Innovative instruments keep aviation finance flying high

A record number of aircraft deliveries are expected over the next decade, with the worldwide commercial aviation fleet predicted to expand by a third.

With passenger and freight set for growth, plane makers are bullish. Airbus is forecasting demand for 40,850 new passenger and freighter aircraft deliveries over the next 20 years. Rival Boeing predicts the global feet will nearly double to 48,600, expanding at a rate of 3.5 per cent a year.

Given that each plane costs the guts of €100 million, funding this growth will be key.

“On the debt side, the larger investment grade lessors have an advantage as they can access the unsecured bond market, which is the deepest well of debt capital available,” says Joe O’Mara, head of aviation finance at KPMG.

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“The lessor bond market was relatively quiet in 2022 as lessors sensibly raised significant amounts of low-rate debt in the prior year. However, the large investment-grade lessors have all successfully tapped that market in 2023.”

There are multiple other financing sources that lessors can access too, including the traditional aviation banks, which remain very active in the market, and an increasing trend of alternative lenders entering the space. “These are typically private equity-backed groups that are generally willing to provide many forms of debt, both secured and unsecured,” he adds.

The increase in interest rates caused some turbulence initially but the initial consternation it caused is now in the rear-view mirror.

“The pace and scale of the interest rate rises were challenging for the sector as it made it difficult to appropriately price transactions, both for new leases and for purchasing or selling aircraft. The rate environment has generally settled, with an acceptance that we are in a higher-for-longer period,” says O’Mara.

“This, coupled with the strong airline demand, has resulted in lease rates increasing materially. In this stabilised market, parties also have a better handle on relative value, which has been helpful to the trading environment.”

One development coming into view is the rise of green bonds, says John Cotter, professor of finance at UCD. These reward environmental initiatives, such as improvements in fuel efficiency, with cheaper loans.

The sector can also benefit from making more generalised sustainability improvements. While the E in ESG reporting refers to the environment, such sustainability-linked loans typically focus more on the S and G (social and governance).

While traditional green bond instruments focus on steps such as replacing existing fleets with more energy-efficient aircraft, increasing the use of sustainable aviation fuel or offsetting CO2 emissions per passenger kilometre, sustainable linked loans are more broad-ranging.

In December, for example, CDB Aviation, a wholly owned Irish subsidiary of China Development Bank Financial Leasing, a lessor, entered into its first sustainability-linked loan, anchored with a $625 million syndicated term loan facility.

In making the announcement CDB Aviation chief executive Jie Chen said the innovative facility marked a landmark transaction for the aviation finance space.

The SLL parameters of the facility are based on three key performance indicators. These include not just reducing the carbon intensity of CDB Aviation’s fleet and focusing on the most fuel-efficient aircraft, increasing the share of new generation aircraft in the lessor’s fleet, but also increasing the level of diversity, equity, and inclusion-related training for its workforce.

In October SMBC Aviation Capital closed a $150 million sustainability-linked loan facility, with KPIs [key performance indicators] including the carbon intensity of its owned fleet and gender diversity across under-represented levels of seniority in the business.

Two years previously, Etihad Airways raised $1.2 billion in a sustainability-linked loan. At the time, Adam Boukadida, chief financial officer at Etihad Aviation Group, said: “Financing our operations in a way that supports both our planet and the people in our local communities is the natural next step of our financing strategy.”

As well as committing to net zero targets by 2050, hitting key milestone goals along the way, it committed to increasing employment and upskilling of Emirati women in the aviation sector, and to meeting KPIs concerning its internal culture.

“Statistics suggest the market for green financing is at a low level and growing. We will see a big expansion of that,” says Cotter.