Export Credit Agency Financing and the Aviation Industry: What Does the Future Hold?
The use of Export Credit Agency (ECA) financing in the aviation industry has ebbed and flowed over the years, and it is often during turbulent times that it has proved to be most popular. Given the current COVID-19 pandemic and the unprecedented downturn experienced by the aviation industry, it is very likely that there will be an increase in the use of ECA financing in the near future.
For those unfamiliar with ECA financing, it is a form of financial support provided by a government agency to promote the export of goods manufactured in the home state, usually in the form of a direct loan or a guarantee to the lending institution that is financing the purchase of the relevant goods. The fundamental premise is that exports from domestic producers of goods and services will be enhanced where foreign purchasers have access to the ECA product — a loan to a foreign purchaser that benefits from a guarantee issued by the Export-Import Bank of the United States (Ex-Im Bank), the official ECA of the United States, is essentially equivalent to buying a U.S. Treasury Bill.
A typical ECA financing structure for the purchase of an aircraft will involve an 85 percent loan from a syndicate of ECA-supported banks, and such loan will be guaranteed by one or more ECAs. The unfinanced portion of the aircraft's cost will usually be an equity contribution (and where made by way of loan, fully subordinated to the ECA loan).
Historical Trends with ECA Financing
Today, there are approximately 80 countries that have established ECAs or some variation of such national export support. The first official ECA, the English Credit Guarantee Department, was established in the United Kingdom in 1919 in the aftermath of World War I. As a general proposition, ECA activity tends to be countercyclical: During economic downturns when banks and other lending institutions are reluctant to provide finance, ECA activity accelerates. By way of example, between 2009 and 2012, Ex-Im Bank helped finance roughly 30 percent of all Boeing's commercial aircraft deliveries.
Conversely, increased availability of traditional debt in the market, along with changes in the ECA financing context (as described in more detail below), combined with high export credit premiums for buyers and borrowers, have resulted in a reduction in the use of ECA financing in recent years, to a particular low in 2015-2016.
Industry Context for ECA Financing and Current Trends
There has been a lot of change in the ECA financing context in the last five years. Ex-Im Bank received its reauthorization in December 2019 after losing it in 2015 — so it was effectively dormant for a 4.5-year period — while ECA activity for Airbus was curtailed as a result of a 2016 United Kingdom Serious Fraud Office (SFO) investigation relating to irregular payments by Airbus to intermediaries that resulted in Airbus' ECA cover being available on a limited, case-by-case basis. In addition, the home market rule, which is an informal agreement whereby Ex-Im Bank and certain European ECAs agree not to provide export credit financing to borrowers located based in their own or each other's home markets, has also proved to be controversial with airlines in the U.S. and parts of Europe that did not qualify for export credit due to the "Home Market" rule. They consider themselves at an unfair disadvantage when compared to airlines outside of these jurisdictions. So the product is not without its detractors.
These events, however, helped spur the development of alternatives to ECA financing, namely non-payment insurance (NPI). NPI is a form of insurance cover offered by an insurance company that pays an insured lender upon a loss caused by the failure of a borrower to make payments in accordance with the underlying financing arrangements. Marsh LLC, in association with Boeing, launched the Aviation Finance Insurance Consortium (AFIC) NPI in June 2017. AFIC sought to take advantage of available capital in the insurance market to cover lenders' credit, aircraft residual and jurisdictional risk, with Marsh LLC being the exclusive broker. Meanwhile, Marsh S.A.S., in association with Airbus, lenders and a pool of highly rated insurers, launched Balthazar, a NPI for lenders and investors funding purchases of new Airbus aircraft, with Marsh S.A.S. being the exclusive broker. The insurers will typically provide 100 percent coverage with terms of up to 12 years.
In turn, other providers — such as Aviation Capital Group (ACG), with its Aviation Financing Solutions (AFS) group — have established guarantee products, much akin to the original Ex-Im Bank product. While not an insurance product as such, economically it provides essentially the same level of support.
These products have been in the market for a few years now, and they are already being combined with established aircraft financing products such as Japanese Operating Lease with Call Options (JOLCOs) and other tax leases. The expectation is that they will continue to develop and cover the same waterfront as would have been customary for the ECAs.
Recent Ex-Im Bank Developments
On May 21, 2020, and following an 11-month review process, Ex-Im Bank took unanimous action to reform two key features of the Ex-Im Bank approval process: the economic impact analysis and "additionality" analysis.
The reformation of Ex-Im Bank's economic impact procedures is intended to ensure a more thorough assessment of the potential impact of any given transaction on relevant domestic industries. The new procedures will attempt to introduce greater transparency for all interested parties by enabling those parties to be proactively notified of potential transactions and have access to the economic impact analysis. For commercial aircraft transactions, the economic impact analysis will focus solely on the economics of the route-specific competition.
The reformation of Ex-Im Bank's "additionality" criteria is similarly intended to introduce a more forensic test when examining whether its support of a given transaction is necessary and not, in fact, a convenient substitute for private-sector financing. Ex-Im Bank will now require a greater level of formal written documentation supporting the case for additionality that includes prescriptive checklists and explanations as to why lenders are unable to provide financing without Ex-Im Bank support. On its face, the rules appear to be designed essentially to ensure that Ex-Im Bank's involvement is genuinely facilitating a transaction that would otherwise not proceed without its support.
However, the practical impact of these new rules is not clear. For example, there is no clear guidance as to what type of evidence would be required to satisfy any such test and, in some instances, mere oral evidence may in fact suffice (assuming the Ex-Im Bank bank loan officer puts a memo on the relevant file). In addition, it would appear that a borrower may apply for Ex-Im Bank financing if "the foreign buyer seeks diversification of funding, including dedicated allocation of funding from ECAs," which suggests a degree of flexibility around the requirement for Ex-Im Bank's involvement to be facilitating a transaction that would not otherwise occur.
ECAs are set to play a significant role for future aircraft financings, particularly for airlines with lower credit rating, if access to traditional debt finance becomes increasingly restricted to those airlines with strong(er) credit ratings. However, since the application and approval process for ECAs takes some time to run its course, it may be many months before there is a rise in ECA-backed aircraft deliveries. Otherwise, it remains to be seen whether the reform of the Ex-Im Bank approval procedures, particularly the emphasis on "additionality," will serve to reduce the number of Ex-Im Bank-backed Boeing aircraft deliveries, or, conversely, whether the reforms will have any substantive impact on the Ex-Im Bank application process, noting that there appears to be no statistical analysis demonstrating how past transactions would fare under the new regime. In the event the reforms do introduce a significant gear shift for Ex-Im Bank that results in its product becoming more exclusive — as opposed to simply one of many financing options available in the market — then that may suggest a potential significant divergence in approach when compared to other ECAs, including that of the European Airbus supporting ECAs.