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The Commercial Aircraft Finance Handbook

Ronald Scheinberg

Introduction

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https://www.routledgehandbooks.com/doi/10.4324/9780203713303-1
Ronald Scheinberg
Published online on: 08 Dec 2017

How to cite :- Ronald Scheinberg. 08 Dec 2017, Introduction from: The Commercial Aircraft Finance
Handbook Routledge
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https://www.routledgehandbooks.com/doi/10.4324/9780203713303-1

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PART 1

INTRODUCTION

‘Aircraft Finance’ is the art of financing aircraft. The Aircraft Finance market is in
excess of U.S.$100 billion per year for the financing of new deliveries.1 Insofar as
commercial aircraft (and related assets) are highly expensive (the smallest in-
production Boeing aircraft, the Boeing 737–700, has a list price of some U.S.$75
million; the largest Airbus aircraft, the A380 has a list price of almost U.S.$390
million; and the GE-90 engine that powers the Boeing 777 aircraft list at approxi-
mately U.S.$24 million each),2 they often need to be financed. With inherent
demand for financing on the operator side, there is similarly a pool of financiers
ready, willing and able to supply financing to meet this demand.
Aircraft are perceived (especially by aircraft lenders and operating lessors – those
who are putting the money in (‘Aircraft Financiers’ or ‘Finance Parties’)) to be assets
that are highly desirable to finance: they hold their value, earn a decent return, are
relatively easy to find and, in many jurisdictions, are subject to beneficial legal regimes
that allow timely recovery in default situations. The world of Aircraft Finance is
dominated by three principal actors: the aircraft operator/airline, the aircraft lessor
and the aircraft lender.3 Aircraft Finance transactions may have all three of these
actors involved in a single transaction, such as one would find in a Back-leveraged
Operating Lease, or any sub-combination:

• airline/operator-lessor, in a leasing transaction;

• airline/operator-lender, in a mortgage financing (reliant on the operator’s
credit); and
• lessor-lender, in a mortgage financing (reliant on the lessor’s credit).

Each of these three parties brings a very different perspective to an Aircraft Finance
transaction.

• The operator wants the cheapest possible cost (rent and return conditions
or fees and interest charges).
• The lessor (vis-à-vis the operator) wants the maximum return (rent and
return condition) and least amount of risk to its Aircraft Asset.
• The lessor (vis-à-vis the lender) wants the cheapest possible cost and
maximum flexibility for use of the Aircraft Asset.
• The lender (vis-à-vis the operator and lessor) similarly wants the maximum
return (fees and interest income) and least amount of risk to the Aircraft
Asset.

Those different perspectives can be summarized, then, by the following

relationships.

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• Return versus Cost.

• Risk versus Flexibility.

Of course, these two categories are themselves linked: the greater the risk, the
greater the required return. Risk tolerance and required levels of return, therefore,
necessarily dictate different approaches between lessor and lenders, and between
lessors and lenders, on the one hand, and the airline/operator on the other.
Exhibit 1.1 summarizes these primary risk/reward categories.
A further, and critical, overlay to this dynamic between the parties is the debtor-
credit relationship among them. One of the very essential elements of the risk
component is that obligations are largely uni-directional: the operator has the
ongoing obligation to pay the rent/debt service and, in the case of a lease, return
the Aircraft Asset,4 while the Aircraft Financiers satisfy their obligations on day one
by delivering the Aircraft and/or financing.5
Efforts to balance all these various rights and risks in the case of any given
financing require a broad skill set. Participants are required to have, or have access

Exhibit 1.1 Primary risk/reward categories

Primary risk vs flexibility issues Primary reward/return vs

cost [economic] issues

Operator • Manner in which maintenance Lessor:

(vs lessor (for example, deferrals) is • Rent
or lender) conducted • Term
• (Sub)-leasing rights • Term renewal options
• Re-registration rights • Purchase options
• Insurance deductibles/ • Security deposits
self-insurance • Maintenance reserves
• Return conditions
Lender:
• Amortization profile (average life)
• Maturity
• Security deposits
• Maintenance reserves
• Interest rate
• Prepayment premium/make whole
• Breakage costs

Lessor • Limit restrictions on re-leasing: • Amortization profile

(vs lender) jurisdiction • LTV coverage
economic terms • Maturity
contractual terms • Security deposits
• Cure rights • Maturity extension options
• Remarketing rights • Interest rate
• Buy-out rights • Prepayment premium/make whole
• Equity squeeze protection • Breakage costs
• Recourse versus non-recourse
Source: Author’s own.

