New rules on financing and lending by export credit agencies and commercial banks could have an impact in 2013 and beyond on new aircraft orders, the market and valuation for used aircraft, and the ability to start new carriers. But uncertainty remains over the staying power and interpretation of the new rules, how they will play out and whether new sources of financing will ameliorate the impact.
“Although it already costs more to arrange financing within the aviation industry compared to a few years ago, we expect the cost of financing could increase further as regulatory changes take shape,” says PwC in an aviation finance report released this month, after the firm interviewed CEOs and CFOs of airlines, aircraft lessors, European banks and other financial institutions in Asia, the Middle East and Europe. “Aircraft deliveries over the next three to five years will need to be financed at a time when liquidity is scarcer and risk is being repriced.”
Those regulatory changes include the full implementation of the Aircraft Sector Understanding (ASU) agreement on export credit agency (ECA) financing that was revised in February 2011 by the U.S., European Union, Canada, Brazil and Japan. The new rules had a two-year transition period that concluded in January, making this the first year that aircraft acquirers will feel the full brunt of the changes.
For example, the up-front percentage under the new rules now range from 8.01-17.92%, depending on the borrower's risk category, compared to 4-7.5% under the previous ASU. The new rules also tie the interest rates more closely to the private market.
The change in the cost is particularly important because ECA financing, once the method of last resort, often became the preferred method in recent years as commercial financing became more difficult to obtain—and, even when it was available, the ECA sometimes had a better offer.
In the years following the global economic downturn, ECAs of countries that produce commercial aircraft increased their support for new aircraft from approximately 15-20% of total deliveries to 30-40%, says Dean Gerber, who chairs the global transportation finance team at Vedder Price. Even some airlines with stronger credits, such as Emirates,and , have been able to make use of it, which was one of the driving factors behind the ASU revisions. In 2012, during the transition phase to the new rules, ECAs still accounted for an estimated 25% of aircraft financing, just under the 27% paid for with bank debt, according to PwC.
The bank support could be more difficult or expensive to come by, too, under new Basel III capital and liquidity standards for those institutions. The Basel Committee on Banking Supervision, with more than two dozen countries as members, issues the recommendations on banking laws and regulations.
Aircraft finance transactions under Basel II have generally required very low levels of capital because they are asset-based financings, fully secured by the aircraft and operating lease rental stream, notes Elizabeth Evans, a partner at the Jones Day international law firm whose specialties include aviation finance. But Basel III, designed to ensure and require a higher level of capital within the banking system, will change that as it starts to phase in this year.
Basel III will require a 3% capital requirement, regardless of the quality of the asset. That means lenders will have to put in more capital in front of “good quality” aviation assets, based on nominal amounts, even if they have been independently appraised at a much higher level.
New liquid asset requirements also will affect lease terms because lenders will need to match long-term loans with long-term funding. That means financiers will be less willing to approve 12-year aircraft financing loans, pushing for shorter terms instead.
The affects of financing becoming more difficult and expensive to obtain could be far-reaching. For example, there is a school of thought that the relative ease of ECA financing has distorted the market, feeding overproduction atand by artificially inflating demand for new aircraft. That “overproduction,” in turn, has lowered lease rates—particularly on relatively young narrowbody aircraft—sped up aircraft retirements and reduced residual values for certain models pushed into early obsolescence.
The new rules could reverse some of that. Some lessors, such as Fly Leasing and Aircastle, already have said lease rate volatility and new rules for ECA financing are making it less appealing for lessors to order new aircraft.
At, CEO Richard Anderson talks about another potential impact—and a positive one, from his perspective. New-entrant airlines will not be flooding the market with new capacity, he says, because it will be more difficult for them to obtain financing under the Basel III guidelines and new U.S. capital reserve requirements.
“It's a much different situation in terms of capital in the marketplace,” he says.
The new ECA and bank restrictions, however, also present an opportunity for new or existing alternatives for financing to grow. For example, well-capitalized aircraft lessors already are anticipating a boost in their business.
“We believe major shifts in the financing market, including declining traditional aerospace bank capacity and more expensive export credit support, will drive more business to leasing companies as a bridge-to-financing market for airlines,” Ron Waishal, CEO of Stamford, Conn.-based Aircastle, said in November. Access to the unsecured debt market, which a company like Aircastle has, is a strategic advantage, he adds. The PwC report notes that lessors, many of which have an investment grade rating and better risk profile, can access more and relatively cheaper capital than airlines.
Evans, however, cautions that the lessors—and everyone else—should be cautious about making predictions about the impact of the regulatory changes for ECAs and banks.
For example, some observers question whether the new ASU will ever be fully implemented. The 2007 ASU was in affect for only three years before being renegotiated, and in 2011 Russia and China only participated as observers, even though both countries are developing new aircraft.
The commercial market is an even bigger question mark.
“Are the capital markets going to open back up? That is sort of the big unknown,” Evans says.
Even if traditional sources do not, some new-entrant banks and private equity firms are showing interest in aircraft financing, and even some insurance companies are considering getting back into the mix after having been burned in the 1990s, Evans says.
PwC notes that sovereign wealth funds backed by the governments of China, Singapore and United Arab Emirates have become part of the fabric this time around. It also believes that aircraft-manufacturer financing may play a bigger role in the future, non-U.S. carriers may find ways to tap into the capital market as U.S. airlines already do, and the ongoing shift of financing from the traditional aviation banks in the West to new players from the East could accelerate.