BOC Aviation Pte Ltd, a wholly-owned subsidiary of Bank of China, recently became the first global aircraft operating lessor to issue offshore notes denominated in yuan. Wong Joon San reports.

In the next few years, with new peaks in aircraft deliveries on the horizon, financing for aviation industry is expected to become more difficult just as it becomes critical.

Large mainland Chinese aircraft lessors like ICBC and CDB Leasing will be tested over the next 12 months. The operating leases on their first aircraft will expire, then comes the tough job of putting them back out onto the market.

International experts cite particular concerns over stipulations written into the original leases that require airlines return leased aircraft in the same condition they were in when the airline took delivery.

Aircraft leasing affords airlines significant flexibility for planning their fleet composition and air routes to ever-changing market demand but leased aircraft also demand careful management. The requirement that the airplanes be returned to the lessor in original condition applies equally on short and long term leases.

"Without a proper technical maintenance plan and supervisory system, the redelivery process may create multi-million dollar losses for the carrier and the lessor," cautions FL Technics Engineering and Planning in a recent report.

If a leasing company examining a return aircraft uncovers evidence of poor document management by the airline during the lease period that airline could find itself having to pay extended lease time while the airplanes are brought back to standard. Airlines may be faulted for infrequent or non-systematical updates on airworthiness; failure to heed service bulletins; failure to care out sufficient maintenance; failure to replace airplane components. Neglect at this level can end up costing the airline a lot of money - but it also presents the lessor with losses as well.

Those factors raise the specter of aviation financing becoming more difficult in the next few years, just as new aircraft deliveries come to a peak and financing becomes more critical than ever.

Airlines that have fared badly, through neglect, during the initial lease period are likely to face very high financing costs.

"Whether the process is managed in-house or not, proper planning well ahead of the redelivery date is the key to minimizing any unpleasant situations," says the FL Technics report.

As international lessors, traditional commercial banks and credit agencies cope with the challenges related to redelivery of aircraft, BOC Aviation's entry into the market is timely. At a time when financing costs already are rising under the weight of global economic currents, BOC can offer alternative financing at competitive rates covering heavy maintenance, aircraft engines and most aircraft components whose manufacture is outsourced by airplane builders like Boeing and Airbus.

AeroStrategy, a part of IFC International, which provides management consulting services to aviation and aerospace sectors, predicts that by 2018, Boeing and Airbus will have "locked up 50 percent of single-aisle customers with integrated maintenance, repair and overhaul (MRO)".

The contracts will include airframe/component maintenance, rotable (component or inventory item that can be repeatedly and economically restored to a fully serviceable condition) logistics and/or fleet management.

Increasingly, the aviation industry is embracing the concept of "total technical support", with suppliers responsible "for pretty much all of the maintenance, asset and engineering support for aircraft." Bundling of component supply and asset management is more common in Europe, where maintenance alliances and areas of specialization have become well developed.

This sort of alliance is expected to spread to the Asia Pacific region in the near future, an area that BOC Aviation is eyeing.

BOC Aviation

Currently, BOC Aviation offers services to airlines and aircraft owners, including direct operating leases, sale and leaseback facilities and third party asset management. The company also provides comprehensive aircraft remarketing, structured finance and technical management services to airlines, banks and other investors.

Now BOC Aviation, thanks to fresh capital from its dim sum bond offerings in November, is able to expand aviation finance coverage, especially covering mainframes and other aircraft parts and components.

Through Bank of China, BOC Aviation can also arrange financing for airlines, on a standalone basis or as part of a wider package combining debt and operating leases.

"As the capital market is flush with cash, investors are looking at investments that offer good yields, before they close their books at the end of the year," says Shamshad Ali, a partner at UK-based PricewaterhouseCoopers (PwC), in a report, Aviation Finance.

