Over the course of last year, there prevailed a feeling that aircraft values and traffic cycles had plateaued, amid uncomfortable disbelief that the upward trend could continue.
"People are mindful of the so-called black swans in the market, but so far they have not appeared in such a radical manner," says Doric's global head of structuring and financing Sibylle Paehler. "The economy is strong worldwide and unemployment is low, as are interest rates. Really, it seems as if the market has plateaued rather than taken a dip."
However, potential downside issues remain – especially the continuation of compressed aircraft lease rates and values, driven in part by the abundance of liquidity in air finance.
ALTERNATIVE INVESTORS HESITATE
Attracting new investors to the asset class remains a target for many in the industry.
In 2016, the arrival of new investors was widely heralded, but in 2017 alternative finance sources did not deploy their capital at the pace expected.
"In terms of new money, there has been interest in the sector of late from pockets of real-estate investors," says SkyWork's managing director Steve Gaal. "However, we haven't seen too much yet in the way of actual capital deployment. Aircraft are still largely seen as an exotic asset class, which makes it difficult for these investors to compete with established funding sources in today's kind of environment."
Doric's Paehler agrees, observing that 2017 was a year in which alternative investors decided to monitor the market.
"While the flow of alternative investment into aviation has been apparent... it is fair to say that they have been monitoring the market more [in 2017] as they seek to understand it better. Particularly the ABS market is being monitored as these investors want to truly understand how these deals are valued," she says.
"They still like aviation; it is just really a process of them developing their own risk and valuation models, and that entails this period of monitoring. The reason they need to do this is that aircraft deals are complex. It's not just about understanding the jet itself, but being able to understand how the lease-rate factors, the maintenance reserves, the return conditions all affect a deal's viability. There's a lot to understand and become comfortable with for these new investors."
Notably, though, some companies have managed to secure equity investment from new players.
"At TrueNoord, we have managed to secure a number of institutional investors [in 2017], including BlackRock, which shows that regional aircraft leasing is seen as a good investment by some of the biggest names in finance today," says the regional aircraft lessor's chief executive Anne-Bart Tieleman.
Away from new lenders, the traditional mainstay lenders of aviation finance – commercial banks – found 2017 difficult and yet abundant with new opportunity.
One senior banker complains that there was too much liquidity in the market, remarking that in some cases "proposed structures for lessors are too aggressive in terms of their loan-to-value, amortisation, and high non-recourse debt balloon features".
However, banks have also found demand for US Reg 144A private placements.
"This is a way for the lessor to diversify its funding beyond the traditional bank market and the unsecured public bond market. Private placement size usually do not exceed $300 million to $400 million," the same banker says.
CAPACITY CRISIS AVERTED
Airlines have had, on the face of it, a pleasant operating environment over the last few years. Low oil prices have allowed airlines on the whole to post strong profits, with trade body IATA expecting airline net profits to rise from a forecast $34.5 billion in 2017 to $38.5 billion in 2018.
Despite this favourable backdrop, a number of high-profile airlines in Europe slid into administration in 2017. Air Berlin and Monarch Airlines were casualties, while Alitalia continues to hunt new investment.
The main question the finance and leasing community were keen to understand was how easily the aircraft operated and leased by these airlines could be remarketed.
In the cases of Air Berlin and Monarch, the jets have been absorbed by the market pretty seamlessly.
"What was very visible [in these situations] is that airlines were operating routes that were in demand, especially in Germany, as ticket prices went up. The aircraft themselves are necessary. However, the business models of those airlines were not fit for purpose," says Doric's Paehler.
The potential sale of Alitalia has been postponed until 30 April, so it remains to be seen whether or not demand for any aircraft the Italian flag carrier sheds as part of its transformation will match that of the Monarch and Air Berlin jets.
MARGINS TIGHTEN IN LEASING
Cheap cost of funds and lower return hurdles have forced down lease-rate factors in the sale-and-leaseback market. Smaller, more aggressive lessors, including Chinese entrants with lower capital costs, have posed problems for rivals by buying aircraft at higher-than-market rates and then offering low lease rates, FlightGlobal understands.
Fitch Ratings has warned that Chinese lessors' access to cheap funding and willingness to offer low pricing on leases could put pressure on the margins of established lessors, possibly impacting their credit ratings.
"A key risk to look out for in 2018 is rising competition, particularly in China, which could place pressure on industry lease yields," says Fitch senior director for financial institutions Sean Pattap.
Some inexperienced lessors are said to have offered lease contracts that have lacked industry standard covenants, such as maintenance reserves.
