ANALYSIS: Will up-front fee financing force an ASU rethink?

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Export credit borrowers are financing increased fees brought about by the 2011 Aircraft Sector Understanding (ASU) and this is creating a loophole that could force regulators to revisit the accord that came into effect this year, say sources.

"This is sending a confusing message to the market," one banker explains. "Do the export credit agencies (ECA) want the commercial market to absorb more aircraft financings? If so, they (ECAs) will have to rethink the fee financing, particularly if there is no real 'drop off' in export credit demand as a result of the move."

Another banker agrees. "By going to the banks instead of digging into their own pockets to pay for the premiums, airlines and lessors are not feeling the weight of the new regulation," he says. "Why should they stop using export credit?"

Robust demand for ECA financing is already having an impact on the banking market, which has seen certain financiers shy away from such deals due to falling pricing levels.

Pricing on US Export-Import Bank (Ex-Im) financings range from 30-50 basis points over Libor, while the cost of European ECA transactions range from 60-70 bps over Libor, say bank sources.

However, those figures are in sharp contrast to pricing levels offered by three bankers in February 2013. Bankers said European ECA deals were being priced in the "high double digits" above Libor, while Ex-Im transactions were closing at Libor plus 60 bps.

"When I consider the cost of buying US dollars and the price of doing the deals, there is little incentive for me to fund export credit financings at these pricing levels," says a European banker, adding: "I know other banks are thinking the same."

According to a London-based financier, competition among bankers "remains rife" as export credit financing is still "very attractive" for airlines, even at higher pricing levels under ASU.

"ASU has not deterred many airlines and with more banks bidding on deals, particularly out of Japan, pricing is extremely competitive," says the source.

According to the financier, export credit funding, at the moment, makes sense for those banks that are interested in transaction volume. "But for those of us who are concerned about pricing, we will hold out for now," he says.

Ex-Im expects to keep pace this year with its $11.6 billion of financing authorisations for fiscal year 2012, even in the wake of costlier ASU terms.

"We keep hoping the level of activity will go down but we anticipate about the same dollar amount as last year, although this will represent a smaller percentage of total aircraft deliveries," Bob Morin, vice-president, transportation at Ex-Im Bank said in an interview with Flightglobal in January.

In first quarter of fiscal year 2013 ended 31 December, Ex-Im authorised $2.3 billion in aircraft financing guarantees, covering 23 aircraft, a sharp increase from the $693 million of transactions in the final quarter of fiscal year 2012.

Though airlines and lessors are expected to opt for alternative sources of financing due to ASU, Morin believes there "might not be as quick a shift [to other financing sources] to the degree many people think".

He notes that "Boeing's production rates are going up not down", so there is a need for even more financing generally, and from many more sources.

Aircastle's executive vice-president of capital markets Roy Chandran agrees. He indicated last week at an investor day that ECA deals remain a popular choice as borrowers can finance the increased fees.

"Regardless of the fact that you might be paying eight or 10 points up-front - you can fund that. And given where our funding levels have stayed, on an amortised basis, it doesn't really translate to a substantial increase in pricing if you're holding the asset until the end," says Chandran.

He believes the other "driver" behind ECA demand has been the advent of the ECA-backed bond, explaining: "Typically, the ECA market has been a bank-funded market, but the ECA bond has come into play and that in turn obviously has helped to drive financing down."

However, he notes a pricing difference between European and US export credit of "roughly about 70 basis points".

Operating lessor AWAS believes it is too early to call whether ASU is having an impact on ECA demand for aircraft financing.

"It's a little bit early - when we're only four months into the 2011 ASU taking effect - to start saying that it is making no difference or that there is an impact because you can get much higher...advance levels," said Simon Glass, chief financial officer of AWAS on an earnings call. "So people are just going to continue to use it, and there won't be a fall in the amount of ECA or Ex-Im financing."

Earlier this month, AWAS delivered a second Airbus A320 to Russian flag carrier Aeroflot from its new order pipeline. The new delivery was financed with ECA support, with the debt portion provided by Apple Bank for Savings. The aircraft (MSN 5565) is the second of a five-aircraft operating lease package agreed last November. An additional new delivery was agreed earlier this year.