Aviation

January 23, 2019
 

South Korean investors build up aircraft teams

With central banks moving very slowly into the cycle of interest rate increases, the allocation to alternatives keeps growing. Michael Marray reports from Frankfurt

This allocation process has gained its own momentum.

Having hired staff and set up specialised units investing in areas such as infrastructure and aircraft, institutions will likely continue buying even as (and if) interest rates return to normal historical levels.

In South Korea, institutional investors began with mezzanine tranches.

Some then moved on to equity.

And Korean banks are now regularly providing dollar-denominated senior debt, which means that some deals are being closed with entirely domestic groups of arrangers, investors and lenders — in addition to transactions with a European partner as arranger or asset manager.

As the market has developed, certainty of execution has improved, although there have been a few examples of arrangers signing up for aircraft and then failing to line up investors.

This means that for many carriers the Jolco market remains preferable, since certainty of execution is very high with traditional Japanese equity arrangers.

In some of the latest deals to close, in mid-December Dublin-based Stellwagen Group acquired a B-777-300ER on lease to Qatar Airways, and in November Korea Investment & Securities acquired two B-777-300ERs from BOC Aviation.

In September Shinhan Investment Corporation (SIC) acquired a B-777-300ER on lease to Air Canada.

Crianza Aviation, established in August 2016, remains an active player, having in 2017 strengthened its presence with the acquisition of EastMerchant.

And on the debt arranging side, KEB Hana has established itself as a name in the market with a series of deals.

Arrangers expect 2019 to be just as busy, with real estate and aircraft both still highly favoured assets.

And in addition to US dollar deals, Korean investors are expected to add more assets denominated in euros and sterling.

On 10 December, Stellwagen Korea completed its first transaction for the Korean market in conjunction with Meritz Securities Korea.

The transaction involves acquisition of one B-777-300ER aircraft, on lease to Qatar Airways.

Seraph Aviation Management, the Dublin-headquartered aviation asset management unit of Stellwagen Group, is acting as servicer for the aircraft.

Stellwagen Group opened a branch office in Seoul in August 2018 to further serve the market.

“We are very pleased to have reached this agreement, having recently opened in the Korean market,” comments David Butler, group chief executive officer (CEO) of Stellwagen Group.

“The transaction is an indication of the great opportunity that exists in the region and Stellwagen Korea looks forward to announcing further such initiatives in due course.”

Seraph manages investment strategies for investors and is not an asset owner.

Seraph, previously operating as Volito Aviation Services Ireland, was acquired in 2015 by Stellwagen and re-branded.

The B-777 remains the widebody of choice, and another recent deal involving BOC Aviation featured two well-established players, Korea Investment & Securities (KIS), a subsidiary of Korea Investment Holdings, and KTB Investment & Securities.

Korea Investment Holdings was established in 2003, offering services, such as alternative asset management, venture capital/private equity investment, and hedge fund management, and over the past several years has moved into aircraft.

KTB has a 30-year track record in specialised investment and asset management, and has brought institutional investors into their first aircraft deals via its fund structures.

In November, KIS acquired two B-777-300ERs from BOC Aviation, with leases to Air France attached.

BOC Aviation had acquired the aircraft around 2010, and leased them to Air France through 2024 with an extension option.

This was BOC Aviation’s first deal with Korean investors.

The infrastructure finance division of KIS sourced the aircraft and acted as overall deal arranger.

KTB Asset Management set up a fund special purpose vehicle (SPV) to hold the mezzanine and equity tranches, and KIS invested via this structure.

Local press reported that there was also a $125 million senior loan from four South Korean banks.

KEB Hana arranged this loan to the SPV, and brought in Woori Bank, NongHyup Bank and IBK Bank.

Airline credit

Air France is an example of the kind of top-name carrier that Korean investors have typically favoured since entering the market three or four years ago.

The market is gradually changing, however, and new player SIC is taking more of an asset focus in addition to looking at airline credit.

Back in February SIC announced completion oft he formation of an aviation business unit by bringing in in-house legal counsel, a financial analyst, and experienced aircraft managers.

