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Maintenance Matters in Aircraft ABS Deals – Part 1

In this edition of mba Aviation’s Insight Series, the Forecasting & Modeling team looks at the way Maintenance is considered in Aircraft Securitizations.

Key Concepts:

  • Maintenance Value and Compensation are significant elements in Aircraft Asset Backed Securitizations (ABS)
  • The Maintenance Support Account of an ABS is used to fund all future maintenance events for the assets in the portfolio
  • Maintenance Value becomes a larger portion of the overall aircraft’s value as it ages

Maintenance value and the corresponding compensation, typically designated as “Supplemental Rent”, “Reserves”, or “End of Lease Compensation” within a lease agreement, contribute an essential element of value and liquidity within an Asset Backed Securitization (ABS) portfolio.

In an aircraft lease, lessors collect maintenance compensation for utilization on the individual components on each aircraft.  These typically include the airframe, landing gear, auxiliary power unit (APU), engines, and engine life limited parts (LLPS).  The chart below depicts a typical distribution of monthly maintenance reserves over each component, determined by cost and approximate interval of each relevant maintenance item on an A320-200.

Within an ABS deal, maintenance compensation collected from the lessees is funded into an aggregate Maintenance Support Account.  Whereas typical leases will divide reserves into individual accounts to be drawn down at the time each component undergoes maintenance, the Maintenance Support Account is used to reimburse all future maintenance events for the assets in the portfolio, and is only required to have funding over a predetermined “look-ahead period”, typically 12 months.

In addition to supplementing cash flows in a portfolio, maintenance adjustments, as calculated by the cost of a maintenance event and the position of the aircraft in its maintenance life cycle, are applied to each aircraft’s Base Value.  The maintenance adjusted values are then used to assess the overall value of the collateral pool and determine the loan-to-value (LTV) on each tranche of issuance.

As an aircraft ages, the overall value of the asset depreciates.  However, the cost to perform maintenance on each of its components increases over time with inflation.  Therefore, as the asset ages, the inherent value of maintenance in the aircraft becomes a larger portion of its overall value.

Based on the full life market value and the full maintenance value of the components on an aircraft, an approximate run-out value on each vintage of the aircraft can be derived.  The maintenance value to full-life value ratio illustrates how the value of maintenance in an aircraft encompasses a larger factor of the asset’s total value over time. The example below is an estimation of the reinvestment needed to bring an A320-200 back to full-life conditions.

As a result of the dynamic between aircraft depreciation and maintenance appreciation, we find two immediate impacts on ABS transactions over time: First, the inherent maintenance value become a larger component of each aircraft’s value and therefore the overall collateral pool. Second, as lease rates decrease with the decline in overall asset value, the maintenance-related cash flows become an increasing portion of the ABS’s liquidity.

In the Spotlight: The Airbus A321XLR

In this edition of mba Aviation’s Insight Series, Ryan Cross, Analyst – Market Intelligence & Innovation, analyzes the appeal of the Airbus A321XLR to Operators.

Key Concepts:

  • Airbus’ A321XLR program builds on the success of the A321neo to bring superior fuel efficiency and narrowbody economics to intercontinental routes.
  • The XLR aircraft offers network carriers an appropriate replacement for their aging Boeing 757-200 fleets.
  • By quickly closing deals with major airlines and leasing companies for the XLR, Airbus has raised pressure on the viability of Boeing’s NMA concept.

First to Market Advantage

Airbus scored a victory with the timing of its launch of the XLR program.  Since it quickly locked down a healthy orderbook from an operationally-diverse range of airline customers, it proved the market’s appetite for a longer-ranger narrowbody aircraft with current engine technology.  The wise decision to launch the XLR dealt a blow to Boeing’s product development strategy.  Boeing was sidetracked for most of 2019 by the grounding of the 737 MAX program.  As it labors over the safe return of the MAX to service, it will probably not make a counterpunch in the first half of 2020.

