As the top aircraft lessor by fleet size, GECAS originates between $5bn to $7bn in new asset acquisitions and sells between $2bn to $4bn of aircraft assets every year. The recent, well-publicised pressure from its parent company to maintain a flat balance sheet has required GECAS – which wanted to retain its market footprint – to become more active in selling off its assets to meet that higher $4bn a year target. The aviation asset backed securitisation (ABS) market has been used by GECAS as one alternative for aircraft portfolio sales. The lessor has acted as the seller and servicer in several large aircraft portfolio transactions in the post-crisis period – AABS in 2013 (along with two engine ABS deals FAN and TRBN), RISE in 2014, and Labrador in 2016. However, Trevor Ricards, the head of US capital markets at GECAS, describes the company’s use of the ABS market as “episodic” and much too slow to originate and execute.
Since there has been a recent change in strategy for GECAS, which means the company can once again grow its balance sheet with a target origination figure of $6bn to $8bn deals per annum, it will still need to sell between $2bn to $2.5bn of aircraft annually.
“That figure is still a significant amount in the context of the aircraft lessor market,” says Ricards. “Having the ability to access the institutional investor market more regularly is important for assets sales, which we make primarily for portfolio management purposes. We focus on closing large scale transactions in a business environment where there is a limited number of customers. While there may be 700-plus lessees, in reality we only want to do business with around 300 of those, which means we have been faced very quickly with exposure issues.”
By selling down aircraft assets, GECAS is creating capacity to conduct new business with its existing customers. For securitisation structures to be attractive in this process, GECAS wants them to be executed quickly and provide access to more liquid institutional capital on the equity side. Deutsche Bank and Citi bankers, together with executives from GECAS and Oz Management (Oz), believe they have created the ideal structure to address these issues on the equity side of ABS transactions with the creation of STARR 2018-1, which they describe as the first truly tradable aircraft ABS portfolio residual.
In this transaction, GECAS is selling a portfolio of 24 in-production Boeing and Airbus aircraft, with a total appraised value of approximately $700 million, to Start Ltd, which is financing its acquisition through issuance of 144A debt and equity. GECAS will continue to service the portfolio and an affiliate of Oz will serve as an asset manager.
Greg Leveto, head of strategic opportunities for the Global Credit and Financing Solutions division at Deutsche Bank who captained the STARR deal, explains that historically the sale of equity, or E, notes in aviation ABS transactions has been a cumbersome process that requires large investments that trade under strict confidentially agreements and require active management.
“Traditionally, an aviation ABS E note has been a large, illiquid investment that requires active management and is originated more like an M&A deal,” says Leveto. “That structure takes too long and has historically attracted private equity-style capital, but we think there are more efficient sources of capital for the risk profile of the underlying assets.”
He adds: “Structured product investors are attracted to aircraft assets equity but they have not had a seamless way to express a positive view, creating the need for a structure like STARR.”
STARR 2018-1 is a Reg S/144A, DTTC-cleared security that trades without confidentially agreements. It is able to trade in small size $1.4 million minimum denominations, with dealers able to make two-way markets and provide monthly marks, according to Deutsche Bank’s Leveto.
In its simplest form, project STARR is a tradeable E note that is intended to create aviation investment opportunities that work in a similar way to other, more mature structured products such as the collateralised loan (CLO) market or CMBS market.
“We consider this to be a new structure for aviation, but at its core we are simply adopting and adapting efficient technology that exists in other, more developed sectors,” explains Leveto. “We are not re-inventing the wheel. The aircraft sector has over a trillion dollars of total market value, it is larger than the US leveraged loan market, yet in structured markets it is an esoteric asset class and trades entirely ‘off the run’. That shouldn’t be the case.”
For aircraft lessors like GECAS, he adds, selling E notes to institutional investors is a preferable avenue compared to the trade sale market, which is selling to competitors. Lessors maintain the positive position as a servicer to their clients’ assets and leverage their own platforms, he says.
Oz was brought in as an asset manager to “ensure greater transparency, advise on the board on certain key decisions and to meaningfully track and analyse the portfolio and its performance”. Further, Oz LP’s purchased a 19.5% stake in the E note. While details surrounding the sale of E notes in past aviation ABS transactions have usually been shrouded in secrecy, the pricing of STARR’s E notes is public – pricing at $91 million at issuance and is currently trading in the secondary market for $93.5 million.
Kumar Velayudham, managing director in US structured credit at Oz Management, explains that Oz is in the middle of the structure, working alongside the servicer to provide “additional reporting, analytics and modelling that will improve transparency and liquidity for debt and equity investors”. GECAS and Oz have been working together for the past 18 months on this deal and Velayudham says that the two companies have a robust plan in place for working together on this and future portfolios and that they are “very well aligned”.
As servicer, GECAS manages daily operations on the leasing side, while Velayudham says that Oz will be advising the board, which will make the final decisions on significant actions such as dispositions.
The enhanced disclosure, synthesised and managed by Oz is enabled by the fact that the asset manager has full access to private-side information throughout the life of the transaction and has conducted the robust due diligence normally associated with a private aviation investor, which helps provide some level of comfort that there has been high quality due diligence done on the assets and around portfolio selection. “Ultimately, sophisticated investors make their own assumptions about lease rates, dispositions and future performance that form their own price and yield expectations,” tempers Velayudham.
