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Global airline finance called a "bubble"

Monday, March 31 15:00:09

Some of the yield-hungry investors pouring money into the financing of aeroplanes are likely to make losses, as they have pushed interest rates down to levels that sometimes do not reflect the risks, a leading lender to the sector forecast.

Ireland is a major global aviation finance hub, second only to the United States in aircraft leasing and trading activity.

According to Aviation Finance magazine, in the past year, it is estimated that financing of the order of $20 billion has been undertaken through Ireland, mostly through the channel of its aircraft leasing companies.

Able to borrow money themselves at rock bottom rates, banks and investors are hunting for asset classes where they can make a higher return. With record numbers of aircraft on order from planemakers Airbus and Boeing, many have been drawn into meeting the surge in demand from airlines for loans.

"There will be money lost in this sector", said Bertrand Grabowski, board member responsible for aviation finance at Germany's DVB Bank, the largest bank lending to the industry excluding groups whose loans are backed by government guarantees.

"Markets are desperately looking for opportunities to deploy liquidity, causing bubbles everywhere - that is not specific to the aviation sector", he added.

Just a few years ago, tougher capital regulations triggered fears that airlines wouldn't find the funds for their expansion plans, as European banks scaled back lending.

But Asian banks helped fill the void and now the sector has drawn interest from longer-term investors such as private equity and pension funds, which are hoping to boost low returns from other assets such as government debt. The abundance of financing has led to a slide in the profitability of loans.

"(Credit) margins will continue to head south. Industry-wide they are down about 100 basis points over the last 12 months for the best names," Grabowski said.

"For some banks who actively support their local airlines in Asia or South America, pricing is becoming more a function of liquidity than of risk. They are offering loans for up to 50-60 basis points less than globally active competitors."

An outside shock such as a rise in oil prices or a political crises such as Russia's annexation of Crimea could disrupt the aviation industry, affecting borrowers' ability to pay back loans, as well as creditors' willingness to lend, he said, adding DVB was ready to take advantage of such a situation.

"We are waiting for the next crisis. We love volatility and will deploy liquidity when others won't. Our best years have been crisis years like 2008, 2009 or 2011."

DVB is planning to hand out more than $2 billion in aircraft financing in 2014 and does not expect its own profitability to suffer as it shifts focus to second-tier airlines, especially in Asia, which accounts for 25 percent of its loan book.

DVB is targeting smaller airlines such as Korean Air , Cebu, Philippine Airlines, AirAsia, Lion Air, Jazeera Airways and Tiger Airways.

"We finance assets, not issuers. And if an airline is unable to repay its loans, we seize the asset and redeploy to another operator", Grabowski said.

While the aviation industry is likely to continue to see its strongest growth in Asia in the long term, investors should be prepared for setbacks, Grabowski said.

He said short-term demand could turn out to be lower than expected, which could force a rethink of orders placed for narrow body aircraft - such as Airbus' A320 and Boeing's B737.

"I would not be surprised if 20-25 percent of the current order book would evaporate or be redeployed in other regions, if possible," Grabowski said.

Ireland's importance in the sector is evidenced by the roster of leading industry players who have chosen to operate out of Ireland, including GE Capital Aviation Services (GECAS), Sumitomo Mitsui Banking Corporation (SMBC), International Lease Finance Corporation (ILFC), Ansett Worldwide Aviation Services (AWAS), Avolon, Industrial and Commercial Bank of China Ltd. (ICBC), CIT and Orix.

In all, nine of the world's ten largest aircraft leasing companies are located in Ireland and recent figures put the number of aircraft managed in Ireland at 3,500 or 50pc of the entire global fleet of leased aircraft.

The number of people employed in the industry is estimated at over two thousand (direct and indirect) - many, if not most of them in highly skilled and well paid jobs - and the sector contributes over E300 million in corporation tax to the Irish exchequer annually, according to a report from Conor Keaveny, Partner and Sean Murray, Partner, Dillon Eustace, Dublin. with additional reporting from Reuters