www.pwc.com               Aviation                finance               Fasten your               seatbeltsJanuary 2013
Foreword                                                Shamshad Ali – Partner                                            ...
Neil Hampson – Partner                    T: +44 (0)20 7804 9405                    M: +44 (0)78414 97220                 ...
At a glance                             The industry has seen record                 Finance is likely to be available    ...
…financing will be expensive as              Some question marks remain                   In the current economicregulator...
6 | Aviation finance | PwC
The opportunityto invest01                  PwC | Aviation finance | 7
Aviation financing offers potential investorsabsolute returns backed by hard assets...               Industry view: ‘We ex...
...and is already attracting the attention of variousinvestors Industry view: ‘I would expect that the rising cost        ...
Record aircraftbacklogs0210 | Aviation finance | PwC
Aircraft orders are at record levels which could openup attractive investment opportunities for investors                 ...
The desire to reduce operating costs particularlyfuel, which now represents a third of operatingcosts for most airlines…  ...
…and geographical expansion have been the keydrivers of new orders. But there is also an elementof speculative orders     ...
Historically, airlines have continued to be able tofind finance and take deliveries of new aircraft evenwhen profitability...
OEM’s are ramping up production to meet demand                                                                            ...
With growing demand for new aircraft the‘waterfall market’ for second hand aircraft isdwindling which is impacting aircraf...
PwC | Aviation finance | 17
The narrow body fleet is more vulnerable to theunfavourable trends in residual values…                                    ...
…and has experienced softer lease rentals                                          Industry view: ‘The reality is there ar...
20 | Aviation finance | PwC
Financing trends03                   PwC | Aviation finance | 21
Airlines are having to work harder and longer toarrange funding for new aircraft orders                                   ...
Availability of long term liquidity is reduced, risk isbeing repriced, and further regulatory changes arebeing implemented...
ECAs, historically a backstop, have now become adefault source of finance. This is set to change…                         ...
…as the New Aircraft Sector Understanding comesinto force from 2013, which is likely to increase thecost of ECA backed bor...
As traditional sources of funding tighten…                                                           As risk is repriced, ...
…the industry will need to tap into new andalternative sources of financing                                            Ind...
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
Etude PwC sur le financement du secteur aéronautique (2013)
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Etude PwC sur le financement du secteur aéronautique (2013)


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Une nouvelle étude de PwC met en lumière l’univers complexe du financement de l’aviation. « Aviation Financing – Fasten your seatbelts » affirme que le marché pourrait faire face à l’un des plus profonds bouleversements de son histoire récente. En effet, dans un contexte économique difficile, les banques européennes sont contraintes de diminuer leurs investissements dans le secteur. Si les investisseurs asiatiques semblent prêts à monter au créneau, le coût du crédit enregistre néanmoins des hausses plus ou moins fortes, dans un contexte où les commandes d’avions atteignent des niveaux record.

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Etude PwC sur le financement du secteur aéronautique (2013)

  1. 1. www.pwc.com Aviation  finance Fasten your seatbeltsJanuary 2013
  2. 2. Foreword Shamshad Ali – Partner T: +44 (0)20 7804 9600 M: +44 (0)7714 7 08756 E: shamshad.ali@uk.pwc.com Aviation financing is a hot topic and The ongoing global economic likely to remain so over the coming uncertainty, the European Sovereign years, as the demand for financing debt crisis, the recent downgrading of deliveries of new aircraft peaks at a time several European banks and increased when long term financing becomes difficulty of accessing US dollar funding unattractive for some of the has raised funding pressure. A number incumbent banks. of predominantly European banks who have historically played a key role are On the one hand, record order books of retracting from the market. This is aircraft manufacturers reflect a period causing tensions in the funding market, of strong orders buoyed by both new which have been heightened by the aircraft types and strong demand in the ongoing bank deleveraging process, emerging markets. On the other, there which in part reflects the impact of new are a number of headwinds in the regulations such as Basel III. aircraft finance market which may make these orders more difficult to finance, Conversely, in tough economic times and potentially, more expensive. and a low interest rate environment attractive yields are harder to find. Investors are looking for hard assets with good returns.2 | Aviation finance | PwC
