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INTRODUCTION TO
AVIATION FINANCE

Paul Ng
April, 2016
Partner, Milbank
History of commercial aviation

• 1 January 1914 – world’s first commercial flight with one commercial passenger on one commercial flight

• 1 January 2014 – an estimated 8 million people flew on nearly 100,000 flights on that day

• Statistics from IATA, show that some 3.1 billion people flew in 2013, surpassing the 3 billion mark for the first time ever

• About 50 million tonnes of cargo is transported by air each year (about 140,000 tonnes daily). The annual value of these goods is some
$6.4 trillion—or 35% of the value of goods traded internationally.

• Aviation supports over 57 million jobs and generates $2.2 trillion in economic activity. The industry’s direct economic contribution of
around $540 billion would, if translated into the GDP ranking of countries, place the industry in 19th position.

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IATA Outlook

• ​IATA’s airline industry outlook for 2016 - average net profit margin of 5.1% with total net profits of $36.3 billion

• The strengthening industry performance is being driven by a combination of factors:

• Lower oil prices

• Strong demand for passenger travel (+6.7% growth in 2015 and +6.9% in 2016)

• Stronger economic performance in some key economies (including a faster than expected recovery in the Eurozone) is outweighing the
overall impact of slower growth in China and the downturn in the Brazilian economy

• Efficiency gains by airlines are illustrated by record high load factors (80.6% in 2015, tapering slightly to 80.4% in 2016). Capacity is
increasing and is expected to move ahead of demand growth in 2016.

• Profits for the Asia-Pacific region expected to grow from $5.8 billion in 2015 to $6.6 billion in 2016.

• Passenger capacity growth is expected to accelerate from 6.0% in 2015 to 8.4% in 2016 as new aircraft are delivered largely to
accommodate growth in the major emerging markets of India, Indonesia and China.

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What is Asset Finance?

• Financing of specific assets or equipment

• As opposed to a project, or a whole business

• May be single assets, or portfolio

• Bank

• Leasing company

• Capital Markets, via trustee

• May be loan or lease, or both combined

• “Security” over asset very important

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Aircraft

• Used and traded globally: “dollar assets”, traded and financed in US dollars

• Very long useful life, 25 to 30 years

• Very high cost – Airbus A320 $88 million; Boeing 737-800 $90 million; Boeing B747-800 $350 million; Airbus
A380 $390 million

• Mobile and potentially dangerous – risk of third party liability

• Global financing market – London, New York, Paris, Frankfurt, Hong Kong and Tokyo

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Cornerstone of Aircraft Financing

Bank Debt

Leasing Export Credit

Companies

Capital
Markets

• Each financing source is susceptible to both credit market and regulatory shocks which can
reduce the supply and increase the cost of financing

• A diverse funding strategy would be prudent for airlines / lessors

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Sources of Aircraft Financing

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Evolution of Aircraft Banking

• The 1960s – 1980s: US Banks lead the way

• Wells Fargo; Chase; Citibank; Bankers Trust; The Bank of America

• The 1980s: Japan to the forefront

• Sumitomo Bank; Fuji Bank; IBJ; Nissho Iwai

• The 1990s – today: European banks take over

• KfW; Calyon; DVB; Natixis; BNP Paribas; Royal Bank of Scotland; HSH Nordbank

• Regional Variants

• Primary source of debt for deliveries in China is Chinese banks – ICBC; China Merchant Bank; Bank of China; China Development Bank;
Agricultural Bank of China; China Construction Bank

• Chinese banks starting to establish a global presence and fund internationally – ICBC provided debt to Korean Air, Lufthansa, British
Airways; CCB to Emirates; Bank of China to Qantas, for instance

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The Banks

• Many banks worldwide specialize in aircraft finance to airlines

• London a major centre for bank financing

• Usually part of larger transportation finance, structured finance or project finance division

• Banks include Citi, Deutsche, SMBC, BNP, CACIB, Natixis

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Secured Loan – Basic Structure Documentation

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Finance Lease – Basic Structure Documentation

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Finance Lease – Basic Structure Documentation (Cont’d)

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Common Features

• Special Purpose Companies

• Limited Recourse

• Engine Interchange

• Hull, Hull War and Liability Insurance

• Hull cover provides hedge v third party claims

• Hell and high water clause

• Quiet enjoyment from lessor and mortgagee

• Interest Rate Swaps

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Security

• Aircraft mortgage

• Security Assignment of lease and hull insurances

• Charge over bank account

• Legal opinion of legal counsel v important

• Import of aircraft

• Local filings

• Ability to repossess, deregister, export

• Withholding tax on lease rentals, documentary taxes

• Advice on strict liability of owner

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Role of Manufacturers in Financing

• Backstop Financing – secured loans or leases

• Asset Value Guarantees or Residual Value Guarantees

• Product Warranties assignable to financier

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Role of Export Credit Agencies in Financing

• Credit Support – Loan or guarantees to support bank loans

• US: Eximbank

• Europe: ECGD, COFACE, HERMES (UK, France, Germany)

• Canada: EDC

• Brazil: Ex-Finamex

• Must qualify as exports

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Illustrative Structure for an ECA Guaranteed Loan
The following represents an indicative structure of an ECA-supported financing for commercial aircraft

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2011 ASU Premiums – Past and Present

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Calculation of Premium Rates

