No Man’s Sky: Business Aviation’s Promising But Uncertain Future
by Phil Neuffer November/December 2015
The business aviation industry experienced growth amid major change in 2015, and is positioned to continue moving upward in 2016, even if the industry will look different than it did just 12 months ago. Stonebriar Commercial Finance’s Michael Amalfitano discusses the past year and what can be expected in the future.
Since the Great Recession, the business aviation industry, like just about every sector of the financing world, has been on the comeback trail. In 2015, the vertical dedicated to business jets took another step forward and now appears to be sailing high above the storm clouds of the mid-to-late 2000s.
Of course, the goal now is to keep that momentum going into 2016 and the years beyond. Despite some challenges on the horizon, the industry is set up to do more than just keep the status quo, even if it takes on a largely different look in the years to come.
Speaking of new looks, industry veteran Michael Amalfitano made a major shift in his career flight pattern this year, joining up with newly created Stonebriar Commercial Finance in July after architecting the global aircraft business of Bank of America Merrill Lynch for over two decades. With such a vast background in the business aviation space, Amalfitano is certainly qualified to speak on the developments of the industry over the past year and to forecast what’s next.
According to Amalfitano, annualized GDP growth rate in the U.S. through the second quarter of 2015 was reading at 3.9%, though economists have since revised their economic forecasts downward in the third quarter (closer to 3%). That is still a marked improvement over the 2.7% recorded in 2014 and represents a solid gain. It also means good things for business aviation, which is an industry that thrives when GDP is growing at around 3% or better.
“GDP is stable and growing and when that happens, so too is the business aviation sector,” says Amalfitano. “GDP is forecasted to grow an average of 3%. That’s a very positive sign.”
In addition to the health of the overall economy having a positive impact on the industry, the fact that demand is increasing, especially in the all-important North American market, is another factor that Amalfitano points to as a driving force behind 2015’s success.
“North America clients’ demand has significantly increased, and that represents 57% of the world’s fleet,” says Amalfitano. “So when the largest segment of the market is growing, that does well for growth.”
Bracing For Impact
Of course, no discussion of equipment finance of any kind in 2015 would be complete without touching on GE Capital. GE’s decision to sell off most of its financial arm sent shockwaves through all sectors, and business aviation was one of them. According to Amalfitano, his industry was prepared for the tremors of April’s announcement.
“GE has been retrenching and reducing and restructuring its aircraft portfolio for the past five to seven years,” says Amalfitano. “So the fact that they’re finally exiting with the announced sale, I think, is going to be less impactful from an industries perspective because I think we’ve already digested that change.”
Even though the industry was at least ready to brace for impact, the GE Capital news is still causing a great deal of strife and shift. Pricing margins have widened and opportunities are now plentiful for new entrants in the market.
“We saw the pricing gapped 30 to 40 basis points just overnight as a result of their announcement. The reason for that is there are no real players in the commercial finance space,” says Amalfitano. “You’ve also seen some new entrants in the market that are non-bank type lenders, ourselves included here at Stonebriar. You’ve heard a lot of private equity firms that have emerged in this segment. That is also a healthy sign, when there are new entrants coming back to the marketplace. In summary, I think you’ll find that as the industry continues to stabilize and grow, the niche players will emerge and continue to provide the type of financing that is needed for all client profiles, aircraft profiles and finance product profiles as we look forward.”
Adding to the opportunities for new entrants into the business aviation space is the fact that many banks are backing out of the segment, primarily due to the increased regulation brought on following the financial crisis. The most pressing of these requirements in Amalfitano’s estimation is Basel III.
“Basel III is going to not only impact the SIFI’s like CIT, but all of the major banks because of the capital regulations that have been placed upon them. This impacts the cost of capital, the price of bank loans and the price of leases, especially for aircraft and other long-life assets that are impacted by the term and impacted by the level of liquidity required to offset the risks that are weighted on term loans and credit facilities,” says Amalfitano. “If they don’t make adjustments to pricing that Basel III requires, then this will result in a lower return unless the asset quality increases and the term of the loan decreases.”