  3. 3. Neil Hampson – Partner T: +44 (0)20 7804 9405 M: +44 (0)78414 97220 E: neil.r.hampson@uk.pwc.comAs a result we expect attractive We expect acceleration in the ongoingopportunities to emerge in the aviation shift of financing from the traditionalfinancing sector for investors looking to aviation banks in the West to newdeploy large amounts of capital players from the East.efficiently. This report is based on a number ofAlready we have seen new investment interviews with key personnel in thisflowing into this sector as funds backed market including CEO/CFOs of leadingby the governments of China, Singapore leasing businesses, airlines, Europeanand UAE have made sizeable investments banks and other financial institutions inin this space. Other institutional Asia, ME and Europe to understand andinvestors such as sovereign wealth analyse the latest trends in the market.funds, insurance companies, pension We hope this research will better informfunds and certain private equity funds the investor community. Despite thecould also be interested in investing in challenges, aircraft financing is anaircraft assets. opportunity for new entrants to earn attractive yields, provided the asset type and the timing is right! PwC | Aviation finance | 3
  4. 4. At a glance The industry has seen record Finance is likely to be available aircraft orders driven by the for the new aircraft as new operational needs of airlines. investors from the East flock Finding funds for these orders to the sector, replacing the will be a challenge traditional banks from the West but… 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. There have been recent attempts for example the Doric II (UK-listed) Emirates financing vehicle and German bond backed by an aircraft mortgage (a new product first used by Nord LB in July 2012).4 | Aviation finance | PwC
  5. 5. …financing will be expensive as Some question marks remain In the current economicregulatory changes and economic around financing of second-hand environment of low interest ratesconditions make capital scarcer. fleets as their values and rentals and economic uncertainty, theIt remains to be seen who will pay soften aviation sector could offer anfor the incremental costs. attractive alternative to new investorsAlthough it already costs more to As airlines take delivery of new aircraft, Aviation finance could provide anarrange financing within the aviation owners must be found for second-hand attractive opportunity to deployindustry compared to a few years ago, aircraft. In the past, airlines from large amounts of capital efficiently inwe expect the cost of financing could developing economies have taken these, ‘hard assets’.increase further as regulatory changes which has created a natural flow oftake shape in particular Basel III and the ownership. This is changing as new and This sector is particularly attractive at aimplementation of the new Aircraft smaller airlines place orders for new time when investor confidence in stocksSector 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 forWhat’s more, as the challenges that the Agency (ECA) finance. This, together investing in aircraft financing is thatbanking industry faces, and in with concerns of oversupply of some investor demand for investing in theparticular the European banks who aircraft types, particularly narrow body, Japanese Operating Lease (JOL) markettraditionally 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 enteringmarket which will intensify the These factors could have a significant this space, but the general consensuscompetition to obtain aircraft financing impact on the demand for the second- among the experts interviewed byand the cost of financing will likely hand fleet going forward. If values of PwC is that more needs to be done tofurther 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 willinghigher cost of financing will have on the customer, as the risk of financing suchcost of travel. aircraft increases. PwC | Aviation finance | 5
  6. 6. 6 | Aviation finance | PwC
  7. 7. The opportunityto invest01 PwC | Aviation finance | 7
  8. 8. Aviation financing offers potential investorsabsolute 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. Why invest in aviation financing? • Deploys large amounts of capital efficiently. • Relatively predictable returns although residual values, especially for older aircraft, can be volatile. • Aircraft – the underlying asset – is truly global in its recognition and usage. • Investment typically secured by a ‘hard asset’, supported by International regulations such as the Cape Town Treaty. • Highly mobile asset – helps with reclaiming and redeploying the asset in case of a default.8 | Aviation finance | PwC
