants
- Reduced advance rate – a five per cent reduction from the applicable maximum advance rate equals one A risk mitigant
- Straight line amortisation
- Shorter tenor – a term of 10 years or less produces one A risk mitigant
Aternatively, payment of a 15 per cent surcharge on the minimum premium rate can be a subsitute for any of the above A risk mitigants.
B risk mitigants
- Cash collateral or LC equal to one quarterly instalment of principal and interest
- Advance payment of one quarterly instalment of principal and interest on each lease payment date
- Maintenance reserves reflecting best practice in the market
Cape Town discount
There is a single, maximum Cape Town discount on the minimum premium rate of 10 per cent under the 2011 ASU. This was the position for category 2 and 3 aircraft under the 2007 ASU. However, for category 1 aircraft, the maximum Cape Town discounts under the 2007 ASU were:
- 5 per cent, for buyer/borrowers rated BBB- and above
- 10 per cent, for buyer/borrowers rated BB+ to B+
- 15 per cent, for buyer/borrowers rate B to B-
- 20 per cent, for buyer/borrowers rated CCC to C
To qualify for the 2011 ASU Cape Town discount, the buyer/borrower, operator or lessor (depending on the structure) must be in a state that has ratified and appropriately implemented the Cape Town Convention and its Aircraft Protocol. That state must have made the qualifying declarations (e.g. as to insolvency repossession, self-help default remedies and IDERA). It must also appear on the then current version of the “Cape Town List” to be maintained pursuant to the 2011 rules.
States can be removed from, or reinstated to, the Cape Town List depending on how they implement and apply Cape Town in practice. There is a more detailed dispute resolution procedure for determining whether a state should be on the Cape Town List than under the 2007 ASU.
Quarterly instalments of principal and interest are the norm. Semi-annual instalments are possible, but the minimum premium rate is then increased by 15 per cent. Amortisation is either by equal instalments of principal and interest; or by equal instalments of principal, plus interest on the reducing outstanding principal. Within these rules, balloon payments appear to be permitted.
Home country rule
The 2011 ASU is expressed to be a gentlemen’s agreement. Outside the 2007 ASU, and so not addressed in that document (nor in its precedessors), is another gentlemen’s agreement – the “home country rule”. Under this informal arrangement, US EX-IM Bank and the European export credit agencies do not offer official support for Boeing or Airbus aircraft in their respective “home countries”, i.e. the United States, France, Germany and the United Kingdom. Neither Canada nor Brazil is party to or observes the home country rule. The assumption is that if, say Bombardier or Embraer, were to be prepared to offer official support for an aircraft to be operated in any of United States, France, Germany and the United Kingdom, then the export credit agencies in those countries would feel justified (outside either the 2007 or 2011 ASU, and the LASU) in “matching” that support.
Form of official support
The form of support available differed under the 2007 ASU depending on the aircraft’s category. All forms of support are available for all new, civil aircraft under the new regime.
As with the 2007 ASU, these are Australia, Brazil, Canada, the European Union, Japan, Korea, New Zealand, Norway, Switzerland and the United States. Currencies Euro, Japanese yen, pounds sterling, US dollars, and other fully convertible currencies for which data is available to construct the minimum interest rates using the 2011 ASU methodology.