Investor’s guide: Private lending in aircraft finance

In older and simpler days, a business seeking debt financing could get a bank loan or, if it was a large corporate, tap capital markets with a bond issuance.  With the advent of complex financial instruments and bespoke structuring over the past 20 years, borrowers have been able to offer institutional investors a way to invest in debt arranged through private and confidential transactions. 

Financiers confirm that there has been a dramatic increase in privately placed debt structures in aviation over the last three years.  Airlines and operating lessors have been able to tap into institutional investors’ significant appetite for yield and US denominated hard assets by offering EETC and ABS-type issuances.

The Ishka View is that private placements will likely retain its appeal to both issuers and new and existing investors. The benefit of a private deal for aviation borrowers is that they can take advantage of tighter margin spreads, opt for smaller deals and ensure more flexibility in the terms of the loan.  Investors, on the other hand, are hungry for private deals to ensure they gain exposure to aircraft assets. Typical private lending structures continue to provide investors with access to attractive returns on a historically well-performing asset class. Moreover these private structure are often structurally enhanced transactions with significant downside/recovery protections.
 

A rose by any other name

Nearly all private lending structures are arranged, and structured, by banks and then placed with investors. The primary appeal of a private debt instrument to an issuer is the confidentiality of the transaction and the flexibility it affords in regards to terms and conditions.  The trade-off for flexibility is normally stronger investor protections and willingness to accept closer investor monitoring on an ongoing basis. An issuance in the public markets is normally subject to minimum amounts and significant regulatory mandated disclosures which may make it less attractive, or prohibitively expensive, for companies with smaller capital-raising requirements.

 

Private lending structures

Private lending for aviation assets is usually arranged through a few principal formats: leveraged loans, corporate direct lending, leveraged direct lending and private placements.

Corporate borrowers will choose to use these format depending on their size, place on the creditworthiness spectrum and pricing/tenor requirements.  Some of private debt instruments are illiquid, while a limited secondary market does exist for others.  Here are the major characteristics in more detail:

Private placements have been relied on repeatedly by operating lessors such as AerCap and aircraft-backed funds such as Apollo Aviation.  In general, private placements are unlisted debt securities—structured as bonds, loans or notes—issued by mature, often privately owned, investment grade or equivalent corporates to a limited group of investors through an agent bank.  Investors participate in negotiating the deal structure and are expected to underwrite their share of the placement which may contain multiple tranches of different tenors and sizes.  With maturities of up to 12 years, private placements are designed to be held to maturity and are therefore illiquid.  They are often issued on a senior unsecured basis, which is protected through strong covenants.

 

Corporate direct lending is normally extended on a bilateral basis to mature, low leverage yet sub-investment grade mid-sized companies.  Such companies may have annual revenues of up to $500 million and be focused on a given geography or market sector and lack diversification. The loan size may vary anywhere from $25 million to $75 million, even though bigger sized deals may be arranged. Corporate direct lending is more likely to be arranged directly with a borrower, rather than syndicated or marketed by an intermediary.  Unsecured borrowing by an airline is an example of corporate direct lending.

Leveraged loans are sub-investment grade instruments issued by large highly leveraged companies to finance mergers, acquisitions and leveraged buy-outs (LBOs) (e.g. by private equity firms).  Deal size varies but can exceed $1 billion, transactions are normally syndicated by investment banks among a group of lenders.  Leveraged loans are typically tranched, with the senior secured loan(s) benefitting from lower leverage and enhanced security provisions compared to the investor protections offered to junior secured (“second lien” or “mezzanine”) tranches.  Typical contractual maturity for a leveraged loan is up to eight years but the borrower often chooses to exercise an early prepayment option.  An emergent secondary market for leveraged loans has improved the liquidity profile for such instruments.  An example of a leveraged loan in the aircraft space would be a buy-out of an operating lessor by a private equity firm.
 

Leveraged direct lending takes form of secured loans, usually in the amount of up to $50 million-$70 million, and advanced directly to smaller, closely-held, usually leveraged firms in a transaction arranged directly with the company or its financial sponsor.  Typical tenor of a leveraged direct loan is up to eight years, however, early prepayment is common. Pricing typically reflects higher risk due to illiquidity, increased leverage and a “single tranche” structure, especially if provided by a single (as opposed to a club) lender. 

 

The Ishka View

Private lending in aviation space, whether on secured or unsecured basis, offers both issuers and investors an opportunity to negotiate mutually beneficial structures which combine strong investor protections with attractive pricing/tenor features.

Private lending has become more popular thanks to a continued rise in the number of investors seeking opportunities with aircraft assets. Many see an opportunity to diversify away from public credits. Others see an opportunity to structure deals that may better fit their particular investment hurdles.

The benefit of a private debt arrangement for aviation issuers is the ability to raise capital without bearing the significant costs and burden of financial disclosure associated with issuance in the public markets. Private lending offers airlines, and lessors, a reasonable degree of flexibility. It also represents a distribution channel for banks to syndicate down debt but still retain arrangement fees. 

Investor demand is still very apparent in this market. Barring unexpected economic shocks, aircraft issuers and investors in 2017 will be building on the already active EETC and ABS market and are likely to enter into more private transactions.
 

Please Note: The views expressed do not constitute investment advice. We accept no liability to recipients acting independently on its contents in respect of any losses, including, but not limited to profits, income, revenue or commercial opportunities.

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