  9. 9. ...and is already attracting the attention of variousinvestors Industry view: ‘I would expect that the rising cost Aviation financing sector exhibits the of capital from traditional lenders will open sort of characteristics that would opportunities for new sources of capital in the attract institutional investors such aviation finance market’ as sovereign wealth funds, insurance Ricky Thirion, Vice President and Group Treasurer, companies, pension funds and Etihad Airways certain private equity funds Sovereign Wealth Financial Investors/ Funds (SWF) Private Equity We have already seen a number of At first glance, aviation financing may SWF-backed funds such as China, not be an obvious investment for PE. Singapore and UAE investing in this asset class. But, we have already seen a number of financial investors backing leasing This is unsurprising given their access businesses with recent ventures e.g. to US dollar funding, longer term Cinven, CVC, GIC and Oak Hill’s investment horizon and appetite for investment in Avolon, Carlyle’s investment deploying larger amounts of capital in RPK, Cerberus Capital’s investment in efficiently. AerCap, Oaktree’s investment in Jackson Square Aviation (now exited) and Terra With the potential for developing Firma’s investment in AWAS. new structures, we expect further involvement of SWFs going forward. We expect to see further deal activity in this space. Far Eastern Banks Banks from the Far East have been at the forefront of some of the larger deals, for example, the acquisition of RBS Aviation by Japanese Bank Sumitomo Mitsui, the sale of DVB’s 60% share in TES to Development Bank of Japan and Mitsubishi Corporation and the recent acquisition of Jackson Square Aviation also by a Mitsubishi Corporation entity. Some Chinese banks may also be keen to expand into the sector e.g. press reports suggest CDB was the under bidder for RBS Aviation. We believe the recent trend of a shift in aviation assets from European banks to the banks in Asia is likely to continue. PwC | Aviation finance | 9
  10. 10. Record aircraftbacklogs0210 | Aviation finance | PwC
  11. 11. Aircraft orders are at record levels which could openup 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). Airbus and Boeing orders, deliveries and backlogs 3,500 12,000 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 Orders Deliveries Backlog Source: Boeing and Airbus websites, PwC analysis PwC | Aviation finance | 11
  12. 12. The desire to reduce operating costs particularlyfuel, which now represents a third of operatingcosts for most airlines… Although there is an element of speculative orders, on balance we believe there are genuine operational and business reasons for the current mega orders from emerging markets A number of factors have contributed to -- This has been a key driver of this ‘abnormal’ peak: aircraft orders in 2011 and 2012 following the launch of the A320 • A continued focus by airlines on NEO and 737 MAX short haul driving down operational costs aircraft. in an era where the cost of a barrel of fuel in excess of $100 is the ‘new -- New technology aircraft with lower normal’ and with fuel now carbon emissions also help airlines representing a third of total operating with their broader environmental costs. This has driven the demand for objectives and better place them for new technology aircraft with a future when global carbon pricing innovative improved composites and is fully implemented. more fuel efficient engines. -- Manufacturers’ estimates suggest significant savings, for example, according to Boeing, a B787 saves c.16%-19% operating costs (on a per available seat kilometre basis) over a B767. 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 Assumes fuel price of $125 per barrel (2009 USD)12 | Aviation finance | PwC
  13. 13. …and geographical expansion have been the keydrivers of new orders. But there is also an elementof speculative orders • The strong economic growth in In-service Aircraft by region On order Aircraft by region emerging markets over the last 4% 2% decade has increased the appetite for air travel in these populous regions (China, India, Brazil) particularly within the emerging middle classes. • The replication of successful 27% 34% Low Cost Carrier (LCC) 34% 34% models, which has driven 52% exponential demand for air travel and aircraft in emerging regions and 19% made flying affordable for their increasingly prosperous populations. 28% • Re-fleeting of US Airlines as they look to replace over 2,000 aging MD 80s and 737s. North & South Am erica Asia, Australasia and Middle East • Competition amongst airlines to Europe Africa offer the best and newest technology Source: Flightglobal (e.g. B787 and A380 flying experience) to their discerning customers. This is especially true of airlines operating in highly contested Short haul aircraft outstanding orders – Top 6 routes and markets (e.g. Japanese and the Middle Eastern markets). 400 • Airlines in developing 350 countries are increasingly taking delivery of brand new aircraft (e.g. RwandAir which operates a 300 130 new 737NG and has B787s on order directly with the manufacturer).No of aircraft on order 250 Historically, such airlines took 34 deliveries of second-hand aircraft 200 from more established players 100 59 which created a natural waterfall 130 200 for aircraft. 150 150 37 Although there are genuine business 100 201 and operational factors that have fuelled 150 the current demand, orders have also benefited from what some in the 50 100 100 72 65 industry describe as longer term, more ‘speculative’ mega orders for the - short haul type, predominantly from American Air Asia Norwegian Lion Air Indigo Southwest lower cost operators. Over the last Airlines Airlines couple of years just six airlines have B737 MAX B737NG A320 Current A320 Neo accounted for over 1,500 short haul aircraft orders. Source: Boeing, Airbus and American Airlines websites PwC | Aviation finance | 13
