Download PDF

FINANCE: Asset based finance
Aviation finance:
The beautiful game?
Simon Finn, SVP for aviation and aerospace at DVB Bank, gives us his analysis of current
aircraft, aviation financing, and explains how best to navigate through the ups and downs
of market cycles.
T
hanks to the World Cup, we’ve had a summer of
football clichés; ‘It was a game of two halves’, ‘it’s all
to play for’ and the ubiquitous ‘at the end of the day’
all crept into commentary with monotonous regularity.
Of course, just like football, aviation is a ‘funny old game’.
Just as football is affected by unexpected events (biting,
Spain’s loss and England’s demise – okay, maybe not that
one), aviation is at the mercy of many changing dynamics.
Circle of life
It is worth reflecting on the degree of change that has
occurred in our industry in recent years. After the global
10
financial crisis and ensuing credit crunch, aircraft
manufacturers became concerned about a possible
lack of aircraft finance; conversely, much of the
industry now believes there to be too much available
capital. But at DVB, we expect this perennial cycle of
too much, or too little, finance.
Likewise, there is the cycle of aircraft supply and
demand. The prevailing sentiment during the first half
of 2014 was that the supply and demand for commercial
aircraft is relatively balanced, yet there is now a growing
sense that the industry may be exposed to an oversupply
of aircraft at some point within the next five years.
AIRCRAFT FINANCE GUIDE 2015 • www.afm.aero
FINANCE: Asset based finance
The third cycle to strongly affect aviation business is
aircraft technology. Manufacturers will periodically
introduce new technologies designed to extend durability,
improve performance and reduce operating costs.
management of seat capacity was exemplary as the
financial industry emerged from the credit crunch, but,
more recently, the effectiveness of capacity management
has deteriorated.
By themselves, each of these three key cycles exhibits
a degree of predictability. Therefore, we can detect
emerging trends and adjust our strategic activity to
cope. For example, as the finance cycle has developed
into its current phase of abundant liquidity, we have
witnessed pressure to reduce pricing, extend financing
to weaker credits and increase loan advances to win
business in the face of stiff competition.
Most of us are aware of the long order backlogs for
narrowbody aircraft and know that this has made it difficult
for airlines to judge their seat capacity requirements. For
aircraft delivered over the past 18 months, the duration
between the initial order and the eventual delivery date has
averaged around four years. Almost 45 per cent of such
deliveries took even longer.
New market offerings
Indicators for the industry cycle as a whole are a little
less black and white, however. We may look to air traffic
growth and profitability, or perhaps capacity. Airlines’
Aside from the traditional problems in attempting to
pinpoint traffic growth and network development,
airlines also face the twin temptations of very low-cost
AIRCRAFT FINANCE GUIDE 2015 • www.afm.aero
11
FINANCE: Asset based finance
finance and attractively priced aircraft from
manufacturers anxious to bridge their way to the
production of new technology. This has led some to
wonder whether there will be an over-supply of aircraft.
It is, however, possible to second-guess manufacturers on
the aircraft technology cycle. Still, this can be complicated
for all but the most seasoned of pundits, as the signals
can be confusing.
Remember Boeing’s PR on the 737NG replacement
option? They were adamant that putting new engines on
the 737 didn’t make much economic sense. They pushed the
argument to the point that everyone except Avitas’ Adam
Pilarski believed them (including many within Boeing itself!).
In general, though, manufacturers signal their intentions
through the process of marketing, launching, selling and
certifying new technology aircraft. This takes many years,
which gives the industry time to adjust to any changes in
the relative attractiveness of existing aircraft.
to its development schedule. Occasionally, a high-profile
event like an engine failure or a service entry experience may
make headlines and create consternation among the aviation
community, but it is rare for this to have a lasting effect on
the underlying demand and value of such aircraft.
However, there is plenty of evidence to suggest that
new-generation aircraft have a lasting and visible effect
on the demand for existing aircraft. A glance at the value
retention of Classic 737s in the years following the entry
of the 737NG is guaranteed to raise an asset-based
financier’s blood pressure.
The common attraction to new-generation products is the
opportunity to reduce fuel by 15 to 20 per cent. In a world
where jet fuel prices are high, it’s difficult for an airline to
stand and watch its competitors reap profits from lower
operating costs while its own finance team sails their
airline ever closer to bankruptcy. This is particularly true
for widebody aircraft where flights tend to be longer,
payloads heavier and savings per aircraft are significant.
