Aircraft continue to be tradeable assets because the needs they serve cannot be met in any other way.
Renewable energy finance.
More money was invested in renewable energy in the first six months of 2021 than the first half of any other year, according to tracking by BloombergNEF. But analysts still say “immediate” funding is needed to reach global net zero emissions goals. More money was invested in renewable energy in the first six months of 2021 than the first half of any other year, according to tracking by BloombergNEF. But analysts still say “immediate” funding is needed to reach global net-zero emissions goals. Globally, $174 billion of new investment was made in renewable energy capacity, equity raised by specialist companies, and related areas, like storage, through June – a 2% increase from the same period last year. The total was, however, 7% less than the record set for a six-month period in the second half of 2020. Analysts noted that a decline in investment in new renewable energy projects was offset by record private ($28.2 billion, +509%) and public ($5.7 billion, +111%) fundraising.“Renewable energy investment has withstood the effects of the global pandemic, in contrast to other sectors of the energy economy where we have seen unprecedented volatility,” said Albert Cheung, head of analysis at BloombergNEF. “However, a 1.8% year-on-year increase is nothing to write home about. An immediate acceleration is needed if we are to get on track for global net zero.”
Albert Cheung, head of analysis at BloombergNEF.
“However, a 1.8% year-on-year increase is nothing to write home about. An immediate acceleration is needed if we are to get on track for global net zero.”
Task Force on Climate Change Financial Disclosure.
Investment Institutions pull back on aircraft financing.
1. Most aerospace banks and many investment institutions have pulled back from the aircraft asset backed securities market. Some do continue to trade aircraft ABSs because of the high yields they offer relative to prime investments.2. The air transportation industry has significantly less access to conventional funding for current operations and climate change technology.3. Airlines cannot rebuild equity or refinance debt for operations, and then raise the funds needed to get gas turbine engine emissions reducing technology. 4. International financial institutions have been providing loans and grants to the governments of low- and middle-income countries for the purpose of pursuing capital projects for decades. 5. The objective is to develop similar structures in alternative asset financing markets capable of overcoming the credit limits that conventional banks must apply to lending. 6. New funding sources are slowly entering the market. Some are the same organizations calling for airlines to address their aircraft emissions. 7. These funding sources are informally referred to as green banks. 8. They take the form of collective Investment Schemes (CISs).9. CISs are schemes, in whatever form, including an open-ended investment company, in pursuance of which members of the public are invited or permitted to invest money or other assets in a portfolio, and in terms of which, (a) two or more investors contribute money or other assets to and hold a participatory interest in a portfolio of the scheme through shares, units or any other form of participatory interest; and (b) the investors share the risk and the benefit of investment in proportion to their participatory interest in a portfolio of a scheme or on any other basis determined in the deed. 10. Green banks have different lending and grant aid criteria for climate change, emissions technology projects.
11. Greening financing is provided by a range of investors, government agencies, wealth funds, pension and insurance companies, multinational corporations, civil society groups and their constituents.
12. Shannon Aero is developing relationships with green banks, specifically for the purpose of building funding capacity for green aviation technology projects.13. The goal is to fund the investments needed to reduce aircraft carbon emissions, and to build sales channels for monetizing the carbon credits generated. 14. Green Climate Funds (GCF), will become the main vehicle for financing airlines and airports in developing nations, to mitigate and adapt to climate change.
15. Research, shows that the risk to the airline industry recovery, from the Pandemic, is that it overlaps with carbon crunch deadlines, just over the horizon. 16. Air travel recovery cannot wait for the climate crisis to pass because, a recession is likely before the crisis ends. The higher central banks increase interest rate to defeat inflation, the great are the chances for a recession.
Green banking. Green banking is any form of banking that benefits the circular economy based on use, reuse, repair, remake, and rebuild. It offers financial instruments suited to meeting the requirement to transition aircraft to CORSIA Net-Zero emissions standards.
Green banks.Green banks finance the transition to clean energy, for industries transitioning from CO2 emissions to zero CO2 by 2050.
Green Finance.Financial inputs and regulations for green and non-green airlines are the same:1. Aircraft CO2 emissions.2. Fleet replacement. 3. Inconsistent profits and losses.4. Ancillary revenue growth.5. Persistently low passenger yields.6. Control of costs, labor, fuel, insurance, and cost of funds.7. Equities, bonds, & derivatives funding.8. FX exposure.
