Government Support in Financing the Aviation Market

Elizabeth EvansAndrew SteinbergSeptember 15, 2010

UBM Aircraft & Engine Finance & Leasing Conference

Overview

Aircraft Finance NextGen Finance

Andy Steinberg advises airline, aerospace, and travel technology companies on strategic and regulatory issues before the U.S. government, including the Federal Aviation Administration and the Office of the Secretary of Transportation.

Liz Evans concentrates her practice in aviation, project, and satellite finance as well as in equipment leasing and related transactional work, including private placements of debt and equity, structured finance arrangements, asset-based financings, and leveraged leasing.

AIRCRAFT FINANCE

Background on Export Credit Finance• Export Credit Agency (ECAs)

• Institutions, private and/or governmental, that provide financing to support exports of various aircraft and engine manufacturers in the host country.

• The precise terms and conditions of the financing support available from the individual ECA differ.

• Broad parameters governed by the Aircraft Sector Understanding (ASU) (effective July 1, 2007) under which the ECAs of the U.S., EU, Japan, Brazil and Canada agreed to guidelines for financing to provide fair and balanced competition of aircraft exports.

• Key ECAs • Export-Import Bank of the United States (Ex-Im)• Export Credits Guarantee Department (ECGD) in the UK• Compagnie Francaise d’Assurance pour le Commerce Exterieur

(COFACE) in France• Consortium of Hermes Kreditversicherung Aktiengesellschaft and C&L

Deutsche Revision (HERMES) in Germany)• Export Development Bank of Canada • Brazilian Development Bank (BNDES); EXIM Brasil Agéncia Crédito á

Exporta çāo do Brasil S.A.

ECA Financing in Today’s Market• ECAs have been a traditional aircraft financing source for over thirty years. • In 2009, ECA support for Boeing and Airbus increased from 20 to 40% of deliveries.• In 2009, Ex-Im authorized $8.6 billion of aircraft financing (as well as $980 million for

exports of other small-transportation related equipment). This compares with an average of $4.4 billion for each of the past several years. Likewise, the European ECAs substantially increased their support for Airbus deliveries.

From The Wall Street Journal August 13, 2010

Ex-Im Products Offered

To accomplish its mission, Ex-Im offers the following products:

1. Direct loans at competitive, fixed interest rates to foreign buyers of U.S. exports.

2. Export credit insurance, protecting exporters against the failure of foreign buyers to pay their credit obligations.

3. Guarantees to commercial lenders, providing repayment protection for loans to foreign buyers of U.S. exports.

4. Guarantee of bonds limiting the impact on bondholders if the issuer of the bond goes into default.

5. Working capital guarantees, encouraging commercial lenders to make loans to small companies with export potential who need funding for production/ marketing.

Ex-Im Finance Lease Structure

Most Ex-Im supported aircraft transactions use a finance lease structure.

1. A special purpose company (“SPC”) is established to act as both borrower under the Ex-Im guaranteed loan and lessor (or purchaser) under a finance lease (or conditional sale agreement) to the airline purchasing the aircraft

2. The airline assigns its rights under its Boeing Purchase Agreement to the SPC in respect of the aircraft being financed.

Ex-Im Finance Lease Structure (cont)

• The Guaranteed Lender(s) make a loan to the SPC towards the purchase price of the aircraft pursuant to a Guaranteed Loan Agreement (the “Guaranteed Loan Facility”).

• Under applicable regulations, the amount borrowed under the Guaranteed Loan Facility cannot exceed 85% of the net-net invoice price of the aircraft.

• The rent under the finance lease (or installment under the conditional sale agreement) covers the debt service owing pursuant to the Guaranteed Loan Facility.

• As the amount of the Ex-Im financing is limited, the remaining 15% of the aircraft purchase price is often financed by a commercial loan.

• Secured but subordinate to Guaranteed Loan Facility.• Standstill period (often up to 180 days) during which junior debt is

prohibited from proceeding against the aircraft or any joint collateral.

Ex-Im Bank Typical Finance Lease Structure

SPC

Lessee

Ex-Im Guaranteed

LenderManufacturerLoan Agreement

Debt Service

Purchase Agreement Purchase

AgreementAssignment

Assignmentof

LeaseRents

Lessor

Lease

Export Credit Agency

Gu

arant

ee

Aviation Companies Use Export CreditTo Access The Capital Markets

A significant innovation in aviation financing is the export credit bond.

• On October 8, 2009, Emirates airline priced the first US bond offering guaranteed by Ex-Im. The bonds were issued by Amal Limited, a Cayman Island’s special purpose company, which acquired 3 Boeing 777-300ER aircraft from Emirates using a loan provided by Calyon. Amal then issued 12 year 144A registered bonds 100% backed by triple-A rated Ex-Im.

• The first European export credit bond issued by AerCap closed this summer guaranteed by ECGD.

