All appears well in aviation financing: liquidity is rife and bank margins the tightest in years.
No macroeconomic event has destabilised the industry lately, and traffic keeps rising in defiance of aviation's historic cyclical nature. In fact, passenger demand has increased more than forecasts suggested at the start of the year. IATA reports that growth hit a 12-year peak for the first six months of 2017, with a record first-half load factor of 80.7%.
For the past few years, money has poured into aviation, whether from rookie banks dipping their toes in the water with local or top-tier credits, or from investors looking for relative value against other asset classes. There continues to be an oversupply of finance for aircraft, which is pushing margins lower for banks as well as lessors. One banker complains: "There is too much money facing too many deals."
It is not just bank margins that are struggling. Several experienced lessors bemoan the high level of competition in the sale-and-leaseback market. One lessor tells FlightGlobal that when their company lost a sale-and-leaseback deal for new narrowbodies, the airline indicated that bids had come in with a lease-rate factor as low as 0.65. Several lessors confirm that they've seen lease rate factors as low as 0.62 for narrowbodies. Some will not compete at these rates as a matter of discipline.
For airlines, cheap bank debt and locked-in lower lease rates are a gift, of course. But the excess of cheap capital is causing consternation among some who have lived through several aviation downturns. They say excess liquidity can't last forever and are concerned about what a correction will look like after such an extended cycle.
Despite the concerns of those who have seen it all before, the inflow of capital from new to old investors is especially strong in the capital markets, where lessors are building a more liquid bond complex with more unsecured issuance.
Boeing Capital's financing forecast estimated that capital markets would account for nearly $40 billion of a total $126 billion of commercial aircraft funding requirements in 2017. So far, this appears to be on track as the debt capital markets show no sign of faltering. In the first seven months of this year, the same number of ABS deals have closed as did in the whole of 2016. And at least four more deals are in the pipeline, several investment bankers suggest.
In total, since January, 12 lessors alone have raised upwards of $12 billion with ABS and unsecured (both public and private) transactions. There is no question that the capital markets have grown in their support of aviation from the days of the secured enhanced equipment trust certificate (EETC) deals that dominated aviation-focused debt capital markets in the 1990s and last decade.
Additionally, strong fundamentals have allowed airlines to access the unsecured market. LATAM, Singapore Airlines, Finnair, Delta, Ryanair and United have all raised bonds this year – totalling over $5 billion. And the Chinese carriers alone have raised over $3 billion in local bonds. Overall, including nearly $2 billion worth of EETCs that American has raised, the capital markets have raised about $22 billion of commercial aircraft funding already this year.
Institutional investors appear to be getting more comfortable with lessor credits, and while they have previously seemed spooked by the historical loss-making reputation of airlines, profits in that sector at now at record levels, changing the calculus. Corporate credit and an investment-grade rating remain critical, but investors chase yield where they can find it.
So, those awaiting a downturn will have to wait a bit longer: the bull market shows no sign of turning bearish. But all that could change with any slowing in airline profitability, which would be early warning of a cycle nearing the top.
Will banks stop lending first because they cannot make enough margin on secured deals? Or will airline credits weaken, giving banks leverage in negotiations? If newcomers get spooked by the fundamentals shifting from good to bad, certain investors may exit aviation, as in past cycles. And if value investors start returning to other alternative assets, there will be a funding gap that for the last three years has been filled by the public debt markets.
History tells us that we should start preparing for a correction – but also that aircraft will keep flying. For all the anxiety created by the impending unknown, the industry always seems to find financiers.
Source: Cirium Dashboard
