Since last October Joe O’Mara has been in New York, Singapore, and Dublin meeting dozens of aviation leaders. O’Mara, head of aviation finance with KPMG, has been working on the Aviation Leaders Report 2023: New Horizons, and the process involves interviews with chief executives, bankers, rating agencies and analysts covering aviation leasing, airlines, and finance, an industry where Ireland is at the forefront.

It is the sixth report in a series published by KPMG in conjunction with Airline Economics; however, as the pandemic recedes, it is the first report in three years where O’Mara has been able to do many interviews in person.

The report includes insights from leasing heavyweights such as Aengus Kelly, the chief executive of AerCap, Andy Cronin, the new chief executive of Avolon, and Peter Barrett, the chief executive of SMBC Aviation Capital. It also includes contributions from airline entrepreneurs like Conor McCarthy of Emerald Airlines, ratings experts like Betsy Snyder, a director with S&P Global Rating, and bankers such as Greg Lee, global head of transportation banking with Goldman Sachs.

It is the fourth time I’ve interviewed O’Mara on the Aviation Leaders Report. The first time was in January 2020 just before the airline business entered a period of unprecedented crisis as Covid-19 closed the skies and halted travel. In this wide-ranging interview, O’Mara talks about the recovery in 2022, and why he is cautiously optimistic for the year ahead.

O’Mara also discusses a diverse range of topics including asset values, sustainable aviation fuel, the outlook for freight and the emergence of new aviation start-ups.

We began by discussing the outlook for aviation.

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Tom Lyons (TL): What is the overall outlook for the aviation sector that emerges from this year’s report?

Joe O’Mara (JOM): Cautiously optimistic Tom. It’s always been a cyclical sector, but the last three years have thrown out challenges we have never seen before, and hopefully won’t again. To be in the position we are in now is a testament to the resilience of the entire industry.

Yes, there are macro headwinds, which I’m sure we will delve into, but most of the senior executives we spoke with believe the potential upsides outweigh the negatives. 

TL: In terms of airline performance and traffic, how has the market rebounded from Covid-19 in 2022, and what is the expectation for 2023?

JOM: From a financial perspective, global airline losses are on track to be $6.9 billion for 2022. That might not sound great, but when you are coming off a loss of $140 billion in 2020 and $42 billion in 2021, it represents a significant step forward. Even better news is that the industry is expected to return to profit this year. Given where we were not that long ago, it’s a remarkable turnaround.

From an air travel perspective, while the recovery continues to be very strong, there is a continued correlation between restrictions lifting and travel booming. 2021 saw the domestic markets bounce back first. Last year, the recovery extended to international markets where restrictions eased. Once the Omicron wave passed at the start of the year, we saw strong recoveries in international traffic across the intra-Europe, Americas and transatlantic markets. From Q4 on, we have seen really positive movements in Asia too. By the end of the year, international travel was at about 80 per cent of 2019 levels. As Asia, and China in particular reopen, that should drive a lot of growth this year.

One point worth noting is that while we understandably use 2019 as the base year for reference, we shouldn’t forget that populations and global GDP have grown since then. Air travel historically grows at a two-time multiple of global GDP growth. All going well on the restriction and global economic front, we should be in for really strong growth in the coming years.

War, interest rates and volatility

TL: There are some serious macro headwinds facing the global aviation industry from the dollar to inflation to rising interest rates. How well is the sector positioned to cope with this? 

JOM: For non-US airlines, the strong dollar has been challenging, given that fuel and financing costs are typically dollar denominated. That said, the level of pent-up demand has allowed many airlines to pass on costs – including those driven by inflation – on to the willing customer. We did not see that many airline failures last year.

On the leasing side, the interest rate environment has been a challenge. It was no great surprise to see rates rise over the course of 2022, but the swift pace of the increases, and the expectation that more is to come, have caused issues for the sector. Determining relative value with respect to debt terms, for both lender and borrower has been challenging. This uncertainty has been an impediment to some transactions progressing.

There should be a correlation between interest rate increases and a movement upward of lease rentals on aircraft. We saw a significant amount of capital come at the sector in the last couple of years, with the wall of liquidity that was out in the market generally. That overhang of capital has somewhat slowed that movement in lease rates, but we are seeing it now. This should hopefully help in seeing more transactions executed this year.

