Jetrader - May/June 2010 - 16

The State of Aviation Finance
Bright fundamentals once the fog of economic uncertainty lifts
By Steven T. Gaal, President & COO, SkyWorks Holdings LLC

The global ﬁnancial system has navigated uncharted waters since the ﬁnancial crisis fully took hold in 2007. At the core was a loss of investor conﬁdence over the intrinsic value of a broad array of ﬁnancial assets. Conﬁdence was undermined in signiﬁcant part by the recursive relationship that had developed between (rising) asset prices and the real economy. In particular, rising asset prices accounted for ever-increasing growth in consumer spending, which in turn drove further increases in asset prices, and so on until the music stopped. This feedback loop of ever-rising asset prices was induced, directly and indirectly, by a variety of factors. The mass-popularization of phenomena such as online trading accounts and aggressive consumer lending products directly fostered a climate of speculative activity in the ﬁnancial and real estate markets. Indirectly, the current generation’s lack of ﬁrst-hand experience of suffering through a signiﬁcant and extended economic downturn fostered an appetite for excessive risk-taking. Against the backdrop of a broadly troubled ﬁnancial system the aviation ﬁnance sector has remained a virtual safe haven. This contrast is perhaps best seen by comparing the relative strength of the commercial aircraft operating leasing sector to the ﬁnancial extremis experienced by many of the ﬁnancial institutions that own such leasing companies. Similarly, though public data is only partially available, it would appear that loans secured by commercial aircraft have performed well relative to many subsectors of the commercial credit markets. However, the lack of global liquidity has had its impact on aviation ﬁnance—notably a signiﬁcant curtailment of commercial bank

lending activity1 and a temporary lack of access to new issuance in the public capital markets. These factors have led to concerns about “funding gaps” arising in connection with ﬁnancing of new aircraft deliveries, as well as to worries about a collapsing of aircraft residual values due to global air carriers shedding large portions of their in-service ﬂeets and order books to circumvent liquidity shortfalls. However, these concerns have yet to come to pass and it is increasingly likely that the aircraft ﬁnance sector will prove resilient once the economy and ﬁnancial sector further recover owing to a unique combination of fundamentals.

Attractive, “Timely” Fundamentals for Aircraft Finance Sector
The global utility and fungible nature of commercial aircraft is well-acknowledged. This is of beneﬁt to the asset-based ﬁnancier because an aircraft can be re-deployed into regions of the world exhibiting greatest demand. However, what is perhaps of greater signiﬁcance in the “new normal” economy is the fact that global assets such as commercial aircraft are buoyed by the unprecedented growth dynamics of emerging markets such as China and India. Under the “new normal” economic scenario, a number of mature Western economies including the U.S. are at increased risk of economic underperformance over the near term due to ongoing deleveraging by consumers2 and the ﬁnancial sector, high ﬁscal deﬁcits and aging demographics. However, the growth dynamics for air travel associated with the burgeoning middle classes in the major population centers of the world such as China and India should far outweigh any negative shadow cast by exhausted consumers in economies such as the U.S.

In general, growth in spending on air travel is highly levered to overall income growth as a consumer moves up the per capita income curve into the middle classes. In other words, the rate of growth for such a consumer’s spending on air travel is on average much higher than growth in other spending categories such as consumer staples and housing. Given that literally hundreds of millions of people are widely expected to enter the middle classes in China and India alone in the coming decades (a phenomenon without precedent in the history of the global economy) there is strong fundamental support for continued growth in air travel. This in turn directly translates into demand for commercial aircraft and hence strength in collateral values for the commercial aircraft ﬁnancier. Supply fundamentals for commercial aircraft are also beneﬁcial for the asset-based ﬁnancier. Though barriers to entry into the commercial airline sector are low, the barriers to becoming a global aircraft manufacturer are quite the opposite. These barriers extend well beyond the ability to engineer a machine that is superior to what can be produced by the industry incumbents. The barriers also include the ability to provide global aftermarket support such as training, access to spare parts and the like. They also encompass solving the chicken-andegg problem of aircraft ﬁnanciers that are increasingly particular about ﬁnancing only the most popular or “liquid” aircraft types. Such barriers further include overcoming the frictions associated with introducing a new aircraft type into an air carrier that has an infrastructure built around incumbent types.3 The enormous barriers coupled with a limited number of aircraft manufacturers generally results in a rational supply of new

16 The ofﬁcial publication of the International Society of Transport Aircraft Trading

Jetrader - May/June 2010

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