The Hong Kong conferences are over for another year, and our Aviation Finance team had another very productive week at the various sessions. It was great to see so many familiar faces and connect with new people, and doing so in what is fast becoming one of the world’s new aviation finance powerhouse jurisdictions gave the meetings a real buzz.
Aviation seems to be facing a fuel-related existential crisis at the moment, as pressures mount on the industry from various angles.
Within asset finance generally the major discussion is the looming bite of the IMO 2020 regulations, which will reduce the amount of sulphur permitted in ship fuel oil to a limit of 0.50 per cent mass by mass from 1 January 2020. Aside from the huge impact this will have on the world’s vessel owners and operators, it is also anticipated that there will be knock-on effects for aviation.
In this blog post we take a brief look at export credit agency (“ECA”) supported finance in the asset finance industry, and the development of a new template loan agreement by the UK’s Loan Market Association.
The role of the ECAs
ECA finance describes transactions where states (whether by direct sovereign bodies or by separately mandated organisations) provide (financial) support to would-be purchasers of certain goods or equipment constructed in that ECA’s home jurisdiction.
ECA support can make deals both more bankable and more affordable, and has long been a useful feature of asset and project finance. Over the last two decades, a significant amount of export credit support in the form of both guarantees and insurance has been provided to capital-intensive global projects.
With the increased capital adequacy requirements of the Basel III and Basel IV accords, the importance of the sector has continued to grow. ECAs were once seen as insurers of “last resort” and were largely confined to support high risk financings in emerging markets, with much export credit agency insurance having been counter-cyclical. Whilst the perception remains that ECA support increases in importance as traditional financiers become more reluctant to lend (and so provides a bridge where the required debt finance exceeds the available bank liquidity) they just as often will now be found providing specialised products not available elsewhere, for example political risk insurance.
The heatwave may be over but the wave of August out-of-office responses is still building, so rather than post about controversial redelivery conditions or the fascinating behaviour of interest rates, and prompted by the striking intersection of aviation and literature recently, we thought it seemed high time to offer Legal Flight Deck: The Summer Reading Edition. You’re welcome.
The Reed Smith Aviation team were out in force for FIA 2018. It’s always nice to be able to catch up with clients and old industry friends from across the globe on our own doorstep – and even better when it’s in the middle of a heatwave!
Boeing’s executives are likely to be flying back to Seattle feeling very pleased with the week’s work, having secured/announced $79 billion in orders during the show. Vietjet signed an MoU for an additional 100 Boeing 737 Max aircraft and Hawaiian Airlines also confirmed its order for 10 787-9s, while also confirming purchase rights for an additional 10 aircraft. Overall Airbus announced 93 firm orders and commitments for 338 aircraft, including a commitment from JetBlue for 120 of its new A220 aircraft and a confirmation from AirAsia X for 34 A330neos. Embraer had a much more successful show than last year, securing/announcing 265 orders for variants of its EJets.
There was plenty of lessor activity to note across the week with Goshawk Aviation (20 Boeing 737 Max 8 aircraft) making its first direct order from Boeing and Jackson Square Aviation (30 Max-family aircraft) making its first direct purchase from any OEM. Macquarie AirFinance ordered 20 A320neos and ACG ordered a further 20 Boeing 737 Max, taking its current order to 100. Continue Reading
In last week’s case of Triple 7 MSN 27251 Ltd v. Azman Air Services Ltd, Azman Air Services argued that two aircraft lease agreements were void under the English law doctrine of common mistake.
The High Court considered this question and found that common mistake is only sufficient to void a lease agreement (or any other contract) where:
- the mistaken assumption on which the parties acted was fundamental to the contract; and
- the mistake was such that the “contract or its performance would be essentially and radically different from what the parties believed to be the case at the time of the conclusion of the contract”.
According to PWC research, half of the world’s workforce will be millennials (people born between 1980 and 1995) by 2020. It is also estimated that over the course of the ‘Great Wealth Transfer’ occurring over the coming 30 years, this generation will inherit wealth to the value of $30 trillion.
A lot of editorial ink has been spent on the analysis of millennials, especially on the ways in which their spending habits differ from those of previous generations (smashed avocado, anyone?). It has been reported that the particular context in which this cohort grew up – described by one columnist as ‘a series of moments when the big institutions failed to provide basic security, competence and accountability’ – has ‘fundamentally changed the game for Millennials’. They don’t buy houses in the way their predecessors did. They want access to cars, but not necessarily to own them, and would rather have a smartphone anyway. They are characterised by a ‘quirky eco-conscious individualism’. They want workplaces that offer flexible hours and feel like a community, and would rather keep their lives than work towards partnerships or corner offices.