– It is unclear what the European capacity will be as US government entities have simpler regulations than the Europeans, COFACE and HERMES are not set up to guarantee bonds (and did not participate in the AerCap offering), unlike Ex-Im, ECGD is not a bank.

Ex-Im Capital Markets Fundings*

Issue Date Aircraft Amount Pricing

October 8, 2009*1st public bond offering

backed by US Ex-Im

guarantee

3 x 777-300ER

$413mm

12 yr

MS + 55 bps

Coupon 3.465%

October 29, 2009 2 x 737-700 $59mm

12 yr

MS +50 bps

Coupon 3.613%

November 5, 2009*1st lessor to issue bonds

backed by US Ex-Im

guarantee

3 x 737-800 $115 mm

12 yr

MS + 47 bps

Coupon 3.585

December 9, 2009 1 x 767-300ER

12 yr MS + 47 bps

January 12, 2010 3 x 737-800 $88.5 mm

[12 yr]

MS + 45 bps Coupon 3.65%

* This information is based upon previously published public information. Reflects initial pricing only.

Ex-Im Capital Markets Fundings (Continued)

Issue Date Aircraft Amount Pricing

January 2010 1 x 777-300 $126 mm

12 yr

MS + 49 bps

Coupon 3.55%

March 11, 2010 2 x 777-300

3 x 787-800

$298 mm

12 yr

MS + 49 bps / L + 29 bps

Coupon 3.547%

March 15, 2010 2 x 737-800 $59.2 mm

12 yr

MS + 47 bps

Coupon 3.580%

May 19, 2010 2 x 737-800 $74.3 mm

11.5 yrs

MS + 52 bps

Coupon 3.281%

June 18, 2010 5 X 737-800s $190 mm

12 yr

MS + 60 bps

Coupon 3.35%

European Export Credit Bond

Issue Date Aircraft Amount Pricing

June 2010* 1st European export credit bond

2 x A330 $151 mm

11 yr

Coupon 3.795%

NEXTGEN FINANCE

NextGen– What is It?

• Fundamental long-term transformation of how aircraft are operated and airspace is managed

• Shift from air traffic control to air traffic management with aircraft as “nodes” in a network

• Modern communication, navigation, and surveillance (CNS) technologies supporting the transition from:

Ground-based navigation aids to satellite-based (think: GPS)

Analog to digital communications (think: texting)

Disparate systems to integrated IT (think: the Web)

1. ADS-B: Satellite navigation system designed, along with other navigation technologies, to enable more precise control of aircraft during en route flight, approach, and descent.

2. SWIM: Information management architecture for the NAS managing surveillance, weather, and flight data, as well as aeronautical and system status information, providing the information securely to users.

3. DataComm: Digital communications link for 2-way exchanges between controllers and flight crews for ATC clearances, instructions, advisories, flight crew requests, and reports.

4. NNEW : Weather support services – using airborne sensors to create common weather picture across the NAS.

5. NVS: New voice switches provide foundation for all air/ground and ground/ground voice communications in the future ATC environment.

 

Major Systems Within NextGen

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NextGen– How Much Will It Cost?

(The real answer: no one knows)

• Official cost estimates vary: currently in $40 billion range or “significantly more” according to DOT Inspector General

• Several of the new systems are highly dependent on avionics• Roughly split between public and private sector

• FAA: R&D, acquisition of infrastructure, deployment = $20 Billion

• Operators: equipage, training, and related costs = $20 Billion

• SWAG: retrofit could cost from $1 to $2 mm per aircraft

Obstacles to financing avionics

• Immature regulatory framework- no certification or approval mechanisms for certain privately developed services

• The “incentivization” conundrum • Market mismatch: infrastructure spending determined by federal

budget; equipage by private sources• Mobile assets: new avionics are installed in the assets of others

but can they be effectively securitized?• Government monopolies

• Civil aviation authorities and state-controlled air navigation service providers control many of largest commercial opportunities, affecting both procurement and sales of NextGen equipage. To what extent can third parties sell services/products directly to aircraft operators historically provided by the agencies themselves?

What Sources of Financing Work for Avionics?

1. Equity2. Bonds3. Lease Financing4. Vendor Financing5. Public Subsidy (e.g. grants, research funding)6. Debt (private sector)7. Debt (public sector): e.g. World Bank, European

Investment Bank, U.S. Ex-Im Bank

Infrastructure Bank?

• Most US airlines' reluctance to spend on equipage has cast doubt on how fast and effectively NextGen can be deployed

• President Obama’s “Infrastructure Bank” -- part of the $50 billion spending plan -- would “leverage private and state and local capital to invest in projects that are most critical to our economic progress.”

• US DOT Secretary LaHood: "there is an interest" at high levels of the administration in using federal money to equip aircraft with NextGen technology

• But no specific pledge on aircraft equipage -- funds invested as part of the infrastructure plan "will help both the FAA and airlines to install new technologies."

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Thank you