Rising interest rates will probably not become a critical issue for the traditional aircraft finance industry – but for newer sources of capital, it may be a reason to walk away.
An interest-rate hike has been a rarity since the global financial crisis. In December 2016, the US Federal Reserve raised rates for only the second time since that crisis, to a range of 0.5-0.75%.
The Fed now looks set to raise interest rates in mid-March, rather than in or around June as had been forecast by many Wall Street analysts. This is likely to be the first of at least three hikes in 2017.
Given that aircraft financing is mostly denominated in US dollars, what effect will further interest rate hikes have on the industry?
AerCap's chief executive Aengus Kelly was bullish about rising interest rates during a results call last month.
"Rises in [interest] rates have historically being accompanied by rises in lease rates," he noted. "On the used aircraft, there is generally a lag period – it could be six months, give or take. But it only applies to those aircraft that are re-pricing at that point in time as rates are rising."
He added: "Having said that, also, a rising rate environment generally correlates to a better global growth environment, and what we've always observed in the past [is that] the rising rate environment generally leads to asset insulation. So: so long as you're hedged, right, and that you're operating in a decent global economy, rising rates should not be a threat to the business. And as I said, this company does run a hedged book."
Many others share Kelly's view that interest rates are not a threat.
Lenders already have priced in higher interest rates; if not, the burden can easily be passed over to airlines, some financial sources argue.
However, other sources tell FlightGlobal that interest-rate hikes pose considerable tail risk for the industry, particularly lessors.
This is because any refinancing of debt, for example a warehouse facility, will happen at a higher cost than originally, creating potential asset-liability mismatches.
Indeed, in an effort to avoid this, the larger lessors have been pruning their portfolios of older aircraft, sources tell FlightGlobal.
However, others argue that selling older assets is a natural part of the larger leasing platforms' business cycle given their large orderbooks and the nearing influx of new-technology aircraft to the market.
Perhaps the greatest test posed by higher interest rates would be to the new capital from institutional investors that the industry has attracted.
Amid the lower rates that persisted after the global financial crisis, institutional investors went on a hunt for yield. This dragged them away from their traditional investments such as gilts, into – for them – new and exotic asset classes, such as real estate.
Their move into aircraft has been a relatively recent – if significant – phenomenon. Aircraft, when interest rates are low, offered good yields with the added bonus of being movable and relatively liquid assets valued mostly in US dollars.
South Korean funds in particular are a source of new capital the industry is eager to tap, whether for deals or conference revenue.
Yet these new investors have only just started to seriously look at aircraft as investment-grade assets. Therefore, it is reasonable to suppose that they are not fully committed. With the end of the low interest rates that attracted them to aircraft in the first place, where will the motivation to stay come from?
Fundamentally, traditional aircraft players really have nowhere else to go, whatever the level of interest rates.
Institutional investors, on the other hand, have a whole investment universe to which they can turn. Of course, a sudden and complete exit of all the new players is highly unlikely. But it is also unlikely that they will find aircraft such attractive assets in terms of yield, and therefore their presence will be scaled down, on average.
As one industry source told FlightGlobal on the sidelines in Dublin earlier this year: "Same old cycle. New guys will come in when it suits them, and then when it changes again, will we see the private equity lot come back in substantially?"
Source: Cirium Dashboard
