What is an Equipment Trust Certificate
An Equipment Trust Certificate (ETC) is a debt instrument that allows a company to take possession of and enjoy the use of an asset, while paying for it over time. The debt issue is secured by the equipment or physical assets, as the title for the equipment is held in trust for the holders of the issue. In this way, ETCs can be viewed as analogous to mortgaged property. When the debt is paid off, the equipment becomes the property of the issuer, as the title is transferred to the company. If the borrower is unable to meet the payments on equipment-financed debt, the certificate holder has the right to claim the asset.
BREAKING DOWN Equipment Trust Certificate
These certificates were originally used to finance railway box-cars and rolling stock, and the box-cars were used as collateral. Nowadays, equipment trust certificates are used to finance containers used for shipping and offshore businesses, and aircraft purchases.
Airlines are heavy users of Enhanced Equipment Trust Certificates (EETCs), raising billions in financing for their aircraft purchases, due to their high capital spending requirements. Northwest Airlines pioneered the use of EETCs for aircraft finance in 1994. EETCs are versions of ETCs that are issued and managed through special purpose vehicles known as pass-through trusts. These vehicles (SPEs) allow borrowers to aggregate multiple equipment purchases into one debt security. While the trust issues the debt, and acts as a repository for it, handling debt service and payments to investors, the borrower leases the assets from the trust.
In return for greater liquidity and a broader investor base for these financial instruments, airlines, the biggest users of EETCs, enjoy cost savings and greater flexibility by avoiding the need to structure multiple ETCs for individual aircraft purchase. EETCs were further enhanced a few years ago, when tranches, or different slices of debt with different levels of seniority, security, risks, coupons and credit ratings, were introduced.
EETCS have come under scrutiny from the Securities and Exchange Commission (SEC) and Financial Accounting Standard Board (FASB), which questioned their treatment as separate economic entities (from borrowers) for accounting purposes. By using SPEs borrowers are able to keep their debt obligations as “off-balance sheet” items, with the result that their financial statements often do not present a complete picture of their borrowings. FASB issued Financial Interpretation Notice (FIN) 46 to outline when companies should consolidate, or show, off-balance sheet assets and liabilities on their financial statements for these vehicles