Funding the future

The predictions for the demand for new aircraft over the next 20 years is almost staggering. Even the most conservative forecasters estimate demand at more than 40,000 new aircraft. This will see the global aircraft fleet double to more than 50,000, as a significant proportion of the new aircraft will be replacement aircraft for those which have been retired from fleets.

"It is estimated that demand for new aircraft will reach $4 trillion over that period," says KPMG partner Tom Woods. "And this will run at between $140 billion and $170 billion annually." Indeed, some estimates forecast annual spending to reach more than $200 billion over the next 10 years.

The funding to finance that spending will come from a variety of different sources. "Aircraft represent quite an attractive asset class," says Deloitte partner Brian O'Callaghan. "Airlines and lessors are able to fund purchases through securitisations and bank borrowings. Many of the major airlines are also quite cash rich and are able to fund new aircraft purchases in cash."

At present, the main sources of finance for new aircraft are leasing companies, banks, export credit agencies, aircraft manufacturers, airlines, and the capital markets. The choice and availability of the various types depends on the airline in question. For example, leasing may be the only option open to a recently established airline or some of the smaller, low-cost carriers.

On the other hand, the major airlines with long track records and strong credit ratings have access to a range of cheaper financing options, include loans from the commercial banks or the capital markets. They may use short-term leases for a portion of their fleets in order to give them the flexibility to increase or decrease their fleet size in response to changing market demand.

Export credit agencies (ECAs) play a significant role in the funding market. These agencies support exporters by offering credit to their customers, either at better terms than may not be otherwise available or when it is not available at all because the risk is deemed to be too high. During the worst of the financial crisis, about 20 per cent of all aircraft purchases around the world were funded by ECAs. This has now halved to about 10 per cent but it is still expected to play an important role in the market in the coming years.

A major feature of the market in recent years has been the re-entry of the commercial banks. Indeed, their rise has been in direct proportion to the ECAs’ fall. They now account for more than a quarter of all purchases directly and about half of them overall when their loans to lessors and other funders are taken into account.

Capital markets

Most commentators believe the capital markets will play an increasingly important role over the next decade or so as funding requirements intensify. One of the main ways of accessing the capital markets is for aircraft lessors to create asset-backed securities. This sees aircraft leases being bundled into a product which is then sold on to investors. These products allow the lessors to refinance borrowings in order to use that credit for further purchases and can be very attractive to investors, particularly if the aircraft are relatively new and the airline customers have good credit ratings. They can be further enhanced by the addition of a guarantee facility, which makes them attractive to deep-pocketed institutional investors such as pension funds.

Private equity is also growing in significance. These funds can either invest in aviation asset-backed securities or directly in aircraft and are attracted by the relatively high returns on offer.

There are other options for airlines wishing to fund aircraft purchases and these include enhanced equipment trust certificates (EETCs). These instruments are seen by many as the next generation of debt-financing for airlines.

In essence, they are corporate debt securities which are issued by airlines and secured on aircraft in its fleet. The enhancement comes in the form of elements such as debt-tranching, availability of liquidity facilities and what is known as over-collateralisation.

The key advantage of EETCs to airlines is the fact they offer a lower cost of finance than traditional bank borrowings or leasing. The attraction for investors is the same as with other asset-backed securities.

At present, EETCs are mainly used in the US due to certain tax considerations there. In addition, US bankruptcy rules make it quite easy to recover assets on which debts are secured and this adds to the attractiveness of EETCs for investors.

However, interest in EETCs outside of the US is increasing as the capital markets become more interested in the aviation sector due to its strong fundamentals, including increased global passenger traffic, a growing world economy, and the emergence of high-spending middle classes in key markets such as India and China.