ANALYSIS: Aviation financing: l’histoire se répète?

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London
Source: Flightglobal.com
This story is sourced from Flightglobal.com

As the major aircraft manufacturers will point out, the swelling wave of new aircraft coming off their assembly lines will be easily financed by a combination of innovative capital market structures, rapidly expanding leasing companies, a little help from the export credit agencies and, last but not least, a new generation of aerospace banks from emerging countries in Asia and the Middle East.

And according to one manufacturer, the Chinese banks will save the aviation world.

Against this background, it is interesting to look back at the rise and fall of aerospace banks during the past decades.

A global wave that started in North America, later moved to Europe, then Japan and now it has spread to the rest of Asia and the Middle East. While this is not the place for a deeply researched history of the global air finance market, it may be relevant for some of the new players to look back at history and, maybe, learn some lessons.

Way back in the 1980 and early 1990, when I started in the air finance business, working for a small Dutch bank, the finance landscape looked a lot different compared with today. Operational leasing was a relatively uncommon way of financing aircraft and powerhouse airlines like Swissair wanted to have nothing to do with this type of funding.

At an early air finance conference in the New York, Swissair's treasurer actually mentioned something like "leasing is not for us - we just pay cash for our new aircraft". Looking at some old and rather yellowed tombstones, the banks that dominated the air finance market were typically from North America, including names like Citibank, Security Pacific, Chase, Bank of New York, Manufacturers Hannover (Manny Hanny), CIT, Greyhound and Lehman Brothers. There were a few British banks as well, such as Chemical Bank and Barclays.

Riding the wave of upcoming European manufacturer Airbus, the French banks did not stay far behind and, maybe after a few stimulating words from the Elysee, Credit Lyonnais became a rising star, rapidly followed by BNP Paribas and a little later Banque Indosuez.

Remarkably enough, there were a few "brave" Scandinavian, Dutch and Belgian banks active, in particular in the niche market for used and often more difficult aircraft. These included Den Norske, Christiania, NIB, NMB (now ING), Svenska, BBL and - probably the most respected name - PK Airfinance, which is now part of the General Electric empire.

Asian Banks were generally absent, except for a few Japanese players, including Hokkaido Takushoku and Takugin. There were a few "Asian" structures around, including one for Japanese investors, originally established under Japanese legislation to create a little more equilibrium in the Japanese balance of trade; the short-lived Samurai lease, succeeded by the Shogun lease and, later, the somewhat different tax-driven Japanese leveraged Lease.

Although many banks claimed they were doing asset-based financing, very few of them actually were. Most banks, and in particular their credit committees, were more comfortable with credit risks than asset risks, despite the impressive evidence in the 1980s that aircraft values could only go up.

In the days of high inflation, a well-known North American aircraft manufacturer actually handed out booklets containing charts that demonstrated that none of the narrowbody twin jets sold in the used equipment market went for anything less than the original purchase price.

Lessors were equally optimistic. One UK lessor actually maintained that there was no need to depreciate an aircraft.

Some of the leading appraisal firms were recommending a 3.5% annual inflation percentage to calculate future aircraft values. Most of the more junior bankers, in those days, had no doubt about the most optimistic scenarios, probably because they wanted to believe.

Doing aircraft deals was sexy and involved travelling around the globe - something very special in those days. The amounts involved were gigantic and it was easy to impress friends and family by saying "I am in the aircraft finance business" rather than "I work for a bank".

Probably the US banks were the first to discover that there were some more risks involved than met the eye, as they focused more and more on fee generating business that minimized balance sheet use. They found a group of enthusiastic European banks, eager to expand their balance sheets. Often the air finance units were among the first truly internationally operating departments, apart from the far less sexy shipping units.

The typical pattern that emerged in the banks was one of increasing confidence. Initially, transactions were limited to conservative deals for strong counterparties. Unfortunately, this is what all banks preferred to do and, gradually, terms were relaxed and credit quality went down in an attempt to maintain somewhat juicy margins.

With growing self-confidence, the banks believed they actually "understood" the asset and, in the case of a default, would have no problem selling the plane to another airline. Very few banks actually were prepared to really invest in in-house capabilities to deal with any emergency.

PK and CIT were probably among the more sophisticated players. But the outcome of this euphoria was predictable.

Energy crises, terrorism, wars and more stringent noise regulations killed a few of even the best known airlines and, consequently, undermined the values of the assets.

The result: significant losses, long and complex repossession and remarketing processes and, in many cases, winding down of the air finance activities. Obviously, after rain comes sunshine, and a new group of banks emerged to take advantage of the many opportunities in the still sexy air finance business.

In the 1990s and early part of this century, the French and German banks were the global market leaders. To cut a well-known story short, the sub-prime crisis came, caused a domino effect and a global economic crisis hit the Western world. For reasons, often outside of the aviation business, banks, and in some case politicians, decided to refocus on domestic businesses to minimise their international air finance activities. Only thanks to the export credit agencies a funding gap could be avoided; well, for new aircraft that is.

So here we are, in 2012, and it looks very much like we are seeing the wheels of history starting to turn for another round. This time the young, enthusiastic air finance bankers are supposed to be coming from Asia, in particular China. But they have not saved the world yet.

And as for the off-shore businesses, at least so far, in many cases, they are driven by political motivations, highly dependent on global management of liquidity for their own country.

According to the manufacturers, this will change and these financiers will become global players.

The big question is: Will they be able to maintain more discipline compared with their predecessors? Or, will they fall for the temptations of international travel and the glory of the big-ticket deals, while ignoring the many risks in this business?

Undoubtedly, encouraged by the manufacturers, confidence in current aircraft values seems to be high (some almost seem to benchmark against manufacturer's list prices). In addition, appraisers' concepts of future base-values (now inflated "only" by 1.5 - 2%) are not always well understood, despite page-long definitions of values.

Judging by the terms offered by some of the emerging banks for recent transactions for newish, but mature technology aircraft and for "promising" airlines, it unfortunately looks like l'histoire se répète.

Why accept such relatively high risk structures, especially during a time of when thousands of new airplanes are in backlog?

Maybe, as every father or mother knows, youngsters always will be looking to see how far they can push the limits. It is probably just a matter of time before we will see the new banks offering close to, or over, 100% loan-to-values on new, but mature technology aircraft at margins we don't even want to think about.

However, there is always the possibility that things will be different this time around. Maybe bankers can learn from their mistakes. If the "me too" attitude and individual greed can be avoided, maybe the new generation of air finance bankers will do better than their predecessors.

But as every upside has a downside, bankers behaving in a rational way would take a lot of the fun away for those with a view from the City.

Article contributed by Bert van Leeuwen, managing director, aviation research DVB Bank