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MARKET OUTLOOK: The impact of bubbles on aircraft finance

There is a general view to divide economic events into those which are cyclical and those which are structural. There is increasing evidence from across the world that the traditional economic or business cycle is broken; although it is only possible to identify the duration of the cycle retrospectively. This leads to another view and, in particular, whether or not what we are seeing in some parts of the world, particularly outside Asia - although Asia is also affected by events elsewhere - is a series of "bubbles".

Economic and industry bubbles are nothing new and the first evidence of the phenomena is from the 18th century, with the South Sea bubble which lasted nine years.

From a transport perspective there was the railway bubble in the UK, which lasted from the late 1830s to 1846, and from a combined technology and stock market perspective the dotcom bubble, which lasted from 1995 until 2000.

There are many others but in each case the key event has been the availability of liquidity. In hindsight it is possible to argue that the response of governments and central banks to the financial crisis has resulted in what was an economic bubble in 2010 and 2011, where the underlying issues remain unresolved.

What then of the relevance of this to the airline and wider aviation industry? We touched on the consequences of the economic outlook in last month's edition of Airline Business and since then we have seen a number of additional profit warnings from airlines. It is however the issue of the availability of finance against the background of what for some time has appeared to be a supply bubble for single-aisle aircraft which is, or should be, a key issue for concern at the moment.

About 25 years ago, a simple measure to determine whether the airline industry had over- or under-ordered new equipment was to take growth, replacement and the effects of larger aircraft and improved load factors together. If orders were more than 6-7% of the fleet, then this acted as a warning sign. In 2011, based on an installed fleet of 11,700 single-aisles, new net orders for the Airbus A320 and Boeing 737 were equivalent to some 16% of the fleet. Since 2005 - apart from 2009 - the ratio has been greater than 6% and for four of the seven years the ratio has exceeded 15%. Even allowing for time lags between orders and deliveries, this seems more like a bubble than a normal cyclical pattern.

While there are few concerns over the long-term growth potential the airline industry offers, it has seemed for some time that a number of things have got out of synch. This is a situation exacerbated by the changes that have already occurred in the aircraft-financing markets, and here we are perhaps only seeing the tip of the iceberg.


Finding money for pre-delivery payments is a particular challenge at the moment, let alone affordable finance for the aircraft itself when delivery is due. Given the cash-generation pressures for many airlines, this position is unlikely to ease. This is despite new providers of finance entering, or considering entering, the market as they seek long-term assets that will produce reasonable returns through transparent structures.

If further evidence was required of the concerns over stock market and related investments you don’t have to look too much further than the losses announced by JP Morgan from its trades in derivatives or what most observers have considered to be the debacle surrounding the Facebook IPO and the pulling of other planned IPOs. One phrase that is clearly heard now is the "flight to safety" or "flight to quality" by investors. A further indication is the sharp fall in trading volumes in many stock markets, with some Asian markets seeing a 20% fall compared with last year.

However, the new finance will not be provided on what is a "one-for-one" replacement basis. Given rising production rates - not just for narrowbodies but for widebodies too - the requirement for financing continues to increase. The inevitability is that the gap, which is already significant, will increase further.

The converse of this is that those who have money and the desire to invest in aircraft will be selective. Indeed, those for whom this is a new area will be cautious and have very clear risk and return requirements. In this respect it is reasonable to conclude that widebody aircraft with stronger airlines will be more appealing.

What then of the outlook for narrowbodies generally and for those considered to be weaker airlines? Inevitably, a challenge for those directly involved.

Returning to where we started, given that what we are seeing is a "single aisle" bubble, it suggests values also have to fall back too. However, it may not be doom and gloom for all, as any period of adjustment also provides opportunities which arise by accident or design. Not surprisingly, this situation was highlighted by Michael O'Leary when he announced Ryanair's recent fiscal-year results. Any moving market provides opportunities - and this one is no different.

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