Aviation Today

 Financing the backlog - who, when and how?

Last month saw approximately 1,200 attendees descend on Dublin for the 14th Annual European Airfinance Conference, including three IBA representatives – our commercial director, Owen Geach; managing director, Steve Fisk and myself. The main venue, the Four Seasons Hotel, was packed with industry executives as were local pubs, hotels and restaurants. It is clear that the conference is now the headline annual industry gathering in Europe and IBA’s presence was enhanced by its role as one of the sponsors of the three-day event and numerous speaking engagements.

As has been the case for the past few years, there is a degree of uncertainty across the industry with regards to funding, overproduction, residual values and future passenger demand. All of this is happening amidst a turbulent global economy dominated by the euro zone crisis, credit rating downgrades, a static US economy and slowing growth in China.

As was the case in 2009 and 2010, concerns about a funding gap were evident during discussions at the conference. The weakened euro against
the dollar and increasing cost of financing have meant that barely a handful of European banks remain attracted to the industry.

During the conference, there were numerous calls for the export credit agencies (ECAs), banks, manufacturers and other investment groups to
work more closely together to come up with creative financing structures. The size of the current orderbook by manufacturer and indeed that of Boeing and Airbus, as outlined in the graph below, illustrates the volume of deliveries which may require financing.

Recent years have seen the role of institutional investors in aircraft finance increasing and the market needs this trend to continue. Two directives in the near future will also change the goalposts in terms of financing – namely the 2013 ASU (aircraft sector understanding) and Basel III – which could well restrict the role of ECAs and traditional financing methods in the market.

The large contingent of Japanese entities at the conference highlights the role the region’s banks are likely to play in aircraft financing. Sumitomo Mitsui’s recent purchase of the RBS Aviation Capital Portfolio is a case in point. The Development Bank of Japan (DBJ), Bank of Tokyo-Mitsubishi and SMBC are just some examples of such entities.

Overproduction is clearly a big concern. The above Boeing and Airbus Orderbook chart on the next page is dominated by narrowbodies, a backlog which has been bolstered by the launch of both the A320neo and the 737MAX in 2011. Order levels for the neo and the MAX have been staggering and now top 1,800
aircraft across both families.

The manufacturer’s retort to concerns about overproduction points to the lack of white tails in Seattle or Toulouse and low availability of spare current-production aircraft. Large industry events typically attract large numbers of secondary market traders and there were concerns about the impact of overproduction on residual values.

It is a sad state of affairs when sub-10 year-old aircraft are impossible to place and part-out becomes an option. This has been the case for a
marginal number of A320 family and 737NG aircraft in recent times. Such instances have been few and far between but tend to attract a
lot of media coverage and discussion – as was the case amongst conference delegates – which weakens investor confidence.

As the ECAs continue to have a large role to play in financing in 2012, the ease at which previously second and third-tier operators, who once went to secondary market for aircraft, can now obtain new aircraft with this ECA support, is unprecedented. Indeed, the economic usable life of aircraft was a prominent topic of discussion during the conference.

As is the case with any of the larger industry conferences these days, Boeing and Airbus went head-to-head extolling the virtues of their respective products. A 222 aircraft order from Norwegian Air Shuttle split between the A320neo and the 737MAX was announced during the conference and many delegates wondered how the operator would fill these aircraft in an already highly-competitive European lowcost airline market.

However, it appears that the operators are fairly optimistic about the passenger market. Presentations by easyJet, Lufthansa and Flybe all pointed to a positive market outlook, contrasting heavily with a pessimistic view of the market by AWAS chief executive Ray Sisson. It is clear that Lessors face pressure on residual values, and aircraft values are depreciating more rapidly than traditional straight-line curves allow – particularly as manufactures continue to push
replacement technology on to the market.

Lessors continue to place orders directly with manufacturers or chase A320 and 737NG sale and leaseback deals. This is a highly competitive space and it may be the case that lessors may turn to widebody and regional aircraft sale and leasebacks.

Boeing coincided a 787 visit to Dublin Airport with the Airfinance conference to market the aircraft to the swatches of financiers and lessors in town, whilst Airbus moved to outline the pressures Boeing faces internally to manage the mass production of the 787, the development of the 737MAX and the design of
an improved 777 to compete with the A350 – which incidentally faces more delays. Airbus also made a frank statement during the conference to allay concerns about wing cracks on the A380.

Despite the wide range of concerns expressed by various stakeholders, many were also keen to stress that the aviation industry has proven to be resilient. There is no doubt that some operators around the globe face difficulties, and 2012 is likely to see more bankruptcies, but provided the financing community can support the secondary market as well as the huge volumes of new deliveries in the next few years, “white-tails” can be kept to a minimum as was the case during the recent downturn.

Fuel prices raise another, quite daunting, challenge and should encourage operators to achieve further efficiencies in their cost bases. A repeated plea from the investment community during the conference – right up to the Airbus Financiers Event on the final day – was the need to work together to ensure
continued funding for aircraft.

Airbus and Boeing are producing aircraft at a high rate in response to operator demands for new more fuel-efficient technology to reduce the effects of high fuel pricing. There is the danger of a damaging shortfall in demand for second-hand aircraft and the financiers have a big role to play here if they can support prospective buyers – possibly the most prominent issue last week.