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Risk Management for Lessors. Paul Dwyer Head of Risk. 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
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Risk Management for Lessors Paul Dwyer Head of Risk
Topics • Why Risk Management • Asset Risk • Credit Risk • Jurisdictional Risk and Repossession Considerations • Insurance
Why Risk Management Airline Stops and Starts Start-upsFailures 6/20151318 20143844 2013 68 42 2012 51 62 2011 38 53 2010 57 93 2009 63 92 2008 39 108
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
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
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 Profile Size, Market Position, Management • Operating Performance EBITDAR, EBIT and NPAT margins • Debt Service EBITDAR/Interest+Rent, EBITDA/Net interest • Gearing Total Debt (incl.off BS)/Equity, Total Debt (incl.offBS)/EBITDAR • Liquidity Cash/Short Term Debt, Cash/Revenues, Current Ratio • Equity Support Ability and willingness of shareholders to provide support • Linkage to Sovereign Ratings Political 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 Security Deposits MR Shortfall Transition Reconfiguration Off Lease Costs Repossession Economic Exposure S&P Default Probability Mapped from Rating Severity 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 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
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
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 • paul.dwyer@hkac.com