AIRSHOW-High returns and demand lure investors to funding planes

Tue Jun 18, 2013 5:30am EDT

* Major shift in sources of financing ongoing

* Private equity, Asian banks becoming more active

* Some insurers "in the starting blocks" - Fitch

* Move driven by high returns, strong demand outlook

By Andreas Kröner and Maria Sheahan

PARIS, June 18 (Reuters) - The only way to make a small fortune in the airline industry is to start with a big fortune, so the joke goes.

But in a low interest rate world, the returns on offer for taking a bit more risk are exactly what's driving new players such as private equity firms and Asian banks into the $100 billion market for aircraft financing.

The extra competition is helping to keep financing costs at record lows, welcome news for airlines as they spend billions of euros on new aircraft to replace ageing jets with more fuel-efficient, modern planes.

"With interest rates low, everyone is looking for investments with relatively high returns. Airlines offer that because the industry is seen as a bit more risky than others," Michael Nosbuesch, global head of aviation and rail at German state development bank KfW, told Reuters.

Sector bankers said interest rates on secured aircraft loans were now between 2.5 percent and 3.5 percent, and for unsecured loans, rates may approach 10 percent. While lower than in the past, that is still above returns on staple investments such as 10-year German government bonds, which yield about 1.5 percent.

Airlines are highly sensitive to economic swings, but the order books of planemakers like Airbus and Boeing remain filled on hopes for future demand from emerging markets.

Traditionally, the money for new planes has come from commercial banks, capital markets, aircraft leasing companies and government-backed export credit agencies (ECAs).

But with investors looking for ways to put an abundance of cash to work, and European banks slimming down their balance sheets to comply with new regulation, the aviation sector is drawing a more diverse crowd.

"There is a massive shift going on in the aircraft financing market right now," said Kostya Zolotusky, managing director of Capital Markets Development for Boeing Capital Corporation (BCC).

ONLY JUST IN KINDERGARTEN

Airlines are relying less on ECAs because they have become too expensive, and as commercial banks in Europe and the United States retrench, other providers of finance have stepped in to fill the gap.

These include Japanese banks like Sumitomo Mitsui Financial Group and Mitsubishi UFJ Financial Group, private equity companies and more capital markets investors, and the reshuffle is still ongoing.

"We are entering a golden age of aviation finance," Denis Nayden, a managing partner at private equity firm Oak Hill Capital Partners, said.

Oak Hill is involved in the aviation sector via aircraft leasing company Avolon, which it owns jointly with Cinven, CVC Capital Partners and Singaporean sovereign wealth fund GIC. Some financial investors also offer aircraft financing loans directly, via special funds.

Fitch analyst Craig Fraser said some insurers were already active in aviation, while others were "in the starting blocks".

Leasing company Doric Lease Corp, which made a splash at the Paris Airshow on Monday by announcing plans to order 20 Airbus A380 superjumbos, has raised money from insurers and pension funds by placing some aircraft in two new companies that it listed on the London Stock Exchange .

Doric has also issued enhanced equipment trust certificates (EETCs) and closed-ended funds to finance aircraft purchases, and its chief executive, Mark Lapidus, told Reuters there was a wide range of options for financing the new A380s.

"As far as raising equity, that would come from institutional investors who are looking for the sort of profile that we have been achieving with past transactions," he said.

According to specialist aviation think-tank Ascend, aircraft leasing has defied volatility to show remarkably stable returns, helped by the fact that, in tougher times, airlines are more likely to lease planes than buy them outright.

BCC has forecast Japanese banks will account for a greater share of financing in the future, as will capital markets.

"We are in kindergarten in terms of what is possible with capital markets," said BCC's Zolotusky, whose unit arranges financing to support the sale of Boeing products and services.

"We are anticipating a lot of new products coming to market until we settle into a form that is more common to the market."

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