  14. 14. Historically, airlines have continued to be able tofind finance and take deliveries of new aircraft evenwhen profitability has been challenging Despite a tough decade, airlines have taken steady delivery of new aircraft over the last ten years and have always managed to find funding for their orders 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. As a result of the above, many airlines have lost equity and now have weakened balance sheets. Now, airlines arguably have the lowest margins in their value chain. Global commercial airline profitability, orders and deliveries 1999-2012F 20 1,300 15 Number of deliveries (Airbus and Boeing) 10 800 5 - 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 Net profit ($bn) Deliveries Source: Boeing, Airbus and American Airlines websites14 | Aviation finance | PwC
  15. 15. OEM’s are ramping up production to meet demand OEMs will need to closely monitor and manage their supply chain to ensure orders are delivered on time and, more importantly, their new aircraft programmes remain on track On the back of unprecedented orders, the Aircraft production rates over time (Airbus and Boeing) Original Engagement Manufacturers 45 (OEM) have built up record order 42 42 backlogs. At present, these backlogs stand 40 at over 7/8 years of production. To address these backlogs OEMs have ramped up 35 33 production volumes for existing 32 32 31 technology aircraft and are likely to 31 increase it again over the medium term. 30 Monthly production rates 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. Source: Boeing and Airbus websites and PwC analysis New aircraft variants have a Length of delay from initial estimated service date to actual history of delays in production scheduled service date (Boeing’s first 787 was three years late in delivery) and teething troubles as B787 3.5 the first fleet emerges for example the recent issues with cracks on the wings A380 2.3 of the A380. 747 -800 1.0 These programme delays and issues create challenges for aircraft owners A350 1.3 + ?? and operators who are seeking toA320 Neo ???? replace ageing airframes as soon as possible. In a number of cases, they737 MAX ???? either cancel orders all together or default to existing, rather than new 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 technology aircraft to plug their delivery Years delay schedule gaps. Source: Boeing and Airbus websites and PwC analysis
  16. 16. With growing demand for new aircraft the‘waterfall market’ for second hand aircraft isdwindling which is impacting aircraft residualvalues, age and lease rentals The challenge for existing and new investors is to understand the impact the record orders and production rates could have on residual value trends 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.16 | Aviation finance | PwC
  17. 17. PwC | Aviation finance | 17
  18. 18. The narrow body fleet is more vulnerable to theunfavourable trends in residual values… Aircraft orders placed in 2007–10 are starting to deliver in 2012, which are potentially in excess of current demand and are causing softer lease rates for mid life aircraft, in particular for narrow body models Aircraft values and Given uncertainty regarding aircraft age and residual values and the potential for a Aircraft age new generation of aircraft (press reports There is consensus amongst the experts suggest NASA and other key players in the we interviewed that the economic life of sector are working on the next generation aircraft is shortening due to the current of passenger jets) coming into service in ‘supply and demand’ dynamics and that 20–25 years time, it is now even more the standard 25 years is no longer valid. important to be at the front end of This has implications for residual values deliveries in order to generate good and returns. A key question for potential returns. This, though, comes with investors, with the launch of ‘new potentially higher risk of initial technology’ aircraft later this decade, is ‘teething’ problems experienced with whether this trend is likely to continue most new models. or even accelerate? Narrow Body Asset Values Wide Body Asset Values 15% 10% 10% 5% 5%YoY % change in Market Value 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 Source: Morgan Stanley Research, Aircraft Value Analysis CompanyNarrow body = MD83, 737-300, A320-200, 737-700 Wide Body= 767-200/300, 747-400, 777-200, A330- 300 A340-30018 | Aviation finance | PwC
  19. 19. …and has experienced softer lease rentals Industry view: ‘The reality is there are too many narrow bodies in the market hence lease rates are soft’ Managing Director, major leasing business Lease rates This is exacerbated by Boeing and Airbus ramping up production of After a bounce back in 2010, lease rates 737NGs and A320s. The issue of have been under pressure in 2011/12. softening lease rates is more pronounced The problem is more pronounced for for mid-life aircraft as newer aircraft are narrow body where market consensus is preferred by airlines. that due to the current over supply, lease rates are below market expectations. This trend is impacting standard aircraft age and residual value assumptions and Part of the issue can be traced to large is resulting in younger aircraft being orders from lessees placed between parted out. 2007–2010, which are starting to be delivered in 2012 and could potentially be in excess of requirements. Narrow Body Lease Rates Wide Body Lease Rates 20% 10% 15% 5% 10%YoY % change in Lease Rates 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 Source: Morgan Stanley Research, Aircraft Value Analysis CompanyNarrow body = MD83, 737-300, A320-200, Wide Body= 767-200/300, 747-400, 777-200,737-700 A330-300 A340-300 PwC | Aviation finance | 19
