As 2016 drew to a close, it looked as though the aviation cycle had crested – a theory reinforced by a slowdown in global traffic growth just as an oversupply of aircraft seems likely, and by compressed lease rates and aircraft values, driven in part by an abundance of liquidity.
"The aviation demand cycle does remain strong, but trends suggest we may be close to the peak, and the more I think about this, the more I think we are just past the peak," Flight Ascend Consultancy's head Rob Morris said at an industry briefing in November.
Over the course of 2016, a number of downside trends – such as in values and operating yields – all neared critical mass at roughly the same time, creating an apprehensive mood among aviation finance professionals.
The past 12 months have, in a wider sense, been chaotic and fragmented.
Aside from industry specific factors, there were the unexpected macro events with potential downsides, including Donald Trump's presidential election victory, the Brexit vote and the outcome of the Italian referendum, all posing threats to globalisation – and therefore aviation – in the coming years.
Additionally, concerns over a potential economic slowdown in China, the spread of nationalism and the spectre of terrorism lurk in 2017.
However, while last year brought forth a bevy of black swans – with more waiting in the wings – it also threw up a number of events that suggest an industry in mostly positive transition.
Those events include: significant mergers, among both airlines and lessors; an influx of new investors; and new vehicles for aircraft investment.
EXPORT CREDIT SIDELINED
An unusual aspect of 2016 in aviation finance was that for most of the year Airbus's and Boeing’s export credit agencies (ECAs) were unavailable for guaranteeing deals.
The US Export-Import Bank's absence is mostly political, with the agency lacking the necessary quorum of board members to approve new deals. But this is set to be resolved sooner rather than later, so Boeing aircraft should be eligible for ECA support at some point in 2017.
If Ex-Im Bank does not come back online, Boeing 787 customers may still be eligible for support from UK Export Finance – if they have chosen Rolls-Royce engines for their Dreamliners.
Airbus's ECA woes are thornier, however. In April, UK Export Finance voiced concerns over historic applications for ECA support involving Airbus, and the agency's German and French counterparts subsequently halted new Airbus deals. In August, the UK's Serious Fraud Office (SFO) formally launched an investigation into the matter.
The SFO is not renowned for speedy investigations, so European ECA support may take some time to return to Airbus.
Discussions on ways of resolving that situation have been conducted by Airbus and the European ECAs, but no timeframe for a reversal of the present policy has been disclosed by either side.
As a result of the lack of ECA financing, Airbus itself had to extend some €500 million ($525 million) of aircraft financing to customers over the first nine months of 2016.
But a strong and liquid macro financing market has limited the amount of customer support the manufacturer has had to offer, finance chief Harald Wilhelm said during a briefing on the third-quarter results.
This liquidity spared weaker airlines financial pain, as they could pursue financing options that might in other years have been unavailable.
Credit Agricole's global head of asset finance Jose Abramovici says: "We have got some ECA mandates which have not been consummated because of the ECA freeze. Some airlines have been able to secure commercial bridge financings or have selected to do sale-and-leaseback."
However, that abundance of liquidity has, notes Abramovici, made some deals unappealing for banks in the first half of 2016, in terms of either pricing or structuring, whether due to the leverage, amortisation or balloon demands.
Increased liquidity also put downward pressure on lease-rate factors in 2016. That trend is set to intensify in 2017 as an oversupply of aircraft starts to manifest itself.
An example of lease rate factor pressure resulting from oversupply has already been seen in the ATR market, says Aergo's chief executive Fred Browne.
"A glut of new ATR 72-600s ordered by lessors hit the market [in 2016]. Now, to place these aircraft, those lessors had to reduce their expected lease rates. As a result of this, owners of relatively new ATR 72-500s – say, less than three years old – found their mark-to-market values and lease rates under pressure as airlines opted for the newer aircraft over the slightly older one, despite minimal technical differences between the turboprops," he says.
"With the Neo and the Max coming into service, you could see a similar thing happen there, with newish 737-800s and A320-200s suddenly worth much less than expected. For lessors who aren't alive to this possibility, large impairments could be seen as book values of current-generation jets suddenly diminish once the newer tech hits the market."
NEW CAPITAL
The capital markets have long provided an alternative to the traditional bank market for certain borrowers, be they airlines or lessors; and 2016 was no exception.