Already in 2017 SIC had agreed to its first equity investment, involving the sale and leaseback of a single B-787-9 aircraft operated by Germany-based travel and tourism specialist TUI, with scheduled delivery in May 2018.

Doric, based in Offenbach near Frankfurt, arranged and structured the transaction, and is acting as asset manager.

Hanover-based TUI is listed on both the Frankfurt Stock Exchange and London Stock Exchange.

SIC was back in the market in September, completing the acquisition of a B-777-300ER leased to Air Canada.

SIC has expressed the intention to expand further into aircraft investment, and to work with the global aviation community.

“The high level of liquidity around the world has pushed up valuations, and requests for proposals (RFPs) on the sale and leaseback of new aircraft can often attract 50 bids, so we are now also looking at a second option, which is the secondary market, acquiring aircraft from operating lessors,” Kenneth Kang, who heads up aircraft investment at SIC, told GTF.

In the Air Canada deal, SIC signed an agreement with an (unnamed) lessor to purchase a seven-year-old B-777-300ER on lease to the carrier.

The Air Canada fleet includes 19 of this aircaft type.

In contrast, the TUI Dreamliner deal was a sale and leaseback on a new aircraft that featured a group of global banks, and also German institutional participation, whereas the Air Canada transaction featured Korean equity, mezzanine and senior debt.

“Going forward we will continue to work with both Korean and international banks, and also partner with arrangers in Europe — depending on the transaction,” notes Kang.

He views the SIC strategy as being different from the strategies of other Korean investors that have traditionally been focused heavily on the carrier.

“We are paying close attention to the asset side, as well as to the credit side of the equation, so we will be looking at a wider range of lessees than most Korean players are willing to consider,” he says.

Doric, with which SIC worked on the TUI transaction, opened a Hong Kong office in July, and is likely to transact both real estate and aircraft deals involving Korean and other Asian investors from there.

“Korean investors have made sizeable allocations to both aircraft and real estate as part of their alternatives buckets, and we expect to be doing more deals following the TUI Dreamliner transaction in May for SIC,” comments Sibylle Paehler, global head of structuring and financing at Doric.

“We are involved in sourcing aircraft, as well as potentially bringing in German investors in parts of the structure alongside Korean investors, and providing strong asset management experience,” she added.

The TUI deal was SIC’s first equity investment in aircraft.

Doric arranged and structured the transaction, which involves a 12-year lease.

Senior debt was provided by Commerzbank, HSBC and Norddeutsche Landesbank (NordLB).

There was also German institutional participant at the mezzanine level.

“It is important that the mezzanine notes are transferable, so that the investor can sub-syndicate,” explains Paehler.

“Deals featuring Korean investors are typically divide into four or five tranches, with each tranche meeting the exact risk appetite for a particular investor,” Paehler explains.

“With the US dollar very strong at the moment, Korean investors are also interested in euro-denominated deals, and we also see some appetite for transations denominated in sterling”, she says.

For the German institutional investor on the TUI deal, a euro-denonimated deal was logical, but SIC also was interested in doing a euro transaction.

“In general it is quite difficult to source aircraft at attractive prices at the moment, since both the narrowbody and medium-size widebody markets are hot,” says Paehler.

Another arranger told GTF that he expects to see a steady flow of deals in 2019 involving Korean investors and lenders.

“South Korean investors have been quite active in the market since 2015, beginning with transactions for Emirates,” he said, including Emirates A380 transactions involving Stellwagen.

There also have been a number of B-777 transactions for Qatar Airways.

“We are now seeing transactions with Korean involvement across the entire structure, with institutional investors providing equity and mezzanine, and banks coming in with balloon loans as well as senior loans,” he added.

Korean brokerages and banks tend to form partnerships with arrangers from Europe for individual deals, rather than cementing long-term alliances.

Deals in 2016, 2017 and 2018, for example, have featured Doric, Stellwagen, Munich-based EMP Structured Assets, and Magi Aviation Capital.

