Over the past ten years, the Enhanced Equipment Trust Certificate (EETC) market has been characterized by the same group of US carriers doing repeat deals, with United, American, Continental and US Airways all heavy users as a source of funding provided by mainly domestic US fund managers, asset managers and pension funds.
But the market is now being internationalized. Since summer 2012 there have been two offerings from operating lessor Doric, with Emirates as lessee, plus the first ever deals for both Air Canada and British Airways. Turkish Airlines and Norwegian Air Shuttle are viewed as potential issuers, while the first Asia-Pacific deal has been Virgin Australia Holdings with a deal that raised US$776.1 million and was oversubscribed multiple times, according to the airline.
 

Virgin Australia is only the fourth non-US carrier to access the EETC market. CFO Sankar Narayan points out that this is the first time the carrier has accessed the international debt capital markets. The notes collateralized 24 aircraft from the airline’s existing fleet and the weighted average coupon over the expected life of the notes is around 5.5%.
 

Within the US, Hawaiian Airlines closed its début issue in May this year. The US$444.5 million Hawaiian deal allowed the carrier to raise cheap fixed rate financing for the acquisition of six new widebody Airbus A330-200s delivering over the next 18 months. The senior Class A certificates carry a 3.9% coupon.
 

“The fixed interest rates on each of the Class A and Class B certificates are the lowest ever achieved by an airline via a public EETC offering without an insurance wrap,” comments Hawaiian Airlines CFO Scott Topping. “The offering opens a significant new source of future capital for Hawaiian.”
 

EETCs are secured corporate bonds that are full recourse to the issuer, whose underlying credit quality (with either a public rating or a shadow rating) is important to investors. However, they focus heavily on the value of aircraft used as collateral, the specific aircraft types in the pool, as well as legal issues surrounding getting access to collateral in the event of non-payment. Most senior tranches carry investment-grade ratings.

Broader global investor base
For non-US entities, the groundbreaking deal in terms of expanding the market came from Doric Alpha in July 2012, with Goldman Sachs as sole structuring agent and sole bookrunner. This US$587.5 million début offering was followed up by another Doric transaction in July this year, led by Goldman, Citi and Morgan Stanley, with Crédit Agricole CIB providing the liquidity facility and acting as lead manager. The US$630 million two-tranche deal will finance four A380s leased to Emirates. The senior Class A certificates, which have a weighted average life of 5.7 years, pay a 5.25% coupon.
 

London and Frankfurt-based Doric has built up a good track record managing closed-end funds, sold to both retail investors in Germany and to institutional investors via funds listed on the London Stock Exchange. So far, its three London-listed vehicles have all invested in Airbus A380s leased to Dubai-based carrier Emirates.
 

Up to now, Doric has acquired its aircraft via sale and leaseback transactions with airlines, most notably with Emirates. But at the Paris Air Show in June, Doric announced its own US$8 billion direct order with Airbus for 20 A380 aircraft, so its funding requirements for both debt and equity will be substantial in the coming years.
 

Demand for the 2012 Doric EETC was strong in the US, after an extensive marketing and roadshow effort from Goldman which included an Emirates A380 flight around the New York City area for potential investors. Roadshowing in the US was less extensive for the July 2013 offering, as investors have become more familiar with Emirates as a carrier and the A380. But Doric executives did visit Hong Kong and Australia during the pre-deal phase, and held conference calls with Asian accounts as the offering was about to be launched.
 

“Investors in Europe and Asia had a lot of questions about the overall EETC structure, such as the role of the liquidity facility provider. And they wanted to know more about the lessor structure, and the benefits of ownership rights in a repossession scenario,” says Mark Lapidus, CEO at Doric in London.
 

On the début offering in 2012, there was approximately 75% placement in the US, 20% in Europe and 5% with Asian accounts. Distribution was dominated by asset managers, with some buying from pension funds and insurance companies. Placement on the 2013 deal was along similar lines.
 

Not only is Doric broadening its global investor base for EETCs, where it is likely to be a repeat issuer in the coming years, it also has long term ambitions to bring new equity investors around the world into closed end funds.
“At the moment we are concentrating our efforts on raising equity on the London Stock Exchange, most recently with Doric Nimrod Air Three which was listed in July, but we are in continuous contact with potential investors in Asia on both the debt and equity side, and equity funds remain a possibility for the future,” Lapidus says.

New set of considerations
Début deals can be time-consuming and expensive, with extensive roadshowing, but most issuers will do repeat deals, and the Doric/Emirates and British Airways deals have succeeded in solving many of the structural issues.
“We had a team in Dubai covering Emirates, a team in London working with Doric, and sales teams around the world who could educate and work with investors,” comments Radha Tilton, vice-president at Goldman Sachs in New York on the début 2012 Doric Alpha deal featuring Emirates. “On top of that, we had a structuring team in New York with a lot of experience in the transport sector.”
 

For EETC investors, the internationalization of the product brings with it opportunities to get access to new names, but also a fresh set of considerations related to repossession rights in each jurisdiction.
 

The usage of EETC is part of a broader shift towards the debt capital markets by airlines looking to fund their sizeable orders of new aircraft, following a scaling back in the availability of commercial bank debt since the global financial crisis began.
 

Deals from US carriers are underpinned by Section 11.10 of the Bankruptcy Code. During bankruptcy proceedings, creditors are generally prevented from making repossession moves against the company in administration, but aircraft have a special Section 11.10 exemption where the airline has only 60 days in which to get current with payments or return the aircraft.
 

Investors buying paper issued by non-US entities are looking for similar certainty, which is supposedly provided by the Cape Town Convention on International Interests in Mobile Equipment. However many countries have yet to ratify the treaty.
 