Green bonds / thematic or esotheric bonds. The possibilities for social or thematic bonds are endless. Around $200Bn of green bonds were issued in 2021.
Aircraft are net polluters making it difficult to issues thematic bonds until viable engine technology meets emissions standards, which are higher than in the CORSIA scheme, in a timely manner.
Nevertheless, investors foresee high returns from aircraft once they offer positive climate “impacts.” After factoring in the pros and cons of green bonds, borrowing will be cheaper, and the bonds will enhance the reputation of airlines, lessors, and banks, as the pool of buyers grows.
Asset Backed Securities.
Asset-backed securities (ABS) finance pools of familiar alternative asset class types, such as aircraft leases, auto loans, credit card receivables, mortgages, and business loans.
Financial institutions pool multiple aircraft loans into a single security, to create asset-backed securities, that are then sold to investors.
These contractual obligations to pay often rank senior to a borrower’s traditional debt obligations, reducing ABS investors’ exposure to the borrower’s financial health, in this case the aircraft lessors. ABS also has many other investor-friendly features that may help protect against loss and improve liquidity, such as tranching of risk, overcollateralization, and diversity of payers in each underlying pool.
Some ABS and other forms of structured credit continue to offer higher yields than similarly rated corporate or municipal bonds.
The principal job of ABS investors is to analyze the cash flows from these obligations, to assess value and the possibility of loss, rather than aircraft investment decisions. cross asset classes, and require multiple approaches to analyzing and comparing them to other alternative assets.
An example would be to compare the value of airline equity yields. It is the ratio of earnings to the equity invested. The ratio can be used because it measures return on an investment's equity portion. Another way to look at the decision is to think in terms of “certainty” and “uncertainty” with respect to price.
Except for a default by the US government, US Treasuries are perceived as having a high level of price certainty because they offer a fixed income stream, without risk of capital loss, if held to maturity. In contrast, equities suffer from price uncertainty. They do not provide fixed cash flows and future prices are unknown. Investment grade credits fall between treasuries and equities because they have an income stream coupled with default risk.
Funds-In-Trust (FIT).World International Property Organization (WIPO), is a self-funding agency of the United Nations, with 193 member states. WIPO has long-term relationships with a number of key donor countries. These donor countries provide Funds-in-Trust (FIT) to finance technical assistance and human capacity building projects to developing countries and countries with economies in transition.
It is difficult for airlines to increase aircraft productivity in todays market.
Increased aircraft productivity is achieved in three ways with:1. More flight departures per day, either through shorter turnaround (ground) times or off-peak departure times.2. Longer stage lengths (average stage length is positively correlated with increased aircraft utilization as measured by block hours per day.3. More seats in same aircraft type (no first class seating and/or tighter “seat pitch.” (ICAO).
Airlines can improve performance in other ways such as monetizing CO2e.
Start by setting a science-based emissions target or acarbon pricing initiative.
Over five hundred major corporations have committed to science based targets setting greenhouse gas emissions in line with the global goal to keep warming to below 2 degrees C (3.6 degrees F).
In addition, 45 national and 25 subnational jurisdictions have implemented or scheduled for implementation a carbon pricing initiative. Put a price on your carbon (or ask your government to do it). An internal carbon price is a financial mechanism that favors and helps catalyze the transition to low-carbon business models based on four approaches: a. shadow pricing, b. internal carbon tax, c. internal cap and trade and; d. implicit carbon price.Advocate for win-win public policies. When businesses set ambitious, science-based greenhouse gas (GHG) targets, governments have more political support to pass ambitious climate policies, creating “ambition loops” that fast-track clean, low-carbon economic growth.Use your brand. Companies have incredible power of public persuasion through their branding and marketing activities.
Sustainable Brands have set an example by adopting “system-wide brand influence companies ” as one of five key characteristics of corporate sustainability roadmaps.
Brand leverage. Companies can leverage their brand in private conversations with policymakers, investors, suppliers, customers and employees. Speaking out publicly and privately in favor of climate action can feed momentum behind systemic change and contribute to a culture that values the environment.
Given the poor financial performance of the airline sector, green banks will likely be a significant source of funding, for transitioning aircraft as a green asset class.
