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PWC Aviation Finance Fastern Your Seat Belts PDF
PWC Aviation Finance Fastern Your Seat Belts PDF
com
Aviation
finance
Fasten your
seatbelts
January 2013
Foreword
Current orders for new aircraft are at Aircraft deliveries over the next three-
unprecedented levels, driven by the five years will need to be financed at a
replacement of ageing fleets in North time when liquidity is scarcer and risk is
America, demand for fuel efficient being repriced. The key challenge for
aircraft and market growth in the airlines, who have record orders in
emerging markets. place, will be to find financing at a
competitive rate in an exceptionally
Though airlines are currently facing a tough economic environment.
number of headwinds, orders are
expected to be fulfilled. Historically, an Based on our interviews, we believe that
airline’s financial performance has not financing is likely to be found but
had a significant impact on their ability potentially, at a higher price. This is
to secure and finance new aircraft already attracting new investors
deliveries. Although airlines can either particularly from the Far East, with a
defer or cancel orders, there is an number of banks from Japan and China
operational requirement to re-fleet snapping up aviation assets. We expect
the global aircraft pool with more this trend to accelerate.
efficient aircraft.
But, more of this will need to happen
and airlines and lessors will need to be
more inventive and work harder to find
additional sources of funding and
potentially develop new products.
Although it already costs more to As airlines take delivery of new aircraft, Aviation finance could provide an
arrange financing within the aviation owners must be found for second-hand attractive opportunity to deploy
industry compared to a few years ago, aircraft. In the past, airlines from large amounts of capital efficiently in
we expect the cost of financing could developing economies have taken these, ‘hard assets’.
increase further as regulatory changes which has created a natural flow of
take shape in particular Basel III and the ownership. This is changing as new and This sector is particularly attractive at a
implementation of the new Aircraft smaller airlines place orders for new time when investor confidence in stocks
Sector Understanding (ASU) from 2013. aircraft direct with manufacturers, and other financial assets is lower. An
often taking advantage of Export Credit interesting barometer of demand for
What’s more, as the challenges that the Agency (ECA) finance. This, together investing in aircraft financing is that
banking industry faces, and in with concerns of oversupply of some investor demand for investing in the
particular the European banks who aircraft types, particularly narrow body, Japanese Operating Lease (JOL) market
traditionally have been dominant in this could put aircraft values and lease rates is at a near time high.
space, continue to play out, we expect to under pressure.
see some banks retreating from this New investors are already entering
market which will intensify the These factors could have a significant this space, but the general consensus
competition to obtain aircraft financing impact on the demand for the second- among the experts interviewed by
and the cost of financing will likely hand fleet going forward. If values of PwC is that more needs to be done to
further increase. aircraft are driven down, this could ensure better understanding of the
raise questions around financing these sector by investor groups.
Time will tell what if any impact the older aircraft, even if there is a willing
higher cost of financing will have on the customer, as the risk of financing such
cost of travel. aircraft increases.
01
PwC | Aviation finance | 7
Aviation financing offers potential investors
absolute returns backed by hard assets...
Industry view: ‘We expect Japanese banks The ongoing shift from the
to be active in this market’ traditional aviation banks in Europe
to newer players from the East and
Garry Burke, Global Head Structured Finance, North America will continue over the
Standard Chartered Bank next few years
The next few years will be crucial for The general consensus amongst the
aviation financing as new aircraft experts we interviewed was that the
deliveries peak at a time when many of industry needs to do more to ensure that
the traditional commercial banks potential investors understand it better.
remain under pressure.
All key players such as airlines, banks,
New investors are already entering this leasing companies will have to work
space as aviation finance is an asset class harder to attract new investors to the
which can offer attractive returns which sector and create innovative products
are secured against an underlying asset. which can broaden the investor pool.
02
10 | Aviation finance | PwC
Aircraft orders are at record levels which could open
up attractive investment opportunities for investors
Aviation is a cyclical business and
has witnessed a number of peaks and
troughs during its history. Inspite of
this, current orders for new aircraft
are at unprecedented levels
Similar to other capital heavy industries, This record backlog has built up steadily
commercial aerospace is cyclical with the over the last five-seven years reflecting
industry historically suffering from over significant order volumes pre the
ordering of new aircraft in the ‘good 2008/09 recession followed by a
times’ which are sometimes then relatively quieter period in 2009-10.
delivered in the ‘bad times’. The rise in There has been a return to high order
demand for travel and the associated volumes in 2011 which has continued
orders for new aircraft have resulted in into 2012.
current order backlogs at unprecedented
levels (At July 2012, outstanding orders
backlog was c.8500, which represents
seven-eight years of production at
current production rates).