For several years, Boeing executives have pondered whether to commit to the full development of the New Midsize Aircraft (NMA).  A number of loyal Boeing customers are clamoring for a modern replacement for midsize 757 and 767 aircraft.  Nevertheless, the American airframer must now reevaluate the prospects of its NMA; several would-be customers have already defected to its European counterpart.

At the start of the Paris Air Show last June, Air Lease Corporation (ALC) placed the first public order for the XLR.  John Plueger, the leasing company’s chief executive officer, described why the XLR might could squash interest in the NMA for prospective operators: “We think that [the XLR] addresses the smaller size of what Boeing envisions to be the NMA (a larger and smaller version).  It remains to be seen as to market acceptance and economic viability of that program in terms of being able to develop it and deliver it to the airlines at a price point which is compelling…  We will assess, and we are talking with Boeing as they continue to look at the NMA.” More recently, Plueger stated that the NMA’s development prospects had “diminished significantly” because of the broad range of difficulties weighing Boeing down.

Following ALC’s orderbook jump-start with 27 aircraft, GECAS placed an order for 20 aircraft in November.  By winning orders from a duo of prominent lessors plus a pair of market-making American network carriers, Airbus demonstrated the XLR’s appeal among top-tier customer base.

Range Capabilities

The XLR offers 15% greater range than the prior-generation A321LR variant, which in turn surpassed the range of the A321neo by 15%.  When configured with a low-density cabin with lie-flat seats for business class passengers, the aircraft’s range will stretch to 8,700 KM; its flight time will exceed nine hours.  The aircraft offers a 1,500 KM increase over the 757-200 and 1,300 KM beyond the LR variant. From New York, as an example, this means that the XLR can operate deep into South America and far into Eastern Europe.

Conclusions

Reflecting on the first phase of the XLR program, Airbus should take particular pride in the XLR orders it received from American Airlines and United Airlines.  Both operators fly large fleets of 757 and 767 aircraft which will reach the end of their economic life in the years ahead.  By closing those deals early in the life of the XLR program, Airbus elbowed out Boeing from orders from these market-makers.  Among the three American legacy carriers, only Delta Air Lines remains uncommitted to a midsize aircraft replacement order.  The Atlanta-based carrier will eventually need to replace up to 200 midsize aircraft.

Airbus will surely accumulate more orders for the XLR before 2023, when it intends to deliver the aircraft for commercial service. Whether or not the NMA comes to market, Airbus will continue to lure operators to the XLR with an enticing combination of narrowbody cabin capacity economics, intercontinental range, and superior fuel efficiency thanks to modern engine technology.

The Possible Effect of the Coronavirus Outbreak on the Aviation Industry and Aircraft Values

In this edition of mba Aviation’s Insight Series, Sloane Churchill, Analyst – Asset Valuations, uses analysis of the effect of the SARS outbreak of 2002-2003 on aircraft values and the aviation industry to provide insight on how today’s Coronavirus might take its toll.

Key Concepts:

  • SARS increased volatility of market values for older vintage and out of production aircraft types more than newer vintage and in-production types, though market values generally recovered within three quarters. It is likely Coronavirus will similarly effect aircraft market values in the short term, but will have no long-term effects.
  • The timing of the Coronavirus outbreak over the Chinese New Year, slowing economic growth in China, and extensive travel restrictions are expected to make a larger dent in RPK’s than during SARS.
  • No health epidemic of the past 20 years has had a long-term effect on global financial markets, with most recovering with a year. While global airline stocks have taken an immediate hit due to the Coronavirus outbreak, it is not anticipated to have long-term effects on airline stocks.

The Possible Effect of the Coronavirus Outbreak on the Aviation Industry and Aircraft Values

Though the Coronavirus outbreak in China is reminiscent of the SARS outbreak in 2002 – 2003, the effects on the aviation industry have the potential to be quite different. So far, the Coronavirus has infected over 45,000 people, mostly in mainland China, leading to over 1,100 deaths. This Coronavirus is proving to be faster spreading, though less deadly than SARS, with a death rate of approximately 2.1%. Historically, while global health epidemics have hurt aviation by reducing revenue passenger kilometer (RPK) growth in the short term, there have been no long-term effects for any epidemic of the last twenty years, including SARS, Avian Flu, Swine Flu, Ebola, or Zika on aircraft values or the aviation market as a whole.