Introducing an asset manager is effectively adding another intermediary between the servicer and the end investors. Some market observers have stated that it is the servicer’s role to provide such insights to its investors, but the deal participants maintain that Oz will provide much more, as they explain.
As asset manager, an affiliate of Oz will advise the board with respect to aircraft-related decisions not handled by the servicer, GECAS, with a goal of maximising returns to the certificate holders, explains Leveto. Oz intends to provide a significantly improved reporting function, with quarterly and annual updates on the underlying lessees and aircraft types, updated cashflow projections and performance attribution. Oz will also help update the Intex model on a monthly basis, for lease roll-overs, asset sales, appraisal updates and changes in maintenance projections, for example.
Ricards explains that there was an “intensive selection process” to find an asset manager with the capability for this role. Oz was specifically chosen due to their “deep domain knowledge and experience, willingness to make an investment” and “a very effective platform on the CLO side with a strong investor relations capability”, he says.
“The transparency Och Ziff provides in terms of the information flow going to the equity and debt investors, while recognising the confidentiality of lessees, should substantially change the underlying liquidity in the structured aviation market,” says Ricards. “If you review the types of information they are providing – the information flows, the tracking of performance, etc. – all of those elements have never happened in this space before, which should attract more investors attracted to this product as there will be a better understanding of some of the underlying issues and concerns that go on in this space.”
“The improvement in disclosure through detailed reports by the asset manager and a constantly rolled forward transaction model on Intex provides more visibility to both debt and equity on an ongoing basis,” adds Leveto.
Some market observers have suggested that the fees being charged by the asset managers on this deal are too senior in the waterfall and the fact that they were initially contemplated to be paid out in full ahead of the senior bond holders on the debt side, which had put off some debt investors, according to some reports. In response to market feedback, a portion of the asset manager fees were moved down in the waterfall junior to scheduled principal payments of Class A bondholders.
According to Leveto, “the value of the asset manager to all tranches of investors will be established over time.”
Another key differentiator in STARR is that there is a loan to value (LTV) ratio available to debt investors that is based on the current market value (CMV) of the equity as the E notes price simultaneously. In the past, deals have only been marketed on appraised asset value. “Transparent equity valuation is a big changes to the market and takes away some of opaqueness for debt investors in terms of asset selection and valuation,” says Leveto.
To form STARR, Deutsche Bank and Citi approached insurance companies and money managers that they considered to be thought leaders in a pre-marketing process, which yielded orders from 15 accounts in advance of the deal announcement. The E note offering was twice oversubscribed in this pre-marketing stage, and all but one order received an allocation. As mentioned, the paper is reported to be trading up in the secondary markets and both Deutsche Bank and Citi are market makers. Leveto expects other investment banks to follow suit.
“We’re very proud of STARR,” he says. “This structure can materially improve the market. There is a real opportunity for the industry to broaden its investor base, create more transparency, create more liquidity and that ultimately reduce its cost of capital.”
With every ABS deal there is a debt side as well as an equity side to the deal. STARR issues $586.9 million of debt in three tranches: $430 million A notes, rated A by Kroll Bond Rating Agency (KBRA), with an initial LTV of 61.8%, which priced at +140bps spread; $120 million B notes, rated BBB, with an LTV of 79.1%, priced at 5.625% yield; and $36.9 million C notes, rated BB with an LTV of 84.4% that priced at 7.0% yield.
Although the team at Deutsche Bank are keen to focus on the unique aspects of the equity portion of the deal and suggest that the debt portion uses a standard structure already seen in the market aside from the inclusion of an asset manager, sources state that closing this portion of the transaction has faced its own challenges. Regardless of these challenges, says the bank, the three tranches of debt were fully subscribed and are trading at tighter levels than their primary execution.
The desire for many who play in the aviation ABS market is to standardise the product to enable the structures to become familiar to investors and attract greater volumes of investors.
“Standardisation across the aviation ABS debt market has attracted more market participants, which has led to tightening yields and increased liquidity,” says Leveto. “STARR can bring some of the same dynamic to structured equity, and can continue pushing the trend on the debt side as we believe the increased information (both type and format) will be valued over time.”
Velayudham points out that although the aviation market is worth $1 trillion in assets, only a small proportion of that total – less than 5%- is secured in the ABS market. “For comparable asset classes inside the structured world like residential credit, consumer/auto loans, more than 50% of assets sit in an ABS structure because it is used as a primary funding vehicle,” he says. “The aviation world is nowhere near this level, is partly due to the structure and the difficulty in placing equity. Our hope is that with our new structure more of the required funding in the next three-to-five years will be in the ABS market.”
This new STARR structure was created by GECAS and Deutsche Bank to gain greater and more regular access to the institutional investor markets to be able to fund those aircraft sales as the lessor continues to manage its portfolio risk.
While unable to commit to a timeframe, Leveto notes this structure is repeatable and confirms that Deutsche Bank “looks forward to working with Oz and GECAS on another transaction in the near future”.