Airlines that had hoped the close of summer would present a clear picture of the state of the financial markets will be hugely disappointed by the even deeper sense of global uncertainty and market volatility now prevailing.

Financial markets were sent into a tailspin in August by China's stock-market rout and its surprise devaluation of the yuan against the US dollar.

Also, reduced Chinese demand for commodities has devastated commodity-exporting countries, many of which are emerging markets, such as Brazil, and their currencies. EPFR Global, a data provider, estimates that investors have yanked $44 billion out of emerging-market equities and bonds since mid-July.

Unfortunately, for many airlines, this turbulence has coincided with a very strong greenback.

The only certainty, it seems, is that the sharp rise in the US dollar during the past several months does not look set to reverse anytime soon.

While most aviation financiers have shrugged off these market jitters in the name of benign interest rates and fuel prices and a likely lifting of sanctions in Iran, there is no denying that a strong US dollar is a headache for many.

Not only does a strong dollar make operating costs swell for airlines that generate revenue in a different currency, such as the euro, but also, it could force such airlines to pay more to their lenders.

A French banker indicates European banks "may suffer a slight increase in their liquidity costs in US dollars" as a general consequence of the current market situation.


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If prolonged, this situation could affect the cost of borrowing for airlines and lessors, he says.

"Banks may have to reduce their net margins, after the deduction of the liquidity cost, in order to remain in the race in a competitive market where you have also non-European banks that may be less affected by the dollar liquidity issue," he says. "If the liquidity cost in US dollars keeps increasing, banks will have to translate part of this into their future quotes."

However, despite global market turmoil, China's investor appetite for aviation remains firmly intact, argues DVB Bank board member Bertrand Grabowski.

"The domestic market will continue to grow and China's orderbook is well dimensioned for the embedded and somewhat reasonable growth expected," he says.

The economic situation does not surprise him. "China clearly entered a bubble phase a few years ago, based on cheap liquidity and investment mainly in real estate and the stock market. Modest growth in overseas client markets was not helpful in providing sufficient growth for an export-led economy such as China."

He adds: "Those main financial institutions involved in leasing are all directly, or indirectly, controlled by the state... Even if those banks have all underestimated the amount of bad loans, a financial meltdown excluded, China will always support the weakest [state-controlled institutions].

"Will we see less aggressiveness in China's buying of [aircraft] portfolios or businesses in aviation? I don't think so – most of the recent buyers have had an incentive to diversify their investment abroad, and that will continue."

This thinking chimes with Shenzen-listed Bohai Leasing's recent takeover of Avolon in a move that values the Irish lessor at $7.6 billion.

At $31 per share, the deal represents a 3% cut to the previous offer on 10 August, reflecting recent volatility across the global equity markets.

The offer equates to 1.7 times Avolon's book value and allows Bohai to diversify out of the yuan and into highly coveted US dollar cash flows.

It also allows Bohai to merge Hong Kong Aviation Capital, its existing leasing entity, with Avolon to create a larger global leasing force, should it choose to.

However, to further settle Avolon's nerves during a time of rollercoaster financial markets, which does not look set to ease anytime soon, Bohai agreed to increase its deposit by $100 million to $350 million, which will remain with Avolon should the deal collapse.

Source: Airline Business