EETC: The Next Generation of Debt Financing for Airlines around the Globe?
By Mehtap Cevher Conti
Posted: 25th October 2013 09:09Through the use of enhanced equipment trust certificates (“EETCs”), some non-U.S. airlines have recently been able to access the U.S. capital markets as a source of fairly inexpensive capital to finance their fleet expansions. The EETC structure has in effect allowed non-U.S. airlines to obtain financing from a group of U.S. investors that may not otherwise be seeking investment opportunities outside of the U.S.
EETCs are essentially corporate debt securities that rely on the credit of a single corporate issuer (the airline) and are secured by collateral (the aircraft) and are further supported by certain structural elements, such as debt tranching, availability of liquidity facilities and overcollateralisation. As a result of these structural “enhancements”, EETCs have been frequently rated by the rating agencies several notches higher than the rating of the senior secured debt of the issuing airline, which in turn has allowed (until recently) U.S. airlines to take advantage of the broad EETC market to borrow at much cheaper costs than non-U.S. airlines.
EETCs have traditionally been a U.S. financing vehicle since the main underpinning for these structured financings is Section 1110 of the U.S. Bankruptcy Code. Section 1110 of the U.S. Bankruptcy Code provides the necessary assurance to the creditors under an EETC that in the event of the bankruptcy of the issuing airline, they can repossess the collateral aircraft in a timely and foreseeable manner (unless the airline agrees to perform); however, the protections under such Section 1110 are afforded only to the creditors of U.S. certified air carriers.
The Cape Town Convention, an international treaty designed to reduce the risk of loss by creditors in aircraft transactions, has made it possible to expand the EETC structure beyond the U.S. air carriers. In countries where it has been ratified and entered into force (so called “contracting states”), the Cape Town Convention provides creditors in aircraft transactions with protections similar to Section 1110 of the U.S. Bankruptcy Code following the bankruptcy of an airline that is organised in such contracting state.
In a trail blazing transaction in June 2012, Doric Nimrod Air Finance Alpha Limited (“Doric Alpha”), an aircraft leasing company, issued two tranches of EETCs in the aggregate amount of US$ 587,500,000. The proceeds of the private offering, along with the equity investment by Doric Alpha, were used to pre-fund the acquisition of four Airbus A380-861 aircraft, which were leased to Emirates, an international airline based in the Emirate of Dubai, United Arab Emirates (“UAE”). UAE ratified the Cape Town Convention in April 2008 and it became part of UAE Federal law in August 2008. The implementation of the Cape Town Convention in UAE was a big focus for the rating agency in its analysis of these EETCs. The additional factors that the rating agency considered heavily in assigning ratings to the securities being issued were the structural enhancements in the transaction, which mirrored the terms of traditional EETCs issued by U.S. airlines, and the significance of the type of collateral aircraft for Emirates as a “mainstay” of its fleet. This issuance of EETCs was significant for Emirates for two reasons: it gave Emirates access to a deep funding source at a time when the traditional sources of debt financing were constrained and it saved them vital capital in reduced interest rate costs.
Canada ratified the Cape Town Convention in December 2012 and adopted enabling legislation that became effective in April 2013. Just over a month later, Air Canada also took advantage of the EETC structure in a pioneering way. In May 2013, Air Canada closed a private offering in the capital markets of three tranches of EETCs in the aggregate amount of US$ 714,534,000. The proceeds of the offering will be used to pre-fund the acquisition of five new Boeing 777-300ER aircraft, scheduled to deliver between June 2013 and February 2014. The financing of the five new Boeing aircraft using the EETC structure translates into big savings for Air Canada in reduced interest rate costs.
Following on the heels of the Air Canada transaction, in June 2013, British Airways closed a private offering in the capital markets of two tranches of EETCs in the aggregate amount of US$ 928,600,000. The proceeds of the offering will be used to pre-fund the acquisition of 14 new aircraft (six Boeing 787-800 aircraft, two Boeing 777-300ER aircraft and six Airbus A320-200 aircraft), scheduled to deliver between June 2013 to June 2014.
