With an expansion valued at a whopping US$550bn, who will finance the Middle East’s aviation boom? Eleanor Wragg reports.
Strategically located within a four-hour flight of one-third of the world’s population and within eight hours of another third, the Gulf region has become the new global travel nexus, linking Asia to Europe and Africa. International airline passengers who would once lay over in Charles de Gaulle, Schiphol or Heathrow are now more likely to switch planes in Dubai, Doha or Abu Dhabi, and with this comes massive growth for the region’s carriers. The International Air Transport Association (IATA) says annual passenger growth in the Middle East was double the global average in 2014, and aircraft manufacturer Boeing forecasts the region’s airlines will need a further 2,610 planes by 2033.
“The Middle East’s aviation sector has been growing at the fastest pace that we’ve seen, faster than in any of the other regions. Apart from activity by Emirates and Etihad, there are a lot of newcomers in the low-cost space such as Fly Dubai and Air Arabia, and we’ve also witnessed Oman Airline with quite an aggressive fleet expansion. Low oil prices, too, are only going to benefit the airline industry,” says Hussain Al Yafai, executive director and head of corporate for Oman at Standard Chartered, which recently closed one sale and operating leaseback transaction with Qatar Airways for three 777-300ER and five 787-8 aircraft and another with Oman Air for three B737-800 aircraft.
A flurry of high-profile aircraft finance deals has put the region front and centre. Dubai’s Emirates airline recently signed a US$299.5mn club finance lease package led by First Gulf Bank for two 777-300ER aircraft, while Air Arabia signed a US$230mn Islamic financing deal with Dubai Islamic Bank for six new Airbus A320s, which started being delivered every two months from January 2015. Etihad also recently landed financing from Abu Dhabi Commercial Bank (ADCB) for its first Airbus A380-800 aircraft.
And it’s not just aircraft that are being financed. In November 2014, Airbus signed an agreement for aircraft spare parts financing with Abu Dhabi National Leasing Company, the leasing arm of National Bank of Abu Dhabi.
Local banks fund the majority of deliveries
While aviation financing has traditionally been the preserve of European and American banks, the region’s local institutions, flush with cash, are becoming increasingly active in the sector. “Last year alone, more than 65% of all deliveries to airlines in the Middle East were funded from within the region,” said Tim Myers, vice-president and managing director of Aircraft Financial Services for Boeing Capital Corporation in a release. “Over the past few years we have seen great success by Middle Eastern banks and investors providing sources of financing for the Middle Eastern carriers, but they have been expanding outside the region by providing equity, debt, Islamic financing options and more.” It’s been the same story for Boeing’s European rival Airbus, which saw 47% of its aircraft deals in the Middle East between January and November 2014 funded by local banks, up from 17% for 2013 as a whole.
Indeed, aviation finance in the Middle East is thriving, with a significant number of locally-based financial institutions becoming comfortable with commercial aircraft as a reliable asset class for secured lending. “As airlines from the Arabian Gulf have grown over the years they have become more sophisticated in adopting alternative sources of aircraft financing, a need that was brought into sharp focus when many traditional aviation financiers withdrew from the market during the global financial crisis,” says Mounir Kazbari, managing director of Novus Aviation Capital, a Dubai-based leasing firm which in March closed a purchase and leaseback deal for five Boeing B777-300ERs with Emirates.
He adds that whilst European and American banks initially retreated from direct lending in the immediate period following the global financial crisis, they did however stay in the market in an advisory capacity and are now moving back into participative lending and arranging capital markets solutions. “The funding gap at that time provided the opportunity for Middle Eastern-based financiers to gain a foothold in this sector and build up experience and expertise under the guidance of the traditional players. The Middle Eastern investors can now compete on an equal basis having established their market presence with airlines during the time when the former dominant aviation finance providers were not lending.”
Islamic aircraft finance
Another way local banks are getting involved is by offering Islamic finance products. “The sale and leaseback structures in particular are very Islamic-friendly and can easily be tweaked for the Islamic banking world. I see a lot of Islamic banks looking very closely at aviation assets and specifically leasing because that fits right into their Islamic criteria,” says Standard Chartered’s Al Yafai. In response to growing demand for shariah-compliant finance, in mid-2014 Airbus and the Islamic Development Bank (IDB) began seeding a US$5bn aircraft leasing fund to cater to growing demand for commercial financing from airlines not just in the Middle East, but also in Asia and Africa.
