A time for deals - The biggest ever airline order of Boeing aircraft was signed in Bali on 18 November. Law firm Stephenson Harwood completed the $21.7 billion deal for Indonesian airline Lion Air for 230 Boeing 737 aircraft. The deal also includes purchase option rights for a further 150 aircraft.
Elsewhere in Asia Pacific, much activity is taking place on the mergers and acquisitions front. Another deal of the moment is the sale of RBS Aviation Capital,one of the market’s five biggest players, with around 470 aircraft. The sale, which is expected to be worth $6-8 billion, currently has four interested purchasers, including China Development Bank and Sumitomo Mitsui Financial Group.
However, the sale is no reflection on the state of the aviation asset financing market, says a spokesperson for the company: “The company was designated a non-core part of RBS at the end of 2008, and so this has been a long time coming, and it’s part of RBS’ longer term strategic plan. So even though it’s been a very, very strongly performing business, it’s always been the plan to sell it.” In a move also based on non-core business reasons, American International Group Inc (AIG) recently announced plans to sell in excess of 20 percent of International Lease Finance Corporation (ILFC), its aircraft leasing business, in an initial public offering. ILFC is the biggest independent aircraft leasing company in the world by number of aircraft owned, with more than 1,000 owned or managed aircraft and an estimated value of around $3 billion.
As the global economy stagnates, many business sectors are reporting doom-and-gloom scenarios. But not aviation, which is being propelled forward by the tailwinds of Asian demand and new financing strategies.
Looking at the balance sheets of major aircraft manufacturers would not give anyone the impression that the world economy was in the doldrums. Boeing reported third-quarter profits of $1.1 billion in 2011, compared with $837 million in the same quarter last year, beating market expectations and reflecting a nine percent rise in revenue from commercial airplane sales. Competitor Airbus reported a third-quarter net profit of $565 million, up 86 percent from a year earlier. The company also increased its full-year sales forecast by 50 percent on a record order book of $503 billion. Much of this demand for new aircraft is due to the rise in passenger travel, the backbone of the industry, and Asia is a major factor. As the size of the middle class continues to grow in the mega-markets of China and India and increased urbanisation leads to bigger cities and greater population concentrations, passenger numbers are growing too. In China, passenger numbers in 2010 were 3.5 times that of 2000, while passenger traffic in India increased 20.8 percent in January 2011, the fifth consecutive month of double-digit growth. China’s three biggest carriers were among the world’s top 15 carriers in 2010 – measured in revenue passengerkilometers – up from zero in 2000. And this trend is likely to continue.
According to Boeing, around half of the world’s air traffic growth will be driven by travel to, from or within the Asia Pacific region over the next 20 years. China will need 5,000 new airplanes by 2030, at a value of $600 billion. Meanwhile in India, domestic travel will increase by more than nine percent over the coming two decades, according to Airbus, necessitating the purchase of 1,100 commercial jets at a cost of up to $130 billion. “Demand is still high for aircraft, and we’re still seeing huge order books,” says David Brotherton, asset finance partner at Berwin Leighton Paisner (BLP). “The order book is significant in Asia Pacific, and increasingly so. On the whole, there’s a relatively buoyant outlook to the aviation industry at the moment, particularly in Asia. There’s just a question of how this demand is going to be funded. I think that’s the question on everyone’s lips at the moment.”
Nicolas Clouet, senior vice-president of airline marketing for RBS AC in Asia, concurs. “I think that there has never been so many aircraft on order since this industry [started] roughly 60 years ago,” he says, adding that many of the new deliveries are destined for Asia. “This is where things will happen over the next few years, definitely.” However, Clouet feels that while banks will place “a real focus on Asia – developing themes, hiring people, tapping again local financial institutions for the purpose of developing the Asian market,” financing will pose a challenge. “The questions are more where new sources of financing can be found and how things will be structured,” he says.
“Traditional players – which are Western financial institutions – may probably not be enough to [finance] all the planes that are on order. Somebody will have to step up.” And in the aviation industry, this “somebody” is turning out to be innovation. Aviation financing, reinvented The global financial crisis that has curtailed the liquidity of many traditional finance providers, the ongoing euro zone sovereign debt crisis and the new capital reserve requirements imposed by Basel III have combined to force buyers to look to new sources for financing – and they are finding exciting new, and often lucrative, possibilities. These include financing from new leasing companies, overseas bond-backed credit, and self financing.
Baker & McKenzie, for example, has just completed a deal for Air China that is the first aircraft financing deal in China to be backed by an Ex-Im Bank U.S. dollar-guaranteed bond. The financing agreement was completed without the traditional guarantee from a Chinese bank or a sovereign undertaking from the Chinese government. The deal, led by Bakers’ Shanghai-based banking and finance partner, Harvey Lau, is groundbreaking in several ways, he says.For starters, the deal means that financing Chinese airlines with Ex-Im Bank support is no longer seen as a sovereign risk, according to Lau.
Previously, Chinese airlines seeking finance with Ex-Im Bank support needed to provide a bank guarantee as a counter-balance for Ex-Im Bank’s liability. “In the past, all these deals were done as what we call a sovereign risk deal, meaning that even though the aircraft were mortgaged to Ex-Im Bank, the risk that they were taking was really the China risk, not the asset risk, so they were all being done with counter-guarantees from a Chinese bank,” Lau says. The new strategy signals that China’s airlines can now stand on their own feet when it comes to financing, a sign of a maturing market. It also means reduced costs for China’s airlines, as they no longer have to pay a fee to a Chinese bank for the guarantee service, with savings amounting to around three percent of the sum guaranteed.