EMP

In December 2017 EMP arranged a 12-year operating lease deal involving a new Emirates A380.

EMP previously had closed deals featuring Korean institutions, but this time all the various tranches were placed in Korea.

A group of Korean banks provided a $214 million senior loan, denominated in both dollars and euros.

The two junior loan note tranches were underwritten by a Korean asset manager.

Bird & Bird (Frankfurt) acted for EMP, Clifford Chance for the Korean lenders, and Pillsbury for Emirates.

Qatar Airways

One example of a top-tier carrier that regularly has accessed the Korean market is Qatar Airways, in spite of problems related to the economic boycott led by Saudi Arabia.

In July 2018 London-based Magi arranged the sale and leaseback of two B-777-300ERs with Qatar Airways.

KTB arranged equity and mezzanine funding for institutional investors.

Senior debt was arranged by ANZ, and provided by ANZ, IBJ Leasing, and Tokyo Stock Exchange-listed NEC Capital.

At NEC, growth in conventional leasing and financing business, such as in IT equipment, has been sluggish due to heightened competition that the company says results from unprecedented monetary easing.

NEC has thus been diversifying assets, including renewable energy related facilities, aircraft and real estate.

Following the Qatar Airways transaction, Magi had arranged a total of seven sale and leaseback transactions for the airline.

Magi works primarily with institutional investors in Asia and Europe, and Korean investors were also featured in an 2017 transaction, when Magi arranged the sale and leaseback of four B-777-300ERs.

For two of those aircraft, Crianza provided the equity component, Korean institutional investors provided the mezzanine funding, and senior debt was arranged and fully underwritten by ANZ Bank.

Another busy player in the Korean market is Hana Financial Group unit KEB Hana Bank.

It is one of the largest banks by asset size in South Korea, and since 2015 has been increasingly active in the global aircraft market.

Korea Exchange Bank was acquired by private equity firm Lone Star in 2003, which then sold the bank to Hana Financial Group in February 2012.

Management of Korea Exchange Bank and Hana Bank remained separate until September 2015, until an official merger to form KEB Hana Bank.

The bank currently has a balance sheet size of $254 billion.

Since 2015 the merged bank has been increasingly active in the aircraft sector.

In November of that year China Aircraft Leasing Group (CALC) took delivery of the first aircraft from an order of 100 A320 aircraft, and completed the first delivery to new customer Air Macau.

The aircraft was one of four (one A320 and three A321s) covered by a lease agreement between CALC and Air Macau, signed in May 2015.

The remaining aircraft were delivered in early 2016.

Financing by KEB Hana and state-run lender Korea Development Bank (KDB) covered two of the A321s.

Norton Rose Fulbright (Asia) acted as transaction counsel, representing the lenders, and William KK Ho & Co (which has since become part of Bryan Cave Leighton Paisner) was transaction counsel representing CALC.

These were CALC’s first aircraft financed by Korean financial intuitions.

Hana Financial Investment Co was also involved in one of the Qatar Airways deals.

In May 2017 the company invested in $50 million worth of mezzanine debt for a fund set up to buy a Qatar Airways B-777-300ER.

Hana underwrote the entire mezzanine tranche, which was then sold down to Korean institutional investors.

KEB Hana has also been seeking business with the major operating lessors.

In 2016 KEB Hana arranged a $100 million financing for lessor AerCap.

In September 2017 KEB Hana arranged a $300 million lease financing covering an aircraft portfolio for lessor Avolon, which was the first time that Avolon had accessed debt from Korean bank lenders.

The funds were used to acquire seven aircraft, including new B-787-9s and A320s on lease to carriers that include Latam Airlines and Asian low-cost carriers.

KEB Hana typically holds retains some participation and syndicates the rest to financial institutions in Korea and overseas.

KEB Hana also has been involved in midlife aircraft Jolcos, also known as vintage Jolcos.

In September 2018 KEB Hana arranged a $55 million Jolco for JP Lease Products & Services, with proceeds used to acquire two B-767-300ERs and one A321.