Airline financial performance.Airlines are overleveraged. ICAO says that airlines reported revenue losses of $372Bn in 2020 and $324Bn in 2021. The IATA portion of thoses losses were $137Bn in 2020, $51.8Bn in 2021, and a $12Bn loss is forecast for 2022. (IATA). Airlines have to pay back much of the $110 Bn in government aid received during the Pandemic.
Asset Backed Security market.
Aircraft ABSs raised $60Bn-plus between 1996 & 2019.
Companies of scale, such as insurance companies, purchase senior-level debt tranches to ensure low risk and steady cash flow. Mutual funds and ETFs normally purchase junior-level debt tranches with higher risk and higher interest payments.
If an individual investor invests in a mutual fund with junior debt tranches, that investor takes on the proportional risk of default.
Aircraft, unsecured consumer loans, and whole business ABSs accounted for two thirds of esoteric ABS issuance in 2018. Research conducted by Guggenheim Investments, an asset management firm, found that from 1994 to 2013, CLOs experienced significantly lower default rates than corporate bonds. Only 0.03% of tranches have defaulted from 1994 to 2019. Even so, they are sophisticated investments, and typically, only large institutional investors purchase tranches in a CLO. Aircraft ABS issuances in first half of 2019 reached issuance volume of 2018, one of the strongest years of issuance on record for aircraft ABS. The strength of investor enthuasism for the market was driven by factors not present in 2022:
1. Growth in the aircraft ABS market.
2. Ongoing strength in air traffic growth.
3. Continued good lessor credit performance, and
4. Syndicated equity transaction structures that increased investor sponsorship of aircraft ABSs.
Some raised questions qbout the marketed economics of syndicated equity investments, investor interest contributed to the growth in the aircraft ABS market.
According to Guggemheim, in the 1st half of 2019: "Investor demand for investment-grade credit is increasing competition for aircraft ABS." The demand caused: "caused pricing spreads to tighten and new issuance to match prior volume records. Investors shrugged off negative press relating to the growth and evolution of the CLO and leveraged loan markets, and investment-grade CLO spreads tightened 10–20 basis points throughout the second quarterb of 2019. Refinance and reset activity increased marginally as pricing spreads reached 30% of 2018 volumes.
New issuance. According to Guggemheimvolumes remained strong in Q2 2019, on pace to match 2018’s record. Investors favored short maturity, senior tranches of middle-market CLOs, because of compelling risk-adjusted value."
Transition risk to lessor fleets.
The momentum towards greening the economy implies transition risks that represent new threats to financial stability for airlines and airports
The risk of a run on brown assets [oil, coal, gas], similar to that seen during the subprime mortgage crisis, can have widespread destabilising effects.
Proposals on the agenda include a liquidity backstop with an access fee proportional to carbon emissions, and a borrowing rate independent of emissions. It argues that such a facility will help green the economy, re-establish production efficiency. An orderly reallocation of capital to a greener economy can lift long-term growth and facilitate the post-Covid recovery.
Eric Jondeau, Benoit Mojon, Cyril Monnet 16 April 2021. VoxEU.org – CEPR’s policy portal – was set up in June 2007 to promote "research-based policy analysis and commentary by leading economists". Vox's audience consists of economists working in the public sector, private sector, academia and media. It is widely read (the site receives about a half million page views per month).
March 2022 update - Russian-Ukraine War & need to raise interest rates to curb inflations, increases recession risk. Timing the recovery of air transportation may now depend on how fast & high rates have to go. We have witnessed an extraordinary decline in both short- and long-term advanced economy real interest rates, since 1998, from levels of around 6 to 8% to close to zero. In many countries, nominal interest rates are already mildly negative. There are several explanations: (1) an increase in the propensity to save, driven by demographic developments, (2) the integration of China into global financial markets added downward pressure on global real interest rates, (3) though disputed, a fall-off in profitable investment opportunities was followed by a fall in lthe demand for funds to invest, (4) a lower propensity to invest in the wake of the financial crisis. Though the downward trend in rates has been remorseless, it would be unwise simply to assume that the trend will be maintained.
