Jetrader - March/April 2010 - 13

provisions of this nature survive, this will clearly temper institutional behavior. I do not have much faith that in the near term governmental bodies will get this right; we are destined for more regulation, and perhaps we should be. That companies could issue what was, in effect, an insurance policy—i.e. a derivative (credit-default swap)—for some instrument without maintaining some level of capital is astounding. In effect, this was 100 percent leverage, and it was off the balance sheet. For companies that routinely rely on the capital markets, borrowing will become more difﬁcult, loans will be more costly, advance rates will be lower, ﬁnancial covenants will be more onerous, and increased amounts of capital requirements for loans, derivatives, etc., will make achieving a satisfactory return more challenging for ﬁnancial institutions and ﬁnancing more costly. All but the strongest ﬁnancial companies will discover that the ﬁnancing that was so readily available three years ago is nonexistent. In fact, I suspect that even the strongest companies will have challenges, as well. this industry. The newer ABS structures, primarily the non-dividend variety, are performing reasonably well compared to the structures developed in the ‘90s. The newer ABS structures must incorporate more ﬂexibility if they are to provide an enduring solution to aircraft ﬁnance. There will be no “wrapped” structures because the credibility of the monoline insurance companies is shot. Hence, there will be greater amounts of collateral protection and, as noted, higher pricing in the structure. The question will then become, “Can the ﬁnancial community generate sufﬁcient returns to provide capital to ﬁnance aircraft?”—capital that will be attractive to an airline or the lessor. challenged in greater numbers, and, generally, aircraft values will not be as frothy. This will be aided by the reduced number of ﬁnancial institutions providing capital to the industry. For the next 24 months, it will be exceedingly difﬁcult, if not impossible, to raise any amount of ﬁnance on the commercial terms that have been available during the past ﬁve years. Despite this, I was quite amazed at the recent successful execution of several airline EETCs given the fundamental, underlying credit quality of the various issuers. Creativity Loves a Crisis New ideas emerge when old ones fail. The ﬁnancial crisis has changed the perception of risk—regarding companies, collateral valuation, proper pricing and transaction structure. The ﬁnancial crisis has challenged our beliefs in the competence of the models that were portrayed as forecasts for inherent risk. John Kenneth Galbraith once said, “The only function of economic forecasting is to make astrology look respectable.” In summary, this time it’s different. The 2008-2009 crises present less intuitive understandings of the changes in ﬁnance that lie ahead. Many of these changes will be shaped by new regulation that is still being debated. Many of the changes will be as a result of back-tobasics fear. However, make no mistake— there will be a new normal. The New Normal and Aircraft Values Finance and the ease of ﬁnance enhance the value of all types of assets, from refrigerators to real estate. Conversely, the opposite is true. Easy access to low-cost wholesale capital during the pre-crisis era caused many banks to lose sight of sound lending. Capital is now acknowledged as a critical strategic asset and needs to be managed as such. Hence, banks will be more cautious in the structure and provision of loans. This will additionally be impacted by the new regulatory environment. As such, aircraft-asset values will be under greater scrutiny. Appraisers will be Capital-Intensive Industry Challenges For a capital-intensive industry, some companies will face severe challenges in funding their operations. At a minimum, pricing will become more expensive. Lease and loan commercial terms will be more onerous, and this will result in increased costs. This will ripple through the industry in the form of higher rates and ultimately will either be passed to the consumer or absorbed by the airline’s already thin margins. I suspect that the new normal will look more like the 1970s or early ‘80s when capital was scarcer. However, much of this will be deﬁned by the regulation that will be put in place. Governments will want to avoid the notion that any one ﬁnancial institution is too big to fail. This will clearly shape the new normal. The capacity required to ﬁnance the 20,000-plus forecasted new deliveries of the next 20 years will undoubtedly require that the ABS market returns to a degree of health; there are currently some signs of it. These structures provide the proper asset-liability (ALM) match and the ﬂexibility to weather the extreme cycles in What Could the Future of Aircraft Financing Look Like? • Fewer banks would participate in the ﬁnancing of aircraft or PDPs. • Higher bank funding costs that would represent a protracted period of wider spreads. • An ABS market, currently in disarray, could be restructured and re-priced with greater levels of equity and higher pricing. • Unsecured capital markets could be very cautious and ascribe very little value to the quality of a parent company that does not guarantee its subsidiaries obligations. • The ECAs could eventually be far more selective about those companies that they guarantee. • Appraisals could be viewed with much greater skepticism. Jetrader 13

Jetrader - March/April 2010

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