The road to green financing of aircraft. Market Insight & Outlook.
Financing Net-Zero aircraft.
Current Aircraft Finance Market Outlook (CAFMO)2021.
Financing Sources 2020
Debt & Equity.
Down 40% on 2019.
Commercial Bank Debt
Export Import Banks
Export Credit Agencies
Investment & Hedge Funds
Credit Enhanced Funds
Wealth & Family Funds
Air Transportation Finance Covers:
Work Out Expertise
Technology life cycle
New aircraft transactions
Used aircraft transactions
Engine & parts inventories
Product life cycle
Terms & Conditions
Technology life cycle
Oversupply of aircraft.
Higer labor costs & shortages
Disposabe income spent on bricks & mortar, fewer pax.
Evergrande Taiwan Net-Zero design concepts do not translatee into Type certification
Supply chain disruption Reduced frequency & slower trip times, hub-to-hub concentration, labor force upskilling will have to wait.
OEM/MRO material shortages. Loss of investor interest in the sector, deterioration in the quality of the travel product, heavy government investment in Net-Zero technology R&D to appease civil society groups, ageing fleet leading to higer maintenance costs.
What if Boeing is wrong, what then is the outlook for financing Net-Zero aircraft deliveries?
- The aircraft industry continues to depend on the Boeing mantra that in the longer term:
- Key industry drivers are expected to remain stable.
- Key industry drivers will return to the longer term trend apparent since the 1960s.
- Passenger traffic growth is expected to recover to the 4.5% per year around 2025.
- The commercial (aircraft) fleet forecast will return to its 60 year growth trend to date.
- The 10 year commercial aircraft market-share forecast was for a need for 18,350 commercial aircraft, valued at $2.9 trillion – 11% lower than the comparable 2019 forecast.
- Extending the 2030 projection by a decade, Boeing sees a demand for more than 43,000 new aircraft in the the 20-year forecast time period to 2040.
- On the upper end of expectations, the global commercial fleet is expected to reach 48,400 by 2039, up from 25,900 aircraft today.
- A full recovery will take years.
- Airlines globally had begun to recover from a greater than 90% decline in passenger traffic and revenue early in 2020.
- The aircraft financing environment ended 2020 with enough liquidity to finance deliveries.
- The damage to the total aerospace industry as a whole, due to the impact of the COVID-19 pandemic, is minimal.
- The company predicts the value of the aerospace market will be $8.5 trillion from 2020 to 2030, a $200BN drop from its 2019 forecast.
- The real damage would occur in the commercial market.
- Boeing identified stresses particularly in the bank debt and tax equity marketsIn 2021, at the industry level, commercial aircraft delivery funding volume totaled $59 Billion, a 40% decrease from 2019 levels.
- Commercial banks withdrew liquidity and long term dept financing from the market.
- Institutional investors and funds have cut aviation exposure and increased spreads.
- Capital markets for aviation volumes were 70% higher than 2019!
- The percentaged of the global commercial fleet leased is 46%.
- Key financing drivers in 2022.
- Several countervailing drivers are impacting the Boeing projections:
- The 2020 pandemic is having a negative impact on airlines to the extent that the maket may be detached from the economic recovery.
- The failure of the ICAO CORSIA scheme to meet aircraft polution reduction targets, and the fact that those targets are voluntary and perceived as weak anyway.
- Civil society groups want to force change.
- They are demanding the introduction of higher aircraft emissions standards.
- They want the emissions standards enforced by law and heavy regulatory oversight.
- Civil society groups want the new oversight regimen brought forward from 2035 to 2027!
- These groups have leverage with the investment institutions that finance the aircraft market.
- Civil Society Groups and many investment institutions see eye-to-eye on aircraft polution and the urgent need to fix it.
How much money is needed to found the purchase of the Net-Zero aircraft to be delivered over the next 20 years?
~$1.5Tn of Net-Zero aircraft financing needed is a challenge in an era of retrenchment.
Where is the money to pay for aircraft coming from?
- Airbus and Boeing are convinced that global and diversified funding will continue to flow into the aircraft financing sector as the aviation sector navigates the global pandemic and vaccine deployment continues to accelerate. Boeing's near-term view of market dynamics and assessment of financing sources for new commercial aircraft deliveries is restricted because the company does not publish the customary one- and five-year industry financing projections.
