GECAS keen to see development of secondary equity market for securitizations
Following the closing of its second ABS this year, the 20 aircraft, $446.337 million note STARR 2019-2, Trevor Ricards, SVP with responsibility for US Asset Trading at GECAS, and Kumar Velayudham, Managing Director of the global diversified alternative asset management firm, Sculptor Capital, which has helped GECAS pioneer and develop the tradable e-note, discussed with Aviation Finance Contributing Editor John Stanley the background to this highly differentiated offering and their plans for the future development of this important market.

Every year GECAS originates up to $7 billion a year in new assets into its platform and sells between $2 billion to $4 billion. This is a crucial part of its business model, enabling it to manage its lessee exposures and thereby create capacity to continue to do new business with them.

Although it has been an active participant in the aircraft securitization market for the past 20 years, as a seller and a servicer, until it introduced the first ABS with a tradable e-note 18 months ago, STARR 2018-1, some 85 per cent of its asset sales every year were made into the trade market. One of the key reasons for its development of the tradable e-note market has been to achieve a better balance in that mix, with the ultimate target being a 50/50 split between the institutional and the trade market.
Trevor Ricards, SVP Asset Trading, GECAS: 'Improvements in the secondary market have a very dramatic impact on people's ability to continue to play in this space, particularly on the equity side.'

Aviation Finance: Why is the securitisation market so important to GECAS?

Trevor Ricards: There’s two ways to use the ABS market – to raise financing and to sell assets. Our parent provides us with financing, so we use the market to sell assets.

Selling assets is a big part of the GECAS business model. We originate somewhere between $5 billion to $7 billion a year in new assets and then we sell somewhere between $2 billion to $4 billion. The major driver is managing our lessee exposure. There may be 700 lessees in the world but you may only want to do business with about 300.

We have a $44 billion balance sheet and are focused on large transactions. Obviously, it doesn’t take us long to get into the position where we have exposure to lessees that we need to sell down. The key thing to remember, and this is true of virtually all our institutional deals, is that we are actually selling down our exposure to lessees to create capacity to do new business with them, we’re not selling out of the exposures.

There are two ways to sell these assets, either into the institutional market, through the ABS market, or into the trade market. Prior to the development of the tradable e-note 85 per cent of our asset sales were going into the trade market. So, one of the key drivers behind developing the tradable e-note market was to better balance that mix. Now we’re moving towards a 50/50 split between the institutional and the trade market. STARR 2019-2 is our third transaction in the last 18 months, so we’re getting closer to that objective as we move forward. The asset sales side of our business is a key element in our strategy and utilization of the tradable e-note in executing that strategy is something that’s emerging.

The e-note has always been a very important component for anyone involved in transactions where the objective is to sell the entire cap stack. Before the development of the ‘tradable e-note’ there were private placements of e-notes which went to maybe one or two investors. But it was a process very much akin to doing an M&A deal, taking maybe nine to 12 months to execute. Obviously, in our business execution efficiency and timing are crucial and that time frame doesn’t work very well.

So for some time we had been trying to develop the ability to attract new investors into the e-note market who did not have the ability to write a check for anywhere between $75 million and $150 million. The tradable e-note has substantially expanded the number of investors who can look at this space and has also substantially improved transaction timing from initiation through execution.

Our objective is to be in the market twice a year, and I would say we have demonstrated our ability to initiate and execute in that time frame.

Aviation Finance: What new investors have you attracted into the market?

Trevor Ricards: You need to differentiate between the debt and equity for transactions. The debt market has made significant progress over the last three to four years. Structures have become more commoditized and both the tracking of these transactions and the level of issuance has substantially improved. That alone attracts a whole group of new investors from other spaces to take a look, particularly given the types of spreads that are available in this space based on relative value. So, a number of new players have entered this market on the debt side.

On the equity side, as far as the tradable e-notes are concerned most of the passive players are not coming from the aircraft space, but from CLO’s and other hard asset classes, like containers. So there’s a very new group of investors looking at and participating in the space.

Aviation Finance: So is it fair to say that the aircraft securitization market is achieving a broader appeal and enjoying wider acceptance?

Trevor Ricards: Again, I think you need differentiate between the debt and equity market. As I mentioned, the debt market is more developed and enjoying wider acceptance. On the other hand, the equity market or the tradeable e-note is still very early in development and while it is developing there is more work to be done. I would suggest that one of the reasons people feel comfortable with the STARR transactions is because it is a differentiated product. In tradeable e-note transactions you generally have ‘anchor investors’ who are a significant participant in the equity and who generally undertake due diligence on the portfolio. But in STARR transactions there is not only an anchor investor but also an asset manager, that’s Sculptor Capital.

