Financing special report: PDPs, blood from a stone

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Securing financial support for pre-delivery payments is threatening to cause the most painful aircraft financing headache this year

While the aviation financing community is more optimistic of meeting this year's new aircraft funding requirements than it was in 2009, pre-delivery payments are still proving to be an extremely hard sell to the financial sector.

Airlines pay PDPs to manufacturers up to two years before delivery of a new aircraft to help with the working capital associated with production. The amount can total up to 30% of its final cost, and these short-term financings are not included in the industry's estimated $60-65 billion total financing requirement for new aircraft in 2010.

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During the good times of cheap liquidity financiers were attracted to the PDP business, partially as a means of locking in longer-term aircraft financing. However, most financiers now say they prefer secured financings. At the moment, only five banks are said to be active in the PDP market, according to bankers interviewed by Airline Business sister publication Commercial Aviation Online.

"With liquidity tight, there is a preference to lend into a secured aircraft transactions, rather than provide PDPs, as this form of financing is generally not as capital efficient," says a European banker. Another adds that the lack of appetite for PDPs stems from financiers not wanting to find themselves in a position where they need to enforce their rights under the purchase agreement during a downturn.

"It can be tough during a down cycle to either sell the purchase agreement, or to pay the balance of the purchase price and sell or lease the asset," says a banker. "Most financiers will choose to avoid this situation."

Those PDPs which are being completed are being financed at a premium to secured commercial aircraft finance at around 300 basis points over Libor, say bankers.

Although a growing problem, manufacturers have not yet offered much help to support PDPs. "Manufacturers will do the minimum they can get away with. To date it's not been too much, but this year it will be larger," says a Japanese banker. Another banker adds: "They don't seem very keen to help out with sensible take-out prices, which I find odd."

The take-out price is the amount that manufacturers will allow a bank to purchase the aircraft for in the event that an airline goes bust during the construction period. "If an airline falls over during the pre-delivery period often the best way for the bank to recover its debt will be to put more cash out the door and pay the remainder of the sum due, and at least have a tangible asset to show for it," explains the banker. "If they don't buy the aircraft they are simply an unsecured creditor against the airline with little chance of recovery."

Bankers argue that if manufacturers want to help banks get comfortable with PDP finance, they should allow them to purchase the aircraft at the airline-negotiated price, but often they do not. "PDPs remain the exception for us," says Jose Abramovici, Calyon's global head of aviation & rail. "We have legal issues [clawback] and we are concerned with the net fly-away prices assigned to the lenders, which sometimes are higher than the prices at which manufacturers place new orders."

Calyon has maintained a limited role in PDP financing. Last year lessor AWAS mandated Calyon to arrange PDP financing of five Boeing 737-800s to be delivered during 2011. These aircraft are part of the 737-800 global order by AWAS. Calyon is acting as sole underwriter, sole arranger and agent.

Airbus' insistence on the clawback clause, which calls for the refund of equity to the airline by the financier in the event of bankruptcy or default, is further-hampering lender appetite for PDPs. Some financiers say clawback creates a risk they are not inclined to take. However, Airbus says clawback avoids speculative transactions by financiers, particularly operating lessors, which have taken advantage of airline defaults in the past. It also maintains it is more flexible about the use of the clause in today's difficult environment.

Another bank still active in PDP financing, for both Airbus and Boeing aircraft, is France's Natixis Transport Finance. "It remains difficult to reach agreements with the manufacturers, but it is not impossible," says its chief financial officer Marc Bourgade. The bank recently provided a $150 million PDP credit facility to Brazil's Gol Airlines for 737-700s and 737-800s at Libor plus 245 basis points, which is cheaper than the pricing quoted by CAO's five bankers.

"Few airlines had access to this type of financing in 2009," says Gol executive vice-president Leonardo Pereira. "We believe this contract will play an important role in improving our cash flow in 2010 and confirm the financial institutions' positive view of Gol's business plan." All seven aircraft are scheduled for delivery this year.

Last year also saw a newcomer to PDP financing from China. The China Development Bank signed an agreement with AerCap,

covering $86 million in PDP payments and a $272 million long-term funding facility covering four new Airbus A330 aircraft with deliveries scheduled through 2011. Earlier in the year, the lessor signed a $221 million funding facility with German bank HSH Nordbank, covering PDPs for 10 new Airbus A330 aircraft. HSH acted as the sole arranger and underwriter of the facility.

PDP ASSISTANCE?

Financiers have speculated that a "creative" structure may be needed to help airlines with PDP financing during this downturn. "There is a lot of talk, but not much action as far as I can see," says the Japanese banker. "A creative structure would require action by the manufacturers and I don't believe they are willing to take any action on this front yet."

Abramovici says a great product would include the export credit agencies, "but the US Export-Import Bank and the European ECAs have not approved a structure yet". He adds: "Capital markets may also contribute to some form of PDP funding."

Last year Gordon Welsh, head of underwriting for aviation at ECGD, said the agency is considering increasing the pre-delivery period, when the ECAs will commit support, to one year from six months. "If ECAs and Ex-Im can commit more in advance, it would help confidence by the PDP banks that there is a take out of the PDPs," says Abramovici.

This change would prove beneficial in the current climate because financiers would be assured that in supplying PDP financing, long-term ECA support would also be available - which would serve as an indicator they are likely to be repaid.

Further complicating the PDP finance market are production delays, notes Moody's Investor Services in a research report. Moody's says production delays resulted in PDPs becoming "trapped" with the manufacturers while customers waited for their aircraft. "If this experience prompts airlines to seek lower deposits in negotiations on future orders, the airframe manufacturers would need to turn elsewhere for working capital to fund the production process," says Moody's. The manufacturers would face the same problem if banks pulled back on PDP lending, it adds.

One banker believes the manufacturers must be helping airlines with PDP payments they cannot fulfil. "I would bet the manufactures are working with the airlines regarding PDP as they certainly don't want to see deliveries slide," says the banker.

For more on how the downturn has affected PDP financing, view our earlier coverage: flightglobal.com/FundingGap