Updated with additional information on 15 January 2019

Aircraft Non-payment Insurance: AFIC and Balthazar

Over the last two years there has been an absence of export credit supported financings of Boeing and Airbus aircraft, with the European Export Credit Agencies (ECAs) suspending their support of Airbus aircraft and a stand-off in Congress over the future of the US Export-Import Bank (Exim) limiting Exim’s financing capabilities.

AFIC

In response to this, Marsh LLC in collaboration with Boeing launched the Aviation Finance Insurance Consortium (AFIC) aircraft non-payment insurance product in June 2017. AFIC seeks to take advantage of available capital in the insurance market to cover lenders' credit, aircraft residual and jurisdictional risk. The insurers provide insurance coverage to the lenders and assume the risk of default by the airline while the lenders rely on the credit of the insurers. Marsh LLC is the exclusive broker and the consortium of insurers is made up of Allianz, Fidelis, AXIS Capital and Sompo International with each insurer having a credit rating of at least 'A' (Standard & Poor's).

Balthazar

Meanwhile, Marsh S.A.S – a different team from Marsh LLC with separate reporting lines and appropriate barriers in place - has been working as exclusive broker with Airbus, lenders and a pool of highly rated insurers to launch Balthazar, a non-payment insurance product for lenders and investors funding new Airbus aircraft. The insurers will typically provide 100% coverage with terms of up to 12 years. Balthazar aims to provide greater flexibility by allowing parties to use their own transaction documents and covering a range of structures, including tax leases.

What is non-payment insurance?

The basic concept of non-payment insurance (NPI) is similar to export credit support that provides an insurance policy (rather than a guarantee) to lenders. The lenders finance the acquisition of an aircraft, in reliance on the insurance policy covering the risk of non-payment by the airline. The insurance is provided on a several basis with each insurer only liable for its own share of liability in the event of an insurance pay-out. NPI lessens the risk for lenders of financing aircraft for airlines below the top tier by allowing them to benefit from the improved credit rating of the insurers. 

However, there are a number of differences from export credit financing: commercial or intercreditor issues resulting from the use of multiple corporate insurers, differences between insurance law and guarantee law, a different bank capital regulatory analysis, and a risk analysis based on a corporate credit rating of the insurance companies rather than sovereign risk. With NPI, the OECD restrictions on the percentage of national content in the aircraft and the invoice price applicable to an aircraft are not relevant. The informal "home country" rule for export credit is also not applicable, meaning that NPI can also be used by airlines in the US, the UK, Germany and France. Thus, NPI gives lenders the flexibility of being able to accommodate a higher loan to value and to finance a greater number of aircraft in geographies that may otherwise have reached concentration limits (subject to each lender's internal credit requirements).

Is this the end of export credit?

More than US$1 billion of new aircraft deliveries were supported by AFIC in 2017 and Airbus is working on the first Balthazar deal. With the growing popularity of NPI, what does this mean for the future of export credit? Export credit is likely to continue to be an important funding option. NPI is provided on a commercial basis and consequently the insurers' focus will be on the middle tier of airlines. The appetite of insurers to provide coverage to airlines with lower credit ratings may be limited, leaving lower-tier airlines still in need of export credit support. Export credit has also historically been a very important financing option during financial downturns, when the availability of commercial financing has been limited. The broadening of financing options along with the return of export credit sends a confident message to airlines and manufacturers for their future financing requirements.

How great will GATS be?

Novation frustration

Lease novations have long been a source of frustration for lessees and lessors alike, often involving protracted negotiations and a seemingly disproportionate amount of time and energy. As the volume of trading between lessors has increased, this has become a bigger issue for parties to deal with. But why the difficulty? 

While the starting point on novations is to cause as little disruption to the lessee as possible, there are certain inevitable changes to be made to the lease to reflect the change of ownership. These changes must be documented and reviewed. Well-drafted leases should always ensure that there will be "no increased obligations" for the lessee on a transfer; however, in reality, buyers frequently require confirmations, representations and warranties, and often want changes to the lease terms. 

GATS 

Recognising the issues, the Aviation Working Group (AWG) published a template novation agreement in 2017, in an attempt to standardise (and speed up) novations. In May 2018, the AWG went a step further and announced plans for a global electronic aircraft trading system (GATS). 

In GATS, aircraft will be owned by trusts in the US, Ireland or Singapore and the beneficial interests in those trusts will be traded electronically. The benefit of this is that the legal owner of the aircraft and the parties to the lease stay the same, reducing involvement from the lessee. GATS will use standardised documents and the latest developments in blockchain technology, including an "e-ledger", giving owners of beneficial interests a clear record of their ownership. A benefit to financiers taking security over the beneficial interest in the trust will be that this security interest will also be recorded on the e-ledger.

Is GATS the solution?

If GATS can simplify transfers, "bake in" the principle of "no increased obligations" for lessees and minimise lessees' involvement, it should surely be a good thing for everyone - but some questions remain.

Until the AWG publishes full details and guidance, which is anticipated in Q1 2019, it is difficult to assess all the pros and cons of GATS. Some initial issues which may need to be addressed in time include:

• Tax – there may be jurisdictions with withholding tax issues on lease rentals to lessor trusts set up in the US, Ireland or Singapore. Parties may also need to consider tax consequences in jurisdictions where tax authorities may try to "look through" the trust to the beneficiary.
• Recognition – aircraft trusts have been used for years and have proven to be effective, but they are not universally recognised, particularly in civil law jurisdictions.
• Insolvency – will the AWG provide guidance on the insolvency treatment of these structures in each of the US, Ireland and Singapore?
• Lessee protection and credit support – we understand that a lessee's transfer requirements (such as lessor experience, tangible net worth etc.) will be loaded into the GATS system, and lessees will need to positively confirm they have been met on a transfer of the beneficial interest (thus giving lessees the same protection they would have in a novation, by refusing to give the confirmation if the conditions have not been met). We anticipate that lessors will seek to make such conditions as objective and clearly defined as possible in GATS leases, to minimise the potential for lessees to claim a condition has not been met. As with aircraft in trust structures today, lessees will need to consider credit support carefully, and we expect most to require guarantees from the "real lessor" of the trust's obligations under the lease.
• Formalities – English law requires dispositions of trust interests to be in writing signed by the person disposing of the same¹ to be effective. GATS will need to accommodate this, or similar requirements of applicable laws, where relevant. It is not yet clear whether an electronic system can facilitate this.
• Lessee involvement – some lessee cooperation will likely still be needed, such as liaising with insurers for updated insurance documents or where replacement guarantees are provided by the new lessor, though it is intended that some of this could be reduced in time (for example by providing for new insurance documents to be requested and issued electronically).

What now?

Some lessors have attempted to future-proof their leases with an upfront lessee consent for the lease to be put into the necessary trust structure required for trading on GATS or a similar system. As yet this is not a widespread move but, with appropriate protections for the lessee (which will also need to be part of the GATS infrastructure), it seems like a sensible step. We understand that:

• further details about GATS and the standardised documents will be presented by the AWG shortly;
• parts of the system will be launched in early 2019 (in a transitional paper form, with the e-ledger to follow later in the year); and
• parties will be able to amend and restate their documentation into GATS-compliant forms to enable existing deals to be migrated into the platform if desired.

Watch this space. While there are questions to answer, certainly the market is moving towards a more efficient (and lessee-friendly) approach to aircraft transfers and it seems likely that GATS, or something like it, will feature in the not too distant future.

1. Law of Property Act 1925, s53(1)(c)↩