PDP Financing: Complete Guide to Pre-Delivery Payment Loans
September 17, 2019
What is PDP Financing?
The aviation industry and its customers use a variety of financing methods to pay for the manufacture and/or purchase of aircraft. In a previous blog, we explored the use of sale leaseback arrangements for aircraft that already exist. PDP financing, an aviation acronym standing for Pre-Delivery Payment, is financing involving lenders, manufacturers, and aircraft buyers. It is different from a sale leaseback in that PDP transactions pay for the construction of aircraft. In this article, we’ll unravel the complexities of how PDP financing works and review its pros and cons. Also, we’ll show how purchase-leaseback agreements supplement aircraft PDP deals. Finally, we’ll finish by discussing PDP lenders and answer some frequently asked questions.
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PDP Lending and Lenders
Many banks and funding sources decline to participate in pre-delivery payment financing. However, Assets America® can arrange PDP financing with a minimum transaction size starting at $10 million with no upper limit. In addition, we can provide sale leaseback financing and aircraft mortgages up to 100% of value. If you need aircraft financing, turn to Assets America® for professional services that are timely and competitively priced.
How Pre-Delivery Payment Financing Works
Basically, PDP financing is installment financing for the construction of an aircraft. That is, the lender makes periodic payments to the manufacturer/OEM (Original Equipment Manufacturer) as the aircraft construction process achieves set milestones.
The three participants in a pre-delivery payment financing deal are:
- Lender: A bank, private equity firm, or other entity willing to finance the construction of the aircraft. While the lender makes the loan on behalf of the aircraft customer, it pays the loan installments directly to the manufacturer/OEM. The aircraft itself (an asset) and/or its delivery slot secure the PDP financing.
- Manufacturer/OEM: This is the entity building the aircraft. Under a PDP, the manufacturer receives payments as it completes each phase of aircraft construction.
- Customer: The purchaser of the aircraft. Typically, this is an airline company or lessor. The customer is responsible for paying interest throughout the loan term. It repays the principal when the manufacturer delivers the aircraft.
Elements in PDP Financing
- Purchase Price: This is the purchase price at which the lender can acquire the aircraft if the customer defaults on the loan. Note that until a default occurs, the lender doesn’t know about any discounts that the customer received from the manufacturer. Frequently, the manufacturer may adjust the purchase price due to change orders, escalation clauses and other factors. If adjustments occur, the customer may have to prepay them or post additional collateral.
- Lender’s Purchase Rights: This is the lender’s right, but not obligation, to purchase the aircraft if the customer defaults on the loan. Also, these rights grant the lender the opportunity to replace the original borrower upon default.
- Rights of Assignment and Ownership: The right of the manufacturer to assign aircraft ownership to the lender should the customer default.
- Manufacturer’s Purchase Option: This is the manufacturer’s right, but not obligation, to repurchase an aircraft should the customer default.
- Clawback: An attempt by the customer to recover PDPs from the manufacturer should the customer enter bankruptcy. The bankruptcy court enforces clawback judgments, but these judgments are exceedingly rare.
Agreements in PDP Financing
Customarily, PDP deals involve certain agreements:
- Aircraft Purchase Agreement (APA): This contract is between the manufacturer and customer specifying the terms of the purchase. In case of default, the customer grants to the lender a lien over its APA-specified rights.
- Manufacture’s Consent (MC): This agreement is between all three participants that grants rights to each party. For example, the manufacturer acknowledges the lender’s lien in the MC. Additionally, the MC specifies the parties’ rights to the PDPs and the aircraft should the customer default on the loan. Furthermore, the MC specifies the purchase price at which the lender can acquire the aircraft if the customer defaults.
- Loan and Security Agreements: Agreements between the customer and lender specifying the loan terms and collateral arrangements should the customer default. The lender bases collateral requirements on the purchase price minus any equity PDPs that the customer pays the manufacturer. The lender does not fund equity PDPs.
