I was reading the new International Lease Finance (B1/BB+) senior unsecured 5.5yr debt prospectus as I am interested in ILFC and most things AIG. When going through the prospectus, I was reading the covenant package that comes with the debt. One covenant in particular I found interesting, and in this piece I will address it.
First, in case you are not familiar with this company:
International Lease Finance Corporation’s primary business operation has historically been to acquire new commercial jet aircraft from The Boeing Company (BA) and Airbus S.A.S. and lease those aircraft to airlines throughout the world.
As of December 31, 2009, ILFC owned 993 jet aircraft, had 11 additional aircraft in the fleet classified as finance and sales-type leases and provided fleet management services for 99 aircraft. At December 31, 2009, they had contracted with Boeing and Airbus to purchase 120 new aircraft, all negotiated in U.S. dollars, for delivery through 2019 with an estimated purchase price of $13.7 billion.
Now, on with the covenant being focused on from the prospectus (emphasis mine):
Restrictions on Liens
The indenture provides that ILFC will not, nor will it permit any Restricted Subsidiary to, issue, assume or guarantee any indebtedness for borrowed money secured by any mortgage, upon any property of ILFC or any Restricted Subsidiary, or upon any shares of stock of any Restricted Subsidiary, without in any such case effectively providing, concurrently with the issuance, assumption or guaranty of any such indebtedness for borrowed money, that the notes (together with, any other Debt Securities outstanding under the indenture, and if ILFC shall so determine, any other indebtedness of ILFC or such Restricted Subsidiary ranking equally with the notes then existing or thereafter created) shall be secured equally and ratably with such indebtedness for borrowed money; (followed by a list of typical exemptions – existing liens, tax liens…)
Notwithstanding the foregoing provisions, ILFC and any one or more Restricted Subsidiaries may issue, assume or guarantee indebtedness for borrowed money secured by mortgages which would otherwise be subject to the foregoing restrictions in an aggregate amount which, together with all the other outstanding indebtedness for borrowed money of ILFC and its Restricted Subsidiaries secured by mortgages which is not listed in clauses (1) through (8) above, does not at the time exceed 12.5% of the Consolidated Net Tangible Assets of ILFC as shown on the audited consolidated financial statements of ILFC as of the end of the fiscal year preceding the date of determination.
So, let’s define Restricted Subsidiaries (capitalized terms require definitions):
‘‘Restricted Subsidiary’’ means any Subsidiary other than a Non-Restricted Subsidiary; provided, however, that the Board of Directors may, subject to the covenant described under the caption ‘‘—Certain Covenants—Restrictions on Permitting Restricted Subsidiaries to Become Non-Restricted Subsidiaries and Non-Restricted Subsidiaries to Become Restricted Subsidiaries’’ above, designate any Non-Restricted Subsidiary, substantially all of the physical properties or business of which are located in the United States of America, its territories and possessions, or Puerto Rico and which does not meet the requirements of clause (ii) of the definition of Non-Restricted Subsidiary, as a Restricted Subsidiary.
‘‘Non-Restricted Subsidiary’’ means (i) any Subsidiary which shall be designated by the Board of Directors as a Non-Restricted Subsidiary, and (ii) any other Subsidiary of which the majority of the voting stock is owned directly or indirectly by one or more Non-Restricted Subsidiaries, if such other Subsidiary is a corporation, or in which a Non-Restricted Subsidiary is a general partner, if such other Subsidiary is a limited partnership. An initial list of Non-Restricted Subsidiaries will be set forth in an exhibit attached to the indenture.