This has led to a lack of interest in residual value leases by banks, leading to more loans being proposed. While a boon for independent lessors, this trend may hurt banks that remain active in the business aviation industry.
“There are many more loans being proposed, and low margins have eroded because there are more and more lenders racing to the bottom on price to compete for the same aircraft investments,” says Amalfitano. “So, when you don’t have a lease product to differentiate yourself and you’re competing head-to-head with all of the major banks in the space [with] lots more capital coming to market chasing the same deals, bank margins go down.”
While looking backward is always instructive on how to prepare for the future, Amalfitano and the rest of his peers in the business aviation industry must now look to 2016. In general, prospects are bright, with Amalfitano forecasting continued small but steady growth, driven by the U.S. and North American markets.
Aside from demand driving increased growth, there are a host of other factors that contribute to the sunny outlook.
“I also think there is an abundance of capital liquidity in the marketplace. U.S. banks have unused capital that needs to be deployed to credit products that drive loan and asset growth,” says Amalfitano. “This has nothing necessarily to do with business aviation specifically, but when banks have unused capital, they’re looking to invest that capital and so they look for areas of industry segments that are growing and I think business aviation for this year and the years ahead have attributes that lead them to believe that they can be viewed as growth areas.”
Amalfitano also sees cash becoming less of a dominant player in the sector as another reason to feel optimistic.
“Historically, cash has always been over 50% of business. In the financial crisis, we saw cash increase to an all-time high of over 75% of the market,” says Amalfitano. “What’s nice is that we’re starting to see that historical trend again and it’s starting to become more in balance as more and more financing of aircraft has continued to improve. So that’s a good sign for the future as well.”
In addition, corporate buyers are returning to the marketplace with pent-up demand brought on by the financial crisis. During that period, corporate buyers kept their aircraft longer, but they are now returning to a more stable marketplace and looking to turn over their aircraft.
Regulations and Aging Aircraft
With new buyers comes new aircraft, but that is not necessarily a good thing for all portions of the industry. New models of aircraft are being created, but that in turn erodes the value of existing aircraft.
Amalfitano warns of an oversupply of business aircraft and a growing older fleet.
“The OEM’s are pressured to achieve quarterly sales objectives and profits, and they continue to produce far too many aircraft models,” says Amalfitano. “So that’s a challenge and new derivative models adversely impact the value of earlier models.”
Aside from just making new models to meet demand, OEM’s must also create new models to keep up with rapidly improving technology and tightening regulatory requirements. However, those same advances in technology have led to stronger maintenance programs that keep older aircraft flying safely for longer periods of time. While such programs maintain the utility value of such aircraft, it does nothing to help their depleted economic value due to the entrance of newer derivative models.
“There is clearly an abundance of business aircraft in the marketplace. And they often serve very similar missions. And so as a result, when there is a collapse or sharp decline in aircraft values like we just experienced post financial crisis, these aircraft no longer have price points that distinguish them in the marketplace,” explains Amalfitano.
“As we look forward to 2016 and beyond, some would say that we need an actual replacement cycle to take place, meaning that some aircraft that are the oldest of age need to be parked and fully replaced,” says Amalfitano. “That has yet to happen in business aviation.”
Regulations, as already discussed, and government involvement are also things to keep an eye on, as they could have major impacts on the business aviation industry in 2016 and beyond. In particular, the uncertainty surrounding the FAA reauthorization, possible sequestration and the threat of a government shutdown all loom as potential creators of turbulence in the near future. While the FAA received a temporary renewal of funding for operations by way of the Airport and Airway Extension Act of 2015, the extension will end on March 31 of next year. A government shutdown could be even more imminent, with the extension of a “continuing resolution” funding all government services lasting through December 11. While these are somewhat worrisome deadlines, Amalfitano feels that they are sufficient to maintain the strong growth that the business aviation industry has experienced of late.
“While the long-term aviation package is still needed for the FAA, we know that the temporary bill will ensure that things that are related to safety, things that are related to the aviation services that provide services to the industry overall will be uninterrupted,” says Amalfitano. “Now we can focus on the passage of larger resolutions so that the funds will continue for the development of business aviation marketplace going forward.”
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