The SARS outbreak could provide some insight as to how aircraft values and the aviation industry might be affected by the current Coronavirus. mba values research shows SARS disproportionately affected aircraft values. Typically, older vintage and out of production aircraft were hit the hardest after the SARS outbreak, showing the most value volatility in the following two years. Newer vintage and current production aircraft were significantly less volatile.

Market values for aircraft and Brent Crude prices have historically had an inverse relationship; in low fuel price environments, aircraft values tend to increase as aircraft become less expensive to operate, while market values decrease in high fuel price environments. This is especially apparent in older vintage and out of production aircraft, as they are less fuel efficient, and thus more sensitive to fuel price. However, 9/11 and the SARS epidemic broke the correlation between Brent Crude prices and market values, and this relationship does not recover until after the worst point of the SARS epidemic in 3Q 2003 for most aircraft types and classes. After the SARS outbreak, looking at narrowbody aircraft, the market value of a 1988 737-400 and A320-200 fell 14.8% and 42.0% respectively in 1Q 2003 from the previous quarter, while market values for a 1998 737-400 and A320-200 fell 15.1% and 16.7% respectively in 1Q 2003. Market values for a 1998 737-800, which technologically replaced the 737-400, dropped 11.2%. At the same time, Brent Crude prices fell 3.5% from the previous quarter during 1Q 2003.

Generally, narrowbody aircraft values recovered by 3Q 2004 and show no long-term effects from the SARS outbreak. However, there were only limited travel restrictions in place during the SARS outbreak, while travel restrictions in China and internationally during this Coronavirus outbreak have been significantly more extensive, potentially having a larger effect on RPKs than SARS. The immediate reduction in passenger demand caused by these travel restrictions will likely hit narrowbody values slightly less than widebody values, as carriers will rely more on their narrowbody fleets in the reduced-demand environment, particularly in the domestic Asia market.

Widebody aircraft in particular took the brunt of the value hit during the SARS epidemic, as they potentially will in the quarters following this Coronavirus epidemic as well. Like narrowbodies, widebody values recovered by 3Q 2004. The small to mid-sized widebodies such as the 767-300ER and A330-300 showed less volatility than large widebodies. Market values of older vintage aircraft, such as a 1988 767-300ER and a 1994 A330-300, were affected the most, falling 13.3% and 18.8% respectively in 1Q 2003. The newer 1998 vintage 767-300ER and A330-300 market values fell slightly less at 10.4% and 13.6% respectively. With the A330 currently in a soft market, all vintages, but particularly older vintages, could be vulnerable to further market value volatility, as the A330 is a popular widebody in the Asia/Pacific region. The 787, also a popular type in the Asia/Pacific region, could be vulnerable to market value volatility as concerns of overproduction combined with reduced passenger demand might lead to delayed or cancelled deliveries of the type in the near to mid-term.

Large widebodies, such as the 777-200ER and the 747-400 were also heavily affected by the SARS outbreak. Market values for the 1998 vintage 747-400 were hit the hardest by SARS in part because the type was nearing the end of its production run, falling 16.1% in 1Q 2003 while market values for a 1989 vintage only fell 7.7%. This time around, we could see softening of market values for older vintage 777-300ERs, or even the A350-900, as these types are popular on mid to long-haul routes in Asia.

Financial markets took an immediate hit with the shock of the epidemic after the Chinese New Year on January 27th, with the US’s S&P 500 and NASDAQ falling 1.6% and 1.9% respectively, and London’s FTSE 100 Index fell 2.3%. However, so far through the epidemic, the S&P 500 has only fallen 0.16% and the NASDAQ has actually risen 2.0%. Since the Coronavirus was announced, through the end of January, Hong Kong’s Hang Seng Index has fallen 6.7% and Shanghai’s SSE Composite Index has dropped nearly 10.0%.