Similarly, in recent months, we have seen a marked generational change in some of the lenders we work with. While some are determined to carry on as if the GFC never happened, others are looking at building brand new books with innovation and new technology at their core, even in more traditional fields like asset and equipment finance.
All of this has made us wonder. If millennial spending habits are so different from those of previous generations, why should their lending habits stay the same? What happens when the millennials are running those ‘big institutions’? Specifically, what will millennial asset finance look like? Continue Reading
The green button has been pressed – airlines are placing orders for turboprop aircraft at top speed. With high velocity, low thrust and the exciting potential of 3D printing, will turboprops make their return to the “hot spot”? In the constant search for efficiency and ways to generate revenue, there are many advantages to this kind of aircraft and more in store as new technologies highlight the possibilities – some of which are already being realised in projects like China’s ‘Belt and Road’ initiatives and the development of emerging aviation markets.
The turboprop profile is definitely on the rise. With a $332 million order for Q400s placed this week by Ethiopian Airlines, for example, following China’s delivery of 57 MA series aircraft throughout 2017 to New Silk Road regions, and with manufacturers like Rolls-Royce and GE Aviation increasing competitive development in the field, it is fair to say that the turboprop market is experiencing a resurgence of interest. Continue Reading
The aviation industry is a major contributor to the world’s carbon emission and greenhouse gas problem, generating 2% of the world’s carbon dioxide emissions and estimated to account for 3% by 2050. The UK’s aviation sector, for example, was responsible for 34 million tonnes of CO2 emissions in 2012, a figure forecast to rise to 43.5 million tonnes by 2030 .
The huge volume of commercial aviation activity, the long distances we now travel, the massive amount of fuel burned to power the equipment, the release of emissions directly into higher levels of the atmosphere, the ever-growing demand for capacity – this all adds up to a very knotty problem for the industry to address. How can we better balance the need to accommodate unprecedented growth in demand with the environmental imperative to fly far less than we already do?
There are a number of methods currently in use, of varying levels of effectiveness. Continue Reading
More data on aviation’s gender pay gap has become available since our first post on this in January, and a theme has emerged across the more prominent pay gap reports.
This is that although men and women may be paid equally for doing the same job, the figures are significantly affected by the fact that the vast – the very vast – majority of senior and therefore more highly paid jobs are held by men. In most cases, in aviation, this means pilots. We saw in the EasyJet report that just 86 of their 1493 pilots were female; at British Airways the figure is 94% male, at Jet2 it is 95%, and 95% again at Tui Airways. The BA report helpfully notes what their figures would look like if pilots were removed from the equation – there would be a 1% gap, in favour of women. It is clear where the problem is.
So how do we fix it? We have seen countless commitments to ‘close the gap’ and declarations of equal opportunity and gender-blind recruiting, but what does doing something about it actually look like? It may be, after all, that recruitment policies and retention initiatives are not the source of the problem. It may be that it begins much earlier than that. Continue Reading
The sale and leaseback (“SLB”) model has been a key source of funding and portfolio management for lessors and airlines alike for some time now.
There are two principal SLB transaction structures employed for new aircraft, as illustrated below.
The first is the “back to back” sale, whereby an airline pays for and takes delivery of an aircraft as the purchaser under the purchase agreement with the manufacturer. The airline will then simultaneously sell the aircraft to the lessor and takes it back on lease. The second is the “purchase agreement assignment” variant, in which the purchase agreement with the manufacturer is assigned to the lessor before delivery, at which point the lessor pays for and takes delivery of the aircraft and it is leased to the airline. For “used” aircraft, the structure is more straightforward: the airline and lessor would typically enter into a sale and purchase agreement to govern the transfer of title from the airline to the lessor and a lease agreement by which the airline can then take the aircraft immediately back on lease.
Even with changes to accounting rules eroding some of the benefits of lease structures for airlines, these transactions continue to be advantageous for both lessors and airlines alike for a number of reasons.
Airlines may benefit from the continual renewal of their fleet through SLB transactions by avoiding those maintenance obligations that arise around the six year mark. Pricing is another key driver. Whilst lessors, who typically pay a premium for aircraft from manufacturers compared to airlines, will often be able to partially benefit from the airline’s more desirable pricing, the airlines themselves benefit from a sort of arbitrage. The discounts they typically obtain from manufacturers as well as ongoing price escalation usually means that an aircraft is worth more at delivery than at the time the order was placed. This is a pure cash “windfall” for an airline, which can be reinvested into its business, although some airlines do chose to amortise it over the duration of the lease term.
