Risk Management for Lessors Paul Dwyer Head of Risk

Risk Management for Lessors

Paul DwyerHead of Risk

© HKAC | Hong Kong | 3 Nov 15 | 2

Topics

• Why Risk Management• Asset Risk• Credit Risk• Jurisdictional Risk and Repossession Considerations• Insurance


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


Why Risk Management


Why Risk Management


Asset Risk – Beyond Appraised Value

• Aircraft operating lessors are heavily exposed to asset risk.Operating lessors have significant residual values at lease

terminationsLease 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


Why Risk Management

1997 1998 1999 2000 2001 2002 2003 2004 20050

5

10

15

20

25

30

35

40

35.2633.37 32.78

31.62 30.7829.81

28.9128

27.07

32.8 33

29.1

26.8

17.9

13.512.5

3331.8

30.729.6

28.427.3

26.225.3

24.3

9/1997 B737-300 Est. New Price $32.5m

Appraised 1997

CMV rev.

NBV



2000 2001 2002 2003 2004 20050

5

10

15

20

25

30

35

40

4511/00 B737-700 Est. New Price $33.2m

1998 Base Value Forecast



1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 20060

20

40

60

80

100

120

140

1601996 B747-400F Purchased 11/96 $140.0m

1996 Base Value Forecast



• 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


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


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


Credit Risk – Rating Airlines

• Competitive ProfileSize, Market Position, Management

• Operating PerformanceEBITDAR, EBIT and NPAT margins

• Debt ServiceEBITDAR/Interest+Rent, EBITDA/Net interest

• GearingTotal Debt (incl.off BS)/Equity, Total Debt (incl.off BS)/EBITDAR

• LiquidityCash/Short Term Debt, Cash/Revenues, Current Ratio

• Equity SupportAbility and willingness of shareholders to provide support

• Linkage to Sovereign RatingsPolitical Risk, Transferability of foreign exchange


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


Credit Risk – Combining Exposure and Uncertainty

MR Shortfall

Off Lease Costs

Security Deposits

Repossession

Transition Reconfiguratio

n

Economic Exposure

Severity S&P Default Probability Mapped

from Rating

Expected Loss


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


Jurisdictional Risk and Repossession ConsiderationsRepossession 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


Insurance – No one cares about it until they panic


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 valueTotal 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


At 4:00am in Wan Chai, this may be handy….• Emergency Call Number 999• Closest Public Hospital Ruttonjee (Queen’s Rd)• 24 hour Clinic Hong Kong Sanatorium • Coronary Care Adventist Hospital• Restaurant Ratings Openrice.com [email protected]

Documents

Risk Management for Lessors Paul Dwyer Head of Risk