“We do place a lot of importance on Cape Town, and although there needs to be a substantial amount of analysis of the underlying local jurisdiction, it is likely that transactions out of countries that have ratified Cape Town will be less time-consuming from a legal analysis point of view,” comments Craig Fraser, managing director at Fitch Ratings in New York.

Ratifying Cape Town
“Taking the example of the Air Canada deal that Fitch rated, we had a favourable situation in that Cape Town had been ratified, and second that the deal was being done in a legal system that the credit world and Fitch considers to be very reliable,” Fraser explains. “In other jurisdictions we would have to determine how much confidence we would have that Cape Town would be actually be applied as expected in that legal system, if an airline were to enter administration.”
 

Bankers note that although India has ratified the treaty, the Indian courts were reluctant to grant operating lessors access to their aircraft when Kingfisher got behind on monthly lease payments at the end of 2012 and early 2013.
Creditors including Frankfurt based DVB Bank were highly critical of the approach taken by the Indian courts, and the Kingfisher situation with regard to its operating lessors will undoubtedly have been noted too by EETC investors, who may face similar issues in the future in other jurisdictions.
 

The début EETC offering from Air Canada this year was timed to coincide with the Canadian government ratifying the Cape Town Convention. The European Union has ratified the treaty but individual EU countries have not, with the exception of Ireland. In the case of British Airways, the UK has not ratified the treaty but investors felt confident that the UK courts would grant rapid access to the assets in the event of default.

Liquidity facility needed
The British Airways aircraft are being equity-financed via the Japanese Operating Lease with Call Option (Jolco) market, which means that repossession would be done by the Jolco special purpose vehicle (SPV) as owner of the assets as opposed to creditor.
 

In the case of British Airways, investors would probably have been happy to rely upon courts to grant creditors access to their collateral. But for other carriers, possibly including Turkish Airlines, having a structure such as a Jolco may increase investors’ confidence in the repossession scenario.
 

“On the British Airways deal investors were comfortable with a likely repossession timeline and an 18-month liquidity facility, but as the EETC structure is used by airlines around the world, we’ll see other carriers being prepared to do transactions with longer liquidity facilities, as part of the overall cost of getting their deal away,” comments James Cameron, partner in the London office of Milbank, which has acted as adviser on 11 EETC deals in 2012 and 2013, including Doric Alpha, Hawaiian Airlines and Continental Airlines.
 

“Investors and the rating agencies were comfortable with the British Airways EETC structure, which involved a Jolco as lessor and a carrier in a country which has not ratified Cape Town,” says Cameron. “We are likely to see more leasing structures governed by English Law, regardless of whether Cape Town is applicable in the jurisdiction where the airline is based.”
 

For the two Doric Alpha deals in 2012 and 2013, both featuring Emirates as lessee, investors were confident that Doric could quickly de-register and re-register the aircraft according to a pre-arranged process, and have them flown out of Dubai in the event of a default.
 

The United Arab Emirates is not known for easy enforcement of repossession rights for creditors, but a critical point here is that Doric is the actual owner of the aircraft, rather than a creditor seeking to repossess collateral. Emirates is the lessee on the A380s.
 

Even given confidence in a repossession timetable, the rating agencies still demand a liquidity facility to ensure timely payment of interest, which gives EETC bondholders time for aircraft collateral to be sold and the cash distributed. Deals also have cross-default clauses, ensuring that airlines cannot cherry pick aircraft in a collateral pool.
 

Keeping the liquidity facility down in size is important to the economics of the transaction. In the fledgling European EETC market which saw four deals between 1999 and 2004, but never developed further, liquidity facilities ranged from 36 to 42 months. In contrast the Doric Alpha transaction in 2012 was 24 months, and for British Airways it was 18 months.

Safety and simplicity
For the US carriers, EETCs have not only been a cheap source of debt capital, but an exceptionally reliable one, with the market size limited by the availability of aircraft collateral rather than the appetite of the US investor base. Large deals can easily be absorbed by the market, such as the US$1.4 billion offering from American Airlines in July.
 

Regular fund manager buyers in the US include BlackRock, PIMCO, Franklin Templeton, Prudential and T Rowe Price. For example the Pimco Diversified Income Fund holds multiple EETC tranches (issued by American Airlines, Continental, Delta and United) and holds an US$11.4 million principal amount piece of the 5.125% certificates issued by Doric Alpha in July 2012.
 

The TCW Metropolitan West Unconstrained Bond Fund has a variety of EETC tranches in its portfolio, including American Airlines and JetBlue. In 2012 the fund bought pieces of the 6.25% Class B notes issued by Continental Airlines and the 5.9% Class A notes issued by US Airways. Its High Yield Bond Fund bought a US$7.3 million piece of the American Airlines 2013-1 Class B notes paying 5.62%. And the JPMorgan Multi-Sector Income Fund holds tranches issued by Continental and Delta, including a US$2.1 million piece of the Continental 2012-2 Class A notes paying 4%.
 

During the turmoil on global financial markets after the collapse of Lehman Brothers in September 2008, the EETC market bounced back much faster than the senior unsecured market over the course of 2009, as investors moved towards the safety and simplicity of bonds backed by aircraft collateral.
 

Other carriers around the world saw this and are likely to put in place EETC programmes not only as a diversification of their debt funding profile, but also a reliable source of funding in case of future volatility on the unsecured bond markets.
 

Continental Airlines alone has sold more than US$15 billion worth of EETCs since its first deal back in 1996. The record year for total issuance by all carriers was 2001, when US$10 billion worth of EETC paper was sold.