The vast aircraft orders placed by airlines at November’s Dubai Airshow highlight the rapid growth of the Gulf region’s air carriers and represent a bold statement of intent regarding their future expansion plans.
Emirates placed orders with a combined list value of USD 99 billion (mostly Boeing 777x aircraft, along with 50 Airbus A380s), while Etihad also committed to a vast order of Boeing 777x and 787 aircraft (alone worth up to USD 25.2 billion at list prices), along with well over 100 Airbus A320neos, A330 freighters and A350s. Flydubai was also notably acquisitive, purchasing 111 Boeing 737, mostly 737 Max aircraft. Qatar Airways, while perhaps a little more conservative, also purchased heavily, committing to up to 50 Boeing 777x aircraft and five Airbus A330 freighters. To put this in perspective, at the 2011 Dubai Airshow, Emirates’ USD 18 billion order for Boeing 777 aircraft was an all-time record for the manufacturer – just 2 years later that record has been made to look like a relatively small order.
Now that the dust has settled, the question of how to pay for these aircraft will need to be addressed, and the size of these vast orders is driving increasing diversification of the sources of liquidity which are being accessed.
Aviation is a hugely capital intensive industry. A combination of corporate finance and asset-backed finance enable airlines to fund their high operating costs. Given the high cost of aircraft, much of the finance raised by airlines is asset-backed. Traditionally, commercial debt (bank loans and finance leases) has enabled fleet expansion to keep pace with the commercial opportunities in the market. Many of the long-established sources of aviation finance in Europe and North America have become more conservative in their appetite for aviation industry risk in the Middle East, having already accrued large exposures to the region’s airlines. Further, capitalisation requirements mean that many European banks are more reluctant to lend than previously. In addition to the traditional aviation finance lenders’ reduced appetite for deals, some banks in the region, particularly the UAE, have disproportionately large exposures to the real estate market and are seeking to diversify their asset portfolios by investing in other industries – aviation is an obvious beneficiary of this push to diversify.
Banks in the Middle East are increasingly becoming involved in aviation finance transactions. Boeing itself estimates that Middle Eastern financing sources have recently nearly doubled their aircraft financing capacity year on year. Although local banks are relatively liquid (compared with banks in more established markets), they are often less familiar with sophisticated aviation finance structures and a feature of many recent local transactions has been the involvement of experienced aviation finance providers (such as the German and French banks) working in partnership with local banks as security agents, assisting with the structuring and syndicating of aviation finance transactions. As local banks become more familiar with the aviation finance market and its structures, and relationships between the airlines and their local banks mature, we would expect them to become less likely to involve the European banks, instead dealing directly with the airlines.
Islamic financing structures, most commonly Ijarah lease structures, have been used by airlines in the Middle East for many years and continue to be an important source of funding for local airlines. Bond issues have also been a feature of Emirates’ financial plans, issuing Sukuk bonds to a value of USD 1 billion in 2012. As local investors with a preference for Islamic-compliant structures become more interested in obtaining exposure to the aviation market, Islamic finance will feature more prominently in the expansion plans of Middle Eastern airlines.
Operating lessors have grown in the last decades to own approximately 30% of the world’s airliner fleet and represent an important part of the Middle East airlines’ financing options, allowing fleet planning flexibility as well as off balance sheet treatment in relation to the asset by the airline. The exact proportion of the Middle East fleet which is leased is difficult to know precisely, but this is believed to be above the industry average.
US and European export credit agency (ECA) backed finance has been important for airlines globally over recent years. During the credit crunch traditional aviation financiers were restrained from taking on additional risk and the availability of government guarantees which underwrite ECA or EXIM backed facilities meant that risk could, in essence, be taken out of the equation. However, the cost of export credit backed finance has risen significantly as a result of the 2013 Aircraft Sector Understanding, aimed at leveling the playing field between those airlines which have access to ECA financing (airlines outside N America and Europe, home to Boeing and Airbus), and those that don’t (being airlines located in Airbus and Boeing’s home markets). Therefore, while still an important feature for some airlines, bigger airlines which are able to access other sources of finance have moved away from ECA-backed facilities.
New sources of finance are also becoming important to satisfy the Middle East airlines’ voracious appetite for capital. The arrival of capital market finance to the Middle East aviation sector, even if only for Emirates, is therefore a welcome development. Emirates has recently been using the Enhanced Equipment Trust Certificate structure (EETC, essentially asset-backed commercial bonds) enabling it to obtain a significant portion of its finance needs for 2013. EETCs are not commonly seen outside the US, so far only British Airways and Emirates are successfully using this route to finance.