August 10, 2018

Lessors fill the gap as banks struggle to close PDP financings

The shift in pre-delivery payment (PDP) financing from banks to operating lessors is accelerating.

This partly due to major operating lessors using PDP finance as a tool to win sale and leaseback business in a highly competitive market.

In addition, some bank lenders have pulled back because of higher capital requirements on PDP loans versus loans secured by aircraft assets.

“The high levels of liquidity in the market, along with greater appetite on the part of some lessors to do PDPs, has taken some of the pressure off the need for PDP financing from banks,” according to James Cameron, London-based partner in the transportation and space group at law firm Milbank.

Another factor, however, is that Airbus has become tougher on terms and conditions of deal structures.

“PDP financing remains a challenge for a lot of banks, particularly for Airbus aircraft where the transactions tend to be more structured.

“Some of the same banks, however, routinely lend against similar fact patterns for other products, such as project finance,” Cameron adds.

“Historically, only a relatively limited number of commercial banks have been comfortable providing PDP financing which, due to the lack of a hard asset over which security can be taken day one, means that it is viewed far more as a corporate credit risk,” according to Graham Tyler, London-based partner at law firm Pillsbury Winthrop Shaw Pittman.

“Bearing in mind that the majority of airlines looking to borrow in this way are not necessarily the strongest credits and the dichotomy is plain to see,” Tyler adds.

“Then factor in the inevitable interest that the OEMs have shown as regards the form and working mechanics of the consent to assignment, the structure of the deal and of course the step-in price and quite understandably some lenders feel the risk versus reward does not justify participation, notwithstanding the short tenor of such loans and higher margins,” Tyler stresses.

Another lawyer comments that the role of the original equipment manufacturer (OEM) is critical in any PDP deal, and the web of relationships with airlines, aircraft lessors and bank lenders can be complex.

In the case of an airline bankruptcy, banks rely on assignment of the right to buy the aircraft at the so-called step-in price.

If the OEM sets this price too high, it deters banks from making the loan.

Bankers maintain that Airbus currently is setting the step-in price at levels considerably above the actual price being paid by an airline for an aircraft — although the exact amount is hard to quantify since the original negotiated price is confidential information, seen only by Airbus and the airline.

Airbus is generally more willing to co-operate on PDP loans for top-tier carriers, although most of these operators can raise senior unsecured debt at very low margins, or have access to significant cashflow.

Top-tier carriers favoured

Airbus is tougher on conditions for second- and third-tier airlines, making it hard for banks to do deals, although these are precisely the carriers that need to source PDP loans.

“If an airline defaults, the lender is facing the OEM, and has the right, but not the obligation, to buy the aircraft,” explains Marjan Riggi, senior managing director at Kroll Bond Rating Agency.

“OEMs, however, retain the call option to repay the financier and can terminate the step-in agreement with the lender.

“The point of a PDP is that it is a deposit with the OEM, so they don’t want to create contingent liabilities on their own balance sheet associated with PDP loans,” she adds.

“They like to keep their options open in the case of an airline bankruptcy, and might put in place a step-in price for the bank lenders to buy the assigned aircraft that is higher than the price agreed by the airline for the aircraft.

“This can lead to a loss for the lender, assuming that they would even have the resources to purchase the aircraft although they may have only provided a small PDP loan on it.

“PDPs have been traditionally done by banks, given their multiple relationships with airlines, and PDP financing can be difficult in the capital markets, especially since investors do not have a perfected interest in the aircraft that has not even be delivered,” she says.

“At the moment, we are seeing more PDP finance being extended by operating lessors, since they have an incentive to use it to win sale and leaseback business.”

Clawback risk

One point of contention is how so-called clawback risk is allocated.

The problem for the OEM is that, if the airline goes bankrupt, bank lenders can buy the aircraft, having had the right to the order assigned to them.

A bankruptcy court, however, could potentially look at the cash deposit paid by the airline, and insist that this cash belongs to airline creditors and should be returned.

“Where clawback risk resides is always point of negotiation between a PDP lender and the manufacturer,” comments a banker.

“A lot has been said about clawback risk, but the reality is that, if it is an issue at all, it is a very transaction-specific, rather than a generic, issue,” Cameron asserts.