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to, investment banking structuring skills, legal analysis, technical (metal) compre-
hension, insurance expertise, tax and accounting expertise and loan pricing know-
how, to name but a few of the skill sets in which Aircraft Finance practitioners of
all professions must have some level of working knowledge proficiency. Take an
airline bankruptcy, for example. Finance parties holding lease or debt financing of
an aircraft operated by the bankrupt airline must be able to analyze their contractual
rights under the transaction documents (with the airline and the other finance
parties), their rights under law, their rights in respect of the aircraft, the value and
operational condition of the aircraft, their sale/lease remarketing options if they were
to repossess the aircraft, their financing and refinancing (or exit) options and their
risks of ownership and insurance needs on a repossession (among others!). That is
quite an interdisciplinary understanding. While no professional is expected to be an
expert in all these areas, any Aircraft Finance professional worth his salt will at least
know the questions that need to be asked outside his personal area of expertise so
as to be able to build a sufficient knowledge base to respond to developments and
opportunities.
This Handbook is an attempt to provide Aircraft Finance professionals – bankers,
investment bankers, appraisers, lawyers, insurance brokers, airline and lessor
treasury-types and hedge fund, private equity and rating agency analysts – with
resources, not to make them experts in an area outside of their particular expertise,
but to provide a framework for knowing what questions and issues may be coming
into play in a given situation.
Accordingly, this Handbook touches on the various disciplines with which
professionals in this area must deal. In Part 2, the type of assets encountered in
Aircraft Finance are examined. In addition to the usual suspects, aircraft and
engines, we touch on other assets encountered in Aircraft Finance transactions,
including assets that may serve as collateral. In Part 3 we explore the potpourri of
financing structures frequently employed and devices that are utilized to enhance
different structures. Part 4 gets into the weeds with the multiplicity of, principally
debt, pricing-related provisions. Part 5 touches on the different technical terms used
with aircraft and engines. Part 6 reviews terminology employed in matters relating
to the maintenance and return of aircraft and engines. Part 7 covers Aircraft Finance
legal terms, including specialized terms used in contracts and terms that pertain to
laws governing, among other things, the granting of security interests in aircraft and
related assets and the perfection of those interests therein. Part 8 lists and explains
terms relevant in the bankruptcy and work-out contexts. Part 9 details the terms
and concepts frequently encountered addressing intercreditor issues among the
parties involved in Aircraft Finance transactions. Part 10 explores the nomenclature
pertinent to the hull and liability (and other) insurances pertinent to Aircraft
Financiers. Part 11 explains the terminology utilized by appraisers in their efforts
to appraise aircraft. Part 12 covers the disparate contracts and legal instruments
that are frequently utilized in Aircraft Finance transactions. Part 13 reviews a
number of the terms that are often used as short-hand references to certain Aircraft
Finance-oriented contractual provisions. Part 14 goes through a number of other
terms that are ‘terms of art’ commonly used in Aircraft Finance. Finally, Part 15

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provides an overview of the risk factors associated with Aircraft Finance transactions.
Each of these parts has, as appropriate, an introduction that seeks to supply some
context to the relevant practice area.
Any Aircraft Finance transaction is built on five legs: (i) the credit of the debtor;
(ii) the value of the aircraft; (iii) the soundness of the transaction structure; (iv) the
economics of the transaction; and (v) the legal framework of the contracts and
governing law. This Handbook touches on certain fundamentals of all five of these
items.

Notes
1 The Aircraft Finance market for used Aircraft is yet another multi-billion market.
2 Of course, no one pays list price. A better guide to this price level might, at a minimum, be appraised
‘new’ prices. But even at these appraised prices, and even with significant discounts offered by Original
Equipment Manufacturers (OEMs), these are still very expensive assets to purchase and collateral
to maintain.
3 It might be suggested that there is yet a fourth principal actor: the private equity investor investing
in airlines and operating lessors. Such investors typically take a long-term view on the aircraft/airline
sector as the basis for their investments but seek at some point to flip their investments at a profit.
4 Or, in the case of financing by a lender of a lessor, the lessor has to pay the debt service.
5 Of course, until such performance, the operator is taking credit risk on the lessor and/or lender to
perform its obligations. This reverse credit scrutiny has taken on a life of its own in recent years
coincident with periods of illiquidity and the credit crunches experienced by many lessors and lenders.