The UK has not yet ratified the Cape Town Convention; however, the paradigm change that resulted from its adoption by a growing number of countries paved the way to an EETC offering by British Airways. The British Airways offering is unique in two ways. First, the lease agreements in this transaction are governed by English law, including Part IX of the Insolvency Act 1986 (as amended) and the Insolvency Rules 1986 (as amended). In their analysis of this offering, the rating agencies focused on the fact that the general insolvency regime in the UK is robust, creditor-friendly and well-tested by the strong judiciary, and concluded that although the UK insolvency regime does not have the same definitive time period for repossession and specific application to aircraft as Section 1110 of the U.S. Bankruptcy Code or the Cape Town Convention, the structural enhancements in this offering were sufficient credit protection to warrant the ratings assigned to the securities. Second, this is the first EETC offering to employ a Japanese operating lease structure (“JOLCO”), which is a leveraged lease financing with a call option, for the Japanese investor-funded equity investment in each aircraft. In addition to being an unprecedented structure, this EETC offering is a milestone for British Airways, which in 2012 cancelled a bond offering aimed to raise approximately US$ 375,000,000 using the gates at London’s Heathrow airport and the routes between London and New York as collateral. Similar to Air Canada, the financing terms of the EETCs will save British Airways capital in reduced interest rate costs.
Barely a month after the British Airways issuance, in July 2013, Doric Alpha and Emirates raised US$ 630,000,000 in a second private offering structured very similar to their June 2012 financing. The proceeds of the two tranches of EETCs that were offered will be used to pre-fund the acquisition of four Airbus A380-861 aircraft, scheduled to deliver between September 2013 and November 2013.
The securities in all of these recent financings were issued using a private offering in reliance on Rule 144A and Regulation S under the Securities Act of 1933 (as amended) and, as a result, were not required to be registered under U.S. securities laws. Private offerings (such as Rule 144A offerings) are likely to be the preferred route for non-U.S. airlines seeking to utilise the U.S. capital markets as a funding source but preferring not to be subject to the full reporting requirements of U.S. securities laws.
The pricing of the securities that were issued in each of these recent EETC offerings is a strong indicator that the U.S. capital markets remain an attractive source of capital. Additionally, the level of oversubscription and the speed with which the securities were sold in each of these offerings highlight the strength, depth and liquidity of the EETC market in the U.S. Such financial factors also indicate that similar issuances by other non-U.S. airlines will most likely follow in the near term. For example, it has been reported that both Turkish Airlines (“THY”), the Turkish flag carrier, and WestJet, a Canadian low-cost carrier, are actively looking at EETC financing options. However, in the case of THY, the implementation of the Cape Town Convention in Turkey (which ratified the Cape Town Convention in August 2011 but has yet to adopt legislation for its proper implementation) will be the determining factor for the timing of any EETC offering.
Having alternative sources of funding is always important for airlines, but diversified sources of funding have become even more significant in recent years where traditional debt has been limited as a result of turbulent financial markets and export credit has become more expensive. By all indications, EETCs will remain a favoured funding source for the U.S. airlines in the foreseeable future. Furthermore, recent precedent transactions show that EETCs may become more prevalent with a growing number of airlines around the globe and open the U.S. capital markets to a bigger number of non-U.S. airlines.
Mehtap Cevher Conti serves as Of Counsel in the New York office of Vedder Price and is a member of the Global Transportation Finance group. Her practice focuses on asset finance, in particular aircraft and other equipment. Mehtap represents commercial and investment banks, insurance companies, financial institutions, aircraft operating lessors and airlines in a broad range of cross-border finance transactions. These transactions include secured debt transactions, export credit agency supported transactions, revolving credit facilities, leveraged leases, portfolio acquisitions, asset-backed structured financings and securitizations. Mehtap has experience in capital markets transactions, including representing issuers and initial purchasers of U.S. Ex-Im Bank guaranteed bonds, issuers of Rule 144A bonds secured by aircraft portfolios, issuers of unsecured senior debt private placements and initial purchasers of high-yield debt securities. Mehtap regularly handles finance transactions involving multiple jurisdictions throughout the world.
Mehtap Cevher Conti can be contacted by phone on +1 212 407 4988 or alternatively via email at firstname.lastname@example.org