Non-performing loans: Specific issues in trading impaired and non-performing aviation loan portfolios

Alan Bainbridge:
So today we're going to continue the theme around NPLs, and looking specifically at aviation loans, and I'm joined again by my partner Simon Lew. Simon, what specific issues do you see in trading aviation loans in particular in the context of distress and non-performance? 

Simon Lew:
I think firstly to say Alan is up to this point, we haven't seen much in the way of aircraft loan portfolios being traded and certainly not non-performing aircraft loan portfolios being traded. There's an active market in single aircraft loan trades, but not really on a portfolio-wide basis unless it's in connection with the sale of an entire business such as for example the sale by DVB of its aircraft lending platform to MUFG.

Of course, the current COVID crisis has had a very significant impact on the airline industry, perhaps a deeper impact than any other industrial sector. And so most observers think that when the dust starts to settle a number of banks who have up to this point being active participants in the airline industry may feel the time has come to exit and that's the point where we will start to see aircraft loan portfolios coming onto the market in greater numbers than we've seen up to this point.

In terms of the documentation of an aircraft loan, there is quite a marked difference between shipping loans and aircraft loans. In shipping loan portfolios, a lot of the loans that we see being traded are bilateral loans - in other words they're written solely between a borrower and a lender without a security agent in between. That isn't the case in the aviation industry. In aviation loans, the majority of loans, the vast majority of loans are written like this, structured on a syndicated basis so that you have a lender, and you have a security agent and a facility agent, and the facility agent may be the same as the lender. Very often, you will find single bank transactions being written in the aviation market where there is a single lender and that lender still acts as its own security agent and facility agent. Now, a syndicated loan structure is much easier, as far as the transfer of debt is concerned, than a bilateral structure because you can transfer the debt without having to transfer any of the attendance security, so long as the existing security agent is willing to continue in that role.

So the big question in any of these transactions is going to be whether the lending bank who is selling you the debt, if it is also the security agent, is going to be willing to continue in its capacity security agent, or is going to want to transfer that security agency function.

Alan Bainbridge:
So that takes us to the obvious question what if the existing security agent does not want to continue in that role?

Simon Lew:
Well, then the transfer becomes much trickier. If the security agent needs to change, then even if you might not need the consent of the borrower in order to buy the debt, or the consent of the airline in order to buy the debt, and very often, particularly if there's an event of default outstanding, you won't need consents, from the borrower or the airline lessee in order to transfer the debt. Even in that scenario, if you're transferring the security agency function, you will need that their cooperation - that is almost an inevitability. For example, any aircraft loan will have a mortgage over the aircraft and attendant to that mortgage are some additional documents such as a deregistration power of attorney and an IDERA, where applicable, and those are documents that have been entered into by the airline in favour of the security agent in order to facilitate a future enforcement of the mortgage. 

Now, the general feeling in the market, best practice, is that that deregistration power of attorney and that IDERA when they've been granted in favour of a security agent by an airline is granted, if you like, on a personal basis and when you change the security agent, then you need to get the airline to reissue that registration power attorney and that IDERA. Similarly, when you change the security agent, the airline is going to have to notify its insurers and the last payee under the insurers will change from the existing security agent to the new security agent. So again, you're going to need the borrower's cooperation even if you don't need that cooperation in order to transfer the debt itself. Then you may also find that the new security agent has to enter into warranty agreements with the manufacturer of the aircraft and the borrower, as well as the airline, in order to transfer the benefit of any existing airframe or engine warranties that go with the aircraft. So, the cooperation of third parties in the transfer of a security agency function is necessary, but certainly in the current market that corporation cannot in any way be assured. If third parties aren't cooperating, then the only solution really is to try to exist, retain the existing security agency arrangements, or put in place some other form of synthetic transfer, which will avoid the need for third party involvement.

Alan Bainbridge:
And so finally Simon, what happens if the airline is in chapter 11 or some other equivalent insolvency process?

Simon Lew:
Well, the fact that an airline is in an insolvency process doesn't of itself mean the transfer of the load can't proceed. There will obviously be a problem if you need the airline's consent to do that transfer, and you'll have a similar problem if you need the airline's cooperation in relation to the transfer of a security agency function, but there's rarely a requirement to get consent to the transfer of a debt in an event of default scenario. So, if we're just talking about the transfer of the loan itself, and not the attendance Security Agency function, the fact that the airline is in chapter 11 shouldn't affect the ability to transfer the load.

However, if we are dealing with the transfer of a security agency function at the same time, then you are going to need the cooperation of the airline, for the reasons I just mentioned. We'll need a new deregistration of power attorney, we will need help in changing the insurances. In that scenario, although these are purely administrative changes that are going to be made, the airline, if it isn't an insolvency process, won't be able to cooperate in that process without some form of application to the bankruptcy court. You can make those applications to the bankruptcy court, and very often you will get the bankruptcy court to rubber stamp what you are trying to do here, but you have to go through a more convoluted process in order to do it.

Alan Bainbridge:
Thank you