Investors are keeping a close watch on what the US Federal Reserve is doing. With the Fed getting ready to wind down its third round of quantitative easing, which has provided low interest capital to the market since last year, rumors abound as to when this is likely to happen. Some expect the wind down to come at the end of this year. Others predict QE3 will hang around well into 2014, with some saying it may be as late as June before the Fed tightens up on easy money.

As such, when aircraft are delivered over the next three to five years, airlines will be seeking financing just as liquidity starts to freeze up after QE3 winds down.

PwC's interviews among aviation industry stake-holders reveal a wide expectation that financing costs will go up. That became apparent earlier this year with the aviation industry attracting new investors, who expect to face higher interest because they have no track record. Several banks from Japan and China, where many of the new orders have been placed, snapped up aviation assets. "We expect this trend to accelerate," says another partner with PwC, Neil Hampson. Airlines will be fighting for financing at the most competitive rates but they cannot go forward seeking financing when they place their orders. They are required to wait until the manufacturers deliver their aircraft.

"But, more of this will need to happen and airlines and lessors will need to be more inventive and work harder to find additional sources of funding and potentially develop new products.

"There have been recent attempts, for example the Doric II (UK-listed) Emirates financing vehicle and the German bond backed by an aircraft mortgage (a new product first used by Nord LB in July 2012 - the first European covered bond to be secured entirely on aircraft mortgages)," he contends.

Robert Martin, managing director and chief executive officer of BOC Aviation, is satisfied that going to the market was the right choice. "My company was assigned investment grade long-term corporate credit ratings of A- from Fitch Ratings and BBB from Standard and Poor's. "

On November 21, BOC Aviation raised 500 million yuan ($82m) from its second issuance of offshore yuan denominated bonds due in 2018 with a 4.5 percent annual coupon rate. The note's second issuance was over-subscribed by seven times issue value. Investors from Hong Kong snapped up 69 percent of the bonds, while those from Singapore bought 24 percent.

A week earlier, BOC Aviation raised 1 billion yuan through an offshore yuan denominated bond at similar terms. Orders for the 1 billion yuan issue came from 60 high quality, fixed income accounts, widely distributed geographically. The issue was oversubscribed by a factor of 3.5.

Hong Kong investors acquired 56 percent of the notes, 27 percent went to Singapore, 11 percent sold in Taiwan and 6 percent went to Europe and elsewhere. In terms of allocation, 53 percent were picked up by private banks and 26 percent to insurers and sovereign funds, 16 percent to asset managers and fund managers, and 5 percent to corporate investors and others.

Order for 25 aircraft

Earlier, during the 15th Aviation Expo China 2013 in Beijing, BOC Aviation announced an additional firm order for the purchase of 25 of the A320 Family of aircraft comprising 13 A320ceo and 12 A320neo jets. The order comprises A320 and A321 variants. BOC Aviation will make its engine selection later.

The order from BOC Aviation for 25 more A320 class aircraft comes less than a year after its previous order for 50, A320 class aircraft, confirming the fast pace at which the market requires Airbus' fuel efficient, single-aisle planes.

Martin explains: "BOC Aviation raised the 1.5 billion yuan from the capital market to reduce its earlier funding costs. Proceeds from the senior notes would also be used for the company's new capital expenditures and for general corporate purposes."

"Through this transaction, we can now not only lease and finance aircraft, but also (provide financial support to) the various supply chains supporting the manufacturers of aircraft," says Martin.

BOC Aviation is the leading Asia-based aircraft leasing company with a portfolio of 234 owned and managed aircraft operated by more than 50 airlines worldwide and another 101 aircraft on firm order.

The BOC Aviation portfolio is one of the youngest in the leasing business with an average owned aircraft age of under four years. The fleet is primarily based on the popular Airbus A320 family and Boeing Next Generation 737 series as well as the Embraer 190/195 family.

It also includes select wide-body types, such as the Airbus A330 and Boeing 777. Besides direct orders with manufacturers, BOC Aviation also grows its fleet via purchase and leasebacks with airlines.

Contact the writer at joonsan@chinadailyhk.com

(HK Edition 12/06/2013 page6)