After much debate last year, new export credit terms have been agreed that could impact delivery financing. But there is still some uncertainty if or when these new rules will take effect, write Laura Mueller and Victoria Moores in London
Airlines may face steeper financing costs because of a shake-up in the export credit system, which helped shelter carriers and manufacturers from the full brunt of the financial storm. Back in 2008, as the commercial banks slipped into turmoil and previously abundant liquidity dried up, the export credit agencies stepped in to safeguard new aircraft deliveries.
The job of the export credit agencies, such as the US Export-Import Bank and COFACE in France, is to turn export opportunities into real transactions. In the aviation sector, this normally takes the form of loan guarantees, which cut risk for banks and can lower the interest rate for the airline doing the deal.
Originally, export credit was intended to help high-risk airlines, which would otherwise struggle to secure financing. But export credit agencies are effectively a government instrument, supported by the taxpayer, so these deals have historically been balanced with low-risk airlines, such as Ryanair.
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In response to this call for change, at the close of 2010 there were extensive negotiations at the Organisation for Economic Co-operation and Development in Paris. Here, government negotiators agreed in principle on new terms to support the export of commercial aircraft - under the so-called Aviation Sector Understanding. But the jury is still out on when and whether these newly proposed rules will actually come into practice.
The terms would move fees closer to market rates and allow adjustments to reflect market developments. This move, supporters say, should encourage more commercial bank activity as the highly attractive export credit agency deals become more pricey.
Export credit explained |
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"The objective of the agreement is to create and maintain a market- and risk-based fee system that produces a level playing field between manufacturers, airlines and governments," says the OECD. If formally approved, the deal "will unify the previous disparate financing terms and conditions between large and regional jets. It also contains mechanisms to smooth very sharp market movements." The deal includes a transition period for certain previously ordered aircraft, which will be covered by existing financing terms.
A MATTER OF TIME?
However, the finance market remains hesitant about whether these changes will materialise and in the desired time frame of 2013 - especially as a "grandfather" clause means the old rules will apply to both existing aircraft deals and those sealed before the cut-off.
"The recent ECA rules just published will not change much the cocktail of financing used by airlines and lessors for the very reasons that grandfathering and great grandfathering will only gradually be implemented until 2013," says a London-based banker. In fact, he adds, the market is likely to see all eligible borrowers "rushing to get their deals approved" before the changes apply.
"To watch the reaction of ECAs will be amusing, when at the same time they have been accused, rightly so, of being generous to those who did not need it." The banker believes the aviation finance market will never see the new rules fully implemented and that "a new round of discussions" will take place before a new system is in place.
A US-based lessor also believes "a longer period of transition will be needed" before these changes can take place. "This is a huge move. Airbus and Boeing deliveries supported by the ECAs increased from a recent average of around 20% to almost 35% of sales during this financial meltdown," he says. "You can't rip the candy away so easily now. Expect the market to go back to the drawing board a couple of times before this gets hammered out and implemented."
Ryanair finances roughly 60% of its deliveries using export credit structures. With cost-increasing changes at stake, late last year the Irish budget carrier teamed up with nine other export credit beneficiary airlines to form the Aviation Alliance. These 10 carriers, which operate 833 aircraft with orders worth $129 billion, consisted of Cargolux, Emirates, Etihad, Korean Air, Norwegian, Oman Air, Pegasus, Ryanair, Virgin Blue and Wizz Air.
Battling to keep the existing system intact, they argued that airlines currently blocked from export credit under the Home Country Rule should be allowed access - so long as the orders were bona fide exports. But Aviation Alliance lost its bid to maintain existing rates.
Ryanair chief financial officer Howard Millar says: "The new ASU is decided, rates will increase, and the Home [Country] Rule has been maintained. Very importantly, existing aircraft orders for delivery between January 2011 and December 2012 will be under the existing ASU agreement. This covers all Ryanair deliveries and means that we are unaffected by the new agreement and benefit from the lower rates. Between now and the next ASU agreement the Aviation Alliance will campaign for lower fees."
HEALING THE HEALTHY
But, even if the new system is ultimately delayed, the market largely agrees that the changes are necessary. "There are no reasons in the current market why ECAs should absorb almost a third of all financings of new deliveries. And there are no reasons why the main beneficiaries are those credits which are among the best," says the London banker. There is also a new credit ratings system under the new structure. "It will be interesting to see how lessors will be rated under the new grid. We may have some surprises here."
Boeing Capital managing director of capital markets Kostya Zolotusky believes the agreement is the most complicated ASU ever: "There are different sets of views from the manufacturers, home market airlines versus non-home-market airlines and commercial finance houses with different aspirations." In his view, the new agreement will address the issues of supply and demand by making supply more expensive. He believes there will be a mechanism where, if the market "explodes", ECA financing will work as a cap on pricing and liquidity.