The deal also opens up new possibilities for other Chinese airlines, Lau suggests. “There are more benefits for these three big airlines and the airline market as a whole in China, because it actually opened up a new way of financing aircraft in China,” he says. “This structure is not just privy to Air China, it can be adopted and used by other airlines in China, including most notably China Eastern and China Southern.” The few smaller Chinese airlines that have wide-bodied aircraft will also be able to work with Ex-Im, Lau notes. “Ex-Im have made it clear that they would only want to provide support for the aircraft-type that is more difficult for commercial banks to finance,” he says, adding that Bakers has already seen interest from other airlines in a similar deal structure.
Bank financing: Emerging markets in focus
Changes are also afoot in bank financing. Some European banks are moving out of the market because of liquidity problems caused by the European sovereign debt crisis and the new Basel III capital requirements, and new ones are taking their place. “[Liquidity] has been good and relatively strong over the last 12 months, despite some traditional players like German banks, who decided to exit or are less present than they have been in the past, but on the other hand, you have seen a lot of new players, especially in Asia […] which have stepped in,” says RBS’ Clouet. He adds that several Chinese banks and other East Asian banks that are new to the sector have been providing short-term financing to their local airlines. “The Japanese have been traditionally strong, and they remain strong as well,” he says. Others banks, such as Standard Chartered Bank, which has a stable of 48 aircraft, are increasing their
focus on emerging markets where they perceive high potential returns.
“Emerging markets, in particular Asia and the Middle East, are driving this growth,” said the bank in a statement in June. “Financing requirements for emerging markets over the next 20 years is estimated to be around $2,090 billion, some 58 percent of total requirements.” Chinese banks are restricted in their lending abilities by government regulation, but many are stepping up their role by building asset-financing arms that compete competitively with overseas banks and are offering finance to Chinese airlines as well as overseas ones.
Many of the new leasing companies are subsidiaries of the commercial banks, according to Lau. “The Chinese banks had always complained that they were only the losers and not the winners in the aviation market because all the foreign banks came in and lent money to the airlines and they made a profit out of the interest or the fee, while the Chinese banks were only asked to provide a guarantee and make a very minimal guarantee fee, but all the risk would be with them,” he says. “But now things have evolved in such a way that some of the banks have started to be very active in not only lending to the airlines, but also to the leasing companies, and also to airlines in other parts of the world. For example, over the years, banks like ICBC, they lent to Air France, British Airways and others.” Self-financing becomes an option With increasing liquidity problems for commercial banks possibly resulting in banks being less able to offer finance – and with any available financing likely to cost more – airlines may increasingly turn to other funding options including self-financing, says BLP’s Brotherton. And one push in that direction is the cost of export credit or ECA funding.
“Export credit is going to look a little bit expensive in the next few years – that portion of the financing may well go down. The question is where does the financing shortfall come from? I think, surprisingly, a large portion of that will come from airline cash,” he says. At a recent Asia Pacific aircraft finance event, a leading manufacturer forecast that about 30 percent of thefunding gap in the Asia Pacific could come from airlines’ cash on balance sheet, he adds, pointing out that many airlines have enough cash available following good performances in the last few years. “I think we may see a shift towards the lessor finance, perhaps the capital markets, and outright funding by the airlines,” he says. In October, Fly Leasing, a Dublin-based company that leases commercial jets around the world, completed a deal to buy 49 aircraft, bringing its fleet size to 109. FLY’s CEO Colm Barrington said the deal was selffinanced.
“This acquisition was completed without the need to raise any new equity capital by utilising FLY’s available cash. As a result, the new portfolio will significantly grow our earnings per share,” Barrington said in a statement.
Clear skies ahead
Lau says that China’s ratification of the Cape Town Treaty also played a part in Ex-Im’s willingness to re-enter the Chinese aviation market,from which it had been absent for about a decade. The treaty, which
creates international standards for registration of ownership, liens, leases and conditional sales contracts, and various legal remedies for default in financing agreements, makes repossession of an aircraft easier, and that helped Ex-Im feel “more comfortable” about taking an asset as security, says Lau. “The Cape Town Convention actually provides a more standardised protection to the owners of various interests,” he explains. “For example, if you are the sole owner or you are a mortgagee, as in the case of Ex-Im Bank financing, it provides a more clear-cut and judicious recovery mechanism.”
Regulatory restrictions that limit Chinese banks’ lending capacity are also playing a role in changing the face of the financing in aviation, adds Lau, who says it is unlikely that these restrictions will be lifted anytime soon. This means continuing increased participation by China in the industry, he says. “China will play a significant role in the international market, and I believe there will be more foreign banks playing a part in the China market, mainly again because of the regulatory restrictions on the Chinese
banks to lend,” says Lau.
Meanwhile, Brotherton is expecting to see continuing vibrant activity in the M&A sector and throughout the aviation sector, a sentiment which is he said is broadly felt by all participants in the industry. “I do think the aviation market is well positioned,” says Brotherton. “There is still a question mark over how part of the new order book over the next few years is going to be funded, but it will be funded.” ALB