11,000
3,000
10,000
9,000
2,500
8,000
Orders & deliveries
2,000 7,000
Backlogs
6,000
1,500 5,000
4,000
1,000
3,000
2,000
500
1,000
- -
99 00 01 02 03 04 05 06 07 08 09 10 11
Year
787 vs 767 Cash operating costs per Available Seat Kilometer (ASK)
18%
5.2
Long range
6.1
4.9 19%
Medium
range 5.9
16%
4.9
Short range
5.8
- 1 2 3 4 5 6 7
cent / ASK
B787-8 B767-300
Source: Boeing
The last decade has been a tough one for It is against this backdrop that the
the airline industry in general. Although record backlog of orders for new aircraft
there have been some winners, globally should be considered, in conjunction
airlines have incurred significant losses. with the need to finance them.
A number of unusual external events are While airlines can either defer or cancel
partly to blame e.g. 9/11, SARS and orders, both being options used in the
swine flu outbreaks and volcanic industry historically, there is an
eruptions. However, the underlying operational requirement to re-fleet the
story of the last ten years has been global aircraft pool with more efficient
excess capacity, intense competition and aircraft. Historically, an airline’s financial
rise of the low cost carriers which have performance has not had a significant
all contributed to lower returns. The impact on their ability to secure and
financial performance has also been finance new aircraft deliveries.
adversely impacted by the economic
downturn, increases in regulatory costs
and fuel price volatility.
20 1,300
15
Number of deliveries (Airbus and Boeing)
10 800
- 300
Profit/loss (£bn)
(5)
(10) (200)
(15)
(20) (700)
(25)
(30) (1,200)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012F
24
The ramp up of production could, as it
25 has in the past, put pressure on the
supply chain, leaving programmes
20 vulnerable to supply chain delays and
failures. To address this risk, OEMs are
15 consolidating and encouraging
consolidation of their suppliers. At
9 10 8 present, Boeing and Airbus are reliant
10 7
6 6 7 on over 1,500 direct suppliers spread
5 5
5 3 across various geographies.
2 3
1 2
In the short term, OEM’s have reported,
- due to supply chain problems, the ramp
A320 B737 A330 A380 B777 B787
up in production rates is likely to be
2008 2010 2012 (to date) Planned lower than that announced previously.
Although a healthy order book provides As a result of the above, we are seeing a
opportunities to new and existing trend towards a shortening in the
investors and bodes well for the average life of an aircraft from the
manufacturers, the challenge for both is traditionally accepted 25 years, with
that this record level of demand for residual value of 15%.
future aircraft types (which apart for the
A380 and B787, have not yet come to the We have already seen some of the larger
market in any scale) will have implications aircraft owners taking write downs on
for the residual pricing of current asset values of aircraft (ILFC’s $1.5bn
technology aircraft, both those currently write-down in Q4 2011 for example).
in service and those yet to be delivered.
This raises a number of questions:
In addition, mid life aircraft, historically,
• How will residual values trend over
had a natural flow to new and smaller
the next few years?
airlines around the world after the first few
years with top tier carriers. This is • Will further increase in production
changing, with ECA financing, new and volumes of existing technology
smaller airlines are now often taking aircraft, particularly for short haul
deliveries of brand new aircraft. The aircraft, exacerbate these trends?
impact of this is reduced demand for mid
Some experts we interviewed had strong
life aircraft and there is a view amongst
views about aircraft values and potential
some industry experts that there is
net book value problems for existing
oversupply of certain narrow body aircraft.
owners, while others were more
optimistic. It remains to be seen how
this will unfold in the future.
Part out market Another trend is for younger aircraft to
• Aircraft have historically been retired after 25 years in service after which be parted out and sold for spares as
they are taken to ‘jet cemeteries’ to be parted out for resale of working this provides greater value than as an
parts and recycling of other parts. aircraft in operation.
• There has been a recent trend of parting out younger aircraft. This is again
largely due to the ‘supply and demand’ dynamics as availability of middle
aged aircraft has increased.
• Although this may worry investors, it could also provide opportunities for
investors to pick up mid-life to older aircraft, run down the lease rental and
then part out the aircraft to realise reasonable returns.