International airline stocks were also affected, particularly airlines with large international presences and extensive Asian networks. China Eastern Airlines and China Southern Airlines’ stocks have been hit the hardest, both falling around 17.0% during the epidemic, as their networks rely heavily on international routes within Asia and around the globe. The following chart shows how several airlines were affected at various event dates throughout this epidemic, starting December 31, 2019 when China reported a new illness to the WHO, around the weekend of the Chinese New Year, and when the WHO deemed the Coronavirus to be an international public health emergency at the end of January.

Airlines are now more flexible than they were in the early 2000’s, becoming more savvy with capacity and revenue management, making changes to flight schedules just days after the start of the epidemic in response to anticipated drops in demand. Several airlines have cancelled their flights to China altogether, including British Airways, Lion Air, Lufthansa, Air France – KLM, Virgin Atlantic, Delta Air Lines, and American Airlines, with more expected to follow. While cutting flights to and from China might curb the spread of the illness, it could potentially have drastic effects for airlines’ financials. Research conducted by mba’s Forecasting and Modeling Group shows three of the top ten international routes from China to outside of the region by frequency are between China and the United States. United Airlines and American Airlines each serve two of those three routes, with Delta Air Lines serving one route, making them particularly exposed to the travel restrictions. United Airlines is also one of the top ten operators to China by frequency and has taken the largest hit to its stock price so far because of its exposure.

After the SARS outbreak, global financial markets fully recovered within one year, even while continuing to recover from the effects of the 9/11 terrorist attacks. This coronavirus hit during a long boom period for the financial and aviation markets, which may help to mitigate the financial effects of the epidemic on aviation, as most airlines are more flexible and financially fit, and thus more equipped to handle the reduction in passenger demand.  The coronavirus has also affected the manufacturers, as Airbus announced it has closed its final assembly line in Tianjin, China in response to the coronavirus. China’s importance to the aviation industry has grown tremendously since the SARS outbreak 18 years ago, and is essential to many global airlines’ growth horizons, which may make this epidemic that much more painful for the industry. The aviation industry’s fears of an economic downturn ahead combined with the potential severity of this epidemic is likely to perpetuate the rash of airline bankruptcies we saw in 2019, as some financially suffering airlines might not cope with the reduced demand. It would also be reasonable to see a slowdown in aircraft transactions and financings in the near to mid-term, though the ABS and EETC markets might hold solid, as they are more long-term instruments.

The timing of the outbreak is also unfortunate for the industry as the Chinese New Year January 25th, China’s largest travel holiday, was effectively cancelled by the outbreak. According to CNN, in 2019 the Chinese New Year accounted for around 73 million trips by air travel. According to IATA, at the worst of the SARS outbreak in May 2003, RPK’s dropped by about 35% with no travel restrictions by countries. Currently, with the travel ban within China and many other countries limiting travel to and from China, RPK’s are expected to take a sizeable hit. With economic growth slowed to 6.1% in 2019, and resulting reduced passenger demand growth in China over the past two years, if the Coronavirus lasts through the quarter, it could have long-term economic effects, unlike prior health epidemics, as Asia grows to be one of the largest aviation markets in the world.

A Look at Aircraft Finance – Part I

The availability of capital to fund aircraft acquisitions is one of the critical support structures that allows for commercial aviation industry growth and prosperity. In an environment of low central bank interest rates and highly liquid markets, investors from around the world have been flocking to the aircraft finance sector. While the enthusiasm for the industry is welcomed and has provided capital for fleet renewal and growth, some lessons can be learned from the historical progression of commercial aircraft finance that lessors, operators, and investors would be wise to heed.

In this edition of mba’s insight series, we will look at the three major pillars of commercial aircraft finance, the relationship of operators and lessors to those pillars, and the past investment cycles seen in the industry. From this solid foundational understanding, we will explore the importance of accurate asset valuation and discern some lessons that can be garnered from the study of past investment patterns. Finally, we’ll apply those lessons to the future of aircraft finance, identify emerging trends, and look for areas where caution may be warranted.

