As orders for aircraft grow, the need to finance the aviation sector has never been so acute. Eleanor Wragg reports.
While tourists and business travellers in the US and Europe tighten their belts, the new burgeoning middle classes in Latin America and Asia – who boast rising disposal incomes – are boosting demand for air travel, and new routes and airlines are popping up to accommodate them.
However, difficulties caused by the European sovereign debt crisis and new regulatory requirements are leading to growing uncertainty about how the aviation industry’s growing need for financing will be met. According to International Air Transport Association (IATA) data, international passenger air traffic was 7.4% higher in April 2012 than in the same month last year.
Net orders for all Airbus aircraft types during the first five months of 2012 totalled 132, compared with 97 during the same period last year. Meanwhile, Boeing’s first quarter 2012 commercial deliveries spiked 32% from the same period a year before, with the company saying it aims to deliver 585 to 600 commercial aircraft this year.
But with the new Basel III global regulatory standards looming on the horizon, the aviation sector is seeing the withdrawal of capital-hungry European banks, traditionally its key financiers. RBS offloaded its entire aviation business in January, while BNP Paribas and Société Générale have announced they will be reducing their commitment to aircraft loans, leaving a worrying gap in the market. “A lot of European banks have been facing stronger and tighter regulatory oversight and higher capital costs,” explains Gordon Welsh, UK Export Finance’s director of aerospace.
“They’ve had to implement Basel III way ahead of when it formally comes in, so you see some of the traditional lenders and funders of transactions now not doing that type of business very much. It’s also quite clear that the margins that banks charge today have gone up significantly and are certainly approaching 2008/9 levels.” Mark Lapidus, founder of Doric Asset Finance, agrees:
“The margin environment we’re dealing with now, where the best airlines are paying close to 300 basis points, is going to remain with us. We’ve seen a large reduction in financing in terms of how hard it is to find senior lenders for transactions.”
He adds: “It’s a very different environment from what it used to be. Before, we would do a transaction with one bank covering all of the senior debt in a deal for A380s, which requires US$150mn. Nowadays we have to find three banks to club together to do one transaction.”
“We’re really moving back into a relationship banking era, where those banks with which you’ve got long-term relationships and to whom you give ancillary business are doing new business with you,” says Robert Martin, CEO of BOC Aviation.
Change in tactics
One way that European banks are staying in the game is by shifting their role toward structuring deals with outside money rather than committing their own funds.
“European banks may well not be funding the transactions today on their own balance sheets but they are very active in the arrangement of transactions. What they can’t do is put their own balance sheets on the table so they’re using their experience and drawing in syndicates of other banks, creating the environment so that capital market deals and other creative structures can be done,” says Welsh. That’s not to say that European banks have pulled out of funding transactions entirely.
In October 2011, AerCap signed a US$400mn credit facility with a 10-year term to provide long-term fi nancing for 12 Boeing 737-800 aircraft in a sale leaseback deal with American Airlines.
“The Europeans are still lending; the bank that led our American deal for US$400mn was Crédit Agricole, they were the lead underwriter. Most of that deal was done by Europeans,” says Aengus Kelly, CEO of AerCap.
“We’re still getting inbound calls from European banks to give us money so I think what you’re seeing is a fl ight to quality.”
That said, AerCap’s ability to access financing, as the first lessor to issue an unsecured bond without having to provide unencumbered assets, is somewhat different to the majority of the market. As far as any potential shock factor from Basel III is concerned, the industry is mainly worried about its impact on the terms of loans.
“If Basel III were to severely limit the tenor, then it’d be a much bigger issue because in this business you need a long-term robust capital structure. As long as Basel III doesn’t bring the terms below seven or eight years it’s not an issue,” says Kelly.
One issue that is making aircraft financing more expensive is the 2011 Aircraft Sector Understanding (ASU) agreement, which raises the fees that developed countries’ export credit agencies (ECAs) charge for guarantees on aircraft purchases. “We’ve seen a movement in margins, there’s no doubt,” says Martin at BOC Aviation.
“Over the last 12 months we’ve seen a shift of about 100 basis points. We’re now at 200-250 over for our marginal funding cost for long-term, 7-10 years’ secured money. I think we’ll now see a plateau.
“What’s driven this is the new rules put in place for export credit facilities back at the start of 2011, which have effectively taken the floor for aircraft financing from around Libor plus 100 basis points all-in to close to 200 basis points all-in for financing starting next year.
The reason for that is that the upfront guarantee costs for the ECAs doubled for the best risks from 4% to roughly 8% and tripled for the poor risks, from 4% to 12%.” The increase in margins doesn’t seem to have too many people worried, though.
“In our business a few basis points isn’t what makes or breaks you,” says AerCap’s Kelly, who adds that he has raised financing just south of 300 basis points over on a fixed basis on a 1999-build A321 through a large US institution. Nor does it seem to be having too much of an effect on ECA activity in the space.