10%
5%
5%
YoY % change in Market Value
0%
0%
(5%) (5%)
(10%)
(10%)
(15%)
(15%)
(20%)
(25%) (20%)
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Narrow body = MD83, 737-300, A320-200, 737-700 Wide Body= 767-200/300, 747-400, 777-200, A330-
300 A340-300
15%
5%
10%
YoY % change in Lease Rates
0%
5%
0% (5%)
(5%) (10%)
(10%)
(15%)
(15%)
(20%)
(20%)
(25%) (25%)
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Narrow body = MD83, 737-300, A320-200, Wide Body= 767-200/300, 747-400, 777-200,
737-700 A330-300 A340-300
03
PwC | Aviation finance | 21
Airlines are having to work harder and longer to
arrange funding for new aircraft orders
The key challenge for airlines, who
Industry view: ‘Aircraft financing is
have record orders in place, will be to
extremely difficult… banks are being very
find financing at competitive rates in
selective in their lending’
an exceptionally tough economic
Ulf Gedamke, Air Berlin environment
With increasing pressure on cash flows With the overall supply of financing
due to high fuel prices and relatively reduced, airlines need to continually
thin capital structures, many airlines are review their fleet management policy
bracing themselves for the challenge of and actively manage their future
finding finance for aircraft on order. financing. They will need to be mindful
that they have to compete in the global
An estimate at list price of the value of market place for funds and their
the July 2012 backlog is in the region of competitors will not be the usual airlines
$1.2 trillion. Although significant that they compete with on a route basis.
discounts to lists are standard within the
industry, the real cost is still likely to be Our expert interviews reveal that
in the order of$700bn. airlines are already having to work a lot
harder and start much earlier to arrange
funding. To find funding of this
Boeing and Airbus July 2012 order book is worth $1.2 trillion at list prices
magnitude over the next few years
against the backdrop of liquidity drying
4,500 450
up will remain a key challenge. We
expect new structures to continue to
3,943 407 come to the market as airlines innovate
4,000 400
to mitigate a financial ‘crunch’.
• Sale-and-leaseback alternatives
Number of Aircraft
2,500 250
for a given period may enable
2,183
221 bridging of any current financing
2,000 200 200 shortfalls. It can free up capital
and also takes away the
1,569 commitment of future PDP
1,500 150 payments.
• Airlines with substantial local
1,000 825 100 currency income should consider
financing in local currencies
which reduces refinancing costs
500 50 for local or regional banks.
- -
Short haul Short Haul new Long Haul Long Haul new
existing technology* existing technology**
technology technology
# of aircraft List price value $bn
Source: July 2012 order book per Boeing and Airbus websites, PwC analysis
** 787/747-800/A380/A350
Basel III
The Basel accords are the global regulatory framework which aims for
more resilient banks and banking systems through harmonised capital
adequacy requirements. The new Basel III changes will be enforced
gradually from 2013.
In brief, under Basel III the ‘adjusted leverage ratio’ sets a limit independent of
the quality of the assets and the new ‘net stable funding ratio’ requires funding
to match lending maturities. Both will impact future loan conditions for long
term borrowing including for aviation finance.
For airlines, the effect of Basel III could translate into higher loan pricing as
banks pass on higher liquidity costs. It is hard to quantify its specific impact
precisely as lending rates are an interplay of bank risk costs, liquidity costs,
access to currencies.
As a result, airlines may have to cope with increased loan pricing and a more
challenging funding environment.
Historically, the Export Credit Agencies The key point about this source of
of the key airframe and engine funding is that commercial banks still
manufacturing countries, such as the provide the required funding (although
US, UK, Germany, France, Canada and this is changing), ECAs provide
Brazil, have recognised the importance guarantees to make good any specific
of aircraft manufacturing to the national losses incurred by the funding bank in
economies so supported the export of case of default. As a consequence, the
their aircraft by offering guarantees to credit risk for banks is not the airline
cover the losses of commercial banks anymore but the sovereign risk of the
that were lending to relatively risky ECA given the collateral.
airlines.
The cost of financing through ECA-
While traditionally, this type of backed guarantees has historically been
guarantee-based funding has been used lower than commercially available bank
as a backup source, over the last four debt. But, with the implementation of
years ECA backed funding has become the New Aircraft Sector Understanding,
the funding source of choice and has the cost will increase from 2013 as
been used by airlines with stronger premiums are more aligned with
credits (for example Emirates, Etihad, market ratios.