Okay, with this in mind, let’s focus on the exemption from secured debt (the carve-out). As stated, the carve-out here is 12.5% of Consolidated Net Tangible Assets. In the 10k, ILFC identified this amount as $4.7 billion. Sounds reasonable, right? Well, let’s look at their secured debt outstanding (sourced from the recent announcement of their new term loans and the 10k list of secured debt):
Hold it, you say, how do they have $8.2 billion in secured debt when the limit is $4.7 billion? Well:
In addition, we are currently negotiating amendments to our unsecured revolving credit facilities that, among other things, would extend the maturity of our $2.5 billion revolving credit facility that currently expires in October 2011 with respect to the lenders that consent to the extension of the maturity date and, with respect to both of our revolving credit facilities, would increase the amount of secured indebtedness we could incur, assume or guarantee above the current limit of 12.5% of our consolidated tangible net assets. Under our existing public debt indentures and bank loans, we and our subsidiaries are permitted to incur secured indebtedness totaling up to 12.5% of consolidated net tangible assets, as defined in such debt agreements, which is currently approximately $4.7 billion. Therefore, we can currently incur additional secured financings totaling approximately $800 million under these existing debt agreements (this was prior to the TL1 and TL2 credit agreements), provided we receive any required consents from the FRBNY. Furthermore, it may be possible, subject to receipt of required consents from AIG Funding, the FRBNY, and the lenders under our bank loans, for us to obtain secured financing without regard to the 12.5% consolidated net tangible asset limit referred to above (but subject to certain other limitations) by doing so through subsidiaries that qualify as non-restricted subsidiaries under our public debt indentures. We will need to seek relief from our bank lenders with regard to the 12.5% limitation. We cannot predict whether the banks, AIG Funding, or the FRBNY will consent to us incurring additional secured debt.
The restricted, unrestricted subsidiary shell game.
Okay, now that we know this covenant has little, if any, teeth to it, let’s look at the effect. From the chart above, we note that the amount of secured assets (very different from the amount of secured debt due to LTV constraints) is $15.4 billion. If we look at the primary assets of the company (listed as flight equipment under operating leases), we have a depreciated value of approximately $44 billion. Now let’s look at their capital structure:
So let’s take the assets (depreciated, which may cause some debate) and subtract the amount of secured assets: $44B – $15B = 29B. So now we see that we have $29B in unsecured assets covering $22B in unsecured debt, for a ratio of 1.3x. Given that the new term loans are using a 56% LTV, we might assume that the planes could trade around 65-70% of book. Using 70% (just to disprove those who say I am a cynic), we get a value of $20.3B, which gives us an asset coverage of 92%. Admittedly, the ECA loans have low LTVs due to amortization, so there is more value that could accrue to unsecureds.
For the curious among you, I have listed the various secured debt programs at the end of this article.
Bottom line: This covenant has virtually no value. Interesting for a B1/BB+ company. Can’t see that the others hold much more. These are investment grade covenants for a non-investment grade company. Who says credit markets aren’t stronger?
As promised, secured debt programs:
2010 Term Loan 1
On March 17, 2010, International Lease Finance Corporation, as borrower (the “Company”), entered into a new $750,000,000 secured term loan agreement (the “2010 Secured Term Loan 1”). On the same date, an indirect, wholly owned subsidiary of the Company, as borrower (the “Subsidiary Borrower”), entered into a new $550,000,000 secured term loan agreement (the “2010 Secured Term Loan 2”).
The 2010 Secured Term Loan 1 will initially be secured by a portfolio of 43 aircraft and all related equipment and leases (“Aircraft Collateral 1”), with an average appraised base market value as of March 2010 of approximately $1.34 billion, equal to an initial loan-to-value ratio of approximately 56%. Subject to substitution rights, the portfolio of the pledged aircraft will be required to meet certain concentration criteria, including age of aircraft, region of lessees, model type of aircraft, and manufacturer of aircraft.
Max LTV is 63%
2010 Term Loan 2
Initial Funding. The net cash proceeds from the 2010 Secured Term Loan 2 will be deposited initially into a pledged cash collateral account (the “Cash Collateral Account”) and released to the Subsidiary Borrower from time to time as aircraft are transferred to certain subsidiaries of the Subsidiary Borrower (“SPEs”). A portfolio of 37 aircraft and all related equipment and leases, with an average appraised base market value as of March 2010 of approximately $969 million, equal to an initial loan-to-value ratio of approximately 57%, has been identified and approved for transfer to the SPEs (the “Designated Pool Aircraft”). Subject to substitution rights, the portfolio of Designated Pool Aircraft will be required to meet certain concentration criteria, including age of aircraft, region of lessees, model type of aircraft, and manufacturer of aircraft. Funds will be released at an advance rate equal to 56% of the initial appraised value of the Designated Pool Aircraft transferred to the SPEs.