The Three Pillars of Aircraft Finance

When airlines or leasing companies acquire new aircraft, closing the transaction on a cash basis only accounts for about one-quarter of aircraft deliveries. In 2016, cash was used in approximately 28.0% of the $122 billion spent on procuring commercial aircraft.[i] For airlines, in particular, there are drawbacks to acquiring aircraft using cash. The airline winds up assuming the depreciation of the aircraft and the capital outlay is often enough to give both internal accountants and investors significant pause. For leasing companies, the reasons not to use cash in a transaction are much the same; if interest rates are attractive enough, there may be financing avenues that are more economically advantageous. These less cash-intensive alternatives make up the three main pillars of commercial aircraft finance.

Bank Debt

Taking on bank debt was, until the advent of leasing and elaborate collateralization schemes, the primary method by which airlines (and later leasing companies) acquired commercial aircraft. On the surface, bank loans for aircraft look much like a mortgage on a home or commercial building; the bank supplies the upfront cost of acquiring the asset and is paid back by the operator over time with interest added.

While they may seem relatively simple, in reality, bank loans for commercial aircraft can be highly sophisticated financial instruments. There is often an upfront cost to the leasing company or airline; 15.0% of the amount of the transaction is a typical number, but this can vary depending on the value of the underlying asset and the creditworthiness of the entity purchasing the aircraft. Large commercial banks will often pool their resources, spreading the risk among a syndicate of different financial institutions to fund the aircraft acquisition deal. Bank loans can cover the purchase of a single aircraft, or many separate airframe purchases may be packaged together into portfolios worth hundreds of millions of dollars. These loans can be unsecured, or the value of the aircraft themselves may secure them.

Often banks provide loans to airlines or leasing companies on a short-term basis, with the expectation that the purchaser will refinance their purchase. Known as warehouse or bridge loans, these arrangements can involve either fixed or revolving lines of credit that allow the aircraft acquisition to proceed while other financing deals are put into place. Additionally, banks may provide pre-delivery financing to allow commercial aircraft purchasers to make the required payments on new aircraft as they are being built. These payments are often equal to an amount that is between 10.0% and 20.0% of the sale price.

Capital Markets

Banks represent a single source of capital with which to fund purchases. The downside of bank loans is the substantial risk to a financial institution’s balance sheet; they are exposed to the depreciation of the aircraft asset and the risk of operator insolvency in what is a historically highly-cyclical industry. The capital markets offer a significant reduction of risk for lenders, providing financing to the commercial aviation marketplace. By collateralizing the debt, the risk of the transaction is spread out among a large pool of investors. Additionally, leveraging bond markets for aviation financing represents a significant increase in the amount of available capital, creating competition and reducing overall lending costs across the landscape.

Access to investor funds come in three general varieties:

  • Unsecured bonds: These bonds are most typically used by leasing companies who require flexibility in terms of payment profile. While underlying physical assets do not back them, these products are nevertheless very popular. In 2017, approximately $4.85 billion in unsecured bonds were issued to commercial aircraft leasing companies.[ii]
  • Asset-Backed Securities (“ABS”): These securities are backed by the value of the aircraft themselves, and in the case of leasing companies, the value of the rental contracts. ABS’s are complex financial instruments that are organized into tranches of payment priority and risk. The highest tranches are paid first but at lower return rates than the lower tranches. ABS’s are increasingly becoming a popular method for aircraft lessors to tap the capital markets.
  • Enhanced Equipment Trust Certificates (“EETCs”): These instruments function in much the same way as ABSs and are based on the value of the aircraft assets. They are typically issued by a single airline to fund equipment purchases.

Export Credit Agencies (“ECAs”)

ECAs are private or quasi-governmental financial institutions that issue export financing. The reason that ECAs exist is the result of a relatively simple calculation; increasing exports is good for national economies. When a domestic company imports a product to a foreign country, that export comes with political and commercial risks not inherent to domestic transactions. ECAs may provide direct financing, intermediary loans, or interest rate equalization loans to encourage export activity. Direct financing notes for commercial aircraft are standardized financial instruments that are based on a maximum 12-year term.  Examples of ECAs include the U.S. Export-Import Bank of the United States (EXIM), the European Investment Bank (EIB), and the Export-Import Bank of China. Since their role is to provide capital for international sales, the availability of ECA funds is of particular concern to aircraft manufacturers.

