www.pwc.com Aviation finance Fasten your seatbelts January 2013 Foreword Shamshad Ali – Partner T: +44 (0)20 7804 9600 M: +44 (0)7714 7 08756 E: [email protected] 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 Foreword Neil Hampson – Partner T: +44 (0)20 7804 9405 M: +44 (0)78414 97220 E: [email protected] As a result we expect attractive We expect acceleration in the ongoing opportunities to emerge in the aviation shift of financing from the traditional financing sector for investors looking to aviation banks in the West to new deploy large amounts of capital players from the East. efficiently. This report is based on a number of Already we have seen new investment interviews with key personnel in this flowing into this sector as funds backed market including CEO/CFOs of leading by the governments of China, Singapore leasing businesses, airlines, European and UAE have made sizeable investments banks and other financial institutions in in this space. Other institutional Asia, ME and Europe to understand and investors such as sovereign wealth analyse the latest trends in the market. funds, insurance companies, pension We hope this research will better inform funds and certain private equity funds the investor community. Despite the could also be interested in investing in challenges, aircraft financing is an aircraft assets. opportunity for new entrants to earn attractive yields, provided the asset type and the timing is right! PwC | Aviation finance| 3 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 At a glance …financing will be expensive as Some question marks remain In the current economic regulatory changes and economic around financing of second-hand environment of low interest rates conditions make capital scarcer. fleets as their values and rentals and economic uncertainty, the It remains to be seen who will pay soften aviation sector could offer an for the incremental costs. attractive alternative to new investors 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. PwC | Aviation finance| 5 6 | Aviation finance| PwC The opportunity to invest 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. 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 ...and is already attracting the attention of various investors ‘I would expect that the rising cost Industry view: 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.