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Leasing Companies

• Purchase aircraft in bulk from manufacturer

• Negotiate packages of leases with airlines, usually operating leases

• GECAS (GE Capital Aviation Services) a subsidiary of GE Capital, based Shannon

and Stamford, Connecticut

• ILFC (International Lease Finance Corporation) previously a subsidiary of AIG,

based Los Angeles – now purchased by AerCap

• AerCap a Dutch/Irish based lessor, listed on NYSE

• SMBC Aviation based in Japan, acquired RBS Aerospace, so large presence in Dublin

• Avolon Dublin based lessor

• BOC Aviation based Singapore

• Some banks also provide operating lease finance

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Increasing Ownership by Lessors

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Operating Leases

• Lessor keeps main risks and rewards of ownership

• Five year lease of Boeing 737 at a fixed monthly rental of $220,000

• At expiry, airline will hand back aircraft

• Lessor takes residual value risk and reward

• Ongoing maintenance covenants and return conditions very important

• Lessor may take security deposit

• Lessee pays monthly maintenance reserves

• Fixed or floating rate monthly rent

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Operating Lease – Basic Structure Documentation

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Finance Leases

• Risks and rewards of ownership transferred to lessee

• Full pay-out lease – repay entire initial cost plus interest

• Functional equivalent of a loan

• 10 to 12 years in Europe and Asia, up to 25 years in USA

• Lessee has purchase option at end of lease, at nominal cost

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Tax Benefit and Balance Sheet

• Banks have greater taxable profits than airlines

• Banks may claim depreciation benefits or allowances to offset against profit

• Airlines may get off balance sheet treatment

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Cape Town Convention

• Concept of international interest

• Sale agreement, lease or mortgage

• Virtual international registry

• Improved relief on solvency of airlines

• Key to cheaper financing

• Ratified in many key aviation centers – US, Canada, China, India, Ireland, UK,
Ireland, Myanmar

• Protocols for rolling stock and satellites under development

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Recent Developments

• Banking Crisis – European banks hit by liquidity difficulties and risk aversion. Most withdrew from market for new
loans, leading to lack of commercial debt for new deliveries

• Export Credit

• Increased during credit crises as commercial debt decreased. EX-IM provided $3.7m support in 2008, $7.9m by
2010, and over $12m in 2011 for Being deliveries

• European ECAs similarly increased

• Support either by providing guarantees to commercial lenders, or a direct loan from the credit agency

• Controversial – not available to all (“home market rule” observed by US and EU (UK, France, Germany, Spain) but
not by Canada or Brazil))

• Increased regulatory supervision of bank activity

• Basel III – potentially increases costs to bank lending

• FACTCA – potentially reduces payments to bank

• Anti-money laundering; Anti-Terrorism; Anti-Corruption Laws – potentially subjects the bank to criminal and civil
sanctions including fines

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Recent Developments

• Increased reliance on Capital Markets

• US airlines have used capital market products successfully for many years.

• “Enhanced Equipment Trust Certificates” raised $10.2bn for US airlines in 2001. Fell off in mid-2000s because of cheaper European
debt. Back up after 2010 with over eight international airline issuances (not just US airlines).

• Recovered much faster than debt markets after financial crisis

• Relies on “enhancements” to airline credit rating – including liquidity facility to ensure payments of interest, tranching, and strong
repossession/bankruptcy protection in the US

• US “Section 1110” bankruptcy protection for airlines – specific tool to allow financing to airlines. American Airlines successfully issues
EETCs when in Chapter 11 proceedings!

• Overseas EETCs

• Long been mooted as non-US airlines look to access capital markets. Quasi-EETC products in early 2000s (Iberbonds, AirFrans)

• First “modern” foreign EETC – Doric Alpha 2012 (Emirates Airline; Doric Alpha as operating lessor; 24-month liquidity facility; relies on
Cape Town Convention as providing functional equivalent to s1110)

• 2013 BA EETC – first non-US EETC without benefit of Cape Town Convention.

• Others?

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What do we do

• “All of the above”

Financing and Leasing Material Contracts Regulatory and Other Advice

• Predelivery Financing • Acquisition/Divestment • Cape Town

• Finance/Operating Leasing • Maintenance; Power by the Hour; • Insurance

FCPH, Time and Material

• Financing through Banks and • Training Facility • Claims

other Financial Institutions
• Financing through Capital • Simulator Facility • Sanctions advice
Markets
• Equity Investment and Quasi • Setting up of Maintenance Facilities • Emissions Trading
Equity Investments
• Air Services Treaty

• Sales, acquisitions, joint ventures and restructurings involving airlines, lessors and banks; setting up of airlines and
aircraft leasing companies etc.

• Assets: commercial passenger and cargo aircraft; business/corporate jets; engines; simulators; satellites; rockets;
drones; vessels; ships; submarines; trains; locomotives; computer switching devices and other moveable assets

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Awards

• Ranked # 1 (Chambers Global and Legal 500)

• Award Winning Team

• 2015 Awards Global Transport Finance Awards

• AVIATION ABS DEAL OF THE YEAR - EUROPE : Aldus Aviation Limited

• AVIATION ABS DEAL OF THE YEAR – ASIA: Bank of China Aviation

• EETC DEAL OF THE YEAR – EUROPE: Turkish Airlines

• EETC DEAL OF THE YEAR – NORTH AMERICA: American Airlines

• EETC DEAL OF THE YEAR – LATIN AMERICA: LATAM Airlines

• GLOBAL AVIATION M&A WITH FINANCE DEAL OF THE YEAR: AWAS / Macquarie

“Simply fantastic…”
- CHAMBERS

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