There is plenty of evidence to suggest that
new-generation aircraft have a lasting and visible effect on
the demand for existing aircraft
Careful planning by the manufacturers tends to ensure
that each new product announcement is greeted
enthusiastically by the industry and, if possible, by
the public and media also. The high-profile nature of
commercial aerospace may mean that national interests
are at stake as well as the future of the manufacturer
itself – so, no effort is spared in ensuring that airlines,
lessors, financiers and the media all have a positive
view on any new aircraft programme.
Having created this initial positive impression and
(hopefully) translated it into a solid order book, the
manufacturers then face the considerable task of
developing, building, certifying and delivering their
new products to the promised performance targets,
on time and on budget.
The complexity of a modern aircraft makes this a uniquely
challenging proposition for any aerospace manufacturer,
and things can go awry. When they do, usually the first thing
to suffer is the timetable. Whether we think of the A380,
A350, 787, CSeries, MRJ or C919, each has suffered delays
12
Asset analysis
Boeing’s 767 commercial aircraft programme choked
as operators ordered the slightly larger A330. It’s bad
enough to see demand for a product drop, but it’s even
more painful to watch the orders go to the competitor.
So, Boeing adopted a technology-led approach to
recovering its share of the market for aircraft of this size.
The introduction of the 787 has changed the market
for the 767 and A330. However, the development
programme was expensive and the 787’s technology
is not cheap to acquire. While demand for the 767 has
largely evaporated anyway, this has left room for Airbus
to continue selling the A330, albeit at lower prices and
with a wider range of optional specifications.
The introduction of the A350 XWB has had much the
same consequence for the A340 and for Boeing’s current
777 models. Fuel prices have squeezed demand for the
A340, while demand for the original 777 models has also
suffered a drop. This means that airlines are looking to
replace such aircraft (and the remaining 747s) sooner
AIRCRAFT FINANCE GUIDE 2015 • www.afm.aero
FINANCE: Asset based finance
than manufacturers had expected. Prices for 777-300ER
aircraft are likely to feel downward pressure in the face
of the A350-1000.
Also, the 777X will arrive a little late for some operators
that have already retired a large number of 747-400s, but
the new -9X model is an impressive aircraft that may well
prevent many Boeing customers being tempted by the
economics of the A350 XWB. Unfortunately, it will not
encourage demand for the 777-300ER, the market for
which may require stimulation between now and 2020,
when the 777X enters service. The -8X model looks likely
to suffer from a concentration of operators but will probably
hold some appeal for Emirates, Qatar and/or Etihad.
Airbus found a willing market for the A380 in Asia
and Europe where the full service carriers like the aircraft
for their flagship branding. Despite media interest in the
A380, the market appears smaller than either Airbus or
Boeing anticipated. Furthermore, Boeing’s 747-8 looks
increasingly like a rare misjudegment from Seattle as
airlines seem to prefer the larger A380’s branding
opportunity, or the more attractive economics of the
large twin-engine aircraft types. The new 777X is
probably going to cost the A350-1000 some sales.
By itself, all this product movement does not produce
an instant impact on the value of the preceding aircraft;
negative movements in the value of commercial aircraft
14
are generally well correlated with a drop in GDP. Generally,
such economic declines seem to catch the markets largely
unaware and this has led to an increase in debate on the
subject of ‘black swans’, or unforeseen events.
Past ‘black swans’ include the Persian Gulf Conflict,
al-Qaeda terrorist attacks and the global financial crisis.
The timing of such events and the amplitude of their
impact on air travel is what traditionally triggers changes
to aircraft value. But the potential for significant changes
in value increases as obsolescence looms over a
generation of aircraft.
Air traffic growth is healthy and world GDP is also
improving after a long and slow slog. Aircraft finance is
approaching another peak of popularity and airlines are
experiencing low finance costs and a broader range of
funding options. But thanks to a record high in new
aircraft production, some airlines’ seat capacity is
beginning to grow faster than their passenger traffic.
Is the current ebullience in aircraft finance sustainable?
How will the risk associated with today’s aircraft prices
look should another black swan event change the outlook
for aircraft values? Those who see the aviation cycle as ‘a
game of two halves’ will try to mitigate such risks by
carefully selecting assets, counterparties and financial
structures – because at the end of the day, in the funny
old game of aviation finance, it’s all to play for.
AIRCRAFT FINANCE GUIDE 2015 • www.afm.aero
AFG

Download Report