Enforcing PDP Agreements
These agreements specify their enforcement mechanisms:
- The Manufacture’s Consent specifies the lender’s purchase rights should the customer default on the loan. One such right is that the lender can replace the defaulting customer with another customer. Often, the MC may specify what happens if a lender fails to provide a replacement customer. Typically, the lender loses its rights to the collateral and the already-funded PDPs if it provides no replacement customer. The lender must then decide whether to forfeit the collateral or to assume the customer’s obligations. One such obligation is to pay the manufacturer a large balloon payment when the manufacturer delivers the aircraft. Normally, the lender responds by assigning its purchase right before the manufacturer delivers the aircraft. Otherwise, the lender might not recover its collateral for years. The manufacturer may seek to limit the lender’s assignment rights without first giving consent.
- The MC grants a purchase option to the manufacturer allowing, but not compelling, it to buy out the loan. This purchase option is active for only a short time following the lender exercising its purchase right. The purchase amount under this option is the full principal amount, plus interest and other amounts.
If the customer enters bankruptcy, it might try to claw back past PDP payments from the manufacturer. If the customer is successful, the lender will have to pay out the same PDP payments twice. Alternatively, the manufacturer will have to deliver an aircraft for less than the full amount. In some jurisdictions, lenders and manufacturers demand that the customer create a special purpose entity (SPE) that is bankruptcy-remote. However, U.S. courts generally do not recognize the SPE as a separate entity and consolidates its assets with that of the customer.
For a clawback, the customer must show that each PDP was due to preferential, undervalue, unfair or fraudulent circumstances. Naturally, that is very difficult to prove. Frequently, manufacturers insist that they absolutely own PDPs and that the PDPs are not deposits. Thus far, no attempted PDP clawback has succeeded.
Pros and Cons of Aircraft PDP Financing
- PDP financing stimulates demand for aircraft, which helps distribute overhead costs across greater manufacturer output.
- When properly structured, a PDP deal is less risky than other forms of financing.
- Investors can earn a good return on pre-delivery payment financing.
- Many banks are reluctant to participate in the PDP marketplace.
- If defaults rise and lenders take possession of aircraft, disposal becomes more difficult and more costly.
- Some regulators question whether PDP deals are truly asset-backed loans.
Purchase-and-Leaseback with PDP Financing
In a purchase-and-leaseback deal with PDP financing, the customer is a lessor who purchases and leases aircraft. The lessor uses PDP financing during aircraft construction and then leases the aircraft to an airline. A recently completed example occurred in 2018. GE Capital Aviation Services was the customer/lessor, and China’s Okay Airways was the lessee.
For more news about similar deals, you can read this article on the largest PDP financing deal in history at $840 million or this roundup of public large helicopter transactions from the last decade.
Frequently Asked Questions
Can I get total PDP financing?
Typically, total PDP financing isn’t available, as these deals require equity PDPs. In fact, the customer, rather than the lender, funds equity PDPs. Naturally, the lender determines the amount of equity it will require from the customer. Typically, the equity injection for a PDP deal is 20%.
Does PDP financing apply to all aircraft?
PDP financing applies only to aircraft before delivery. Once an aircraft build is complete, pre-delivery payment financing ends. A sale leaseback is appropriate for completed aircraft, as is a straight aircraft mortgage.
How long does pre-delivery payment financing take?
Typically, pre-delivery payment financing stretches out over a year or more. A lot depends on the construction time for the aircraft and the manufacturer’s backlog. Sometimes, customers pay extra to acquire a faster delivery date.
Is PDP financing right for me?
PDP financing makes sense for many aircraft customers looking to purchase new aircraft. The financing requires only a modest equity injection, and the interest rate on these deals is reasonable. Naturally, the devil is in the details, and PDP deals can be rather complex.
While admittedly complex, PDP deals are increasingly popular as an aircraft financing strategy. Independent brokerage firms like Assets America® can provide PDP financing starting at $10M with no upper limit. If you need to finance a new or used aircraft, trust Assets America® to offer excellent terms and professional service second to none.