ANALYSIS: Are rising base rates impacting capital markets financing?

Washington DC
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Airlines are increasingly tapping the capital markets for aircraft financing, attracted to low interest rates and the efficiency of the market.

As of 1 August, airlines and lessors had raised about $15.6 billion in new secured debt, according to Boeing Capital, surpassing the $10 billion issued in 2012 and already surpassing the $14.5 billion the airframer's financing arm anticipated for the year.

"The EETC market is, by far, the deepest and most efficient market that exists today," said Kostya Zolotusky, managing director of capital markets, leasing and aircraft financial services at Boeing Capital, during a briefing earlier in August.

Market stalwarts American Airlines, United Airlines and US Airways have all issued new enhanced equipment trust certificates (EETCs) this year, and low rates have attracted first time issuers Air Canada, British Airways and Hawaiian Airlines to the market.

"Our participation in this market is an important development for us as it represents new opportunities for future aircraft financings at internationally competitive levels," said Calin Rovinescu, president and chief executive of Air Canada, after the airline closed its $714.5 million 2013-1 EETC in May.

The Canadian carrier financed five new Boeing 777-300ERs with the debt, which was split into a $424.4 million 12-year A tranche with a 4.125% coupon, $181.9 million nine-year B tranche with a 5.375% coupon and a $108.3 million five-year C tranche with a 6.625% coupon. The issue was a strong showing for a first time issuer.

But the market is moving.

The yield on 10-year US Treasury notes had more than doubled to 2.88% on 19 August since the beginning of the year.

Yield on 10-year US Treasury notes, 1 January to 19 August 2013

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US Treasury

The increase resulted in the all-in interest rate on United's $720.4 million 2013-1 A notes coming in at 4.3% on 1 August - a 35bp premium over US Airways' $620.1 million 2013-1 A notes that priced in May and 30bp higher than the pricing on its own $711.6 million 2012-2 A notes in September 2012.

Greg Lee, a managing director at Goldman Sachs focused on aviation finance, says that while the upward movement in base rates may discourage some issuers - especially those new to the market - from doing deals it also attracts additional investors who help drive spreads tighter.

"Insurance company appetite tends to look more at overall interest rates more than the spread," he says, citing a recent return of insurance company buyers to the EETC market in recent months.

While United paid a slightly higher coupon on its 2013-1 A issue, the spread on the notes tightened to 156bp over 10-year treasuries on 1 August. This compares to a 216bp over 10-year treasuries spread on 10 April for US Airways 2013-1 A deal and a 220bp over 10-year treasuries on 20 September 2012 spread for United's 2012-2 A deal.

Tightening spreads signal continued strong demand for secured aircraft debt and bode well for the market going forward, regardless of fickleness of government bond yields.

"It is a little more expensive but when you look at it from a historical perspective, you continue to see near record low all-in financing costs," said Zolotusky.

Turkish Airlines and WestJet are known to be considering new EETC issues, despite the rising rates, and veteran issuer Delta Air Lines could tap the market for its unfinanced deliveries of Boeing 737-900ERs in the second half and next year.

The Atlanta-based carrier is slated to take 12 of the type by the end of the year and 19 in 2014.

However, Delta could opt to pay cash for the aircraft as it focuses on reducing its debt load, notes one New York-based lender.

Rising all-in costs could have at least one ancillary benefit. John Morabito, senior vice-president of the transportation finance group at CIT, says that airlines could increasingly look at used aircraft, therefore bolstering values in the market, as the financing costs of owning or leasing new aircraft rise. He adds that there has been a "significant increase" in the number of operating leases this year compared to 2012.

For example, American has financed 29 of its 33 deliveries as of 19 August with operating leases compared to 15 with leases during the same period in 2012, Flightglobal's Ascend Online database shows.

The impact of rising base rates on aircraft financing markets through the balance of 2013 may ultimately be difficult to judge. Not so much because issuers are being deterred but because the most active airlines simply do not need too.

American only has seven deliveries remaining this year without financing, Ascend shows, but is expected to lease these aircraft as it can drive "very competitive" terms as the carrier's treasurer Peter Warlick told Flightglobal in July. Delta remains up in the air as it decides what path to take on new debt, and both United and US Airways have few - if any - deliveries through the middle of 2014 without financing in place.

"The capital markets are often times difficult to predict and fickle," says Morabito, on airlines and lessors' track record issuing new debt.