Navigating Headwinds: Business Aviation Finds Optimism in Turbulence
by Phil Neuffer November/December 2016
With uncertainty once again swirling around the business aviation finance industry from both international and domestic fronts, Stonebriar’s Michael Amalfitano discusses falling asset values and an over-supply of aircraft while still finding the silver lining in the storm clouds.
The last calendar year has been marked by turbulence. From the gutter war of a Presidential election to Brexit to the continued downturn in the energy sector, there has not been much stable ground to be found. Even above the ground, uncertainty rears its ugly head as the business aviation market feels the effects of challenges and threats both within its own industry and from the outside as well.
Taking Stock of 2016
Despite the current environment, there is a strong positive feeling about the business aviation finance industry according to Michael Amalfitano, executive vice president and senior managing director of Business Aviation for Stonebriar Commercial Finance.
Amalfitano points to a number of reasons for a generally positive impression of 2016. First, even with a lower annualized GDP growth rate during the year, hovering near 2%, Amalfitano says there has been increased buying and selling in the pre-owned business aircraft markets. This has been especially true in North America, where healthy U.S. corporate profits and personal wealth, coupled with aging fleets and lower prices for used aircraft have led to increased demand. That increase has made it possible for more regional and local banks to invest in small and midsize aircraft loans, while the larger banks and commercial finance companies continue to invest in larger aircraft.
The current level of capital liquidity in the market is also high, Amalfitano says, since U.S. banks have idle capital that needs to be deployed in credit products to drive loan and asset growth.
However, even among the pleasantries in 2016, there were still some troubling headwinds. Demand may be higher, but it is beginning to level off as current operators hold onto their aircraft for longer periods, opting for seven, eight, nine or even 10-year life cycles rather than the traditional four and six years.
Additionally, with asset values falling rapidly, consumers are attempting to upgrade to newer and larger equipment but for lower cost, which has led to this uptick in the demand for pre-owned aircraft. This added volume of trades for pre-owned models has caused a buildup in inventory as well as declining transaction prices and residual values, which have resulted in soft market conditions. These trends are having a negative effect on the business aviation industry, including the related finance industry, as cash and finance sensitive buyers are looking to other forms of private aviation such as charter, fractional, jet card or club membership rather than ownership and leasing.
That doesn’t mean that there is not a market or a desire for lease products for business aviation. It’s just that most banks are no longer offering traditional lease products despite the high demand. Amalfitano says that banks are finding it more difficult to provide the type of lease products customers may be looking for due to tightening of bank credit standards and regulatory capital requirements. That is a positive development for business aviation non-bank finance providers.
Concerns Across the Globe
As the calendar turns into 2017, the business aviation finance industry will have plenty of opportunity but will have to reach those prospects by overcoming a number of obstacles.
One of the more prevalent problems the industry will continue to face into 2017 is an over-supply of business aircraft on the market. Due to technological advancements and regulatory requirements, new generation derivative models are being produced by the OEMs, but that is having a negative impact on the value of their earlier models. This has led to an overall weakening of manufacturer’s new aircraft pricing discipline as OEMs work hard to balance production levels.
Even as OEMs continue to produce new aircraft models, shipments have not risen. According to the General Aviation Manufacturer Association, airplane shipments fell by 4.5% in the first half of 2016. Amalfitano says this may be another symptom of current owners and operators holding onto existing aircraft for longer periods of time, unable to upgrade out of their existing devalued aircraft. In 2017, the challenge for business aviation finance companies will be continuing to lease and finance aircraft given falling values, fewer deals and relatively flat demand.
That market demand will increase in the years that follow, however. Amalfitano suggests that demand for businesses jets will begin to pick up in 2018 due to sustained growth that is expected for global business travel spending.
Aside from demand itself, a number of global factors have weighed down the industry and will likely continue to do so. Uncertainty in the global macroeconomic environment brought on by political instability, international conflict, terrorism, low commodity prices and the decline of the energy sector have combined to form an amalgamation of uncertainty for most industries including business aviation finance.
Looking back at 2016, the UK’s decision to exit the European Union, commonly referred to as Brexit, is an international incident that will have an impact on financing of all kinds, including business aviation, even if that impact is not yet entirely clear. Amalfitano says the immediate near-term effects were generally constrained to currency volatility, reduced liquidity and pricing changes, among others. What exactly Brexit will mean in the long term is less certain, but it is clear that Brexit will have lasting global effects in many sectors.
“This appears to be more of a long-term issue, which may create further market, economic and political uncertainty for consumers and employers and volatility in the financial markets,” Amalfitano says. “There may also be a potential impact to contract law, choice of law, vendor and supplier contracts and other trade agreements. The UK may have taken a step backwards from globalization which may have substantial implications for growth, corporate profits and assets for the region.”
Incidents abroad are not the only things affecting the international market. For example, as the U.S. dollar has strengthened, it has become more expensive for emerging market customers to acquire aircraft and more difficult for those customers to obtain financing. Bring on the Horizon
For now, Amalfitano expects that the current market will remain the norm in the near future. That means 2017 will likely mirror 2016 with uncertain health of the industry and declining assets values due to a demand versus supply imbalance.
However, there are indications that the current market, which is in a more moderate or even declining condition, will pick up in the next 10 years. In fact, a forecast from ReportBuyer suggests that the global business jet market will be worth $33.8 billion by 2033, growing at a CAGR of 6.86%. While Amalfitano does not believe these projections are indicative of the current market, he does think there are reasons to be optimistic, citing the inevitable reemergence of global economies and the ongoing entrance of new and technologically advanced aircraft into the market, spurring demand.
“The business jet market may also experience a major technology led transformation with the era of supersonic business jets becoming a possible reality by the mid-2020s,” Amalfitano says. “A number of industry OEMs are actively pursuing research and development programs aimed at development of a range of supersonic flight technologies capable of enabling feasible supersonic flights while at the same time meeting regulatory requirements.”
While such developments may be years off, Amalfitano still has a strong positive feeling about the industry, anticipating continued growth of the commercial finance sector for the business aviation industry in 2017, even as challenges loom.
“Being a private lender in the commercial finance space, Stonebriar Commercial Finance is taking advantage of the market dynamics and investing aggressively in business aircraft,” Amalfitano says. “Our market strategy is to grow across the non-investment grade, public corporation, private company and individual sectors within the middle market segments offering clients more creative and innovative, secured collateral structures (asset-based) to acquire, finance and lease business aircraft.”