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Commercial Banks and the Availability of Capital

There are various funding sources in the aviation space, each having distinct attributes, ranging from alternative lenders to banks and capital markets. Currently, the industry is experiencing a significant level of liquidity, with an increased number of players, particularly new alternative lenders entering the market. Commercial aviation proved its resilience, as it returned quickly to profit a mere two years after the start of the pandemic, hence finding a renewed appetite from existing and new investors. While capital markets remain highly supportive, there has been some dampening of opportunity in the context of elevated interest rates and geopolitical uncertainties. However, the complementary nature of various sources of capital continues to fill gaps in financing needs, ensuring a steady stream of capital for the industry.

Looking more closely at commercial banks, they play a vital role in the aviation finance ecosystem, supporting fleet transactions at airlines and lessors by lending against aircraft and other aviation assets. The market remains dynamic and competitive, shaped by macroeconomics and exogenous factors. Recently, the inflationary context and associated higher interest rates have raised the cost of capital and borrowing, with commercial banks having to adapt their value proposition to retain their relevance and attractiveness in aviation finance.

Changing Market Conditions

Off the back of the pandemic and the geopolitical climate, inflation rose. To curb the rise in prices, interest rates were revised as part of monetary measures throughout the world. Consequently, airlines and lessors, faced with higher costs of capital, have been diligently reviewing and restructuring their balance sheets to increase their financial flexibility and immunity to any prospective future Black Swan events or downcycles.

Another dynamic in aviation finance has been the limited flow of new aircraft deals, owing to constrained supply chains and limited new aircraft deliveries. As a result, new delivery financing is tracking below historic levels, resulting in increased competition for deals. This competition not only arises from commercial banks and the debt capital market but also from airlines and lessors’ own balance sheets as they pursue their own financial policies of deleveraging. Airlines and lessors are increasingly using cash reserves to finance transactions, aiming to increase their unencumbered asset base to target investment grade (IG) credit ratings.

To meet rising passenger traffic demand, airlines have turned to the midlife market for capacity, with financing moving to older assets. In response, banks have adapted their offerings to serve this segment, with deal structuring becoming more sophisticated with varying transactions being presented, ranging from aircraft undergoing passenger to freighter (P2F) conversion, part-out or an aircraft less one engine.

A Shifting Market

There is some evolution at play in the banking sector. For one, we see more mature banks, which managed to navigate the COVID-19 market unscathed and are thus comfortable in their ability to comprehend the market dynamics, delving further down the risk curve. This is the case with MUFG, which acquired DVB Bank’s aviation platform on the eve of the pandemic. Despite the high level of exposure, through astute portfolio management and capital allocation, only nominal losses were recorded. In turn, this increased the bank’s confidence in the platform’s ability to manage risks in a challenging operating environment.

Established banks are now widening their considerations to include nonrecourse transactions and greater balloons and are taking a greater position on the assets’ liquidity. Some less mature bank players may opt to take a more cautious approach, as uncertainties prevail in terms of market dynamics. Those players will remain focused on the biggest credits, new technology equipment and full payout, though margins for such scarce deals have suffered from a race to the bottom and substantial oversubscription. Banks’ credit appetite, product offerings and regional participation differ greatly based on their physical presence. In Europe, where the core of the aviation finance banks and some of the most sophisticated ones are to be found, they remain agnostic in terms of the geographic spread of their support — albeit supporting national champions — and tend to be more aggressive on deal structuring. While some European banks have reduced or exited their aviation exposure, we have conversely seen new entrants. Some lenders have reduced their aviation loan exposure in the context of corporate sustainability reporting (CSR). It remains that key European airlines require an increasing role from commercial banks to support their sustainable aviation initiatives, for example via sustainability-linked loans. Key European banks form part of the various sustainability working groups, for instance, the Center for Climate-Aligned Finance, IMPACT and the Net-Zero Banking Alliance.

In APAC, the banking sector is highly fragmented and tends to serve local airlines, aside from first-tier global credits. The exchange rate between the U.S. dollar and the Japanese Yen was not propitious to Japanese Operating Lease with Call Option (JOLCO) transactions in recent times, but the market has returned. Looking ahead, we expect demand for JOLCO equity to continue to outstrip supply, with banks providing debt support at aggressive pricing. Chinese banks are growing increasingly prominent, with a strong focus on the high-growth domestic market. Other Asian banks, especially from Japan and Korea, have started venturing into the midlife space.

In the Middle East, the regional banks in the Gulf Cooperation Council (GCC) finance almost solely local credits, which are often supported, explicitly or implicitly, by large state shareholders with well-defined strategic objectives. It is the region’s ambition to grow its aviation sector. Around half of the financing is via Sharia-compliant products with the other half fulfilled through commercial debt.

In the U.S., regional banks remain America-centric, more so as America is the largest market in the world in terms of fleet size and home to large lessors. Some of the largest multinationals are doing cross-border transactions and are successfully attracting global liquidity into syndicated transactions. Structured capital markets are also a significant capital-raising avenue for American airlines and lessors, with transactions like asset-backed securities (ABS) making a strong return in 2024.

MUFG as a Case in Point

MUFG is somewhat unique in its ability to cover the full spectrum of financial solutions, thanks to its extensive in-house expertise, ranging from insurance, coverage and origination, financing, advisory, structuring, capital markets, asset management, aviation research and credit functions. It also has a truly global team, with offices in London, Amsterdam, Los Angeles, New York, Singapore and Tokyo, fostering fluency in the various regional intricacies associated with aircraft deal structuring. The Global Aviation Finance Office (GAFO) has US$15 billion global aviation finance exposure, covering in excess of 1,200 aircraft among 200 clients. The franchise has grown from strength to strength and, in 2023, MUFG committed over US$4 billion and arranged 70 transactions. In 2023, it provided constructive and bespoke solutions to efficiently support the market, including a bridge financing for AviLease and Minsheng Financial Leasing, an engine JOLCO for BBAM and Volaris, a secured term loan with Sun Country Airlines and Air India. More recently, MUFG supported Asterion Industrial Partners with the lease financing for two widebody aircraft, Viva Aerobus with a cross-collateralized portfolio of aircraft and engines, Elevate /Porter with a secured term loan and CALC’s inaugural warehouse facility.

Concluding Comments

The aviation finance industry benefits from a diverse pool of funds from capital markets to commercial banks. As the market evolves, banks are providing comprehensive financing solutions to support the industry more efficiently than ever. Relationship banking has become paramount, with plain vanilla transactions giving way to more intricate deal structures requiring deep expertise and a client-focused approach.

The collective experience of banks and their respective clients steering through the recent Black Swan events has solidified the greater than ever importance of relationship banking within aviation finance. As Tye Holmes, MUFG Aviation’s head of origination for EMEA, commented: “Relationship banking is not just lending against aircraft; it is about having the in-house capabilities to understand our clients’ problems to tailor the most suitable financing structures. MUFG is more than a balance sheet lender; we are a solution provider.”