Special purpose companies (SPCs) are often set up on PDP loans, with a legal opinion on bankruptcy issues to mitigate this risk.

The total amount of instalments of pre-payments could be 10% to 20% of the aircraft purchase price, but since the OEMs calculate this using the list price, not the actual delivery price, which is often 50% less, that could mean 20% to 40%.

Where a PDP loan is signed, the airline might put in 25% cash (equity position) and the PDP lender 75%.

And as low-cost carrier Norwegian notes, final cash payments are subject to changes in delivery and pre-payment schedules, certain contingent discounts or other adjustments of the purchase price.

The final purchase price for an individual aircraft is not known until the time of delivery.

Balancing act

Given all these factors, there is a balance to be struck between a lender’s exposure and the ease with which the lender can exercise its security in a default situation.

Also subject to a balancing act is the airline’s ability to manage its assets and to negotiate freely with the manufacturer, and the manufacturer’s ability to retain payments for completed work, the comfort that such payments will not be subject to claw-back, as well as visibility as to the identity of the ultimate purchaser of the aircraft.

The bottom line, however, is that, if the OEM wants to take a tough line on negotiating the PDP facility, then deals can be difficult to close.

Co-operation is key element

“I would strongly advise airlines to ensure — right from the beginning in the purchase agreement — that the manufacturer will fully co-operate on PDP financing”, says Marc Bourgade, chief executive officer (CEO) at Stellwagen Finance, who closed a significant number of PDP financings when he was head of aircraft, export and infrastructure sectors and clients at French bank Natixis, as well as chief financial officer (CFO) at Natixis Transport Finance.

Bourgade subsequently completed many additional PDP financings after joining Stellwagen in March 2016.

“Airlines should also negotiate the step-in price for the PDP financing, so it is agreed from day one, and is not a number that the manufacturer comes up with at last minute; airlines should also ensure that there is an agreement on no clawback,” says Bourgade.

“Clearly the airline has significantly more bargaining power while negotiating the initial purchase agreement than after.”

Over the past several years, there has been little business done by bank lenders, although there are exceptions, notably the PDP loans provided by ING Capital for 12 A350s being delivered to Ethiopian Airlines, plus a Norwegian deal for 50 A320neos.

Lessors move in

The slack has been taken up by operating lessors that are increasingly dominating activity in the PDP market.

Their motivation is that, as the sale and leaseback market has become fiercely competitive, it has become an increasingly useful tool when bidding on requests for proposals (RFPs).

Aircraft lessors that previously offered PDP finance as a way of differentiating themselves have found that competitors have now staffed up in this area.

Where lessors used to be a able to generate some higher margin business with their PDP loans, they are now finding that pricing is also being squeezed on this product.

“The marked change over the past few years has been that as the operating lease market has increased market share year-on-year, that, combined with a multitude of new operating lessor entrants, particularly from Asia, has meant that lessors quite simply have had to consider offering up PDP financing to try and differentiate themselves from their competitors when responding to airline RFPs for long-term leasing options,” Tyler explains.

“To say that this is the norm may be one step too far, but it is certainly being seen quite frequently.

“This in turn has enabled some banks to structure deals where they are providing senior debt into the structure based off the operating lessor’s credit, which is often stronger than that of the airline, leaving the operating lessor to make a junior loan for the remainder of the amount to be lent,” Tyler adds.

Pre-delivery leases

“Some lessors have been able to further innovate by utilising a relatively new concept whereby lessors with their own aircraft orders and relationships with OEMs have been able to structure novation and slot sale structures that include pre-delivery leases.

“In such structures an airline’s aircraft delivery position is effectively sold to a lessor, such that the airline is discharged from future PDPs and refunded any PDPs already made.

“The lessor will then make all future PDPs, while the airline enters into a pre-delivery operating lease with the lessor, under which the airline makes payments – often styled as a commitment fee – matching the PDPs payable by the lessor to the OEM.

Fund market option

“Finally, another potential option for PDP financing is the fund market, where the available yields are still quite attractive, but to date there have not been that many deals closed and the feeling is probably that this segment of the market will not prove to be that attractive for them,” according to Tyler.

One of the best-established players is SMBC Aviation Capital, which offers a wide range of financing products to the market.

