With the opening of Europe's investment markets for raising aircraft finance, competition with the USA is due to hot up
Anthony O'Connor/LONDON
The disappearance of the mainstay finance alternatives for many carriers has meant increased reliance on government-backed aircraft financing deals. "As fewer financing alternatives are available, that puts more pressure on those that remain," says Robert Morin, vice president of the transportation division of the US Eximbank, Washington DC. "The market brings to us the deals that it can't do."
With distinctly polarised competition between Airbus and Boeing in the large (100-plus seats) commercial aircraft market, a scratch beneath the surface reveals that the government plays a vital role in financial support. The airline industries in the USA and Europe are fully deregulated and open to competition. As such, they should be free from government influences. Nevertheless, the government plays as forceful a role as ever in aerospace and aircraft sales, benefiting many deregulated airlines.
The way aircraft are financed depends largely on trends in banking and finance markets.
Call for modernisation
There are now calls to modernise, however, the principal agreement on which the USA and the Europeans provide support for aircraft sales. The Large Aircraft Sector Understanding (LASU), which dates back to the mid-1980s, defines the accepted code of practice of how aircraft are financed with support of the export credit agencies. While the US perception is that the launch subsidies given to the Airbus A380 programme are intrinsically unfair, there has been similar transatlantic debate over how far the USA and the Europeans will go to support sales of their aircraft.
In Europe, Airbus sales are supported by the export credit agencies (ECAs) of the Export Credit Guarantee Department (ECGD) in the UK, Coface of France and Hermes of Germany. The Europeans take a mixed portfolio approach to the airlines for which they will provide export credit cover. They have supported developing carriers like Croatian Airlines, Qatar Airways and Chinese airlines. They also extended support to Cathay Pacific at the end of December, which in finance circles is considered to be a first-tier carrier and, as such, could tap the commercial markets for funds with ease. However, the ECAs support airlines across the board.
In the USA, US Eximbank mainly provides support for Boeing products if there is no other viable option from the commercial banking sector. Typically, each agency guarantees finance deals of up to 85% of the aircraft's total value, with the other 15% coming from commercial banking loans or from the airline's own equity.
LASU was agreed as part of the OECD protocol and restricts airlines in France, Germany, the UK and the USA from taking advantage of export credit support. Known as the Home Country ruling, the USA and Europe are likely to discuss this in the context of updating LASU.
Airline appeal
Disagreement and debate over the past two years has centred on the way the US Eximbank and the ECAs have adapted financings to make them more appealing to airline users. LASU allows for 12-year financing, but for many airlines this is too short a term. Consequently, both sides have completed transactions involving the use of mismatched loans to extend the length of the finance term and make it more attractive. The US Eximbank has a structure in place which also gives longer financial benefits to aircraft financings. "The fact that LASU is limited to 12 years deters some airlines," says Morin.
The US Eximbank has also eased financing for three airlines in the Asia-Pacific region this year by offering the option under the "Jet Fuel Index Interest Rate" scheme. If an airline suffers from hikes in jet fuel prices, it can take advantage of paying lower financing costs under the US Eximbank-supported deal. It then makes up the balance when jet fuel prices go down.
Direct comparisons between the support provided by the USA and the Europeans is difficult because there are so many variables. The only common factor the US Eximbank and ECAs share is the support - as part of their larger mandates - of their aerospace industries through exports.
Supporting aircraft sales under LASU guidelines is expensive for Europeans. LASU offers a fixed rate for up to three years in advance of deliveries. Aircraft purchasers lock into this rate and play wait-and-see. If, at the time of delivery, this rate is cheaper than the commercial bank borrowing rate for long-term debt, the buyer will probably take the cheaper option. That is precisely why top-tier carriers like Cathay Pacific are taking advantage of it.
However, from March this fixed-rate option will cease to be available to airlines and leasing companies when they sign their purchase agreements, says Chris Leeds, head of the ECGD's aerospace team in London. "We are not just doing this to please the Americans," he says. In contrast, the US Eximbank does not book much of its business through this fixed-rate approach.
One of the greatest mismatches in the field of aircraft finance is that government policy may cater for the provision of aerospace sales support, but it lags behind rapid market changes.
Throughout the 1990s there was talk on both sides of the Atlantic that LASU should be redefined to take account of the changing needs of the market. Leeds explains that when LASU was first in place, Airbus did not have the top airline and leasing companies on its order books. The fixed-rate finance option was a good marketing tool for airlines with weaker credit profiles.
The provision of export credit support can be part of a larger international trade relations issue - the grey area where politics and economics merge. A leading European aircraft finance lawyer says that he was once astounded when he saw documentation of an industry order being related to "other" exports which were all part of a larger international trade relations package.
A classic example of the highly competitive nature of the large commercial aircraft sector was shown four years ago when France's President Jacques Chirac visited Beijing to sign a sizeable order for Airbus aircraft destined for several Chinese carriers. The next day, respected media from around the world decried the visit on the basis of Chirac's lack of morals in the face of China's record on human rights. At the time, an industry source in Washington DC said that this was the Washington lobbying machine doing what it does best. Months before Chirac's visit, then US Vice President Al Gore had signed a similar deal in Beijing for Boeing.