  20. 20. 20 | Aviation finance | PwC
  21. 21. Financing trends03 PwC | Aviation finance | 21
  22. 22. Airlines are having to work harder and longer toarrange 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’. 3,500 350 350 Potential mitigations for 3,000 300 airlines Value (@ list price) $bn • 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 *737 MAX/A320 NEO ** 787/747-800/A380/A35022 | Aviation finance | PwC
  23. 23. Availability of long term liquidity is reduced, risk isbeing repriced, and further regulatory changes arebeing implemented Leasing companies over the years have Industry view: ‘A number of banks are trying to sell steadily built up a significant market substantial portfolios of aircraft financing – up to $6bn at a presence and now have >30% market share. They have not only financed new time to improve their capital positions’ deliveries but have increased their Frank Wulf, MD Aviation Finance, DVB Bank market share through purchase and lease-back transactions. Leasing companies are currently preferred by investors, lenders and airlines due toGenerally, in tough economic times, The ongoing global economic their better risk and reward offering.liquidity becomes more scarce and uncertainty, the European Sovereignhence, financing an aircraft gets debt crisis, and the challenges faced by Cash and equity financing by airlinestougher. Despite those challenges, European banks in accessing US dollar has not been as popular in the recenthistorically the industry has found new funding and improving their capital past. The primary reason for this is thesolutions and aircraft have always been positions has raised funding pressure. necessity for airlines to have reasonablefinanced. European banks have played a key role cash buffers to cover normal operations in the past but many are now looking to and be able to deal with unusualPost the 2008–09 global financial crisis, reduce their exposure to this sector. situations (e.g. volcanic eruptions,when bank financing was more scarce, earthquakes, SARS) which putthe Export Credit Agency (ECA) Public debt and capital markets have significant strain on the business.guaranteed financing stepped up and become more challenging as investorswas seen as a saviour. With ECA look to safer havens such as government Japanese Operating Leases are a steadyguarantees, banks were seen to be more bonds. But, we are seeing new more and attractive source of financing, forwilling to provide debt and, with sophisticated capital market products example Lufthansa and Air Francereduced risk, were able to price more backed by ECA/US-ExIm which are A380s were financed through JOLs incompetitively. attracting more interest, for example the Q2 2012. recent Emirates, ACG and Ryan Air issued bonds backed by ExIm. 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. PwC | Aviation finance | 23
  24. 24. ECAs, historically a backstop, have now become adefault source of finance. This is set to change… 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 key agencies involved with aircraft financing are:Export-Import Bank of the Federal Export Credit Export Development CanadaUnited States (ExIm) Guarantees (Germany) Canada’s Export Credit Agency isThe bank assists in financing the export Euler Hermes helps to promote German self-financed and works to support andof US goods and services to exports by offering guarantees that develop Canada’s export trade byinternational markets, filling the protect German companies in the event helping Canadian companies respond tofinancing gaps that the private sector is of non-payment by foreign debtors. The international business opportunities.unwilling to accept. ExIm is different German export credit scheme isfrom the other ECAs as it can provide managed on behalf of the Federal Brazil Development Bankfunding if required. Government by Euler Hermes and The BNDES is a Brazilian federal PwC Germany. company aiming to provide long-termExport Credits Guarantee financing to Brazilian companies of allDepartment (UK) Compagnie Française sizes. Its key goals are theUK Export Finance is a government d’Assurance pour le strengthening of capital structures ofdepartment that provides government Commerce Extérieur private companies as well as the (Coface) development of capital markets.assistance to UK exporters andinvestors, principally in the form of The Coface Group is a trade risk and creditinsurance policies and guarantees on insurance expert, offering creditbank loans. insurance to companies, regardless of their size, sector or country.Source: Agency websites24 | Aviation finance | PwC