Minimal ECA involvement
Boeing’s latest Current Aircraft Finance Market Outlook predicts export credit usage will be minimal in 2015, although there are some standout examples of creative use of ECA backing, including Emirates’ US$913mn sukuk issuance guaranteed by UK Export Finance to fund the acquisition of four Airbus A380-800 aircraft, expected to be delivered in April, May, June and July this year. The deal marks a number of firsts, being the first ever sukuk bond guaranteed by the British export credit agency and the largest
ever capital markets offering in aviation to involve an ECA guarantee.
“Given the expansion rate, I think the airlines are going to have to be innovative,” says Al Yafai. “They’re going to have to look at different structures. We’re seeing fewer debt structures and more sale and leaseback structures. We’re seeing more capital markets issuances to support aircraft finance. It’s not pure aircraft lending anymore; it’s that, coupled with various structures to supplement the expansion rate. They are having to widen up the product range because of the actual demand for incremental aircraft.”
Lessors set to drive innovation
Meanwhile, Boeing predicts that aircraft lessors are expected to support a large share of deliveries this year, while driving significant innovation in aircraft finance. This is certainly the case in the Middle East where, given the sheer number of aircraft needed, airlines have to consider all options.
“The reality in the Middle East is that the amount of orders cannot be absorbed by any one balance sheet,” says Aengus Kelly, CEO of leasing firm Aercap, whose customers in the region include Emirates, Qatar Airways, Oman Air, Etihad and Air Arabia. “When the stream of deliveries was much smaller and the volume of dollars was smaller there was more of an ability to finance them locally or out of cash resources from the owners. But now as the big orders start to deliver, that’s just not feasible and all airlines in the region are moving more towards the operating lease product.”
Even the region’s governments are getting in on the action, with Oman and Brunei’s sovereign wealth funds partnering to set up an aircraft leasing firm with capital of US$520mn. The new venture, Oman Brunei Aviation Leasing Co (OBALC), will invest in and manage the purchase and lease of commercial aircraft operated by airlines in the Middle East and globally.
Immense growth prospects
The latest Dubai Air Show in 2013 made aviation history with a record order book of aircraft, parts and MRO deals exceeding US$200bn, and the shift in focus of the aviation sector to the Middle East shows no sign of abating. The region’s governments have made aviation a top priority, pouring money into airport infrastructure: last year, Dubai International Airport snatched the title of world’s busiest airport from London Heathrow, with a 6.1% annual growth in international passengers to 70.4 million. The emirate is building a new hub at its other airport,
Al Maktoum, which will have capacity for another 240 million passengers, and other airports in the region are ramping up capacity to cater for an estimated 400 million passengers by 2020. An eye-watering 40,000 pilots will be needed over the next 20 years, and analysts forecast US$119bn in airport development contracts will be awarded there between now and
the end of 2016 alone.
This multi-billion dollar expansion of airports and airline fleets in the Middle East creates unprecedented growth prospects. The emergence of over 40 low-cost carriers in the region has also helped to increase the density of flights and extend route networks further into Asia, Europe, Russia and even Africa, creating a feedback loop of ever-growing demand. No one source of financing can support this growth alone; direct lending, manufacturer finance, leasing and export credit will all play a role, as will funds, private equity and Islamic financing.
The place to be
“The outlook is very positive for the Middle East region. It already has some of the world’s fastest-growing connector airlines based within it and huge potential once political factors curtailing demand in certain areas within the region are overcome,” says Novus Aviation Capital’s Kazbari. He compares it favourably to other regions that are either dealing with over-capacity, such as the Asia Pacific region, or are heavily focused on capacity discipline, such as North America. “This is capping overall growth at the industry average or below whereas the Middle East region is expanding at double this rate. The Middle East, therefore, is definitely the one to watch and the place to be for aircraft financiers. This fact is underlined by the growing number of aircraft lessors and banks having a presence there.”
Aercap’s Kelly agrees: “The Middle East is certainly a priority for us,” he says. “It’s a growing market, it’s a connecting market between Europe and Asia and they are fast-growing airlines.”
And with a growing, young population with high disposable income, a fast-developing tourism sector, masses of expatriate workers who travel back and forth for work and a near-perfect geographic location making it an ideal transport hub, the Gulf region has all the fundamentals in place to underpin growth in its aviation sector for years to come.