“when a lessor buys an aircraft from an airline in a SLB transaction, they know what they are getting and when they are getting it; there is no forward-looking gamble on market conditions and, in particular, there is no guess-work around the price of the aircraft”
Timing is also important: SLBs give lessors access to next-generation aircraft even where they have not placed orders for them. The alternative (at least for lessors looking for new aircraft) is to establish their own order book. But if they do this, they need to factor in price escalations and the uncertainty of the future aviation market (not to mention the uncertain future value and even utility or desirability of that particular aircraft or aircraft type). Further, order books come with the inevitable conundrum of pre-delivery payments – and the market to finance them is not the easiest to navigate.
With a significant number of new lessors entering the fray over recent years, SLBs have become a particularly attractive tool, enabling these new entrants to increase both their fleet size and their breadth of clientele in one move. Unfortunately for operating lessors, the desirability of the product for airlines means that the market is now super-charged.
Partly as a consequence of this, lease rates are at record lows and a lessor that wants to be competitive in this space will need a low cost and diversified funding base. They would also be well advised to mitigate their credit position by diversifying in relation to both airlines and jurisdictions. This does, of course, assume that all lessors will get the opportunity to participate, which is by no means a certainty. Market anecdotes suggest that whilst the pool of suitors for airlines offering SLB transactions is often vast, many airlines are now seeking to limit the number of participants in their RFPs to enable them to run a manageable process.
The inevitable consequence of a competitive process is that lease provisions are being more keenly fought over and lease rate factors are being pushed down. We understand that even lower calibre airlines are now requesting half-life return conditions and shorter lease terms. Lease provisions and pricing are an area where lessors need to exercise caution. It is all very well offering “rock bottom” lease provisions and pricing now, but experience suggests it can be difficult to improve them again even if the market picks up (or at least, there will be a time-lag before lessors can do so).
We are very excited to welcome our new Paris team, as we have now been joined by partner Victoria Westcott and counsel Florent Rigaud, as well as senior associate Elaine Porter (joining shortly) and associate Abdullahi Mohammed.
This new team brings significant diversification to Reed Smith’s global asset finance capability, adding particular expertise in working with lessors to our existing strengths on the financing and airline sides. Our colleagues in Paris are currently the only English and French law qualified team practising in both the English and French languages, giving us a unique ability to serve our clients not only in the United Kingdom and Europe, but throughout the Francophone world.
Florent’s client base includes a number of operating lessors, and he has kindly agreed to be interviewed for our blog – we hope you enjoy! Continue Reading
Australians are well known as keen travellers, and our geographical isolation has meant that air travel has long been a very important part of this aspect of our national identity. Perhaps unusually, this has grown into a strong local affinity for certain models of aircraft – especially the big ones. But is this set to change?
The Boeing 747, for example, has long held a special place in Australia’s heart. It was a 747 that set the then record for a flight carrying the largest number of passengers while evacuating 673 people from Darwin after Cyclone Tracy in 1974, it was the 747 called ‘City of Canberra’ that set the new commercial aircraft distance record in 1989 when it flew non-stop from London to Sydney, and it is a 747 immortalised by Paul Kelly in ‘Sydney from a 747’, still sometimes played while a flight circles the Harbour as it waits to land.
The current favourite is the A380, which was so quickly embraced and absorbed as part of our travelling lives. Its rock star status is such that Qantas have recognised that passengers may book particular flights just to fly in this model, with a section on its website headed ‘How do I book the Qantas A380?’ setting out the particular flight numbers and routes on which a passenger can be (almost) guaranteed to fly on one. It has become one of our familiar characters, and for a lot of expats the A380 is one of the important constants of our trips home. There is nothing like the feeling of stepping off QF2 in Sydney on Christmas morning – material worthy of the Qantas Christmas advert.
The Invasion of Low-Cost Airlines
The transatlantic market, typically the most lucrative aviation market in the world, is under attack.
Research carried out by Telegraph Travel in conjunction with OAG, the air travel analysts, has revealed the pressure being put on traditional carriers by low-cost, long-haul disrupters.
Telegraph Travel asked OAG to compare this winter’s transatlantic capacity with 2016/17. In terms of total seats on offer, British Airways remains the biggest player for flights between Europe and North America, but the low-cost airlines are closing in fast.