Policy interest rates are constrained because they are mildly negative. Japan illustrates how easy it is to slip into a deflationary trap – and how difficult it can be to escape it when rates are at current levels. Consequences.A world of low interest rates may encourage investors to search for high yield, leveraged transactions, using aircraft. This risks a speculative asset-price based boom and busts cycle.
Funding strategy.The Federal Reserve policy is to keeps the fed funds (interest) rate within a 2 to 5% range to maintain a healthy economy, as it was between 2011 and 2015. Today, the rate is at 1/4 to 3/4%. The core business of investment institutions (banks, insurance companies and pension fund) is to trade in prime assets such as US treasuries but with rates as low as zero, they also trade in higher risk, higher yield, alternative asset classes such as real-estate and aircraft, as well as securities in industries classed as brown assets, oil, coal, gas and cement. Investment institutions buy higher risk securities to improve overall returns because they are subject to fiduciary duties of prudent investment, including the duty to diversify.
Risk adjusted financing.
Risk-adjusted return on capital (RAROC)* is an investment risk-measurement based on reaching a target profit. Depending on the method used, the risk (the amount of economic capital consumed) calculation can be expressed as a number or a rating for aircraft asset backed securities. A RAROC formula would be: (Income - operating expenses - expected operating loss)/ Economic capaital). The floor for risk tollerance is measured in comparison to US Treasuries, because that is assumed to be the virtually risk-free investment. As years passed from 2009 to 2019 aircraft RAROC risk was falling. As the rate for borrowing from the Fed increases to defeat inflation, the the risk-adjusted return on aircraft will be higher.
* RAROC measures the risk-adjusted financial performance of an investment. It is used to compare the profitability across alternative asset classes. Different measures yield slightly different result. For many investment institutions the risk adjustment of capital is based on the capital adequacy guidelines set by the Basel Committee.
The investor has to decide the aircraft risk that must be accepted to reach a desired rate of return.
The aircraft investor has to detertmine the reward or return that makes it worthwhile taking the risk of buying an A320, B737 or any other aircraft. There are several methods of risk-adjusting performance, such as the Sharpe ratio and Treynor ratio.
Interest rate trended down and the aircraft ABS market took off.
Interest rates are Fed management tool - in time will revive industries like aircraft, airlines & airports.
What if?If a legislative and regulatory deadline is set for the grounding of aircraft because no viable engine emissions technology solution is found, would they become "wasted assets?"
Investment Law - could it offer breathing space for financing aircraft powered by gas turbine engines?
Many experts see climate change as a one-way risk for banks that fund brown assets. While some large institutional investors have called on all companies to embrace a transition to a low-carbon economy, such a transition will occur only with the invention of scalable, as-yet-unavailable breakthrough technologies, that render fossil fuels uneconomic, and/or, require a level of cooperation among nations, that has no historical precedent.
While deeply unpopular, preparation for a high-carbon state of the world in 2050 is important for investment institution beneficiaries. Insurance policy holders and pension receipients left unprepared for a future high-carbon world are likely to have little sympathy for investment advisers who gambled on a low-carbon environment, by misjudging a green future. As courts have stated with respect to ERISA fiduciaries, “Good faith does not provide a defense to a claim of a breach of these fiduciary duties; a pure heart and an empty head are not enough." Brown assets for prudent investors. Alon Brav and J.B. Heaton. Duke University. September 21, 2021.
Thepossibility of a transition to a low-carbon economy is an aspirational one, especially in the air transportation market, but institutional investors are not hired to think wishfully on behalf of their beneficiaries. For as long as this state of affairs persists, investment institutions cannot divest from alternative investment assets such as aircraft, or bown assets such as fossil fuel, oil, goal and gas.
If the world does not successfully transition to a low-carbon economy and investment institutions have divested from alternative asset classes, it would create considerable legal and reputational liability for institutional investor fiduciaries.
To fail to invest in brown assets and aircraft, would ignore the fact such investments would be valuable, if the world fails to transition out of the high-carbon economy. Investment institutions have already figured that out. The Paris Agreement was approved in 2015. Since then, sixty major investment institutions have invested $4Tn in the fossil oil industry because it offers the high returns that investment law requires them to do! The $60 Bn invested in aircraft between 1990 and 2019,
No matter how serious a social problem is – and climate change is an extremely serious social problem, and no matter how risky it is for investment managers – the immense weight of investment law requires them to maximize risk-adjusted financial returns and that includes the returns from stagmatized assets. Aircraft may also provide a valuable hedge against the costs of climate change if the world fails to transition.