Sumitomo Mitsui Banking Corporation (SMBC) and its subsidiaries can arrange or provide secured aircraft financing, export credit agency (ECA)-supported financing, and PDP financing, as well as arranging Japanese operating leases (JOLs) together with Sumitomo Mitsui Finance and Lease Co.

SMBC highlighted the importance of PDP financing when announcing results to 31 March 2018.

“It was a positive year for our sale and leaseback business, particularly in Asia and South America, where we have continued to execute deals of scale with our long-term customers, including 10 B-737max8 aircraft to Aeromexico, 11 A320neo aircraft to Avianca, and 13 B-737max8 aircraft to Jet Airways,” the lender reported.

Partnering with shareholders

“In the majority of these deals, we have been able to partner with our shareholders to offer PDP financing which has given us a competitive advantage,” SMBC reported.

SMBC Aviation Capital has been offering PDP financing for some years.

Back in May 2014, the lessor executed a PDP funding facility and lease agreements with Air Europa for five B-787-8s as part of a sale and leaseback transaction.

The aircraft were delivered between March and December 2016.

In a recent deal with South Korean carrier Asiana, SMBC provided PDP financing as part of a sale and leaseback agreement involving six A350-900 aircraft.

SMBC’s first A350-900 was delivered to Asiana in April 2017, and the sixth was recently delivered.

Hong Kong-based Goshawk, which is owned by NWS Holdings and Chow Tai Fook Enterprises, has also been offering PDP finance for several years, viewing it as an advantage to be able to offer balance sheet solutions to clients rather than just trying to win out on RFPs based on price.

In October 2017, for example, Goshawk delivered the fourth B-787-9 aircraft to Etihad as part of a sale and leaseback transaction.

The package of four aircraft included an innovative structured PDP financing facility, signed in July 2016.

China Development Bank unit CDB Aviation Lease Finance currently is strengthening its position in this area.

Last year, CDB Aviation Lease Finance announced a series of executive appointments, as well as the establishment of additional office locations around the world.

In 2017, the lessor placed some large orders, including 45 A320neo-family aircraft, as well as 42 B-737max8s, 10 B-737max10s and eight B-787-9s.

According to CDB, the 2017 orders marked the culmination of that important pillar for growth.

The final pillar will be deployment of fresh capital into a full range of activities, from PDP financing, sale and leaseback transactions and portfolio acquisitions, to actively trading aircraft.

CALC moves on Latin America

Meanwhile, in January 2018 China Aircraft Leasing Group Holdings (CALC) entered into a purchase and leaseback agreement with PDP financing as a bundled package solution with the Latin America low-cost carrier group Viva Air, for five A320-200 aircraft.

The aircraft are scheduled for delivery to the carrier between 2018 and 2019.

The transaction marks CALC’s first move into Colombia and Peru, and another important move in deepening its presence in Latin America in partnering with Viva Air.

Viva Air is a Panamanian-headquartered group, created by low-cost carrier specialist Irelandia Aviation, led by Declan Ryan, son of Ryanair founder Tony Ryan.

Irelandia has successfully developed six low-cost carriers around the world, (Ryanair, Allegiant, Tigerair, Viva Aerobus, VivaColombia and Viva Air Peru), which combined have a fleet of over 420 aircraft.

Around the same time, Viva also tapped PDP financing with GE Capital Aviation Services (Gecas).

In January, Gecas arranged a sale and leaseback, together with PDP financing, for Viva Air in a transaction for 10 A320 aircraft to be delivered in 2018 and 2019.

“We appreciate the relationship we’ve developed with Gecas over the years, and the ability to offer PDP financing along with the sale and leaseback made this an ideal solution for our operations” commented Declan Ryan, who is also a founding partner of Irelandia Aviation.

PDP financing has also traditionally been been critical in winning business with Aeromexico.

In the fourth quarter of 2017 SkyWorks acted as arranger/advisor to Aeromexico on the combined PDP and sale and leaseback financing for 25 aircraft (17 B-737max8s and eight B-737max9s) with a trio of operating lessors: Jackson Square Aviation (JSA), SMBC and Ping An.

All aircraft are scheduled to deliver between 2018 and 2020.

Mitsubishi UFJ subsidiary JSA closed a PDP facility with Aeromexico in conjunction with the long-term sale and leaseback financing for five of the B-737max8 aircraft.

