Aviation Finance

Outlook 2011/2012 for key aviation segments

With air transport volumes back to pre-crisis levels, the industry seems well positioned for a period of relative prosperity. According to International Civil Aviation Organisation and IATA forecasts, system-wide global traffic expressed in tonne kilometres performed (TKP) is to increase by 5.3% in 2011, compared to 11.6% in the recovery year 2010. The 2011 figure represents a combination of continuing strong growth in the passenger markets with initial signs of stagnation in the cargo market. It is expected that during 2011 capacity in available tonne kilometres (ATK) will increase to 6.1%, a level that may slightly exceed the increase in demand.

The ambitious growth of the Middle Eastern carriers is set to continue in 2011/2012. For 2011 the Middle Eastern carriers are expected to add 11.4% ATK, slightly exceeding the projected increase in demand of 10.5%. Asia-Pacific takes second position with 6.9% TKP growth, followed by Latin America (6.3%) and Africa (5.5%). The mature markets in North America and Europe lag, with anticipated growth of 3.7% and 3.5% respectively.

Whilst IATA still expects the global airlines to generate a profit, the net result is anticipated to decrease from the US$15.1 billion level in 2010 to US$9.1 billion in 2011. Main concerns for 2011/2012 include the anticipated capacity growth, potentially resulting in reduced load factors and reduced pricing power. In addition, a continuing increase in the fuel price level could easily turn the net results for the airlines into a loss, as seen several times in the past.

The outlook for the equipment market in 2011/2012 is positive for modern new equipment. While first deliveries of the new B787 should finally take place, the delivery volume is unlikely to cause any oversupply in the widebody market. Consequently, demand for widebodies, including older designs, is expected to be strong. Both Airbus and Boeing have announced that they are considering increases in annual production of their best-selling widebodies. While this will accelerate the burn-off of their backlogs, all these aircraft should have no problems being placed in the market. Longer term, when deliveries of B787 and A350 gain momentum, an oversupply of current generation aircraft – that have served as interim lift – could materialise.

In the narrowbody market, the A320 and B737NG reportedly are sold out until 2014. The huge backlog for these types will assure new aircraft can be placed almost effortlessly. The impact of the ”generation change” implemented by the launch of the A320neo will not be felt during 2011/2012. While the launch of just another version of an aircraft may not seem too important, DVB believes that this step has the potential of triggering a number of other developments in the market. It is unlikely that Boeing will not respond to this action of its archrival Airbus, and either a re-engined B737 may be announced or – more likely – a more radically redesigned product will be offered. Interestingly enough, Airbus has already indicated it may launch its own – more radical – new narrowbody design by 2017/2018 for entry into service around 2025. Should this relatively quick succession of new aircraft designs become reality, the impact on economic life of existing aircraft – as well as aircraft value dynamics – may be significant, albeit only in a few years from now. DVB research indicates that historically aircraft values have been most impacted by a combination of the availability of new superior technology successor aircraft, coinciding with a downturn in demand for air transport. DVB’s policy already today takes this scenario into account.

Despite the market recovery we do not anticipate a strong rebound of values for older ”classic” aircraft. The surplus of aircraft from this generation is significant, airline demand is limited, and financing will remain a bottleneck. More trades may take place but at continuing depressed value levels. Some younger aircraft may be converted into freighters to replace the significant fleet of outdated cargo planes that will not return from the desert storage areas. Used equipment from more recent aircraft generations may show a stronger value and liquidity performance. The emerging leasing companies looking for rapid portfolio expansion will ensure robust equipment prices for the most popular types in sale-and-leaseback transactions. A number of lessors are already intending to pursue initial public offerings (IPOs) in 2011/2012. Apart from the anticipated first mover advantage, the potential longer term destabilisation of the narrowbody market may be an incentive for a rapid execution of these IPOs.

On the finance side, it seems the government-supported export credit agencies will continue to play a significant role in providing debt funding to airlines and leasing companies, although alternative sources of funding – such as capital markets funding or commercial bank debt – will clearly be available in many cases. The new ASU agreement will most likely not impact the role of export credit in 2011/2012 as many transactions will enjoy ”grandfather” or even ”great-grandfather” rights, entitling the airlines to the benefits of the old regime. While this form of financing clearly limits the market for commercial asset-based financiers such as DVB, we expect that in the period 2011/2012 there will still be ample opportunities. With more banks returning to the airfinance market, mainstream transaction with first-tier airlines will see reduced margins. DVB’s business model, however, allows us to avoid the most crowded part of the market, so while we anticipate increasing competition, margin pressure should remain limited.