We actually spent a lot of time going through the process of determining whether we needed an asset manager. Then we went out with an RFP to a limited number of players who could actually tick the box, who were willing to invest in each of the transactions and who also had the ability to provide an investor reporting portal. GECAS did not have the infrastructure when we began this process.

The third thing we recognized was the value of adding somebody with experience in the space and who was well known to the investor community, so investors would have comfort knowing they were looking at the portfolio.

In our case what’s also unique is that not only does the anchor investor undertake due diligence on the portfolio, they also are involved in the selection of the assets within the portfolio. In each of our STARR deals, for example, we’ve shown Sculptor about 40 aircraft and then it has gone through an in-depth underwriting process to select the aircraft it feels is appropriate for their LPs.
Kumar Velayudham, MD, Sculptor Capital: 'With close to $10 billion issuance annually its at a point that it catches people's eye and ... it is likely there is going to be a material increase in the amount of debt that's issued and traded. On the equity side ... the investor base is still small - but they're getting more sophisticated by the day.'

Kumar Velayudham: We’ve been significantly involved in this space for a while now. We’ve taken part in traditional e-note sales, what used to be called 4a2 processes before, and, as Trevor mentioned, it’s almost like a M&A style process, there’s very limited liquidity in those investments.

So, we worked alongside GECAS for about two years before we came come up with a structure, governance and all the other details that led to the first tradable e-note, STARR 2018-1 in June of that year, and since then we’ve done two more transactions.

The process has pretty much remained the same in all of them. GECAS presents us with a portfolio of approximately 40 assets. We have underwriting models which we use and we try to pick the best 20 that work for our investors, and that is a consistent process at this point. In terms of the timing itself, at this point we’d be comfortable saying that once the portfolio is finalized, the process is done within eight weeks, versus the 12-month process before.

Trevor Ricards: I would add that in addition to achieving the objectives for Sculptor’s LPs, we also take into consideration that we need to establish a portfolio that meets the requirements for optimized debt financing. So you need to take into consideration lessee diversity, geographic diversity, lease maturity profiles etc. You also need to design a portfolio that produces the type of cash-on-cash returns that the market requires. So, there’s quite a bit of iteration in terms of what’s involved in trying to get one of these transactions done.

Both ourselves and Sculptor have been involved in this space for a long period of time and it is very complicated. However, I think we have a very strong relationship in terms of how it works now.

Aviation Finance: What areas of opportunity do you see for improvement in the tradable e-note space?

Kumar Velayudham:The tradable e-note market is just 18 months old and it’s still growing, so there is a lot of room for improvement in the market. One of the key areas of focus for us, the issuers, the banks and the sector as a whole, is to try to improve the secondary market liquidity. That is part of the feedback that we’ve got from a lot of the investors in the space.

And even though there has been a standardization of structures over the last four years in the debt space which has caused the debt liquidity to go up and attracted new investors to come in, there is still some variation between the deals in terms the appraisers being used, maintenance and other deal assumptions. So we think those things need to be more standardized for the sector’s liquidity to increase.

The last thing is to potentially have more checks and balances in place so that the quality of the assets coming into the ABS market are acceptable and produce good returns for the investors.

Trevor Ricards: I would strongly echo those comments. One of the nice things about the primary market is that you have the opportunity to sit down face-to-face with investors and explain the differences between transactions. When it comes to the secondary market, that’s not necessarily the case – and that’s particularly true in the equity.

So the notion of moving to more standardization in related to assumptions and appraisals is really crucial, as well as talking to the banks about providing additional support to secondary trading. Improvements in the secondary market have a very dramatic impact on people’s ability to continue to play in this space, particularly on the equity side.

Aviation Finance: Do you think further improvements in transparency are needed to help develop liquidity in the secondary market?

Kumar Velayudham: If you look at the level of reporting before the tradable e-note versus STARR 2018-1, I think most market participants would agree that it has set the benchmark for reporting and the level of transparency has improved significantly in the market. We don’t actually see that much more need for improvements in reporting. But I do think that if all the other asset managers or issuers can also keep things more up to date it could improve secondary market liquidity. Liquidity is partly a function of perception and to the extent that there are any deals that are deficient in any way, it affects every other part of the market at some level.

Aviation Finance: What changes are you seeing in terms of the geographic locations of interested investors?

Trevor Ricards: As far as debt is concerned, it is still primarily a US product. A lot of substantial players who would be household names are now participants in the space. I think from a geographic standpoint there have been some preliminary discussions with some European institutions, but they have not historically played here. There have also been some discussions with Asian debt investors, again without a great deal of success.

On the equity side, that’s evolving. Looking at the transactions from STARR 2018-1 up to STARR 2019-2, we have seen a movement towards a US investor base relative to an overseas investor base. However, we do have quite a bit of interest coming out of the UK in this product on the equity side.

Every once in a while, you have to stop and think about where we are in the process. The market really has existed for the last 18 months, so it’s evolving fairly quickly and the amount of issuance, frankly, over that period of time, is quite extraordinary.