Capital markets & funding options.
Capital markets globalization led to a convergence of accounting systems. One is used in the USA, the UK and the Netherlands. It focused on equity financing. Investment institutions in France, Germany, and Japan focus on bank financing. The latter is focused on profits, equity funding and equity returns. The latter is based on bank lending, minimizing tax liabilities, minimizing declared profits, and tax assessment compliance.
As the Delta Air Lines results for 2021 show, cash flows can be boosted if programs are introduced that allow the passenger to pay-as-you-go over a year or so plus the kind of benefits that low cost carriers charge for.
1. Redeploying retained earnings.
2. Reducing working capital.
3. Sale of surplus/onused assets.
4. Reducing stock inventory levels.
5. Deferring payment to suppliers.
6. Debt collection
7. Discount selling hold over seasonal stock.
IMF funding instruments Oil as an Exogenous Shock Event. Fuel represents around 25% of an airlines operating cost. Airlines, together with the travel and tourism industries, would benefit from an oil funding facility, similar to the ones provided by the IMF between 1974 and 1976. Financial support was offered to countries as supplementary financing to address balance of payments problems and the adverse impact of higher oil prices that follows the the oil price shocks. Loans under the Oil facilities were repayable in 16 quarterly installments 3–7 years after disbursement. A generalallocation requires a finding by the IMF that there is a global need for additional liquidity.Allocations of SDRs are made to participants in the SDR department (currently, all IMF membersare participants) in proportion to their quotas in the IMF. The size of a country’s quota takes into account its GDP, current account transactions, and official reserves. Quotas determine members’ capital subscriptions to the IMF, voting power, and the amount of financial assistance available to them from the IMF. Quotas are normally reviewed, and possibly adjusted, every five years.
IMF - Concessional Assistance - Exogenous Shock Facility.The IMF created Concessional Assistance funding in 1976 updated as follows. 1999. PRGF fund. Poverty reduction and growth facility. Provides concessional funding assistance to low-income countries.2006. ESF. Exogenous shock fund. Provides assistance for low income countries facing sudden and exogenous shocks but do not have a PRGF arrangement.2008. RAC. Rapid access component. Provides emergency assistance in a single disbursement.2008. HAC. High access component. Provided in multiple disbursements subject to reviews when more resources are needed. IMF Quota. Evolving Concessional assistance loans are provided at a subsidized interest rate to countries that qualify, such as : 1. Extended Credit Facility (ECF). 2. Standby Credit Facility (SCF).3. Rapid Credit Facility (RCF)(2010).4. Rapid Financing Instrument (RFI) (2012).Fuel represents around 22% of an airlines operating cost. The hardest hit countries directly, and indirectly, the carriers registered within their borders, together with the travel and tourism industries, would benefit from a project similar to the ones provided by the IMF between 1974 and 1976. Financial support was offered to countries as supplementary financing in response to the oil price shocks, to address balance of payments problems and the adverse impact of higher oil prices. Loans under the Oil facilities were repayable in 16 quarterly installments 3–7 years after disbursement.
Banks that will continue to finance alternative asset classes & those that will divest from oil.
Mark Keane."In 2019 Delta in partnership with American Express began offering new products and services to stimulate traffic. Buy now, pay later option for air fares or Pay-as-you-go, is the idea that you can book your flights now, and pay for them in installments, interest free. The traveler pays the plan amount each month plus a fixed fee. The passenger can qualify for access to over 1,200 airport lounges in more than 130 countries worldwide, as well as complimentary benefits like room upgrades, free breakfast for two, late checkout, early check-in, and hotel credits. The cost of the ticket is charged to the passenger’s AmEx card. (Source INC.). The carrier can charge higher fares and boost revenues, provided the carrier and the passenger have a co-branded American Express card. Delta reported, full year 2021 adjusted pre-tax loss of $3.4Bn on adjusted operating revenue of $26.7Bn. At year end of the company had $14.2Bn in liquidity, including cash and cash equivalents, short-term investments, and undrawn revolving credit facilities. Delta expects the program to bring in as much as $7Bn of revenue by 2023." Mark Keane.