A Brief History of Aircraft Finance Trends

Up until 2008

The business of investing in commercial aircraft is nearly as old as the airline business itself. Technological development has always outpaced the ability of operators to afford to purchase the latest and greatest technology or to renew their fleets as they reached the end of their useful lives. For most of commercial aviation’s history, bank loans have been the “coin of the realm” of the aircraft finance world; banks would make loans that were normally backed by the aircraft themselves. Airlines would eventually own the aircraft, having assumed the costs of purchase, financing, and depreciation throughout the life cycle of the assets.

Bank loans for aircraft purchases often did not provide operators with the flexibility they required to refleet (or shed airframes) in response to market demands. Additionally, outright aircraft purchases can encumber airline balance sheets with numbers that are unattractive to potential investors. To address the need for operator flexibility and to meet market demand, commercial aircraft manufacturers began leasing aircraft in 1968. This first boom in leasing was led by McDonnell Douglas and Boeing who were looking to move their DC-9s, 727s, and newly developed wide-body products.

The intrinsic value of aircraft assets and the investment opportunity presented by providing capital to airlines operating on razor-thin margins was realized by corporate entities outside of traditional aviation circles. In 1967, GECAS wrote its first commercial aircraft lease to Allegheny Airlines. In the mid-1980s, amid an environment of falling interest rates and a commensurate plummeting of Treasury bill yields, institutional investors began to look for stable instruments that offered superior returns. They found those opportunities in the aircraft leasing market. Non-aviation companies as diverse as Xerox, IBM, and General Motors—even Greyhound—held lease notes on a substantial percentage of the world airline fleet.  On the back of this private capital, the total value of large commercial aircraft deliveries increased from less than $20 billion in 1982 to more than $50 billion in 1990.[iii]

With the growth in aircraft leasing by both dedicated aviation financing companies and others, new investment instruments were conceived to handle demand. The early 2000s saw an increase in more complex ABS and EETC-type products and increased competition in the financing space. After the shock of the 9/11 attacks, the commercial aviation industry seemed to be in a phase of solid recovery. There was abundant competition to write loans for new aircraft around the world. An AIN article in December 2007 quoted an anonymous lender who said, “I’ve seen some competition provide 100-percent financing on old aircraft, creating loans that were underwater from day one.”[iv] The market was overheated.

It is essential to pause for a moment to consider the importance of aircraft valuation to understand historical trends in aircraft finance. Most of the instruments (secured bonds, bank loans, ABSs, and EETCs) used to access capital for aircraft purchases are based on the value of the underlying assets themselves. In the case of the airlines, the market value of the aircraft is the operative value. For leasing company purchases, both the value of the aircraft and the rental contracts must be considered. Any historical evaluation of finance trends must include a careful assessment of aircraft valuations over time. The value of any of these transactions to the investment community is directly proportionate to the value of the assets which underlie those arrangements.

The 2006-2007 financial crisis to the present

The aircraft lending market was not the only overheated economic sector. It is now well-known that, in 2006, U.S. real estate values crashed as a result of excessive sub-prime lending. After years of easy money based on mortgage-backed investment instruments and foreign investment, portfolio values were reduced to dust virtually overnight. Liquidity in the market dried up almost entirely. There was virtually no money in the capital markets for lessors and airlines to borrow for aircraft acquisitions.

After the crash, the value of aircraft—and thus the value of aircraft based investments—took a similar hit. While the overall reduction in aircraft market values were not as dramatic as what happened to the stock market, they were negatively impacted to a degree that was palpable to prospective investors. Those institutional investors who had just had their “hair singed” by the worst economic crisis since the Great Depression were in little mood to get burned again. The anemic economic environment led to massive reductions in consumer spending, forcing airlines to slash the number of available seat miles (“ASMs”) in the marketplace and right-size their fleets.