Before rejoining CIT, Jennifer Villa Tennity – who had served as chief risk officer of the bank's leasing arm – told FlightGlobal that problems could arise from the flouting of lease standards.
"The softening of return conditions leave millions of dollars per asset essentially exposed," she said. "This will become brutally clear in a default, but also even in a scheduled return where you are taking back an aircraft that will need a lot of money invested in order to bridge to the next operator."
New capital's resolve to weather any downside events related to its aircraft investments has yet to be truly tested.
One effect of this cheap money, though, has been to make the returns offered in the sale-and-leaseback market unappealing to more established lessors.
While the influx of cheap capital has raised heckles in some quarters, others highlight the diversity of investors' risk profiles.
"Now there has been some criticism of Chinese capital driving down rates, but really it is all a matter of what your expectations are," says Doric's Paehler. "If you are happy with 2%, then that is what you go for. Really it is just the American investors who expect 15% as they have a different risk profile. There is a market for both now."
UNLOVED ASSETS STRUGGLE
A number of assets came under scrutiny in 2017, including the Boeing 777.
"Values for the 777-200ER have continued to steadily decline at a rate steeper than normal depreciation. The failure of VIM-Avia has put aircraft back onto the market, some of which had only been placed a few months prior," says Flight Ascend Consultancy's head of valuations George Dimitroff.
"Between January and December we have seen drops of 17-18% to 777-200ER values for our Pratt & Whitney-powered base model, but the Rolls-Royce-powered examples have seen greater drops, of 30% or more in some cases. This is because of weaker underlying engine values in a part-out scenario and also because coincidentally the majority of aircraft available have been Rolls-Royce-powered," he adds.
Skywork's Gaal sees this as part of a trend where airlines favour smaller widebodies.
"The pressure on 777 values is a further indication that there is a continuing pivot towards smaller widebodies. These aircraft are optimised for more airlines with their reduced capital and operating costs. For the typical airline, the thing you are sacrificing is the seats in the back at the bottom end of the yield curve," he says.
The A380 is another jet that certainly seems too large for most airlines, and with the first ones starting to come off lease, the viability of the secondary market for Airbus's flagship widebody remains a delicate subject.
While Hajj carriers and even charter operators like Hi Fly have been mentioned as possible second homes for Singapore Airlines-operated A380s, the fact is that the first one was returned and remains in storage while its owner Dr Peters tries to find a buyer or another solution, such as part-out.
As the A380's future remains unknown, Bombardier's CSeries programme got a boost from a tie-up with Airbus.
The surprise announcement that Airbus and Bombardier would join forces on the Canadian manufacturer's small narrowbody programme, with Airbus providing hefty sales and marketing support as part of the deal, could add momentum to what had been considered a flagging programme.
TrueNoord's chief Tieleman, however, adopts the wait-and-see stance many are still taking with the CSeries.
"I think the Bombardier and Airbus deal covering the CSeries is a positive move due to the marketing and sales impetus that Airbus can lend to the project. The deal still needs to go through, however, so we will have to see; but if the programme gains traction [in 2018] thanks to this tie-in, then it would potentially be an asset that interests us," he says.
BLACK SWANS OR BLACK CHICKENS?
At the end of 2016, a number of macro and micro downside factors looked to be reaching a critical mass, creating a slightly fearful mood. These included micro factors such as operating yields, as well as the political climate gaining a nationalist bent, for example from Donald Trump's surprise US presidential election victory and the UK's Brexit vote. These events were seen to threaten globalisation – and therefore aviation – in the coming years.
And while these dynamics remain latent, any imminent or catastrophic impact seems to be have been averted in the aviation industry.
However, Avitas's senior vice-president Adam Pilarski warned delegates at the ISTAT EMEA conference in Edinburgh in late September 2017 that aviation was in the midst of a bubble that might very well burst soon.
"We are in the mother of all cycles," he said. "Twelve years is just the upside so far."
Previous cycles lasted as long as 11 years, including the trough, said Pilarski, citing Avitas data.
He listed what he called "black chickens" – known factors that could affect aviation finance in the future, including an interest-rate hike, the abundance of widebody orders by Middle Eastern airlines, and a global recession.
Skywork's Gaal identifies another potential downside: changing airline behaviour.
"There's the question over airlines now starting to act like lessors. Norwegian has their leasing arm, as does AirAsia, and of course you have to think Indigo may look to use some of their massive order in such a way. How this affects supply of aircraft in a downturn is still an unknown in the market," he says.
While threats do continue to linger, global GDP growth shows no sign of abating. If airline profits rise to $38.5 billion in 2018 as IATA predicts, the industry may be celebrating another year of expansion and success in 12 months' time.
Source: Cirium Dashboard