With record Boeing deliveries in 1999, the US Eximbank also posted a record $6.3 billion in loan authorisations during its 1999 fiscal year to 30 September on total aircraft sales of $7 billion. In figures released in mid-December for the 2000 fiscal year, coverage was reduced to $3.5 billion in loan authorisations on aircraft sales amounting to $4 billion. This accounted for 63 aircraft deliveries to 19 airlines in 15 different countries, reflecting a lighter delivery year for Boeing.
Record year for UK
The UK's ECGD too reported a record year for 1999/2000 (to March 31 2000) for all UK exports but also the highest level of coverage it has ever given the aerospace sector - mainly Airbus - amounting to £1.3 billion ($1.88 billion) of UK sales. The French agency Coface and Germany's Hermes provided similar cover for Airbus, but Spain's export credit agency Casa does not support Airbus sales.
While the USA offers sales support to deals which it says the market cannot do, it is not always so simple. The US Eximbank has provided cover for a large portion of Boeing's sales into the Asia-Pacific region because the cost of financing for many of these carriers would be very high in the commercial banking sector. "Airlines know that, within reason, Exim and the ECAs will try to support the sales of aircraft for their respective manufacturers by offering support to a whole host of different applicants. Airlines also know that this finance route will save them considerable amounts," explains one air finance banker in London.
Banking and finance sources in the aircraft finance market estimate that as much as40-45% of all new commercial aircraft deliveries were financed through export credit-supported transactions in 2000. While this form of finance has proved an important funding tool for Airbus and Boeing to secure sales, creative developments have occurred in the commercial banking market.
The last year has seen a renewed focus on developing the European capital markets to provide funds for international aircraft finance. With its many legal differences and, indeed, cultural disparities in offering a pan-European finance solution for airlines seeking finance, Europe lags behind the USA. The USA has always benefited from a private-sector airline industry, a uniform legal system and a willingness, based on familiarity, from investors to inject funds into the sector.
Nevertheless, a finance deal completed for US major Continental Airlines in November shows that the European capital markets are becoming more comfortable in international aircraft finance. The $176 million deal covers a number of the airline's Boeing aircraft and has been structured as securitisation.
Securitised deals package a number of aircraft against which securities or notes are sold to investors. Essentially, each investor holds bonds bearing a certain interest rate over a set period of time known as the term.
Jose Abramovici, head of Credit Lyonnais' Parisian aerospace team, says European investors welcomed the Continental deal because it features a floating rate and not a fixed rate of interest as is typical with comparable deals done in the USA.
The deal is a landmark in the securitisation market as it has largely been sold to European investors, says arranging bank Credit Lyonnais.
While Continental went for a dollar-denominated structure, reflecting most of its sales, Abramovici says the structure could be applied to a carrier with mainly Euro-denominated sales. This type of structure could pave the way for other airlines in Europe and Asia Pacific.
On a technical note, the Continental deal is known as a floating-rate enhanced aircraft trust securities (FEATS) structure. For investor confidence, the financing structure features credit ratings from the main ratings agencies.
The senior tranche is considered to be special because it is pure and not wrapped by a specialist insurance agency, as is the case in many deals. Rated AAA by Standard & Poor's and Fitch IBCA, it has a 12-year maturity, is valued at$92 million and has a coupon of 49 basis points. The subordinated tranche is rated A- by the two agencies, runs over 10 years, is valued at$84 million and features a coupon of 70 basis points. This means that investors will get 0.49% and 0.70% respectively over an agreed bank lending rate on the amount of funds they invest.
Spanish flag carrier Iberia has played an important role in developing an investor appetite for this kind of structure in the European market. Credit Lyonnais joined Tokyo Mitsubishi International and Morgan Stanley in jointly underwriting the Spanish carrier's second European enhanced equipment trust certificate (EETC) structure in Sept-ember. The deal, valued at $200 million, helped to finance some of Iberia's 2000 delivery of Airbus A320-200s and Boeing 757-200s.
Opening the market
The opening of the European investment markets for aircraft finance is an important development in financial circles. Most US majors have tended to tap the US capital markets through EETCs - some totalling more than $700 million. But in the last quarter of 2000, the investor appetite for these kind of bond deals had slipped. Sources say that this is one of the reasons why Continental Airlines sought access to European funds.
Financiers work hard to ensure that deals like these are enhanced so that they receive investment-grade ratings, such as the AAA rating in the Continental FEATS deals. Without it, investors will just shy away and invest their funds elsewhere.
Among financiers there is a split in opinion over how the European capital markets will grow. Some believe this funding source may become an alternative source of funding for the US majors when the US capital markets are depressed. Others believe that Iberia's example will convince other carriers to follow suit. "The fact that Europe's capital markets are becoming more receptive to ploughing in funds to aircraft finance can only be a positive step. Albeit a long-awaited one," says one senior London-based banker.
Source: Flight International