PDP finance is key product

JSA is an experienced provider of PDP finance, with the aim of helping to win sale and leaseback business.

As far back as 2011, JSA announced the first of seven A320 deliveries to Concesionaria Vuela Compania de Aviacion (Volaris).

The delivery was in connection with a long-term operating lease, for which DVB Bank provided senior debt.

JSA has also provided PDP financing to Volaris in connection with this deal.

Back in 2015, JSA signed sale and leaseback financing to deliver two B-787-8 aircraft to Air Europa in 2017.

In connection with this financing, JSA and Air Europa entered into a PDP financing facility.

Last October, JSA closed its PDP facility with Aeromexico in conjunction with the five B-737max sale and leasebacks.

Regarding the Aeromexico transaction arranged by Skyworks, SMBC Aviation Capital signed a sale and leaseback agreement for 10 B-737max aircraft that included a PDP facility for all 10 aircraft.

This transaction represents SMBC Aviation Capital’s largest-ever transaction with Aeromexico.

“It demonstrates our unique capabilities to provide customers with comprehensive financing solutions,” commented Peter Barrett, CEO of SMBC Aviation Capital, in a November 2017 news release.

The first of these aircraft — and the first B-737max8 in the SMBC fleet — was delivered to the carrier on 5 July.

DAE has access to capital

Dubai Aerospace Enterprise (DAE) has also been active in PDP finance.

Last December, EgyptAir took delivery of its ninth B-737-800NG, subject to a sale and leaseback agreement, including PDP funding, that the operator signed with DAE in October 2016.

In April, DAE Capital delivered its first new B-787-9 aircraft to Bahrain flag carrier Gulf Air.

This delivery represented the first of five B-787-9 aircraft subject to a sale and leaseback agreement with PDP financing that was signed between DAE and Gulf Air last November.

The remaining four aircraft will all be delivered during 2018.

DAE has plentiful access to both global and regional bank debt, and on 21 May signed an unsecured revolving credit facility — the type of large-scale revolving credit facility that helps aircraft lessors to extend PDP loans at attractive prices.

The unsecured four-year revolving credit facility has an initial commitment of $480 million and an accordion feature that allows the facility to be increased to up to $800 million at any time after initial closing of the deal.

The facility includes both conventional and Islamic tranches.

Bank arrangers were Al Ahli Bank of Kuwait, First Abu Dhabi Bank and Noor Bank.

German fund arranger KGAL and its joint venture German Operating Aircraft Leasing (GOAL) have occasionally provided PDP financing alongside sale and leaseback deals.

Back in September 2016, GOAL, a joint venture between KGAL and Lufthansa, arranged the sale and leaseback transaction, including PDP and long-term financing, for three B-737-800 aircraft with Air Europa.

Two of these aircraft are now in KGAL’s Aircraft Portfolio Fund 1 (APF1), with the other in a club deal with two institutional investors.

GOAL is asset manager, as well as remarketing agent for the aircraft.

All three aircraft were delivered to Air Europa in 2017, and financed with Norddeutsche Landesbank (NordLB) as senior lender.

“We do see some RFPs that request PDP financing, but they are a minority and are not generally a crucial point to get a sale and leaseback transaction done,” according to Jochen Hoerger, managing director for the aviation asset class at KGAL.

“Many airlines finance PDPs out of their own liquidity.”

APF1 raised €400 million ($467 million) of equity and leveraged this with €400 million of bank debt.

Another fund, APF3, has since been launched by KGAL.

Insurers and pension funds “There is a growing pool of insurance companies and pension schemes in Germany looking at aircraft, and we are still seeing strong appetite from banks to provide the debt,” said Hoerger.

APF3 has already sourced €200 million worth of aircraft, and the fund could eventually grow to the same size as APF1.

Lessees for the two funds include Finnair, Flybe, VietJet, IndiGo, Oman Air, Air Europa, Avianca, VivaAerobus in Mexico, and Denver-based Frontier.

The KGAL Group’s aviation asset class set a record in the 2017 financial year, achieving a new business volume of €1.3 billion, representing an increase of 30% year-on-year.

KGAL‘s aviation team was able to acquire 21 aircraft valued at €740 million for its institutional funds.

Ethiopian Airlines

The high level of PDP lending from lessors leaves little room for bank loans, although there are exceptions.

