ANALYSIS: An upside/downside look at EETC A380 funding

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The Doric Nimrod Air Finance Alpha Ltd Series 2012-1 enhanced equipment trust certificates (EETC) - which will be used to fund the delivery of four Airbus A380 aircraft to Emirates in the second half of 2012 - are the first EETCs with Cape Town Convention (CTC) eligible financing, writes Benjamin Millard, senior risk advisory analyst at Ascend.

The CTC became part of the United Arab Emirates' (UAE) federal law upon the country's ratification of the treaty in 2008. The success of the Emirates deal proves that there is international appetite for EETC financing. Previously, deals have been done only twice outside of the USA and these were before the CTC came into existence.

The deal also proves that the capital markets are another funding option for the enormous orderbook of aircraft destined for UAE-based operators. There are 380 Airbus and Boeing aircraft on firm order for the UAE, including 300 widebodies, of which 78 are A380s.

Over 90% of the backlog is to be delivered to Emirates and Etihad in the next decade. With Doric Series 2012-1, as well as successful German KG-style financing placed by Doric for Emirates-leased A380s recently, it is clear that the capital markets are receptive to A380 deals.

The pricing for the senior tranches (5.125%) and junior tranches (6.5%) was competitive and comparable to that of recent US transactions. This suggests that investors believe in the long-term prospects for the A380, and perhaps more importantly, the long-term future of Emirates. It also shows that investors have some comfort in the legal regime, as there has been no precedent of legal enforcement of CTC financing in the UAE.

Also helpful was Emirates' ownership by a highly-rated sovereign, the Dubai government, through its investment arm. Despite the negative A380 headlines recently on wing rib-feet cracks - reflecting the unknowns that come with newer aircraft - Doric Series 2012-1 was significantly over-subscribed, according to the underwriters.

Ascend's Aircraft Rating also has a favourable view of the Engine Alliance-powered A380, with a one-year rating of A7+ and five/10-year ratings of B7+. We have the A380 on positive watch (denoted by the +) and will consider a rating upgrade if Airbus regains momentum on new orders. Airbus indicates that it will likely not reach its 2012 target of 30 aircraft deliveries because of the wing fix. In future years, however, the orders will need to exceed 30 units annually (more than the scheduled production), for Airbus to maintain the momentum.

Ascend's B7+ long-term rating puts the A380 future Base Values on a gentler depreciation curve of 8-9% year on year. This in turn leads to loan-to-value (LTV) ratios that are well below 100% on both tranches to maturity, which indicates that there is satisfactory over-collateralisation until final maturity.

Using Ascend's Downside Risk Value forecasts for the A380, however, the A (senior) tranche LTVs are substantially higher and B (junior) tranche LTVs are well above 100% at their peak. This is explained by the high potential downward volatility for A380 Market Values below Base Values (30%) that are incorporated into Ascend's A380 ratings. The A380's values have higher volatility because of uncertainty on how severely its values could be hit during a downturn, particularly given the lack of a defined secondary market at this stage, unlike the more commonly-financed widebodies such as the Boeing 777 or A330.

The conclusion is that Doric investors will likely be over-collateralised well enough during a normal market. However, in the event of a second major downturn before the end of the decade, A380 residual values are likely to fall more sharply than those of other aircraft acting as collateral in EETCs.