I think the investment banks have spent a lot of time knocking on doors in various European jurisdictions with limited success to date. However, as is true of any space, as interest continues to grow and people become more aware of what’s going on in that space, and taking into account the developments that we’ve seen over the last 18 months, I think investors are going to naturally start asking questions about what’s going on.

Look at Asia, for example, which is a significant investor in the aircraft space. We’ve actually had transactions in which GECAS has participated as a seller and a servicer and in which the equity has been provided by Korean investors with the debt placed in the US. So there is clearly interest in the space. As to whether they are going to participate in the tradable e-note format remains to be seen.

Aviation Finance: What impact, if any, will changes in aircraft technology affect valuations within mid-life ABS portfolios?

Trevor Ricards: To be honest, I’m not sure how big a concern this really is. The reality is that the crossover point, when the number of in-service NGs and ceos will be equal to neos and MAXs, is at best the middle of the next decade. And with what’s going on with the MAX today that’s probably even further out. So the impact on actual value over that period of time is likely to be limited.

One important thing to remember, I think, is that people are also recalling the days of the move from classics to NGs and how there was a precipitous drop off in value with the introduction of the ng. But first of all, there weren’t as many aircraft in service then and secondly it was truly a step change in technology. You had not only new engines involved in an ng compared to a classic, you also had fairly substantial changes in the fuselage itself as well as wings, whereas if you compare a neo and a MAX, they are designed primarily for engine improvements, which is equal to 10 to 15 per cent maybe in operating efficiency. And in this day and age, if you take into account what’s going on with oil prices, the actual impact of that is not nearly as significant as it used to be.

So, the prospect of degradation in the value on some of these so-called ‘mid-life’ aircraft is not as big a concern as I think some folks may believe.

Aviation Finance: In some securitizations the divergence between appraisers in their valuations of individual aircraft is substantial. Does this have a negative effect on investor sentiment?

Trevor Ricards: My view on this is that the one thing you can rely on is that the appraisers are always going to have diverse views! So the reality of the situation is that you want to make sure that you have a similar set of appraisers for all of the transactions. That way you can look at them like-for-like across the board and understand how the transactions actually look relative to each other for things like IRRs, advance rates etc. Because you can have significant variances in the values given by each of the appraisers but at the end of the day you want to be able to compare them.

So, what we find in this space now is there seems to be a convergence on the use of certain appraisers by and large and then the fall-back position that seems to be taken by everyone is that they also do an Ascend valuation, which is viewed as the more conservative of the appraisers for most of the transactions. So then you have an ability to understand how each of the transactions line up one against the other. I think that’s the more important piece than looking at the variation that exists amongst various appraisers for the underlying metal.

Kumar Velayudham: I agree 100 percent with Trevor. Standardization is already happening and will hopefully happen more widely next year. At this point we have had close to 15 tradable e-note deals and you can see that most of the deals are starting to look very, very similar, except for a few. There’s also a reasonable pipeline going forward, and I think the bankers are probably making an effort to push for convergence in the assumptions and appraisals so that it’s easier for everyone to evaluate them.

Aviation Finance: What are your expectations for future growth in the aircrafts ABS market?

Kumar Velayudham: Barring any large macro headwinds, it looks like the debt market is set to grow. There is a strong investor base, with close to $10 billion issuance annually, and it is at this point that it catches people’s eye and becomes large enough for analysts to start taking a look at it and have an allocation for it. It’s at that threshold, so we think it is likely there is going to be a material increase in the amount of debt that’s issued and traded.

On the equity side, there could be more differentiation going forward as the investor base is still small – but they’re getting more sophisticated by the day. The equity market trades today to a headline yield, with limited differentiation. But we’ve already seen in the last three months that there is more differentiation between a platform like STARR, which is programmatic, with all the things we’ve spoken about, like asset quality, third party manager etc., versus other issuers. We think going forward there will be more of that as the investor base becomes more sophisticated.

Trevor Ricards: There’s a very large issuance pipeline, but there’s also more of a movement towards standardization of assumptions and appraisers. Increasing support in the secondary market is going to be key to making sure that this market evolves correctly. So I think lots of people are going to be focused on how the market evolves in 2020.

From our own perspective, we feel strongly we have a very differentiated product in the market, both with respect to what our objectives are in accessing the market and the actual structure of the transactions that we do. We’re not one of those players who is coming into the market to take advantage of developments we’ve seen over the course of the last 18 months, we’re in for the long haul.

Now we are focused on basically improving both liquidity and support in secondary trading, which is key to the market, because our objective over the longer term is to develop a regular way market for investors in the space. It’s in our interest on a long-term basis and I think it’s also in the interests of our investors in the long-term.

Vol. 9 Issue 25 of Aviation Finance