Apollo Aviation, Aergen and Castlelake issued ABS deals in 2016, with GECAS and Aviation Capital Group coming to market closing transactions in the final weeks of the year.
But it was Air Lease's $800 million debut securitisation BBIRD-2016-1 that set a benchmark for the rest of the industry, achieving the lowest pricing for a post-financial crisis aviation ABS, with the coupon on its AA tranche at 2.49%.
The deal introduced new investors to this asset class, which is becoming a popular with lessors as a refinancing tool.
Consistently in the ABS market and outside of it, investors looked to aviation as a means of putting their money to work in a low-interest-rate environment.
Steven Gaal, managing director at SkyWorks Capital, says a surprising number of new investors entered the market last year.
"In 2016, what really stood out was the number of players looking at entering the aircraft leasing sector, from insurers to pension funds to Korean, Chinese and Japanese investors," he says. In addition to arranging financing, SkyWorks advises clients on sourcing capital.
"The industry did not anticipate the extent to which this has taken place, which is likely a reflection of the ongoing hunt for yield, a desire for US dollar-denominated assets, and growing investor recognition that aircraft are relatively low-risk assets," Gaal adds. "The fact is that the total need for aircraft financing is many times oversubscribed. Some investors are finding it hard to get their foot in the door."
He notes that aircraft as assets have to an extent been commoditised by this wall of liquidity.
"There are far more investors who want the core assets. For example, a 737-8 Max has many more investors willing to look at it than the 737-9 Max. But when you have so many looking to finance the core, it is easy to find the liquidity that wants the assets that are, relatively speaking, on the demand fringe.
"Therefore, even if the interest-rate environment does change, and rates are hiked, then there is still a well of liquidity out there that will replace those who perhaps go back to their more traditional investments."
Investec Bank in 2014 launched a closed-end fund that invests in aircraft debt – the first of its kind – and last year closed a second. In April, the two funds had about $700 million in assets under management. The bank is in the process of arranging a third vehicle, FlightGlobal understands.
It was in 2016 that the trend towards aircraft debt funds began to really take hold, with the launch of a number of new vehicles.
French bank Natixis's asset management arm launched an aircraft and real estate fund, while Ray Sisson, former leasing chief of AWAS, announced a new asset-focused fund, Avi8, as his new project.
While AVi8 plans to build a young fleet comprising mainly Boeing 737s and Airbus A320s, but also widebodies such as 787s, through traditional leasing deal structures, such as sale-and-leasebacks, it will also aim to attract additional investors into aircraft through separate funds.
"Some investors want speculative-order sale-and-leaseback deals with good credits for a middling yield, while others will want to obtain higher yields through acquiring current aircraft already on lease. AVi8 can cater for both through our planned funds," Sisson told FlightGlobal in November.
Mid-year in 2016, Stellwagen Group announced its plan to launch its StellCap fund. Led by ex-Ryanair chief financial officer Howard Millar, the 10-year closed-end fund is intended to have $1 billion-worth of assets under management by the end of 2017.
The plan is for the fund to have $5 billion in assets under management, focused on the 737s and A320s but also including A350-900s and 787s.
"We want to disrupt the aircraft financing market, which is in dire need of innovation," Millar told FlightGlobal in June. "The aviation finance banks and the operating lessors have been dancing to the same tune for the last 30 to 40 years, and that's not the way forward."
He has argued that airlines will be able to source through StellCap a cheaper form of finance than operating leases, since the fund will exclude maintenance reserves and offer larger-than-usual balloon payments.
New players appear to pose a potential threat to banks, which may find themselves restricted by Basel IV regulations. However, Credit Agricole's Abramovici remains sanguine: "New players are always welcome, as it will force the existing bank to get smarter in order to survive."Having said that, I think that the airlines and lessors will always need banks to sustain their revolving credit facilities, hedging programmes, advisory... and we think they like to deal directly with their financing bank instead of relying on intermediaries."
This year is likely to bring a true test for these vehicles, especially given the fact that their targeted investor base may be shyer about putting money into aircraft in a higher interest rate environment.
However, the unpredictability that defined 2016 did not stop aviation finance from sustaining its stability, with liquidity providers extending capital even in the stark absence of ECA support. And with a huge amount of capital keen to invest into the asset class, a funding gap has looked mercifully unlikely to arise.
Source: Cirium Dashboard