Security Interest and Ranking. The 2010 Secured Term Loan 2 will be secured by (a) a pledge of 100% of the equity interests of the Subsidiary Borrower and its subsidiaries, including, without limitation, indirect subsidiaries of the Subsidiary Borrower which are expected over time to own the Designated Pool Aircraft, and (b) a pledge of any existing and future intercompany indebtedness among the Subsidiary Borrower and its subsidiaries and (c) the Cash Collateral Account, subject to release of funds as described above.
Loans from AIG Funding
In March 2009 we entered into two demand note agreements aggregating $1.7 billion with AIG Funding in order to fund our liquidity needs. Interest on the notes was based on LIBOR with a floor of 3.5%. On October 13, 2009, we amended and restated the two demand note agreements, including extending the maturity dates, and entered into a new $2.0 billion credit agreement with AIG Funding. We used the proceeds from the $2.0 billion loan to repay in full our obligations under our $2.0 billion revolving credit facility that matured on October 15, 2009. On December 4, 2009, we borrowed an additional $200 million from AIG Funding to repay maturing debt. The amount was added to the principal balance of the new credit agreement. These loans, aggregating $3.9 billion, mature on September 13, 2013 and are due in full at maturity with no scheduled amortization.
These loans (and the related guarantees) are secured by (i) a portfolio of aircraft and all related equipment and leases, with an aggregate average appraised value as of September 30, 2009 of approximately $7.4 billion plus additional temporary collateral with an aggregate average appraised value as of September 30, 2009 of approximately $10 billion that will be released upon the perfection of certain security interests, as described below; (ii) any and all collection accounts into which rent, maintenance reserves, security deposits and other amounts owing are paid under the leases of the pledged aircraft; and (iii) the shares or other equity interests of certain subsidiaries of ours that may own or lease the pledged aircraft in the future. In the event the appraised value of the collateral held falls below certain levels, we will be forced either to prepay a portion of the term loans without penalty or premium, or to grant additional collateral.
As of now, the perfection of the security interests has not been accomplished. The Fed, however, has so far let it slide.
ECA Financing
In January 1999, we entered into the 1999 ECA facility to borrow up to $4,327,260 for the purchase of Airbus aircraft delivered through 2001. We used $2,800,000 of the amount available under this facility to finance purchases of 62 aircraft. Each aircraft purchased was financed by a ten-year fully amortizing loan with interest rates ranging from 5.753% to 5.898%. The loans are guaranteed by various European Export Credit Agencies. We have collateralized the debt by a pledge of the shares of a wholly-owned subsidiary that holds title to the aircraft financed under the facility. At December 31, 2009, 32 loans with an aggregate principal value of $146,111 remained outstanding under the facility and the net book value of the related aircraft was $1,780,011.
In May 2004, we entered into the 2004 ECA facility, which was amended in May 2009 to allow us to borrow up to $4,643,660 for the purchase of Airbus aircraft delivered through June 30, 2010. Funds become available under this facility when the various European Export Credit Agencies provide guarantees for aircraft based on a forward looking calendar. The financing is for a ten-year fully amortizing loan per aircraft at an interest rate determined through a bid process. We have collateralized the debt by a pledge of the shares of a wholly-owned subsidiary that holds title to the aircraft financed under this facility. As of December 31, 2009, we had financed 66 aircraft using approximately $3,961,381 under this facility and approximately $2,858,652 was outstanding. The interest rates are either fixed or based on LIBOR. At December 31, 2009, the interest rates of the outstanding loans ranged from 0.45% to 4.71%. The net book value of the related aircraft was $3,990,970 at December 31, 2009.
Disclosure: No position
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