But why was change needed? One banker blames ECAs for today's lack of commercial activity: "Appetite for aviation financing is being killed by the ECAs. There is more appetite out there than what is obviously available, but this supply is being killed off because the ECAs are pricing us out of the market." Another source says: "Ex-Im financings are currently closing at [the low rate of] Libor plus 25 basis points. Don't US taxpayers deserve more respect than that? These agencies should be working to limit exposure and not compete with lessors and banks to be the biggest provider of financing to the airline industry."
These top tier airlines can easily tap commercial debt at good prices, especially with their long-standing relationship with banks, but they admit they "would be crazy not to take up the cheap pricing" available through ECA-backed financings.
Until 2008, airlines with a strong credit rating were able to secure export credit at around 3%, but since then the rate has risen to 4%. Under the proposed new structure, Airline Business understand minimum exposure fees for airlines and lessors rated AAA to BBB- would increase to 7.74% upfront or 137 basis points a year. For BB+ and BB ratings it will rise to 10.47% upfront or 184 basis points a year, while for CC ratings, the cost will widen to a 14.77% or 257 basis points a year.
Under the new agreement, rates will be reset every year and there will be a two-year transition, making it difficult to predict the final table as the market could go though eight quarters of rate changes. Three financiers canvassed by Airlines Business agreed that the new terms are "adequate" and "reflect market risk better" than previous terms.
MARKET IMPACT
Researchers at Credit Suisse believe the new system could have far-reaching repercussions on the aviation market. On a positive note for the manufacturers, the research team does not envisage a hefty drop in aircraft orders as ECA critics have suggested. These critics maintain that large aircraft orders, such as those placed by Emirates, have been fuelled by the availability of cheap funds.
"We think ECA activity will slow, but won't necessarily impede orders," writes Robert Springarn in a Credit Suisse research report. "We see ECA volumes declining because the new ASU will stipulate higher rates more on par with commercial funds; grandfathered low-rate orders [pre-2007] must deliver in 2010 or revert to prevailing terms, and we sense sponsoring governments want ECA volumes to recede to pre-recession levels, which could be assisted with a cap."
While a drop in ECA support to airlines "may alter airline market shares", especially if there are changes to the Home Country Rule, "it may not impact orders, which we see as more dependent on continued economic recovery, air traffic trends, and a thaw in commercial aircraft lending rates and liquidity".
Springarn warns that the "extraordinarily elevated levels of support provided specifically by the US Ex-Im bank" are not sustainable and that the US Treasury intends to bring the level back to more historically normal levels. He believes this will occur "naturally too though", as Ex-Im support comes at a "higher price and commercial banks become more active and more competitive".
Springarn says the situation is "slightly more favourable for Boeing than Airbus, based on backlog composition". Fuel prices and currency will continue to influence airline order activity, he notes. One effect of the new deal, says Credit Suisse, could be increased manufacturer funding, particularly from Airbus.
"Airbus customer financing has historically increased as ECA financing has contracted and therefore we do not rule out a scenario where Airbus has to step up its level of financing to customers from current low levels."
"In the past downturn, Airbus self-financed around 15% of deliveries, compared with current levels of around 3% and with a significant transition in the financing environment, we believe it is likely this could increase from current levels going forward."
Credit Suisse also believes the "combined effect of a potential change to export credit rules and sustained pressure on used aircraft residual values could result in lower appetite for new aircraft, as borrowing costs across the industry rise and risk mitigants are placed on the availability of export credit to customers outside Europe and the USA".
Part of Credit Suisse's "fundamental caution" on Airbus in relation to export credit changes relates to the pressure on used aircraft residual values that "could raise the economic viability of the secondhand market compared with that of new aircraft".
According to Springarn, used aircraft are "depreciating at a rate of around 5% per year" and as a result "a five-year-old Airbus A320 costs 25% less to lease than a one-year-old A320". Springarn speculates that this discount would increase further for new aircraft.
"Other than improvements in cabin technology, we are not aware of any significant technology advances during this time to accelerate the depreciation of such modestly aged aircraft and therefore believe factors such as less costly and more liberal financing and regulatory drivers, such as emissions legislation, are helping to support new aircraft demand," he explains.
What is slightly more concerning, notes Springarn, is the "increasing scrappage rate of Airbus aircraft currently in production as well as the falling average age of stored aircraft", both of which support the view that the used market is suffering at the expense of a major replacement cycle. "The major question is whether this is being supported by an increase in export credit financing, but with the imminent introduction of the new ASU in 2011, there should be greater clarity on this uncertainty going forward."
For more on the export credit and general financing climate, check out our new Airline Business Interactive, packed with videos, expert commentary and animated graphics
Source: Airline Business