Ryanair, and various Chinese carriers).
The issue is that airlines from around the world, some of which are highly
profitable, have benefited from using ECAs as a reliable and relatively cheaper
source of borrowing, which some argue gives them an unfair advantage.
The situation has been particularly severe in the US where the Air Transport
Association of America representing a number of key ‘home operators’,
recently sued the Ex-Im bank for providing a financing solution to Air India for
its 787 deliveries which they argue will provide an uneven playing field to a
direct competitor.
As aircraft deliveries peak over the next We are already seeing some creative
few years, at a time when long term US financing solutions being introduced for
dollar financing becomes scarcer for the example, the issued Nord LB Aircraft
major European banks, there are Mortgage covered bond and Doric Nimrod
significant challenges for the industry as Alpha issuance of Enhanced Equipment
a whole to find finance for the new Trust Certificate (EETC) to finance A380s
deliveries. All the major players in the for Emirates. Developing an EETC type
industry including manufacturers, product for European airlines would help
financiers, airlines and lessors will need enlarge the pool of funds and bridge some
to work harder to attract new investors of the funding gap.
to the industry.
More of this will need to happen and, to
attract new investors, may require
development of new products which are
acceptable to them. We explored earlier
2011 vs 2012 sources of aircraft financing in this publication what types of investor
may be attracted to the sector. In terms
100%
3%
7% of financing we expect to see the
following trends:
90% 14%
Non-European banks with access
18%
to US dollars will strengthen their
80%
market share.
ECA financing will play a pivotal Aircraft lessors will become even more aircraft. However, recent regulation is
role in global aircraft transactions important as they attract new investors likely to make these unattractive as the
despite the change in the ASU which particularly from the Far East. additional compliance costs will make
will increase the cost of borrowing. these less profitable.
We also expect the current trend of sale
Since ECAs are still ultimately accessing and lease-back by airlines to continue as Given the attractiveness of the asset
the same funding pool as the airlines airlines free up much needed liquidity other specialist funds may come into
themselves, they may be requested to for operational needs in a tough play to tap into institutional demand.
adjust their instruments to new funding economic environment. One such example is the Doric Nimrod
sources. Some existing ECA guarantee Asset funds which have raised capital
products are already quite sophisticated The expected increase in the cost of ECA on the London Stock Exchange to be
particularly in the US e.g. recent ExIm backed financing and with many banks used solely to finance a number of A380s
backed bond issues such as the recent now offering much lower LTV ratios, we for Emirates.
Emirates and ACG bond issues. are also likely to see an increase in the
demand for operating leases.
European counterpart agencies are
likely to follow, with the ECA backed While lack of bank credit would also
AerCap bond at the end of 2010 being affect lessors, they are typically in a
the only official ECA support for a debt better position to access alternative
capital markets deal so far. sources of funding. We have looked at
the role of lessors in more detail in a
Increased use of capital markets later section.
particularly for the non-US airlines.
These funding sources will become Manufacturers’ financing may play a
more important but will only really be bigger role in the future to fill the gap as
accessible to those operators with the has been the case during previous
better credit ratings. downturns. We expect manufacturer’s
share of funding to increase going forward
Historically, the US airlines have been as demonstrated by the recent American
able to use this source of financing as Airlines Boeing order which includes the
the US Bankruptcy Code provided a provision of $13 billion of committed
clear legal framework, for investors financing from the manufacturers
and financiers, for repossession in case through lease transactions.
of default.
Other sources of financing: A380
The Cape Town Treaty aims to provide operators have been successful in using
similar protection to investors, but, it the attractiveness of the aircraft to
remains untested to date. Despite the access private investors through KG
fact that, the need for increased (Kommanditgesellschaft) funds.
transparency has made capital markets KG funds are a specialist corporate form
less attractive for airlines, we expect of partnership used to finance large
airlines to adapt and prepare for more
activity in the capital markets.
