Aircraft finance transactions under Basel II have generally required very low levels of capital because they are asset-based financings, fully secured by the aircraft and operating lease rental stream, notes Elizabeth Evans, a partner at the Jones Day international law firm whose specialties include aviation finance. But Basel III, designed to ensure and require a higher level of capital within the banking system, will change that as it starts to phase in this year.
Basel III will require a 3% capital requirement, regardless of the quality of the asset. That means lenders will have to put in more capital in front of “good quality” aviation assets, based on nominal amounts, even if they have been independently appraised at a much higher level.
New liquid asset requirements also will affect lease terms because lenders will need to match long-term loans with long-term funding. That means financiers will be less willing to approve 12-year aircraft financing loans, pushing for shorter terms instead.
The affects of financing becoming more difficult and expensive to obtain could be far-reaching. For example, there is a school of thought that the relative ease of ECA financing has distorted the market, feeding overproduction at Airbus and Boeing by artificially inflating demand for new aircraft. That “overproduction,” in turn, has lowered lease rates—particularly on relatively young narrowbody aircraft—sped up aircraft retirements and reduced residual values for certain models pushed into early obsolescence.
The new rules could reverse some of that. Some lessors, such as Fly Leasing and Aircastle, already have said lease rate volatility and new rules for ECA financing are making it less appealing for lessors to order new aircraft.
At Delta Air Lines, CEO Richard Anderson talks about another potential impact—and a positive one, from his perspective. New-entrant airlines will not be flooding the market with new capacity, he says, because it will be more difficult for them to obtain financing under the Basel III guidelines and new U.S. capital reserve requirements.
“It's a much different situation in terms of capital in the marketplace,” he says.
The new ECA and bank restrictions, however, also present an opportunity for new or existing alternatives for financing to grow. For example, well-capitalized aircraft lessors already are anticipating a boost in their business.
“We believe major shifts in the financing market, including declining traditional aerospace bank capacity and more expensive export credit support, will drive more business to leasing companies as a bridge-to-financing market for airlines,” Ron Waishal, CEO of Stamford, Conn.-based Aircastle, said in November. Access to the unsecured debt market, which a company like Aircastle has, is a strategic advantage, he adds. The PwC report notes that lessors, many of which have an investment grade rating and better risk profile, can access more and relatively cheaper capital than airlines.
Evans, however, cautions that the lessors—and everyone else—should be cautious about making predictions about the impact of the regulatory changes for ECAs and banks.