In July of 2008, before the long-term impacts of the financial crisis were fully evident in the aviation industry, U.S. airlines flew more than 93 million ASMs system-wide. As the airlines aggressively cut capacity and parked airframes, ASMs fell to a low of 68.5 million in February 2010. ASMs did not recover to 2008 levels until July of 2011.


One of the major financing avenues that the commercial aircraft industry turned to was ECAs.  These quasi-governmental financial institutions stepped in to provide critical funding for aircraft manufacturers to export their products overseas, giving lessors and operators around the globe access to desperately needed capital to right-size their fleet mixes. By 2011, ECAs were the source of a full third of all commercial aircraft finance capital.[v]With the dramatic reduction in liquidity in the market, aircraft buyers, lessors, and manufacturers were forced to turn to financing systems outside of the capital markets to fund purchases of aircraft. Even as ASMs were reduced, newer and more fuel-efficient aircraft were making their way into airline fleets. Aircraft type shifts were particularly apparent in the regional airline sector; as mainline fleets mothballed inefficient older aircraft, regional airlines saw deliveries of larger and newer aircraft (the Embraer E-170 and E-175 were particularly notable).

As time passed since the shock of the financial crisis and world markets stabilized, the aircraft financing landscape underwent changes that rebalanced the capital sourcing mix. To spur consumer spending and bolster their economies, central banks around the globe slashed interest rates following the crisis of 2006-2007. These rates fell to—and remain—near historic lows. Those low rates, coupled with astounding industry growth and record airline profits, made both bank loans and capital markets plentiful sources of aircraft finance capital once again. The same low interest rates brought investors looking for better bond yields back to the market, adding more available capital to the mix. The amount that ECAs contributed to the total financing picture was impacted to the greatest degree. In 2011, 33.0% of aircraft financing was provided by ECA institutions. That percentage fell off precipitously in 2014, and by 2017 ECAs only provided 4.0% of the $122 billion in commercial aircraft capital.[vi]

Discerning patterns in investment from the past

Based on our look at the history of aircraft finance trends, it is possible to come to a few general conclusions.

  1. Valuation is critically important. The overall value of nearly all of the available financing instruments to both the financial institutions and their investors is predicated on the value of the underlying assets. In most cases, these are the aircraft themselves.
  2. Aircraft values, and thus the value of any investment instrument predicated on them, tend to track with GDP. This makes practical sense; as GDP falls, so too does consumer spending. Less consumer spending leads to less money entering capital markets. Airline bottom lines suffer directly as well. In poor economic conditions, discretionary travel spending tends to fall off. In the financial crisis of 2006-2007, aircraft values suffered—and remained somewhat flat for a period afterward—as airlines “right-sized” their fleets to the demand.
  3. Low interest rates tend to stimulate both bank loan and capital market financing (ABS/EETC/secured bonds) activity in the commercial aviation finance space. This applies to both lessors and operators; lessors have become especially active, as the airlines have learned that leasing aircraft allows for increased flexibility and attractive balance sheet benefits.
  4. ECA is an option, but not preferred in the face of low interest rates and highly-liquid capital markets. The standardized terms of these credits are often inferior to bank loans and the capital markets, making them an unattractive “last resort” option for many operators and lessors.
  5. The market is cyclical, and recognition of trends tends to lag behind reality. As we saw in the run-up to the financial crisis, when loans were being written for aircraft at a loss, unbridled enthusiasm for an asset class can create so much competition in the marketplace that financial institutions write notes that, on later examination, prove to be less than worthwhile.

Where is aircraft finance headed?

The commercial aviation finance industry is complicated, but by applying the lessons learned about the evolution of the aircraft financing sector and how investment patterns have changed in response to external events, some reasonable predictions can be made regarding the future. When projected industry growth, anticipated aircraft orders, interest rates, and levels of current investment are considered against historical data, clear directional indicators begin to emerge.