04
PwC | Aviation finance | 29
Lessors are to play a key role in the future as they
are better placed to attract new investment
Leasing companies are set to play a key
role in financing aircraft deliveries in
Industry view: ‘Banks are more interested
the future as they are better placed to
in financing leasing activities’
attract new investment. As a result,
Ulf Gedamke, Air Berlin leased aircraft will grow at a higher
rate than owned aircraft
As the demand for financing deliveries Leasing is now a preferred choice for
of new aircraft peaks at a time when most airlines these days, which is in
long term financing becomes less sharp contrast to their preference of
attractive for the incumbent banks, we owning aircraft outright a couple of
expect new investors to step in. decades ago. There are clear operational
benefits such as flexibility and access to
delivery slots and also significant cash
flow advantages.
Global fleet forecast and leasing penetration
As a result of the above shift in
behaviour, leasing’s market share has
CAGR2011-2021F increased from around 12% of the
Leased 5.6% global fleet in 1990 to around 32%
Owned 1.7% today. The penetration of leasing
Total 3.0% companies is likely to increase further as
airlines look to fill the funding gap left
35 45% by banks and investors. Some market
forecasts suggest a share of around 40%
40% by 2020.
30
Already, there has been a flurry of
35% activity in this space with a number of
25 new leasing companies backed by a
% of aircraft leased (penetration)
20 quickly.
25%
But, as with other businesses in the
20%
market, we expect leasing companies to
15 have to work harder to find financing for
their aircraft. They will also be impacted
15% by any increase in the cost of financing,
10 although they may benefit from
10% investment grade ratings which allow
them to better access capital markets.
5
5% We also expect a continuation of the
trend of sale and lease back
arrangements by airlines to leasing
- 0%
companies, as the airlines look to free
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
up liquidity.
Over the last year (more pronounced in short haul aircraft)and there are signs in the
Leasing rates have
market that they may soften further in the near future especially for single aisle aircraft.
softened
Particularly for the mid-age aircraft are under pressure and are likely to come under
Aircraft values further pressure as new orders are delivered. This has an implication for the assumed
aircraft age, a key assumption which determines depreciation, lease factors and returns.
Aircraft such B787s and A380s come into market and A320 NEOs and B737MAX are
As more new technology launched later in the decade, lessors with older aircraft technology on their books may
find less demand for their aircraft.
The aircraft leasing market is dominated have made active use of capital markets The new entrants have quickly built up
by two very large US entities, GECAS e.g. ILFC’s recent issuance of $750m portfolios through acquisition of
and ILFC. Beyond this, the Top 10 is unsecured debt and closure of a senior existing companies, purchase and lease
increasingly being challenged by fast secured loan of $900m early last year. back transactions and acquisition of
growing new entrants. portfolios from competitors.
Both lessors have raised capital by
The ‘Big two’, GECAS and ILFC, selling aircraft portfolios in the past for We expect to see more deal activity in
dominate the market in terms of both example ILFC’s sale of 53 aircraft to the medium term.
fleet size and value. Both have fleets Macquarie and AWAS’s purchase of a
larger than Delta Air Lines, the world’s GECAS portfolio.
largest airline by number of aircraft.
Outside of the big 2, a number of newer
They also dominate the order backlog, players (e.g. HKAC, Avolon, Jackson
with 190 and 228 aircrafts on order Square etc.) have entered the market
respectively, as of July 2012. Along with with funding from a variety of sources
other lessors based in the US, they are from sovereign wealth to capital
better placed than other territories with markets and private equity.
their ability to raise USD financing, and
New Entrants
800%
Jackson Square Aviation*
400%
Avolon Aerospace Leasing
40%
Fleet value growth, 2010-11
30%
AerCap
Top 10
AWAS
20%
CIT Aerospace
Big two
Aircastle Advisor Aviation Capital Group
10% BBAM
BOC Aviation
0% GECAS
RBS Aviation Capital
ILFC
(10%)
(20%)
(500) 500 1,000 1,500 2,000 2,500
For more information about any of the issues raised in this report, please contact
any one of those listed below or your usual PwC contact:
Ronan Doyle
Partner – PwC (Republic of Ireland)
Banking & Capital Markets
ronan.doyle@ie.pwc.com
Cameron Green, Donal Boylan, Frank Wulf, Garry Burke, James Chin, Lovis
von Andrian, Mark O’Connell, Richard O’Halloran, Ricky Thirion, Roger de
Peyrecave, Rupak Ramachandran, Stephan Cors, Ulf Gedamke and all those
who generously made time to be interviewed but requested not to be quoted.
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should
not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express
or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law,
PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any
consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision
based on it.
© 2013 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to the UK member firm, and may sometimes refer to the
PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.
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PwC | Aviation finance | 39
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