Anticipating Revised Rules Affecting Aircraft Finance Transactions

In 2011, financing markets began to inch toward pre-crunch availability levels; however, as the production schedules for each of the major aircraft manufacturers increase to produce more energy-efficient equipment, there will be even more demand for such financing. Against the backdrop of high demand, financiers and airlines must now prepare to adapt to the new finance regulatory regimes of Basel III and the 2011 Aircraft Sector Understanding ("ASU"). While it is not anticipated that either new regime will limit the availability of credit again, it is expected that both will make aircraft financing more expensive.

Basel III

Basel III will become effective in 2013. Announced as a reaction to the credit crunch, the new capital and liquidity standards of Basel III are designed to ensure (and require) a higher level of capital within the banking system. Aircraft finance transactions, under Basel II, have generally required very low levels of capital because they are asset-based financings and, as such, are fully secured by the aircraft and operating lease rental stream. In the past, the financiers' ability to lend has been largely dependent on the appraised value of the aircraft and the resulting loan-to-value ratio. As many other asset-based financings landed in default (in part because the quality of the assets turned out to be much less than was anticipated by the financiers), secured aircraft and engine financings, including securitizations, were unfairly painted with the same black brush (even though the appraised value of the aircraft assets did not change for the worse). Rather than relying upon the financiers and appraisers to accurately assess the credit-quality of the aviation asset, Basel III takes a blunt instrument to the art of aircraft finance.

Under Basel III, the new leverage ratio will require a 3 percent capital requirement, regardless of the quality of the asset. This means that lenders participating in aircraft finance transactions will have to put in more capital in front of "good quality" aviation assets, based on nominal amounts, even if the same have been independently appraised by a third-party appraiser at a much higher level. Additionally, under Basel III, the new liquidity coverage ratios will require banks to own greater levels of liquid assets. The new net stable funding ratio ("NSFR") requires that the available stable funding ("ASF") ratio must equal or exceed the required stable funding ("RSF") ratio. This...