“We’re still doing US$10-12bn, but the aircraft mix changed last year and there was much more need for support on wide bodies than on narrow bodies, so our volume was higher but the number of aircraft was lower.
Our percentage share is 25-35% depending on how you calculate it, so it’s still a big number and it hasn’t materially changed since the crisis,” says Welsh at UK Export Finance. “In my view, in five years’ time, export credits will still be a fairly big component of what goes on in aviation, but it’ll be pretty much through things like the capital markets in many different guises,” Welsh adds.
Capital market products, in particular enhanced equipment trust certificates (EETCs), while barely used in Europe, have been used extensively by US airlines for the past decade or more, although the constraints placed upon the asset make them unpopular among aircraft lessors.
“The big insurance companies and fund managers have been playing in the EETC private placement market for years. We are open for business with all of those institutions, subject to credit. We have a policy of acceptance of non-bank institutions,” says Welsh.
Another option to fill the gap is the bond market. “That’s the area that’s probably going to grow most looking forward,” says Martin.
“For us, the Singapore dollar bond market is important. There are other bond markets in Asia that are beginning to look interesting that we haven’t tapped yet. Hong Kong is a market that’s interesting, Tokyo will be interesting and as they unlock the various reserves from China, that’s going to be interesting as well.” BOC Aviation also receives funding from Bank of China, which it uses countercyclically.
“When the market is stretched in terms of funding, we tap on the fi nancing put in place with our parent company. In 2009, we utilised this source for US$2.5bn of purchase and leasebacks,” says Martin. And Bank of China isn’t the only Asian bank eyeing the space.
“The Japanese banks have come back, with SMBC being the biggest,” says Welsh. “Mizuho is very interested in coming back into the business; we’re actively talking to them at the moment.
The Development Bank of Japan has two mandates on two of our deals at the moment, and they’re very interested to get back into the game.” The growth of Asian financing goes hand in hand with the region’s increasing demand for new aircraft, which is driven by urbanisation and economic growth. “10 years or more ago the largest proportion of commercial bank fi nancing would have come from European banks.
Today, 70% or more of that comes from banks in the Asia Pacific region. We can see a shift towards the Asia Pacific region in terms of numbers of aircraft being delivered to the industry,” says Martin. Of late, there’s been a flurry of activity in the region.
Japan’s Sumitomo group bought RBS’s aviation unit for US$7.3bn in January, while Embraer and Beijing-based ICBC Financial Leasing in April signed a memorandum of understanding on aircraft financing and leasing for the sale of Embraer airliners and business jets in China, with total programme support set to reach as much as US$2.5bn over the next five years. “We’re seeing a lot of European and US carriers beginning to come to Asia now, asking Asian banks to lend money to them,” says Martin.
“Over the last year at Bank of China we’ve done financing for Ryanair, for easyJet, for Lufthansa, for British Airways and for Air France.
On the leasing side of the business we are very actively working on trying to open up capital markets here in Asia.
This to us is a very important future source of financing, not just for us but also for the airlines in this region because if Western governments decide to restrict export credit, there needs to be an alternative,” he adds. Boeing’s long-range forecast for 2011 anticipates delivery of 33,500 new aeroplanes over the next 20 years, valued at more than US$4tn.
Given the scale of projected aircraft deliveries, leasing companies will undoubtedly have to be a larger part of any airline’s fi nancing strategy.
“While the European lenders are not as prevalent as they used to be, this has been more than offset by the capital markets in the US and Asian banks entering into the sector, as well as the increase in leasing activity, which has offset the slack that’s been created by some of the European lenders scaling down their presence,” says AerCap’s Kelly.
“There will not be a case where aircraft will not get financed, because there is a lender of last resort in our market, which is the manufacturers themselves,” says Martin. “When we get to a point where people cannot get funding from commercial banks, from ECAs and from the bond market, the lender of last resort is the manufacturer.”
In comparison to other sectors, the aviation sector is very small. While Boeing and Airbus make US$70bn a year of new products, a large portion of that is financed locally either by airlines themselves or by ECAs, reducing the amount of funding that goes into the global market every year.
This means that the industry has always had a relatively small group of large-scale financiers, and with different speeds of regulation in different markets; if one region’s banks pull out, another region’s banks will pick up the slack.
“This is a hard asset, it’s got a long useful life, it has an average loan to value of probably 55% over a 7-10 year deal, banks get paid between 275 basis points and 400 basis points over and big leasing companies can move the asset if things go wrong,” says Kelly at AerCap.
Given this set of facts, lenders who put the work into understanding the industry are fi nding the risk/reward trade-off to be very attractive. GTR
Key trends in aviation
- Pricing on deals going up even for top airlines
- More banks needed to club together on transactions
- Banks preferring not to commit own funds
- Asian institutions increasingly active in financing