Commercial aircraft financing surpassed the $100 billion mark for the first time ever in 2013 and the level of financing required to cover this year’s deliveries is set to be even higher.
The commercial jet aircraft market required $104 billion worth of financing last year, while manufacturer forecasts estimate that $112 billion in funding will be required during the next 12 months.
The increased funding requirement is being supported by higher production rates. Boeing’s 737 monthly production rate will reach 42 aircraft this year and the US manufacturer expects a rise to 47 units a month within four years as the re-engined and updated Max version is introduced into service.
Airbus increased its A320 production rate to 42 in 2013 and is exploring a possible rise in this rate to 44.
The market will also absorb more widebody aircraft in 2014, but financing is expected to remain smooth with no “white elephants in the room”, says a financier.
Flightglobal’s Ascend Online database lists 1,370 new Western jet deliveries in 2014 and 1,378 units in 2015.
Of this year’s deliveries, Asia-Pacific is expected to represent 42% of the total output with 572 units being delivered to carriers in the region.
Financing requirements for commercial jets are set to effectively double over a five-year period to 2015. In 2010, the market required about $62 billion worth of aircraft deliveries to be funded. For 2015, $125 billion is forecast by Boeing Capital (BCC).
Over this period, government-backed export credit agencies (ECAs) are forecast to provide the bulk of financing along with the commercial debt market.
However, ECAs have also facilitated the evolution of new capital markets liquidity brought by new banks into the export credit space. This created new structures to address the commercial banks’ long-term funding cost concerns and opened new opportunities especially with operating lessors.
BCC expects ECAs to contribute to 18% of new commercial jet aircraft deliveries in 2014, down from 23% in 2013. In 2010, ECAs accounted for 31% of the new deliveries or $19.2 billion.
Last year brought full implementation of the 2011 Aircraft Sector Understanding agreement, which notably involves an increase in the minimum premiums payable and the requirement for additional risk mitigants for weaker credits borrowers. As expected, ECA-guaranteed financing became more expensive. However, in a low interest rate environment, overall cost remains competitive, especially when considering European ECA and Ex-Im bond structures.
The main "emerging" source of finance since 2010 has been the capital markets.
Back then, capital markets represented $1.5 billion worth of new aircraft deliveries. In 2014, capital markets will absorb 22% of the total deliveries, up from 14% in 2013. This translates into $24.6 billion worth of deliveries for the upcoming year.
Last year, non-US carriers raised $9.7 billion in enhanced equipment trust certificates (EETCs), with Air Canada, British Airways and Virgin Australia tapping the market along with Emirates Airline through the Doric issuances.
US airlines raised $13 billion in EETCs, says BCC, while the lessor issued more than $6.9 billion in capital market debt financing as of 3 December 2013.
Boeing's leasing arm expects further aircraft financing activity to emerge from the private placement market in 2014.
“We continue to see a rapid change in the capital markets with the new type of liquidity in the capital markets coming from the private placement market,” says Kostya Zolotusky, managing director of capital markets and leasing for BCC.
He anticipates that hedge funds, private equity firms and insurance companies will expand their financing roles in 2014.
“What we are seeing is lots of investors that are active in the EETC space are saying we are not getting enough of this product, we want more,” says Zolotusky.
He adds: “When you have an EETC, the orders are far greater than what is available, and so you have lots of institutional investors fighting for orders for up to $200 million, and they are getting a fraction of that.”
Those institutional investors are starting to have conversations with financiers about buying pieces of new deals and “taking down” the old aircraft, he says.
The investor would link directly with an airline for one, two or three aircraft and structure the deal in a similar manner as an EETC, he says.
“Because certain airlines are not able to put together a package of aircraft to finance up to $1 billion, or the typical size of a capital market issuance, they may turn to the private investment market,” says Zolotusky.
“Typically, $700 million to $1 billion is a good size in a capital markets issuance, but in the private placement market airlines can do $50 million to $300 million deals on a single-institution basis.”
Zolotusky also expects more activity on the asset-backed securities (ABS) market going forward.
“One of the concerns of the ABS market is historically, the unpredictability of the tenor. If there is a market dislocation, you could extend the term,” he explains.
He says BCC is engaged in conversations with potential customers about structuring ABS deals that “go to scrap” in order to provide a more “predictable horizon” on the tenor.
Cash contribution from airlines and lessors will account for 23% or approximately $26 billion worth of deliveries, says Zolotusky.
