Aviation was been exceptionally – and often uncomfortably – visible to the public eye over the course of 2019. The powerful combination of the grounding of the 737 MAX fleet as a result of tragedies and the advancing ‘flygskam’ (‘flight shame’) movement had influenced the global conversation to a significant extent by the middle of the year, which was then compounded by various airline insolvencies and an announcement from a British political party as part of an election campaign that it would investigate a complete ban on private jets from 2025.
As an asset class and as an industry, aviation has been attractive to investors for some time now, as its relative youth as a market compared to its peers and the reliability of its returns have drawn funds from all over the world. Recently, however, it has seemed that some of the features of the market we have come to take for granted have been evolving. For example, the words ‘long haul’ now bring to mind an image of the two-engined 787 Dreamliner, rather than its four-engined predecessors. The famed “double digit” returns for investors may be easing (with IATA reporting a 5.7 per cent ROI for the end of 2019), investments once considered “platinum” are now being sent for part-out, reports of ‘trade wars’ are developing on a weekly basis and we appear to be coming to the end of the era of low interest rates and oil prices.
However, we are also seeing increasing attention from new investors and ever-growing passenger demand figures which, together with the evolutions noted above, indicate a maturing market with a new set of trends being observed by aviation financiers.
Innovation + investment = ?
One of the most striking trends is the emergence of alternative sources of funding for the sector. The AFIC product, for example, is making strides in the wake of the freeze in export credit finance, and is an example of the kind of innovation that distinguishes aviation finance from that available to other asset classes. We are also seeing new leasing platforms being designed, both in established markets with established aircraft models and in emerging markets with more varied and perhaps unexpected models. Some of these follow familiar formats and structures, while others are designed specifically to fit within less well charted regulatory landscapes, such as that emerging in China. Aviation is also receiving more and more attention from funds and private equity sources, as sustained high yields, growing passenger demand and a relatively long asset life offer an attractive level of stability.
Adding to the offer is the sustained level of self-reflection and willingness to improve that is characteristic of the aviation industry. The leading example of this is, of course, the Cape Town Convention, the benefit of which sets aviation apart from other asset classes for financiers. We have continued to see increasing consolidation among operators, as the recent run of airline insolvencies continued over the course of 2019. This means that financiers, especially those who may be new to the industry, are increasingly focused on security and enforcement channels, and on the Cape Town Convention in particular. The importance of IDERAs and of the Convention’s ‘self help’ options should not be underestimated here, and we have seen the effectiveness of IDERAs in particular in the various recent insolvencies.
A similar aviation-focused development is the Global Aircraft Trading System (GATS), which is designed to enable more efficient trading and financing of leased aircraft by streamlining and standardising the transaction structure and documentation suite, and increasing transparency and trust in the process by using, from the end of Q1 2020, “a secure, live and searchable electronic ledger displaying results of ownership and security interests in GATS”. This is likely to be useful for simpler transactions, but as more funds enter the market with more complex structuring requirements, it may be the case that the GATS system underestimates the amount of legal work – and work from all parties – involved in operating and trading these assets.
This combination of innovation and investment is making cash so readily available that we are hearing that there is far more money being offered than there are aircraft to support it, with corresponding pressure on margins also registering in the market. There are, for example, funded aircraft leasing platforms struggling to find aircraft, as popular models attract multiple bidders and corresponding rises in price. This is exacerbated by the grounding of the 737 MAX fleet, and operators normally relying on aircraft coming to the end of their time in passenger service and ripe for re-purposing are finding their supply dwindling, as mid-life aircraft continue to be kept in service for longer to accommodate demand for capacity and delayed new deliveries.
‘Flygskam’ is another trend to have registered with aviation investors in the last year, with HSBC research identifying a substantial rise in the frequency with which climate change issues were raised on airline/investor calls in 2019. Despite constant technological advances and an annual drop of 2 per cent in fuel consumption per seat kilometre, HSBC finds that aviation’s annual global growth of 5 per cent (despite reductions attributable to the flight shame movement) has meant that emissions have in fact increased overall. Although other asset classes are responsible for far more of the world’s transportation emissions, aviation’s exceptional visibility on the international stage and more personal connection to its market will mean that climate change and the contribution of aviation to global emissions will need to be one of many front-of-mind issues considered when deciding where to place funds.
In counterpoint to these aviation-specific features, it is also becoming clear that ready cash and those responsible for putting it to work are increasingly asset-agnostic, drawn by reliable returns and market sophistication rather than by the assets themselves. These investors are often already active in shipping, rail, real estate and even aerospace as they look for new opportunities in aviation.
There are also some concerns about regulatory changes requiring greater capital reserves for insurance companies, and requirements to hold higher risk-based capital, making equity investments harder, so there is a real sense that funds are doing their research and making their preliminary ‘learning curve’ aviation investments now, to put themselves in the best possible position ahead of anticipated changes in the landscape.
It sounds quite general, when we say investing in ‘aviation’, but we are actually talking about an involved degree of analysis, as the industry’s characteristic returns are highly dependent on funding the right aircraft, flying the right route, with the right operator.
As has been highlighted in 2019 with the announcement that the A380 would not continue in production after 2021, followed by the grounding of the 737 MAX fleet, the equation that allows investors to balance capacity and demand with available assets, together with pressures like the flight shame movement, is constantly changing, and investments that at one time appear “platinum” are as subject to passenger travel preferences, oil prices and geopolitics as everything else. Each sector within the industry will have its own pressures and opportunities, so it is crucial for financiers new to the industry to come to grips with its highly sectoral nature before investing.