One high-profile deal involves ING Capital, which has been supporting deliveries of the A350 aircraft to Ethiopian Airlines.

Ethiopian Airlines ordered 14 A350-900 aircraft, comprising 12 ordered directly from Airbus and a further two sourced from AerCap Holdings.

In 2016 the carrier became the first operator of this aircraft type in Africa, with the first two aircraft coming from the AerCap order book.

In June 2016 ING Capital announced that it had closed a $107.5 million PDP financing for Ethiopian Airlines involving A350-900s.

ING Capital was sole lender and facility agent.

ING Capital subsequently arranged and funded the PDP financing for all 12 A350-900 aircraft ordered directly from the manufacturer, delivering between 2017 and 2019.

The other big deals have been done by DVB Bank.

In January 2016, Arctic Aviation Assets (AAA), a subsidiary of Norwegian, arranged PDP financing on 50 A320neo aircraft scheduled for delivery between 2016 and 2019 — in a deal that also featured engine manufacturer support.

In May 2017 AAA closed a PDP financing for four B-787-9 aircraft to be delivered in the fourth quarter of 2017 and the first quarter of 2018.

DVB was arranger and lender of the PDP financing, providing a revolving credit facility.

Subsequently, AAA signed a letter of intent (LOI) for the PDP financing of six B-787-9s with backstop sale and leaseback agreements.

Deliveries are scheduled for 2018 and 2019, and Norwegian said that the deal had improved its liquidity by $250 million.

Norwegian has also put in place a credit facility that can be used for PDP financing/liquidity totalling NOK1 billion ($122.6 million), and arranged by Oslo-based DNB.

Banks used to dominate

The PDP market, however, has changed dramatically since the days when banks dominated, both before the financial crisis and in the years immediately after, when many new lessors were still adding expertise in this area.

In the years after the financial crisis, bank debt was in short supply, and banks tended to do PDP deals to help out relationship clients.

At that time the French banks dominated, with transactions from Calyon, BNP Paribas and Natixis.

Some banks viewed it as attractive because it was short-term, repeat business with high margins.

Pricing on two-year PDP loans was often higher than that on 12-year aircraft-backed term loans.

Relationship banks and arrangers

In 2013 Aeromexico was still doing PDP deals with relationship banks rather than operating lessors, and the carrier signed a $109 million, 12-month financing for the two new B-787-8 aircraft.

Banco Santander Mexico, which acted as mandated lead arranger, provided $66 million of the total, with an unnamed bank providing the rest.

The borrower was a trust constituted under Mexican law to mitigate clawback risk in the event the purchaser wished to retrieve their PDP.

The two Dreamliners were delivered in December 2014 and January 2015.

In 2014 Natixis arranged PDP financing for four B-777-200 freighters for Ethiopian, and around the same time provided a $150 million PDP credit facility to Gol Airlines for B-737-700s and B-737-800s.

In 2014, SAS (Scandinavian Airlines) signed a PDP financing facility for two A330-300 and six A320neo aircraft.

The facility was structured as a revolving credit facility under which SAS could draw up to $74 million in total, with a maximum of $54 million outstanding at any time.

DVB Bank was sole arranger and financier of the facility.

As well as traditional aerospace banks, specialised arrangers also entered the market.

In June 2013 Aviation Finance Corporation (AFC) and Natixis completed the first-ever multi-tranche debt capital market PDP financing for eight A330 aircraft for Sao Paulo-based conglomerate Synergy Group, majority owner of Arianna.

The $263 million PDP facility was rated in an effort to attract insurance company investors.

New Orleans-based Global Hunter Securities (which later in the year merged with New York-based Seaport Group) acted as placement agent for the junior tranche debt.

At the time, the placement to institutional investors seemed to indicate a new capital markets-led approach to PDP financing, but this never really developed as the operating lessors took over this role.

In July 2015, AFC announced closing of a PDP financing for a B-787-8 aircraft to be delivered to Air Europa in 2017.

AFC arranged funding for 100% of the PDP requirement and closed the transaction in fewer than 30 days to meet tight timelines by leveraging AFC’s access to the capital markets.

In March 2016 Air India finalised PDP funding that totalled $155 million for three B-777-300ERs due for delivery to the flag carrier in the first quarter of 2018.

