Risk Management for
Lessors
Paul Dwyer
Head of Risk
Topics
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Why Risk Management
Asset Risk
Credit Risk
Jurisdictional Risk and Repossession Considerations
Insurance
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Why Risk Management
Airline Stops and Starts
Start-ups Failures
6/2015
13
18
2014
38
44
2013
68
42
2012
51
62
2011
38
53
2010
57
93
2009
63
92
2008
39
108
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Why Risk Management
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Why Risk Management
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Asset Risk – Beyond Appraised
Value
• Aircraft operating lessors are heavily exposed to asset risk.
Operating lessors have significant residual values at lease terminations
Lease terminations force lessors to remarket aircraft
• Asset risk is an assessment of the fundamental ability of an asset to retain value
over time, essentially a measure of its volatility.
• Aircraft future value appraisals, by themselves, are not risk management
solutions
• Appraisals provide a forecast of potential future values
• Appraisals do not provide a probability of achieving that future value
• Appraisals are not residual value guarantees
• Problem not with the appraiser but rather the user
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Why Risk Management
9/1997 B737-300 Est. New Price $32.5m
40
35
35.26
33
33.37
32.8
31.8
33
32.78
30.7
30
31.62
29.6
29.1
30.78
28.4
26.8
29.81
27.3
28.91
26.2
28
25.3
27.07
24.3
25
20
Apprais
ed 1997
CMV
rev.
NBV
17.9
13.5
15
12.5
10
5
0
1997
1998
1999
2000
2001
2002
2003
2004
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2005
Asset Risk – Beyond Appraised
Value
11/00 B737-700 Est. New Price $33.2m
45
40
35
30
1998 Base
Value
Forecast
25
20
15
10
5
0
2000
2001
2002
2003
2004
2005
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Asset Risk – Beyond Appraised
Value
1996 B747-400F Purchased 11/96 $140.0m
160
140
120
100
1996
Base
Value
Forecast
80
60
40
20
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
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2006
Asset Risk – Beyond Appraised
Value
• Aircraft value forecast models currently exhibit significant heteroskedasticity
• VaR models suffer from lack of data, short term focus and recent history
• More developed models (e.g. GARCH) have yet to be developed and adopted by
the industry
• We can however identify aircraft that will likely exhibit greater volatility.
• You can rank aircraft by their potential future volatility and their forecasted
decline in value
• Appraisers increasingly providing volatility ratings
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Credit Risk – Quantifying Expected
Loss
• Risk is the combination of exposure and uncertainty
• For operating lessors credit risk exposure (as opposed to a lender) is a function
of time off lease and expenses
• Credit exposures differ significantly depending on transaction structure
Maintenance status and reserves, security deposits, Eurocontrol, airport
and mechanic liens, rentals, registration and aircraft specification issues
• Uncertainty is defined as default probability
Default probability is a function of counterparty credit rating
Every lessor needs a counterparty rating system that uses a consistent
process based on quantitative and qualitative analysis to rate
counterparties with regard to default risk
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Credit Risk – Expected Loss
• Expected Loss (EL) is the average loss a financial institution can expect to incur
from holding a portfolio of assets over time, not to be confused with actual
losses (issues of correlation and granularity)
• From a statistical view it is the mean of the probability distribution of possible
losses
• EL is an average that provides a benchmark in quantifying and measuring the
risk in a financial portfolio
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Credit Risk – Rating Airlines
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Competitive Profile
Size, Market Position, Management
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Operating Performance
EBITDAR, EBIT and NPAT margins
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Debt Service
EBITDAR/Interest+Rent, EBITDA/Net interest
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Gearing
Total Debt (incl.off BS)/Equity, Total Debt (incl.off BS)/EBITDAR
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Liquidity
Cash/Short Term Debt, Cash/Revenues, Current Ratio
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Equity Support
Ability and willingness of shareholders to provide support
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Linkage to Sovereign Ratings
Political Risk, Transferability of foreign exchange
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Credit Risk – Rating Airlines
• Ratings need to provide adequate discrimination
• Scale needs to provide greater delineation of non-investment ratings as
relatively few airlines are highly rated
• Counterparty credit rating can be capped at foreign long term sovereign rating
of the lessee country
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Credit Risk – Combining Exposure
and Uncertainty
Off Lease Costs
Repossession
Transition
Reconfiguration
Security
Deposits
MR Shortfall
Economic
Exposure
S&P Default Probability
Mapped from Rating
Severity
Expected
Loss
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Jurisdictional Risk and Repossession
Considerations
Legal considerations
• Effectiveness of Judicial Process in a Default
‐ Cape Town Treaty: not perfect
‐ Ability to timely repossess, deregister
and export aircraft critical
- Deregistration POAs and IDERs not
always effective
• Liens
‐ Airport and mechanic
‐ En-route Navigation, Eurocontrol,
NAV Canada
‐ Governmental duties, Customs duties,
local and national taxes, Emission Charges
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Jurisdictional Risk and Repossession
Considerations
Repossession in practice
• Deregistration POA not recognized by DGCA
‐ Required “Non –Objection Certificate”
‐ Court finally ruled it was not required
- Aircraft was out of country in possession
of lessor
• Lien Magnet
‐ Airplane deregistered and in possession
of lessor but in country
‐ Subject to airport liens and other
charges, finally released
• Aircraft condition important
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Insurance – No one cares about it
until they panic
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Insurance – No one cares about it
until they panic
• Lessors primarily rely on lessee’s insurance
‐Hull, spares, liability, war risk
War risk written out by AVN 48B, written back with AVN 52D
‐Agreed value in excess of net book value
Total loss only (“TLO”) may be required if acquiring aircraft from
another lessor
‐Liability amounts significant > $750m
• Lessors typically do not see policy
‐Rely on Broker certificate
• Lessors often do not know underwriters identity
‐More aviation insurance is underwritten outside of London Market
‐Increasing use of contingent coverage by major lessors and lenders
‐Useful link http://www.iuaclauses.co.uk
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At 4:00am in Wan Chai, this may be handy….
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Emergency Call Number
Closest Public Hospital
24 hour Clinic
Coronary Care
Restaurant Ratings
999
Ruttonjee (Queen’s Rd)
Hong Kong Sanatorium
Adventist Hospital
Openrice.com
[email protected]
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