We are currently in a period of growth within the capital markets. Even as the airlines and lessors took advantage of greater bank loan availability and deleveraged risk in 2017, the capital markets sector is poised for continued growth in 2018 and beyond. Lessors, who typically require large amounts of capital to fund large purchase orders from commercial aircraft manufacturers, can be expected to continue to utilize the ABS and other bond-related instruments that have proven to be advantageous for them.

The overall growth of the capital markets and higher availability of bank loans is being driven from both a demand and a money-supply perspective. Demand for commercial aircraft continues to be strong and is anticipated to remain so for an extended period to come. In the next 20 years, it is expected that more than 41,000 new airframes will need to be delivered. This number will be driven by not only fleet replacement as airlines look to take advantage of more fuel-efficient designs, but also by traffic growth. The demand is particularly strong in Asia, which will account for more than 16,000 of these deliveries.[vii]

Even as interest rates have begun to climb slightly, they remain near historical lows. That fact has driven more lenders and investors looking for superior returns into the commercial aircraft finance space, increasing the overall supply of available capital in the market. New entrants have been primarily institutional investors in Asia who are looking for relatively stable instruments to grow their portfolios predictably.


Low interest rates and abundant capital will likely lead to a growth in the role that bank loans play in aircraft finance as well. As commercial banks in Eastern Asia and Australia have entered the space, competition has begun to increase among financial institutions to write loans. The competitive environment has suppressed lending costs for lessors and operators, ensuring bank loans will remain an attractive financing option.

Airlines and lessors have recognized the benefits of bank loans and the capital markets. The aircraft finance picture today is one that is relatively balanced with cash, loans, and ABS/EETC instruments accounting for about 90.0% of capital sourcing. Strong, liquid markets, low borrowing costs, and low interest rates have relegated ECAs to a fairly minor role in commercial aircraft finance. The percentage of capital sourced from ECAs can be expected to remain in the single digits into 2018 and beyond.

Some cautionary signs point to potential issues on the horizon. The influx of new lenders and institutional investors creates greater competition in the aircraft finance space. That is a good thing for lessors and operators, as it continues to allow them to access capital on desirable terms. However, as was seen before the 2006-2007 financial crisis, exuberance can disguise warnings that the market is overheated. That is why accurate valuation is essential; it is the value of the assets underlying an investment (whether it be a bank loan, an ABS, or an EETC) that determines its ultimate worth, not transitory movements of the market.

Interest rates creeping in an upward direction add another cautionary data point to the aircraft finance picture. Airlines, in particular, have demonstrated a strong willingness to aggressively control both capacity and debt. As interest rates move higher, history shows that consumer spending tends to fall. Reductions in consumer spending tend to result in fewer revenue passenger miles being flown for discretionary travel. Since a large percentage of the world airline fleet is leased, operators are well-positioned to absorb fluctuations in demand; leasing allows them the flexibility to adjust the number of seats in the market in a reasonably short period. If demand were to be substantially impacted by unexpected events, aircraft market values could be negatively impacted.

[i] Hammond, Rich. Aircraft Finance. Boeing , 2017.

[ii] “Aircraft leasing company bond issues 2017.” Aircraft Investor, www.aircraftinvestor.com/articles/aviation-finance-data/aircraft-leasing-company-bond-issues-2017/

[iii] Richard Aboulafia | Aviation Week & Space Technology. “Opinion: Short-Term Memories Can Lead To Big Miscalculations.” Opinion: Short-Term Memories Can Lead To Big Miscalculations | Master the Supply Chain content from Aviation Week, aviationweek.com/master-supply-chain/opinion-short-term-memories-can-lead-big-miscalculations.

[iv] Padfield, R. Randall. “Aviation Finance.” Aviation International News, 3 Dec. 2007, www.ainonline.com/aviation-news/aviation-international-news/2007-12-03/aviation-finance.

[v] Hammond, Rich. Aircraft Finance. Boeing , 2017.

[vi] Boeing. Current Aircraft Finance Market Outlook. Boeing, 2018.

[vii] Boeing. Current Market Outlook 2017-2036. Boeing. 16 Jun. 2017.