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Feature: When bank debt becomes a cash trap

15 February 2011

Non-recourse loans can be attractive to the borrower because they are less risky to the overall asset portfolio.

Tags: Non-recourse debt  |  cash trap  |  bank debt  |  loan-to-value (LTV) ratio  |  Pamela Hendry

Non-recourse debt can be a way of protecting a lessor’s business. In the case of default, either by the lessor or one of its customers, the bank will seize the collateral. However, the bank can only seize the particular portfolio of aircraft pledged in the loan.

If the collateral is not enough to cover the outstanding balance – for instance, if aircraft values have dropped – then the loan becomes a loss for the lender. From this perspective, a non-recourse loan can be attractive to the borrower because it carries less risk to the overall asset portfolio.

The lender, however, certainly has ways to ration the risk that, in turn, can become cash traps for borrowers, most notably lessors. Airlines are less susceptible because they tend to do recourse borrowing, which gives lenders full recourse to an airline’s assets should it default on a loan....

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