Deutsche Bank provided the debt.

The German bank is not a regular PDP lender, and the transaction can be viewed more within the framework of relationship banking.

Lessor PDP facilities

For bank lenders still interested in short-term PDP lending, business has shifted to putting in place facilities for the operating lessors themselves.

The large lessors, however, generally are investment grade and can also access the capital markets for cheap senior unsecured debt.

That leaves limited opportunities for the banks.

Nonetheless, there are still some deals getting done.

One bank that has completed many PDP loans in recent years is Frankfurt-based DVB Bank, and in 2017 the bank was involved in transactions for Goshawk (three B-737-800s) and DAE Capital (15 A320-200s).

DAE Capital put in place a PDP financing for 15 A320s that were originally ordered in June 2016 by AWAS — a lessor that was subsequently acquired by DAE.

The aircraft will all be delivered by December 2018.

Like many lessors, DAE usually had financed PDPs via cash on its own balance sheet.

DVB Bank and Crédit Agricole CIB were joint lead arrangers.

Vedder Price advised lenders in the deal while Clifford Chance was counsel for DAE.

AWAS had previously done PDPs with Investec Bank.

In June 2012, AWAS closed a revolving $120 million PDP facility, fully underwritten by Investec Bank and used to finance A320-family aircraft in the AWAS order book.

The revolving structure effectively provided AWAS with $240 million of PDP finance over a two-year period.

In October 2017 CALC closed its first unsecured syndicated loan which featured a 4.5-year maturity.

The loans will be used to finance or refinance part of the PDPs to be made for aircraft acquisition.

Launched at $175 million, the loan closed at $425 million after receiving an overwhelming market response, reflecting the market’s growing knowledge and confidence in the aircraft leasing industry.

“CALC has been one of the first companies to complete an aircraft transaction in Hong Kong through the newly established leasing platform,” said Barry Mok, deputy CEO and chief financial officer of CALC.

“This loan again showcases our leadership position in providing flexible arrangements, and it is the first large-scale PDP syndicated loan after Hong Kong’s Legislative Council passed a new tax regime for the industry,” Mok added.

Chinese banks run the deal

China Everbright Bank (Hong Kong) and Industrial and Commercial Bank of China (ICBC) (Asia) acted as mandated lead arrangers, bookrunners and underwriters on the CALC deal.

China Minsheng Banking Corporation (Hong Kong) and Chiyu Banking Corporation acted as mandated lead arrangers.

Bank of Jiangsu (Shenzhen) acted as lead arranger.

Bank of Communications (Hong Kong), Bank of East Asia, Bank SinoPac Co (Macau), Chong Hing Bank, Cathay United Bank Co (Hong Kong), Mega International Commercial Bank (Hong Kong), EnTie Commercial Bank and Taiwan Co-operative Bank (Hong Kong) acted as arrangers.

OEMs favour first-tier lessors

From the point of view of the OEM, PDPs provided by highly rated operating lessors that have signed a sale and leaseback on the aircraft look more attractive than having third-party financiers doing PDPs — greatly adding to the complexity of negotiations where things do not go as planned.

Airbus currently has several A330s painted in the livery of Hainan Airlines and other HNA Group carriers parked at Colomiers near Toulouse.

The aircraft have not been delivered because cash-strapped HNA Group fell behind with payments.

Hainan Airlines has previously used PDP facilities provided by Bravia Capital Partners, involving two B-737-800NGs, two B-787-8s, and 20 E190s.

There is no record of PDPs on the A330 deliveries, and the absence of a third-party financier will remove one potential added complexity from the difficult negotiations between Airbus and HNA Group.

HNA slump in market cap

HNA Group lost more than $3 billion of market capitalisation during the week ending 21 July, highlighting the continued problems of the indebted company by resuming operations of shares that were suspended for more than six months.

HNA Group suspended several listed companies to hedge against losses during a liquidity crisis that began in the second half of last year.

Since then HNA Group has sold $16 billion in assets, with more for sale.

On 21 July, Hainan Airlines shares in Shanghai plummeted 10%, the maximum allowed in a single day.

Bohai Capital Holding — the unit that owns most of HNA Group’s high-interest lease and financing operations — lost 28% since it resumed operations on 17 July, and HNA-Caissa Travel Group shares fell 19%.