Hana Financial Investment is also active in real estate.

In November 2018, Hana, together with Korean firm IGIS Asset Management, acquired the landmark Trianon skyscraper in Frankfurt.

The seller was NorthStar Realty Europe Corporation, which had acquired the 45-story tower, which is the headquarters of Deka Bank, from a Morgan Stanley fund in 2015.

Local media listed the purchase price as €670 million.

Crianza

Early in 2017, Crianza acquired a majority stake in EastMerchant, the veteran aircraft lease arranging firm run by Baldur Vander and Patrick Giese.

Vander is now CEO of Crianza Aviation, which has a strategy of being an operating lessor with a widebody focus, combined with the ability to offer tailored investments to institutional investors.

Crianza grew quickly after being formed in 2016 by Korean alternative investment IMM Investment Corporation and Cerritos Holdings.

Cerritos Holdings is an independent Seoul-based financial services provider, and has been involved in cumulative investments of over $4 billion.

IMM focuses on venture capital, mezzanine and infrastructure, with 12 venture capital funds and 13 private equity funds under management.

Total assets under management are KRW2.1 trillion ($1.87 billion).

One of the private equity funds is the Crianza Aviation Mezzanine/Infra fund.

The strategy is to build a sizeable portfolio, thus giving investors access to a well-diversified pool of aircraft types and airlines.

EastMerchant had become involved with Crianza on a deal involving two A330s, and then invested in Crianza itself.

IMM and Cerritos them made the offer for EastMerchant, which will remain an independent operating entity within Crianza.

Also active in the market is brokerage firm NH Investment & Securities, which was also involved in the 2017 Qatar Airways deals.

NH underwrote $70 million of mezzanine debt for a fund acquiring two B-777-300ERs, and sold it down to institutional investors.

NH is heavily involved in global real estate deals, as well as some shipping deals.

KDB and NH Investment & Securities each recently underwrote a $15 million subordinated debt tranche to help refinance the $330 million acquisition of three new vessels by Teekay, an operator of crude and LNG tankers.

Teekay also sourced $260 million in 12-year senior debt from KDB, Export-Import Bank of Korea (Kexim) and a group of global banks to refinance the shuttle tankers, built by Samsung Heavy Industries.

In July 2017, KDB, KTB Asset Management and Uni-Asia signed a memorandum of understanding (MOU) on ship finance, tapping on KDB’s $1bn Ocean Value-up Fund Program.

KDB’s Ocean Value-up Fund Program was introduced in 2015 with the aim of supporting small and medium-sized shipping companies by helping them build new vessels and purchase secondhand units.

The program has supported 12 projects since inception, and KTB has been actively looking to pursue more projects with foreign shipowners.

Alternative investment firm Uni-Asia’s shipowning arm is Uni-Asia Shipping, which operates drybulk carriers.

As at end-April 2017, Uni-Asia Shipping operated a fleet of nine bulk carriers with capacity ranging between 28,300dwt and 37,000dwt.

The Uni-Asia group also has businesses in property investment and management and hotel operations.

Under terms of the the MOU, KDB will provide up to 70% of ship financing for Uni-Asia, with the remaining 30% to be arranged by Uni-Asia itself.

KTB will provide the necessary services to establish and afterwards manage the investment fund.

Uni-Asia was delisted from the Singapore Exchange (SGX) in early June 2018 as part of the group’s ongoing restructuring by way of a scheme of arrangement.

On completion of the restructuring, Uni-Asia will become wholly owned by NewCo Group, an investment holding firm incorporated in January 2018.

KTB Asset Management recently hired a vessel-financing expert and has been drumming up ship financing business in the UK, Germany and Singapore.

In addition to shipping KDB has been active in the aircraft market over the past several years.

KDB is the largest government policy bank in Korea, offering clients a broad range of financial products and services with expertise in corporate banking, investment banking and corporate restructuring.

In the aviation finance arena, the bank offers diverse financing solutions to global airlines and aircraft lessors.