Bank debt is expected to decline in 2014 in percentage-point terms. The commercial debt providers will account for 25% of this year’s funding requirement, a drop of three percentage points from 2013. In terms of dollar funding, this translates into $28 billion worth of new deliveries, compared with $29.1 billion in 2013, estimates BCC. Back in 2010, commercial banks represented 24%, or $15 billion worth of annual deliveries.
Operating lessor Avolon expects commercial bank lending to continue as an important source of delivery financing, but with a more "globalised profile". Direct bank lending will stabilise in a relatively narrow range around $30 billion per annum over the next 10 years, while market share will decline slowly from almost 30% to around 20%. Bank lending to lessors has considerable scope to increase within their total volume and bank ownership of leasing platforms will also expand further as an alternative route to growing balance-sheet exposure to the sector, says the lessor.
European banks continue to play a vital role, despite having shored up reserves to meet tougher bank regulation capital rules. They have reinvented themselves as mandated lead arrangers in the marketplace and syndicated the debt to other banks.
Last year brought the resurgence of secured lending from traditional aviation banks, while some Western banks re-entered the aircraft financing space in the second half of the year in an aggressive way. “Liquidity is less than an issue now and they are keen to participate again as active lenders,” says a financier.
Existing regional banks upped their game last year and expanded their presence beyond local relationship lending.
The “eastward shift” observed over the past few years in aircraft financing also comes as Asian carriers represent the largest proportions of new aircraft deliveries over the next two years.
Chinese banks will continue supporting local deliveries in financing aircraft in yuan. “The Chinese banks' issue is dollar availability,” says a financier. However, he forecasts that in the end they will finance aircraft in yuan with the airlines converting into dollar terms themselves.
He also observes that Hong Kong-based banks are more open to cross-border transactions than their mainland counterparts.
Avolon expects that more Asian banks will take equity as well as debt positions in commercial aircraft. However, most emerging financial markets will remain insufficiently developed to support the significant expansion of local bank engagement in aircraft financing, which is too often hampered by restrictive regulatory and fiscal constraints on capacity, term and interest rates, argues the lessor.
A recent study from Avolon shows that leasing companies represented 35% of annual deliveries financing in 2012 and 2013. In 2014, lessors, including internal and external financing, will contribute to 38% of the market funding requirement.
Over a medium term, Avolon expects funding through the lessor channel to grow by more than 10% on average per annum. By the middle of the next decade, the share taken by leasing companies will reach 50% of new aircraft deliveries, argues Avolon. This will be achieved through a combination of capital supply and demand factors.
Nevertheless, lessors continue to diversify their funding sources. In 2013, two leasing companies tapped the ABS market, while in the second half of the year, there were further unsecured debt issuances in the marketplace – a further testament of the strength of capital markets for operating lessors.
Matthew Little, vice-president of transportation and infrastructure at Goldman Sachs, thinks the recent unsecured deals by lessors are indicative of a few developments in the capital markets.
He says that only a few years ago the spread differential between issuing unsecured, versus on a secured basis, was around 250 basis points, but that yield has compressed to within 100 basis points depending on the issuer.
Also, he says, lessors are benefiting from investors that are “reaching for yield”.
He adds: “The depth of access afforded in the unsecured markets is really a manifestation of investors searching for higher yield in an environment where it has been increasingly harder to find that.”
Issuers that come to market with a debut transaction "only benefit over time due to the virtuous interaction with investors", notes Little: “As you see more leasing companies access the capital market, it creates this virtuous circle environment where pricing tightens for issuers.”
However, Burrell notes that there are positives and negatives in the unsecured versus secured markets, and for this reason “not all issuers are racing to do unsecured deals”.
He says: “Part of the problem is unsecured gives you the flexibility to trade assets because there are less restrictions on specific assets, but on a negative side you have maturity walls you have to hit... My advice: get a balance of financings.”
Boeing Capital's Zolotusky says “realignment and balance are the words that best describe 2014’s aircraft financing environment. We anticipate adequate financing at reasonable prices as the industry works to respond to balanced global customer demand and an accelerated replacement cycle resulting from higher fuel prices.
“We continue to watch how global monetary policies could potentially impact aircraft finance. However, we believe the industry is well positioned for the outcomes of inflation, higher interest rates or a combination of both. Asset portfolios are excellent inflation hedges, and current all-in aircraft financing costs are at historical lows.”
Source: Airline Business