  25. 25. …as the New Aircraft Sector Understanding comesinto force from 2013, which is likely to increase thecost of ECA backed borrowing Export Credit Agencies (ECAs) have Industry view: ‘With a market-reflective played a crucial role over the last four pricing this (new ASU) will shift the focus of years by stepping in when liquidity ECA financing to its genuine raison d’être – dried up in 2008 and are very likely to availability, not affordability, of funding’ continue playing an important role. However, due to the new ASU the cost of Stephan Cors, Head of Aviation Risk, such financing is set to increase, adding PwC Germany to the challenge for the airlinesNew Aircraft Sector ECA financing cost increasesUnderstanding (ASU) which governsthe rules of ECA financing, will come (12 year repayment term, asset-backed)into force in 2013, and is likely to resultin a considerable increase in premiums. OLD ASU New ASUThe New ASU is actually already in Entity rating Per annums Up front % Per annums Up front %effect but will have more impact from spread (bps) spread (bps)Jan 2013 when the current two yeartransition period ends. AAA – BBB- n/a 4.0% 142 8.01% BB+ – B- n/a 4.75-6.25% 189-271 10.73-15.58% CCC – C n/a 7.5% 303-310 17.50-17.92% New ASU for aircraft sales contracts agreed post 2010 and/or deliveries post 2012 Source: OECD and PwC analysis Challenges to ECA financing The role of ECAs has been under the spotlight in recent years because the ‘home airlines’ are barred from utilising this type of financing (there are some limited exceptions e.g. at present AF KLM, Lufthansa and BA each have the option to finance two A380s supported by ECAs). 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. PwC | Aviation finance | 25
  26. 26. As traditional sources of funding tighten… As risk is repriced, the competition to obtain financing for aircraft may intensify and the cost of financing may go up. We believe that the industry as a whole will be able to attract funding but the new sources of finance will need to be tapped into 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. 70% 25% Several European banks have had recent rating downgrades due to their exposure 23% to the ongoing European debt crisis and 60% they have started withdrawing from % of financing balance sheet heavy investments such as 50% aircraft and shipping finance. 28% 40% We expect Non-European banks with 25% better access to US dollars to step in and already we have seen a flurry of activity 30% involving the banks from the Far East. For example, Sumitomo Mitsui Bank’s 20% acquisition of RBS Aviation, Mitsubishi 30% Corporation and Development Bank of 27% Japan’s investment in TES and the well 10% documented interest of ICBC in the sector. 0% Banks from emerging markets other 2011 2012 (Est) than China are showing interest but are Bank debt ECA financing not competitive yet due to higher Cash Sale & lease back refinancing costs and regulatory or fiscal Capital markets Manufacturer restrictions to offer long term financing with fixed interest rates. Source: Boeing and Airbus, PwC analysis26 | Aviation finance | PwC
  27. 27. …the industry will need to tap into new andalternative sources of financing Industry view: ‘The capital markets outside the US need to be harnessed to play a bigger role in aviation finance’ Ricky Thirion, Vice President and Group Treasurer, Etihad AirwaysECA financing will play a pivotal Aircraft lessors will become even more aircraft. However, recent regulation isrole in global aircraft transactions important as they attract new investors likely to make these unattractive as thedespite the change in the ASU which particularly from the Far East. additional compliance costs will makewill increase the cost of borrowing. these less profitable. We also expect the current trend of saleSince ECAs are still ultimately accessing and lease-back by airlines to continue as Given the attractiveness of the assetthe same funding pool as the airlines airlines free up much needed liquidity other specialist funds may come intothemselves, 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 Nimrodsources. Some existing ECA guarantee Asset funds which have raised capitalproducts are already quite sophisticated The expected increase in the cost of ECA on the London Stock Exchange to beparticularly in the US e.g. recent ExIm backed financing and with many banks used solely to finance a number of A380sbacked 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 arelikely to follow, with the ECA backed While lack of bank credit would alsoAerCap bond at the end of 2010 being affect lessors, they are typically in athe only official ECA support for a debt better position to access alternativecapital markets deal so far. sources of funding. We have looked at the role of lessors in more detail in aIncreased use of capital markets later section.particularly for the non-US airlines.These funding sources will become Manufacturers’ financing may play amore important but will only really be bigger role in the future to fill the gap asaccessible to those operators with the has been the case during previousbetter credit ratings. downturns. We expect manufacturer’s share of funding to increase going forwardHistorically, the US airlines have been as demonstrated by the recent Americanable to use this source of financing as Airlines Boeing order which includes thethe US Bankruptcy Code provided a provision of $13 billion of committedclear legal framework, for investors financing from the manufacturersand financiers, for repossession in case through lease transactions.of default. Other sources of financing: A380The Cape Town Treaty aims to provide operators have been successful in usingsimilar protection to investors, but, it the attractiveness of the aircraft toremains untested to date. Despite the access private investors through KGfact that, the need for increased (Kommanditgesellschaft) funds.transparency has made capital markets KG funds are a specialist corporate formless attractive for airlines, we expect of partnership used to finance largeairlines to adapt and prepare for moreactivity in the capital markets. PwC | Aviation finance | 27