BA raised its available number of seats by 1.1%. Norwegian, on the other hand, raised its transatlantic capacity by 111.4%, whilst WOW Air has grown by 31.1%.
Other legacy carriers such as Delta, United Airlines and Lufthansa, the second, third and fourth biggest transatlantic airlines, are also treading water having increased capacity by just 3.2%, 2.6% and 2.9%, respectively. Meanwhile, Virgin Atlantic has cut its number of seats resulting in a drop of 3.2%.
Nevertheless, a few premium airlines are bucking the trend. Iberia and Aeroflot both increased capacity by more than a quarter this winter. In addition, Emirates added almost 50,000 transatlantic seats, driven largely by the introduction of flights from Italy and Greece to North America.
The gender pay gap has been an issue of much public discussion in the last year. The latest figures show that the overall national average for the pay gap between male and female full-time employees stands at 9.1%. However, the aviation sector is one which has seen particularly negative results.
With new rules regarding pay gap reporting in place and the April 2018 reporting deadline looming, this issue will not be going away – rather, it is likely to become more prominent as more results are published. For example, EasyJet’s announcement of its figures in late November generated a number of headlines, many of which summarised the results as ‘EasyJet admits 45% pay gap between women and men’.
What a year it has been! At the start of 2017, Reed Smith had no aviation finance team. We have now established teams in London, New York and Abu Dhabi (and we’re not done yet!). Across the board we have structured and closed a diverse range of transactions for lenders, lessors and operators alike (and we still have one or two to go as we all race for the finishing line that is the Holidays).
Throughout, we have been grateful for the support of our clients who have stood by us during our respective moves, and we are excited to close the book on the first phase of our project as we move into 2018. The new year will see the continued development of our practice and will, we hope, give us the opportunity to form deeper partnerships with our existing clients as well as to establish new partnerships to support additional players in the aviation industry.
Establishing a new practice from scratch is inevitably somewhat turbulent for all involved and this got us thinking about the other turbulence and interruptions experienced on a sectoral basis by the industry this year. With this in mind, it seemed like a good moment for us to pause and take stock of 2017. Continue Reading
As we open our Advent Calendars each December, thoughts inevitably turn to Christmas, the New Year, and to what the next year will bring.
But this year we are also looking 12 months ahead to New Year 2019.
Why? Because January 2019 will see International Accounting Standard (IAS) 17 replaced by International Financial Reporting Standard (IFRS) 16.
Now accounting standards may not be the most festive or exciting of topics, and to many of our readers that may sound like an insignificant change. Indeed the legislators themselves have said that it should cause “only minor changes from the current standards”. However, the general consensus is that in the aviation industry, the effects may be more profound. Continue Reading
What to do if you are an aircraft leasing company struggling to lease your aircraft? For one lessor, Dublin-based Amedeo, the answer is to create its own “virtual airline”.
Amedeo has apparently been struggling to attract new lessees for its fleet of Airbus A380s – it currently has 12 under management and a further 20 on order.
They believe the best way to utilise the company’s assets is now no longer to just lease the aircraft to airlines but to operate them directly under what they believe could be a new model for air transport. Continue Reading
The airline leasing sector has already had an incredibly busy year with major moves towards consolidation in the form of the purchase of lessor AWAS by DAE in April.
Leasing plays a significant role in the aviation sector as a whole – with leased aircraft estimated to account for 40-45% of new aircraft purchases. Consolidation is not the only factor driving change and shaking up the sector. Major players are increasingly noting competition from new Chinese entrants to the market. Many more have benefited from Chinese investment.
Chinese lessors are making real waves in the sale and leaseback market by the terms they can offer for new aircraft purchases. We know that the Chinese lessors we work with have ambitious plans, not least because of China’s huge domestic market (industry estimates put demand at around 6000 new aircraft over the next two decades).
What opportunities and challenges does this influx of new entrants pose for the aviation industry as a whole? Continue Reading
The Reed Smith aviation team have returned to their offices in London, New York and Hong Kong but memories of this year’s Airline Economics “Growth Frontiers” Hong Kong conference are still fresh in the memory (or as fresh as they can be with jet lag!).
Hong Kong’s Grand Hyatt was packed to the rafters with all of the leading industry stakeholders. Many of the key players we spoke to touched on recurring themes that seem to be the focus of the industry’s attention. For those of you who missed out (or who enjoyed the conference too much…) here our some of the Reed Smith team’s key take-away points, scribbled down on the long flight home.