KDB is by far the most active and largest financier of the aviation sector in Korea, with plans to further expand its international client base in Americas and Europe.

KDB has aviation finance desks dedicated to deal origination in Singapore and London.

In April 2018 KDB took a $50 million particpation in a six-year senior loan to Jakarta-based low-cost carrier Lion Air, as part of a $420 million refinancing led by GE Capital Aviation Services (Gecas) unit PK AirFinance.

Gecas announced on 13 April conclusion of an aircraft financing transaction covering 51 aircraft operated by parent Lion Air Group.

The financing covers 21 B-737-900ERs operated by Lion Air and 30 aircraft on order by the low-cost airline, including B-737max8s and max9s, as well as A320neo and A321neo aircraft, according to Gecas.

And in August KDB was part of a syndicate led by DVB Bank that led a financing for 12 A319-100, 15 A320-200, four B-767-300ERF and one B-767-300ER for Latam Airlines Group.

The syndicate was comprised of DVB Bank (structuring agent, joint lead arranger, underwriter and agent), BNP Paribas (joint lead arranger and underwriter), Airbus Group Bank (co-arranger and underwriter), Sumitomo Mitsui Banking Corporation (co-arranger and underwriter) and KDB (co-arranger and underwriter).

Korean institutions are also looking for business in Taiwan.

In December 2017 KIS acquired a B-777-300ER on lease to Taiwan-based China Airlines for a reported $165 million.

The seller was Aviation Capital Group (ACG).

This was the first investment by a South Korean investor in an aircraft flown by a Taiwanese carrier.

Senior debt from Taiwan

Although Taiwanese institutions are not particularly active in aircraft equity, Taiwanese banks have become sizeable players on the senior debt side, including lending to major operating lessors.

Active lenders include Bank of Kaohsiung, Bank of Taiwan, Bank SinoPac, Cathay United Bank, Chailease Finance, Chang Hwa Bank, CTBC Bank, E SUN Commercial Bank, Exim Bank of ROC, First Commercial Bank of Taiwan, Hua Nan Commercial Bank, Industrial Bank of Taiwan, Land Bank of Taiwan, Taichung Commercial Bank, Taipei Fubon Bank, Taishin International Bank, Taiwan Business Bank, Taiwan Co-operative Bank, Taiwan Shin Kong Commercial Bank and Yuanta Commercial Bank.

Steady economic growth and strong corporate balance sheets are expected to support the banks’ collective asset quality.

Moody’s Investors Service forecasts annual system loan growth of around 5% in 2018 and 2019, compared with 3.6% in 2017, with lending to small and medium-sized enterprises (SMEs) being the key growth driver.

Stable economic growth in Asia also supports the asset performance of banks’ overseas lending.

Banks are able to support faster loan and risk-weighted assets (RWAs) growth through internal capital generation.

Margins on banks’ domestic lending will remain depressed by intense competition and modest loan demands, but those on foreign currency-denominated lending will widen, according to Moody’s.

The loan-to-deposit ratios of rated Taiwanese banks averaged a low 74% in June 2018.

Their refinancing risks are limited because they have low reliance on wholesale funding and a high proportion of liquid assets.

Liquidity conditions will remain ample as a result of the central bank’s accommodative monetary policy, according to Moody’s.

“Steady economic growth and strong corporate balance sheets will support the asset quality of banks in Taiwan,” says Sonny Hsu, a Moody’s vice president and senior credit officer.

Middle Eastern Mezzanine

South Korean institutional investors have a strong appetite for mezzanine debt, including via fund structures, but the Middle East has also developed as a strong market for mezzanine tranches.

Following the success of Tamweel Aviation Finance (TAF), in March 2018, Dubai-based Novus Aviation Capital announced the launch of a second junior debt fund — Tamweel Aviation Finance II (TAF II) — dedicated to financing Airbus aircraft.

The first Tamweel Fund was launched in July 2013.

As with the first fund, TAF II is a partnership between Airbus, Development Bank of Japan (DBJ), NordLB and Airbus Group Bank.