- 1. One of the main factors affecting airline success is bringing aircraft supply and passenger demand as closely together as possible.
- 2. The airline uses a methodological planning approach for selecting the fleet mix.
- 3. Selection of an aircraft for operating a defined route network is a key element of planning. It has a direct impact on the airline's profitability and on cost reduction.
- 3. Most airlines operate short haul and medium haul routes.
- 4. The airline uses a methodological approach for selecting the fleet mix.
- Fleet planning & financing model.
- Fleet planning is a multi-criteria decision making process that decides:
- Fleet composition. Fleet size. Aircrasft Type Cost (EA) Deposit (EA)* Financed. Cash Reqd.
- Regional routes: 75 to 100 seats 7 A220/EMBRJ $30M $10M $20M $140M
- Shorthaul routes: 120 to 180 seats 8 A320/B737 $50M $17M $33M $264M
- * Deposit: 20% to 40% ~ 30%
- Challenges. Aircraft financing presents unique challenges that may not exist in the financing of other types of assets. These challenges include:
- Cost of buying aircraft is high.
- Potential buyers of the aircraft if there is a default under the loan agreement, indenture or lease, as applicable.Illiquid nature of the aviation market.
- Liquidity: Airlines and lessors are starved of liquidity and assets are heavily leveraged.
- Price: On average across the potential orderbook of 43,000 to 48,000 Net-Zero aircraft, the average price of a new one will be in the $30M to $50 million each in 2022 dollars.
- Deposits: The amount the borrower will be required to commit to the aircraft financing transaction can be in the 20% to 40% range.
- Down payment: A typical airline might have to find in the range of $400M in cash to replace gas turbine powered aircraft fleets with Net-Zero aircraft, for a typical airline operating a mix of 15 regional and short/medium haul aircraft.
- Used Net-Zero aircraft do not exist cutting off the option of building a Net-Zero fleet around used aircraft.
- Direct operating costs are high for in service fleet and the DOCs for Net-Zero aircraft are unknowable at this state in the life cycle. .
- Aircraft are mobile assets and so the jurisdictions where the aircraft is expected to be located during the financing term may vary.
- Credit exposure management of distressed airlines and lessora is restricting extending credit to customers with low credit ratings.
- Financing structure, term, equity, debt, lease, interest rate, funded amount, residual value, ROI and exit are all under stress.
- Debt service is challenges as airlines delay lease payments or negotiate reductions.
- Security enforcement for events of default have mostly been limited to non-payment on aircraft loans. Other events of default are airline insolvency, breach of warranties or representations which the lender believes will have a material impact on the airline’s ability to meet its obligations under the loan agreement.
- Interests in the aircraft and related assets in the different pools will vary.
- Regulatory interrelationship between Supernational, national, state and local laws and rulations make for complex legal structures..
- International treaties and conventions historically set norms/yardsticks for countries in framing policies and making laws on safety and route rights. With the Kyoto and Paris, treaties and conventions. are driving the timing of the swithch to Net-Zero aircraft.
- Complexity of the interelationship between treaties, laws and regulations when negotiating aircraft transactions.
- Documenting for the aircraft financing transactions is complex and expensive.
- Insurance coverage and cost, loss events, accidents and incidents.
- Cost of transferring ownership to buyer.
- Transfer of ownership, registration, deregistration, certificate of airworthiness are time consuming processes.
- Care and maintenance is regulated and the costs are high.
- This limits the number of participants that have the requisite expertise to participate in these projects and may put significant pressure on aircraft operators’ cash flows.
Financing aircraft that emit pollution!
Outlook secular, economy, aircraft, orders & deliveries.
The Outlook Shannon Aero produces evaluates Net-Zero aircraft market demand against supply of the gas turbine fleet, fossil fuel powered, & replacement aircraft propulsion from biofuel, battery/electric, hydrogen, synthetic & hybrid energy.
- Expect the global economy trend of uncertainty, volatility and inflation to continue to late in the decade.
- Political leadersips may undergo considerable change as they navigate the divergent interests in their economies vs CSGs.
- Key economy sectors will struggle to return to pre-pandemic levels, transportation & energy being susceptible to black swan events.
- Societal pressure may grow for the global economy to transition to renewable, sustainable energy, transportation, travel and tourism.
