Jetrader - May/June 2010 - 17

aircraft coming into the marketplace based on projected long-term growth in air travel. By way of contrast, a lower-barrier sector such as cargo vessel manufacturing has resulted in a situation of literally dozens of new shipyards competing for market share. This results in the potential for highly unpredictable and unjustiﬁable changes in supply such as the 25 percent increase in bulk carrier vessel capacity incurred in 2009.4 This increase was far in excess of long-term growth rates in demand and occurred at a time when the U.S. and Europe were in recession. SkyWorks’ proprietary analysis of aircraft trading values shows that trading prices are interdependent upon relative growth rates in supply and demand. Hence the aforementioned situation where supply growth is severely out of synch with underlying demand levels can result in extreme volatility for asset values.5 The duopolistic competitive situation of large aircraft manufacturing on the other hand should not generally result in supply increases that grossly exceed long-term growth in underlying demand. As such, the prohibitive barriers to entry in the commercial aircraft manufacturing sector are of beneﬁt to the aircraft ﬁnancier. This should outweigh any impact attributable to the generally weak state of ﬁnances for many commercial airlines provided that a lease or secured loan is conservatively structured. A further fundamental in support of aircraft ﬁnance relates to the intrinsic nature of commercial aircraft. In particular, commercial aircraft receive favorable tax advantages in many jurisdictions, and also have an embedded inﬂation hedge. The tax advantages are generally attributable to the fact that the economic life of a commercial aircraft typically spans two to three decades whereas it can often be depreciated for tax purposes in less than 10 years. This results in the opportunity for an owner of such an asset to receive a signiﬁcant deferral in taxable income. Inﬂation protection arises from the fact that aircraft have signiﬁcant inputs of raw materials and labor, each of which will customarily increase with general inﬂation. History has shown this effect with highly inﬂationary periods resulting in higher than average increases in both selling prices of new aircraft as well as residual values of used aircraft. Given that the state of the market is such that a lessor can generally use “uninﬂated”

residual value assumptions when calculating required rental rates, there is virtually a free inﬂation hedge currently embedded in this asset class. These two intrinsic fundamentals are very timely when considering that a number of the developed economies are pursuing extraordinarily aggressive monetary policies to avoid entering a deﬂationary spiral. At the same time, many of these nations are mounting unprecedented ﬁscal deﬁcits. The monetary phenomenon that is underway is causing increasing concern about the specter of inﬂation being unleashed. Likewise, the current ﬁscal deﬁcits that are being compounded by rising entitlements and decreasing tax receipts due to aging demographics portend substantial increases in marginal tax rates for the wealthy in the near future. A comparison of current times to recent U.S. economic history perhaps draws greatest parallel to the 1970s. That era represented a golden age for aircraft leasing, as inﬂation protection and tax shelter were highly valued investment attributes. Given the parallels to such period that may be forming we may even see the re-birth of a broad tax-based aircraft leasing market.

consistent proﬁtability, the aircraft ﬁnance sector already made a shift from a creditbased market to an asset-based market during the previous downturn.7 The assetbased orientation for the aircraft ﬁnance sector has in turn resulted in relatively limited distress heretofore in the most recent downturn. Provided the economic recovery continues to gain strength, it is likely that market observers will look back and see that the aircraft ﬁnance sector performed notably well through a period of unprecedented economic and ﬁnancial challenges. This favorable track record combined with the attractive fundamentals discussed hereunder portends a resilient aircraft ﬁnance market to come in the near future.
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Conclusion
Though much uncertainty persists throughout the global economic and ﬁnancial system including the potential for further increases in oil prices and the need for the aircraft manufacturers to carefully weigh production targets6, the current dynamics of the “new normal” favor the aircraft ﬁnance sector. Although the airline sector itself still has yet to establish broad and

Excluding loans guaranteed by export-credit agencies. 2 It should not be entirely surprising that the negative savings rate in the U.S. was unsustainable. 3 For example, the ability to use pilots interchangeably on aircraft that share a “common type rating.” 4 Source: SSY Consultancy & Research Ltd. 5 Aviation is of course subject to large short-term ﬂuctuations in demand from time to time that will generally result in ﬂuctuations of aircraft trading prices; however, it does not face large swings in supply that would further exacerbate asset price volatility. 6 Although few competitors in large aircraft manufacturing results in a rational supply environment, a counterpoint is that such manufacturers must be cautious in setting production rates as it is difﬁcult to make large reductions in production output due to unique supply chain complexity. 7 This is evidenced by the fact that maximum terms for secured aircraft loans provided by commercial bank lenders have shortened to a maximum of 10-12 years on average.

Jetrader 17

Jetrader - May/June 2010

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