The vehicle is managed by Novus, and will focus on providing attractive junior and mezzanine financing solutions to airlines and leasing companies.

“We are very excited with the launch of the second edition of our junior debt platform and would like to thank our partners for their continued support.

“The growth outlook of the airline industry along with the large delivery stream are expected to drive an increasing demand for this type of financing product,” said Mounir Kuzbari, managing director at Novus.

“Since DBJ strongly believes junior loans will support finance activity for airlines and lessors, we are very pleased with TAF II’s successful closing,” added Masashi Kumagae, general manager at DBJ.

“Within the last few years, Tamweel Aviation has been established as one of the leading providers of junior debt in the aircraft finance market, and the performance of the vehicle and the strategic value it adds to our business model is even higher than we had expected before joining in 2014,” said Oliver Gruenke, director at NordLB.

With the commitments allocated to TAF now fully invested, NordLB joined successor fund TAF II.

In June 2018, Gecas and Novus closed a debt financing agreement with Philippine Airlines (PAL).

Gecas unit PK AirFinance provided senior debt for the acquisition of four new A321-200neo aircraft, while Tamweel signed up to provide a mezzanine loan for each aircraft.

The loan will finance PAL’s acquisition of the aircraft and a spare engine, part of the airline’s strategy to grow medium-range routes while modernizing the fleet.

The first aircraft delivered in May 2018.

“PK AirFinance has enjoyed long-standing relationships with both PAL and Novus,” said Shinji Sato, executive manager at PK AirFinance Japan.

“The opportunity to work with Novus to support PAL’s growth strategy is a natural extension to our relationship.”

“The combination of asset type and stakeholders involved in this transaction makes it appealing for both Novus and Tamweel Aviation Finance, one of the industry’s leading mezzanine loan providers,” said Hani Kuzbari, managing director at Novus.

“This debt structure is an attractive value proposition and we look forward to replicating this with both PK AirFinance and PAL on future transactions.”

Overheated markets

Against this background of overheated markets, and with a large number of new players chasing both new and midlife aircraft, there are concerns about valuations.

In the recently published Aviation Finance Outlook 2019, Scope Ratings warned that market conditions remain relatively benign, but that a price correction could be close at hand.

According to Scope, pre-crisis aircraft valuation trends are reasserting themselves.

“In particular, market players have become less discriminating in valuing different versions of aircraft models, fitting a pattern of previous late-cycle behaviour, says Helene Spro, analyst at Scope.

Scope’s analysis of 26 years of data shows a trend of the market neglecting to take aircraft-specific factors into consideration around two years before a crisis, and narrowing valuations have proved a feature in 2018.

“Along with abundant liquidity and high loan-to-value (LTV) ratios, this creates a market vulnerable to external shocks,” says Spro.

“Certain riskier investments might suffer losses if a disruptive event occurs.”

One example is the market values for a 2018-vintage A320ceo aircraft and the newer technology A320neo, estimated at $45.42 million and $46.36 million respectively, according to aircraft valuation specialist Oriel.

The valuation gap is small even though the new-engine model has 15% better fuel efficiency, according to Airbus.

The present values of the A320neo and A320ceo should be fundamentally different due to the cost savings potential from reduced fuel burn.

If both aircraft are financed with the same LTV, the credit risk is higher for the A320ceo.

It is more likely the A320neo will recover some lost market value after a crisis compared with the older-technology model.

Volatile oil prices and rising interest rates represent the main short-term external risks for the commercial aviation sector in 2019.

High fuel prices in particular partially explain the default of a number of small European carriers, including Primera Air, VLM, Small Planet, Azur and SkyWork.

Scope has seen little effect from these defaults on aircraft values due to the benign overall market environment, marked by continued economic growth, falling unemployment and growing demand for air travel.

The effect would be more severe if larger carriers were to default in a downturn.

“We believe benign market conditions will continue into 2019, but investors should perform conservative risk assessments to build value buffers to prepare for a market downturn,” says Spro.