- The rate of change in technology will accelerate as new manufacturing processes, equipment and tooling are introduced.
- Returns across asset classes may be more volatile as resource diversion and disruption continues the downward pressure on earnings.
- Disruptive investors with resources to create change will build new industries, products and services.
- Long term interest rates will continue to be low, and additive to positive rates of return that would otherwise be lower for securities.
- Equities markets may experience substantial differentiation across regions and sectors.
- It is likely time for the aircraft leasing industry to to return to the pre-Pandemic, attractive returns required by private credit providers.
Risks from Rogues Gallery of 2022 risks. (Bloomberg)
Aircraft market outlook.
Net-Zero Aircraft launch outlook.
- The concensus market trading view has weakened, but remains that, commercial aviation has always been a long-cycle business, the inference being that it will always return to the long term growth trend line.
- OEMs tend to define the parameters for measuring the future market for commercial aircraft, sensetizing market beaviour for economic cycles, market shocks, tecnological advancements, social and political change.
- The tendency for the aerospace sector to accept the OEM market outlooks for over 60 years, will likely change.
- Airlines, service providers, banks, lessors, regulators, politicians, opinion formers and civil society at large, will look to independent industry analysyts to provide their perspective on the investment dynamics of the aerospace sector.
- As of 2020 the OEM view of the market has focused on near term uncertainty more than any forecast before.
- Not surprisingly the OEMs are hesitant to return to bullish aircraft market outlooks common prior to the Pandemic.
- The present concern is that air travel is detached from the global econonomy as other sectors show signs of economic recovery.
- This has engendered a loss of confidence and a sense of going it alone, especially for the lessors, who carry the burden of financing, placing and, for the first time, managing the orderbook faced with disruption in the new and aftermarket aircraft supply chains.
- The financial institutions confidence in commercial aircraft as an asset class has been considerably weakened to the point where their is a scarcity of liquidity and banks rely on lessors to liquidate portfolios in a controlled manner.
- Their is widespread acknowledgement that the tripartite shock of pandemic, black swan events and climate change have disrupted the shape of the aerospace sector, the air transport industry and the aircraft supply chain.
- The value of the current fleet of commercial aircraft and the valuation of the replacement fleet of Net-Zero aircraft from an equity, debt, collateral and residual value point of view will, in future, have to price in assumptions that were not relied on prior to the Pandemic.
- The changes in asset valuation will eventually feed into balance sheet valuations for all stakeolders.
- It will take several decades to identify the operating economics of Net-Zero aircraft versus the gas turbine powered aircraft in todays fleet.
- Overall the burden of working through the aircraft market crisis has fallen on the lessors and asset managers for the transition from today's fleets to tomorrows replacements, believing renewable, SAF fuels will be mass produced, have regulatory approval, be price-competitive with attractive DOCs.
Order & Delivery timing risk
- Decisions are being made today to order gas turbine powered aircraft entering the decline phase and for Net-Zero aircraft in the R&D design phase of their life cycles.
- As the order books stands today both technology groupings will be in service within the next few years and over the next 20 years.
- CO2e emissions standard for current fleet is based on studies from the mid-1990s that were more or less incorporated into the ICAO CORSIA scheme in 2016.
- Aircraft that came off the production line in the last 20 years would comply with the CORSIA scheme as currently defined.
- Concerns are emerging that the emissions compliance standard in the ICAO CORSIA scheme for new aircraft is voluntary, not seen as effective, not all stakeholders have signed-off on it, and may not comply with standards enforceable by legislation and regulations on the agenda for 2027.
- If any aircraft similar to those illustrated above do go into commerial production, the manufacturer will have to commit to building a family-line similar in scope to the range Airbus built over 50 years.
- This carries enormous financial, engineering, regulatory and political risk.
- To phase out the current aircraft fleet will require government supported R&D investment in unproven designs over 20-40 years with no guarantee the investment will be paid back.
- It needs a global concensus for energy sources/storage/supply and use because Chicago Convention countries must agree on common design standards.
- Before buying, airlines, lessors, lenders, investors and insurance underwriters will want assurances that any new design will deliver similar payload/ranges, similar operating economics, reasonable capital costs & type certification. MROs will need to know their re-equipment investment will be recouped. These new designs will need the acceptance & confidence of the public.