At the recent series of air finance industry briefings and conferences in Hong Kong, there appeared to be growing consensus that the global aviation industry cycle has peaked and is on its way down – albeit one that should be manageable.
At a recent industry briefing Hong Kong, Flight Ascend Consultancy’s head of consultancy Rob Morris opened the conference noting that global traffic growth is slowing, aircraft values and lease rates are compressing, whilst air cargo remains structurally broken. Its traffic-light scorecard showed much more amber indicators than the greens of the last few years.
“The aviation demand cycle does remain strong, but trends suggest we may be close to the peak, and the more I think about this, the more I think we are just past the peak,” he said.
Morris added that with passenger traffic due to end the year at between 5-6%, it appears to be the start of a “slow settling” that will take growth over the next year below-trend.
That is also the opinion of IATA, which has called the second quarter of the year as the peak in the airline profits cycle.
A number of carriers have reported slipping load factors, with demand failing to keep with recent capacity increases. That has led many airlines to start discounting, driving up competition and compressing unit revenues. That has not yet had an impact on profits thanks to the lower cost of oil, but if left unchecked will start to be felt from next year.
Nonetheless, most carriers appear to be well positioned to remove incremental capacity, particularly the major legacy airlines. Those that have retained their older aircraft, either on lower-rate leases or fully amortised, are able to simply put them out to pasture or return them to lessors. And even if oil prices start to tighten further, the newer types on-order and available will act as a natural hedge.
That is not to downplay that the pockets of concern. Turkey, Russia and South America all remain challenging, with carriers there still reeling from political and economic issues that have no end in sight.
But as for a large, global-scale issue that could lead to a major spike in aircraft being parked, only a major shock could force carriers to ground entire fleets.
RATE RECKONING
More pressing for investors and lessors is the almost certain prospect that US interest rates will start to rise again in the near-term.
But, for most in the industry, that is no surprise. The greater surprise is how long it has taken.
Nearly two years ago most lessors were bracing for funding costs to go up, but the Fed’s dovish stance appeared to extend the holiday for many. Even without export credit agency (ECA) funding and some banks being forced to tighten their lending criteria, the capital markets have been willing to provide buckets of liquidity for things with wings.
In any case, most sophisticated lessors and investors have already positioned for the inevitable rate rise. Many have used the opportunity to lock-in attractive fixed-rate debt from the capital markets, while others have balanced their exposures by tying their floating-rate leases to variable interest rates, and vice versa.
Those that have not positioned themselves may well be caught out if their funding costs rise dramatically, and even more so if lease rates start to compress further.
It will then be up to asset managers to work hard – both to manage the assets through the down-cycle, and to reassure new investors that all is fine, even if returns start to compress. The last thing any investor in this industry wants to see is a fire-sales of aircraft as investor look to exit the industry.
The wider concern will be over which sources of funding will still be available if higher rates see the deep pool of the capital markets start to dry up. The looming Basel IV regulations could severely limit bank financing for aircraft, and the lack of export credit funding, concerning for some, even though the industry has survived much of 2016 without access to guarantees.
As its prerogative, the market is dealing with that particular disruption. UK Export Finance has indicated a willingness to lend for Boeing aircraft with Rolls-Royce engines, while Boeing and Airbus themselves are likely to step in an finance some aircraft if required. And, all being well, Ex-Im should have its all-important board quorum by the end of the year, which would allow it to start functioning on aircraft financing again. And the sooner that bribery investigations in the UK and Europe are finished, the sooner those ECAs can start lending again.
SOFT LANDING
As always, it is not the size of a downturn that causes the most dislocation, but the speed at which it happens. To that, there appears to be little consensus, and much will depend on political outcomes such as Brexit and 'Trump-it.'
Nonetheless, all signs point to an industry that is well positioned for a downturn. Airlines have levers available on capacity, while lessors and investors should be prepared to weather the storms that have long been a part of this industry. Barring any major upsets, it should be a comfortable downturn for all.
Source: Cirium Dashboard
