In the same way Ryanair transformed the airline industry, the airline’s former deputy chief executive Howard Millar, is shaking up the aircraft leasing market with a new mortgage financing structure and an innovative approach to aircraft finance with his new company Stellwagen Group, which announced its first A380 sale-leaseback deal with Emirates yesterday.
“The operating lease product hasn’t changed at all in the 30 years since it was invented,” says Millar, now COO of Stellwagen Group and CEO of the newly formed Stellwagen Capital, who was speaking to Airline Economics at the sidelines of the IATA AGM in Dublin. “When I left Ryanair, I started to look at the operating leasing market and realised there was a big flaw. Airlines don’t get anything out of it except paying lots of money for operating an aircraft they give back at the end of the lease term. We are providing airlines with a new model that is an attractive package product that aids cashflow and they own the asset at the end of the lease period.”
Under the new financing model, Stellwagen will lend up to 85% of the market value of the aircraft and provides for a large balloon payment at the end of the loan, which is calculated at the end of ten years at 50% of the future market value of the aircraft.
“Compared to an operating lease structure, for the mid-tier carrier, this structure is better for cashflow by about 60%,” says Millar. “The big difference is the balloon payment. Although there are banks that will offer balloon payment options, they are very low, circa. $3-4 million at most but certainly not for 50% of the future market value of the aircraft at the end of a ten-year loan. This mouse trap is much better for airlines because they get to own the aircraft at the end of ten years, which they can refinance it or sell it.”
Millar calls this structure his “operating lease killer”. This structure does not require the airline to pay any maintenance reserves to the lessor since the airline retains ownership of the aircraft. “We don’t care how the airline maintains the airline but it will affect future market value so it is up to the airline to take good care of their asset,” says Millar.
When Millar was at Ryanair, they did have a few aircraft on operating lease. And although Ryanair didn’t pay maintenance reserves, they were required to return the aircraft in a certain condition at the end of the lease. “Ryanair had seven year leases and at the time we felt they were very inefficient because we had to do maintenance work at the time of handing back the aircraft, which we maybe didn’t need to do for a few years. When the return conditions don’t tally with the lifecycle of the aircraft, this is an inefficient arrangement for the airline. It was this downside, which made me start to look at how we could improve the operating leasing product using this mortgage style of financing.”
Millar is also developing a unique approach to raising financing to support their new aircraft funding model, which is based on the Real Estate Investment Trust (REITs) model. Millar intends to create Commercial Aircraft Investment Trusts or CAITs, which are essentially investment vehicles for aircraft assets, comparable to alternative investment funds (AIFs). Investors, including insurance companies and pension funds, will buy into the $1bn trust, which is structured as a ten-year profit participating note (PPN), which will be listed on the Irish Stock Exchange, with investors paid an annual coupon of 8-9%. The funds will then be used to purchase aircraft assets up to $1bn for a fee and a margin of 350 basis points over swaps.
“I was looking at REITs and how they are structured, some included PPNs, which as listed vehicles are very tax efficient. The trust is also a regulated company and investment grade rated, which ticks a lot of boxes for certain investors. I would hope to get investment grade rating. This is a really secure investment backed up by secure assets, which unlike property, can be moved. Seraph Asset Management will be responsible for managing the aircraft in the portfolio, which we will restrict to 737s and A320s, with a smattering of 787s and A350.”
Stellwagen plans to incorporate an investment matrix into the PPN that will address concentration risk issues by placing limits on airlines, countries etc. “80% of the portfolio will be restricted to low-risk first mortgage assets, but with the remaining 20% we can do something different, such as second mortgages for lower tier airlines or pre-delivery payments.”
This is all great but loaning money for aircraft purchases at a fee plus 350 bps over swaps won’t generate the promised 8-9% returns for the PPN investors. This value is generated by securitising those loans and making a gain on loan trading.
The development of this structure, which has been a joint effort between Millar and Stellwagen Group chief Douglas Brennan, is well advanced. Stellwagen has spoken to a number of interested investors from around the world, with many airlines also expressing interest in funding as well as some operating lessors.
“We are already talking to investors and airlines,” says Millar. “If I had a $1bn today, I could easily advance $2bn. I have also lessors interested in financing their own aircraft using this format using us as the backstop financings for their operating leases.”
Stellwagen has a first draft prospectus completed and has appointed legal counsel, Clifford Chance, to assist with the formation of the structure and AIFIM registration. Millar says all of this administration will be completed by the end of the July, ready to spring into action by September with a global roadshow.
Millar intends to issue a number of these funds once the first one has been launched and is a success. Although £1bn seems a significant number, in aircraft terms, it is 20-30 assets – a modest target for an industry at the start of a heavy delivery cycle. “This product won’t be cheaper for all airlines but what it does it give access to significant funds, while aiding cashflow and profitability – in short it is a better deal for the airline. I believe airlines will be willing to pay a little more to receive a larger balloon and ultimately ownership of the asset at the end of the lease period.”
Look for the forthcoming issue of Airline Economics, which delves a little deeper into this proposed aviation financing structure.