Paris Air Show

Commercial Aircraft Buyers Enjoy Unprecedented Capital Access

 - June 14, 2017, 4:00 AM
Aircraft finance markets are flushed with new sources of capital, and this is supporting global exports of airliners such as this Boeing 787 to markets including China. [Photo: Boeing]

Commercial aircraft continue to outperform virtually any other asset class in which financiers can invest, resulting in perhaps unprecedented levels of competition and some of the “cheapest” access to money that airlines have ever enjoyed. As a result, manufacturers continue to express a bullish outlook even while interest rates begin to show some signs of increasing.

Liquidity is some of the highest I’ve ever seen,” Boeing Capital Corporation president Tim Myers told AIN. “We’re seeing a lot of new investors coming into the space. Because when you look at aircraft finance as an investment alternative, it has really proven itself since ’08-’09, when the financial crisis hit. If you look at other fixed assent type of investments and aircraft have continued to outperform almost everything else. The airline industry is profitable again, so that’s driving people into the space, but we’re seeing continuing new investment coming in from places like Korea, places like Australia…the Japanese regional banks are back in the business…Taiwan.”

The influx of money has come from virtually every kind of source. Myers characterized the number of leasing companies that have entered the market as “phenomenal,” resulting in an environment where, for Boeing, 40 percent of its airplane placement funding comes from lessors. According to Airbus COO for customers John Leahy, lessors account for some 50 percent of all the funding for the European company’s airplanes.

For Boeing, bank debt accounts for some 34 percent of its placements—from sources around the globe–while direct cash purchases amount to about 26 percent of its sales. “The one thing that we’ve seen with commercial aircraft bank debt is it’s coming from everywhere, whether its the European banks that were strong; the U.S. banks are playing; Australia is kicking in; the Middle East banks are participating; you’ve got banks certainly in Asia,” said Myers. “But it’s competitive. You’ll probably hear some rumblings about how competitive it is. Some people are coming off new aircraft and going down into the second tier airlines and looking at used aircraft just to chase yields.”

Capital Markets Kick In

Meanwhile, capital market funding from instruments such as Enhanced Equipment Trust Certificates (EETCs) account for another 31 percent of the marketplace, and export credit agencies typically back another 9 percent.

Embraer director of customer finance Marcelo Santiago noted his company saw six EETC placements for E-Jets in the last three years, a clear indicator of the confidence financiers have shown in the marketability of that narrowbody line in particular.

There’s a lot of liquidity out there,” said Santiago. “I would say that all the sources are very open to the customers nowadays. Capital markets are very strong in the U.S., we have commercial debt from banks, lessors and the [Brazilian export credit agency, BNDES.]”

Deliveries for Embraer this year will involve roughly one third lessors, one third commercial banks and a third BNDES, he added, giving Embraer a healthy balance of financing sources.

I would say that Embraer is in a different position in the regional aviation segment because the E-Jets from an asset standpoint is considered by the financial markets as a narrowbody aircraft,” noted Santiago. “So we don’t face the historical constraints that the regional aircraft have from the financing segment. The regional segment was heavily dependent on ECA financing, which is not our case.”

While regional airlines generally continue to consider ECA financing “more efficient” or, in a word, cheaper to access than private markets, this year Embraer expects that BNDES financing will account for only about 25 percent of its deliveries.

Although Santiago said he hasn’t seen any chilling effect resulting from the protectionist rhetoric of U.S. president Donald Trump, the company has seen more hesitation to support a negotiated sale to Iran on the part of the financiers, he reported. “With Iran, since Trump, we are facing some challenges in moving forward, to move quickly with the discussions because a lot of the banks and lessors we are talking with want better visibility of what is going to happen,” said Santiago.

Overall, however, the Embraer finance executive said the regulatory reforms Trump has proposed could actually bring more liquidity to the market. “But when you have a lot of liquidity you can have a big problem later on,” he added. “We saw what happened in 2008.”

Santiago also sees a potential for higher interest rates, and thereby a trend toward more leasing deals. “Lessors can access capital more efficiently than the airlines, which can help them because now they face a lot of competition with EETCs and bank debt and other sources,” he noted. “So I think the interest rate is a key factor in what might happen. It can change a little bit the dynamics of the financing source not only for regional aviation but everybody.”

Happily for Boeing, the strength of capital markets and bank funding softened the blow of the government’s failure to renew the charter of the U.S. ExIm bank, and by mid-April Trump had named two nominees to serve on the board of directors, thereby restoring the quorum the board lacked, preventing it from approving transactions larger than $10 million. Meanwhile, Airbus continues to suffer an interruption of export credit agency funding while it works to address “irregularities” involving third-party consultants.

Export financing accounts for much of the success of the aerospace industry in general, particularly during lean times, said Myers. During the financial crisis of 2008-2009, export financing accounting for 30 percent of Boeing’s deliveries. In fact, Airbus never once dropped production rates—they increased during that time—even while the financial markets had become nearly frozen. Without ECA financing, the company undoubtedly would have faced the expensive proposition of dropping rates substantially.

Meanwhile, Boeing, through its participation in the Aviation Working Group, spends a lot of time and effort fostering an environment that encourages financiers to take the risks associated with backing commercial aircraft sales. Myers cited the Cape Town Convention as one of the important elements of ensuring such a healthy environment. In the event of bankruptcy, airlines registered in a country that has ratified the convention must ensure their airplanes either go back to their owners or they must renegotiate their contracts with lessors or banks within, typically, 60 to 90 days.

We’ve found that by having Cape Town ratified in different countries and then adopted by the [Organization for Economic Cooperation and Development (OECD)]…creates more access to the financial markets for the airlines that reside in those countries,” said Myers. “Boeing has been pushing that kind of initiative with the Aviation Working Group (co-chaired by Boeing and Airbus comprised of airframe and engine OEMs, banks and leasing companies).”

Sixty-five countries have so far ratified the Cape Town Convention, but Myers would like to see more. “We’re looking to see more of the Europeans really move. The UK ratified Cape Town and we were hoping to see that kind of be where Europe would really start taking off…Now most European countries have fairly sophisticated bankruptcy laws already, but still I think Cape Town would make it easier for those countries to do the kind of financing…especially if they were trying to do international EETCs and things like that.”

Myers also stressed the importance of the ability to freely and quickly transfer airplanes across borders in the event of lease expirations, for example. “So we’re trying to work with [ICAO] and the various civil aviation authorities around the globe to try to create some kind of a standardized cross-border transfer for airplanes,” he noted. “This is a very sensitive topic because it involves safety standards, other issues with different countries, but the entire industry will benefit from having these standards in place and the ability to move aircraft freely because it adds to the mobility of the asset.”

Of course, ease of mobility lessens risk for investors and, therefore, the longevity of the asset and its residual value. Under the status quo, however, it takes too much time and expense to transfer airplanes in Myers’s estimation. “There are ways we think that we can work together with the right aviation authorities to bring them together…because it will basically lower the cost of financing for everybody, if we can make that happen.”