There are fears that higher interest rates may drive new investors, such as pension funds, away from aviation. However, even in a worst-case scenario of insurers and pension funds losing all interest in aviation, there is unlikely to be a funding gap, since aviation finance attracts an array of willing investors.
Rather, it is lower lease rates – partly a function of the abundance of liquidity in the market – that should be heeded by those running and investing in lessors.
Over the past 18 months or so, institutional investors such as insurers and pension funds have been ramping up their investment presence in aviation as part of a wider hunt for yield amid low interest rates.
Albeit that Basel IV looks like it will further restrict banks' ability to be providers of debt, many bankers saw a future where they could arrange loans on behalf of institutional investors, thus still earning fees for their employers. There have been also a number of funds and vehicles set up to tap these sources of capital.
However, the conditions that have attracted institutional investors to aviation look likely to change imminently.
The US Federal Reserve is widely expected to hike interest rates next week – for the first time this year, and only the second time since 2009.
Federal Reserve Bank of Chicago's president Charles Evans was quoted by Reuters on 5 December as saying: "We are on the cusp of a period of rising interest rates."
If and when rates rise enough, insurers and pension funds are likely to switch their attentions back to their traditional investment targets such as government bonds.
Fundamentally, if a blue-chip government or corporate bond is offering the required yield, an insurer – with its complicated asset-liability management – is unlikely to plump for the relatively riskier investment of an aircraft.
The worst-case scenario is that higher interest rates will mean that all the institutional money disappears. However, insurers and pension funds may retain a presence in aviation in order to diversify their investments.
Whatever the outcome, a consensus among aviation finance sources is that there is an abundance of liquidity in the marketplace chasing deals.
"The fact is that the total need for aircraft financing is many times oversubscribed," says Steven Gaal, managing director at SkyWorks Capital. "Some investors are finding it hard to get their foot in the door. This seems to be part of a trend towards a commoditisation of the aircraft financing market.
"What I mean by that is that there are far more investors who want the core assets. For example, a 737-8 Max has many more investors willing to look at it than the 737-9 Max. But when you have so many looking to finance the core, it is easy to find the liquidity that wants the assets that are, relatively speaking, on the demand fringe.
"Therefore, even if the interest-rate environment does change, and rates are hiked, then there is still a well of liquidity out there that will replace those who perhaps go back to their more traditional investments."
However, this abundance of liquidity is far from ideal for lessors, sources in the sector tell FlightGlobal.
The argument is that a tsunami of cash is pressuring deals downwards from the leasing perspective, with lease-rate factors being squeezed by competition from within and outside leasing.
One leasing source compares this to the pinch airlines feel when their yields are hit in a similar fashion, noting that both result from competition and excesses in the marketplace, in this case the sheer number of lessors plus a lot of investors looking to throw money at aircraft.
Ultimately, the source adds, this means profits will suffer.
Whether or not higher interest rates drive institutional money away from aviation is not the crucial issue. How lessors cope with lower lease rates is. One response would be to demand cheaper aircraft from Airbus and Boeing.
Another may be more consolidation among lessors.
Source: Cirium Dashboard