The interest rate volatility has brought home the importance of hedging and liability management strategies for leasing groups. Those that have a capital structure based on a stacked maturity over a longer-term period are better placed to manage the challenges of this environment. The volatile market has also highlighted the importance of being able to access multiple funding sources and the importance of growing and maintaining relationships across the financing field.

TL: Russia’s invasion of Ukraine has had a big impact on the industry from planes being seized to the price of fuel. How is the sector coping with this crisis?

JOM: The invasion has had a significant impact on the sector. In a sudden fashion, you had the effective loss by leasing companies of over 500 aircraft, with a value of around $10 billion. A small number of aircraft were recovered, but the vast majority were not.

It was interesting that the large-scale lessors had the ability to absorb the full P&L hit on the expected loss when we saw the $7 of publicised impairments across the leasing community. It again speaks to the resilience of the business model. Those lessors now have claims against various insurers that will likely run for years, but at least from a financial reporting perspective, the future outcome should all be upside.

The Russian challenges have led to issues for leasing groups in terms of the cost and the ability to insure their aircraft. They have also, to a degree, spooked some investors away from the space, heightening wider concerns around geopolitical risk for such a global business. I’d be hopeful the latter issue has faded, but clearly, the issue arising hot on the heels of Covid-19 was less than ideal.

Lease fleet expansion and asset values

Operating lease share of the commercial aviation industry. Source: Cirium Schedules / Aviation Leaders Report 2023: New Horizons

TL: What are the big trends emerging in relation to the aviation leasing industry?

JOM: There is lots to delve into here. First and foremost, the importance of leasing as a financing tool is continuing to grow. With a greater appreciation for the flexibility that leasing offers and with most airline balance sheets still challenged, lessors continue to fund an increasing number of new deliveries. That could be from aircraft leasing groups having orders direct from Airbus or Boeing or stepping in to fulfil an airline’s order and then leasing that aircraft back to the airline.

The percentage of leased aircraft has broken past that 50 per cent threshold, and it is likely that lessors are funding closer to 60 per cent of new deliveries currently. The dominant view from industry leaders is that over the medium term, the overall percentage is more likely to move towards the 60 per cent mark than to recede. That’s great for Ireland, given our strength in the sector.

Another consistent theme of the discussions I had was that the importance of scale is increasing. As the leasing product becomes more commoditised and as lessors seek to chase the most attractive aircraft and airline credits, scale will continue to be a differentiator. Those that can access the widest pool of debt and equity investors, that can control maintenance costs, that can maximise their purchasing power, are the ones that will be able underwrite larger transactions and grow faster. That should be good news for the investment grade lessor as they look to build market share. For others, it is about playing smarter and operating sometimes in more niche spaces.

Coming back to the financing market, investment grade lessors wisely filled their boots at very attractive rates in the unsecured bond markets over the course of 2021, and this, coupled with the interest rate challenges we spoke about, has meant very little issuances took place last year. This will likely change over the course of 2023 as the leasing community goes back to that very important and deep well. It will be interesting to see if those lessors can achieve similar spreads to 2021. One would be hopeful they will.

On the other side of the capital markets, the aviation ABS (asset-backed securities) market had a very muted year, having bounced back stronger and quicker than most had expected in 2021. A notoriously sentiment-driven space, the challenges arising from Russia, together with the interest rate environment and the broader challenges of the wider ABS market, meant only a handful of deals executed last year. There were some green shoots towards the end of the year, but it remains to be seen if this important financing channel will return in a meaningful way in 2023.

Stepping into the breach to fill some of this gap has been the alternative lender class. Predominantly private equity backed players have played an increasing role in financing aviation transactions and the expectation is that the importance of this funding source will continue to grow.

TL: What are you seeing in terms of asset value movements and the wider trading environment for aircraft?

JOM: There are some push and pull factors on the values side. The manufacturers have had significant issues with delays on deliveries, stemming from supply chain issues and challenges with new technology engines. This has meant we are seeing shortages in meeting the resurgent demand and that, coupled with the overall inflationary environment, has pushed asset values higher.

The counter to this is that some lease-encumbered assets may suffer from lease rate factors that reflected the previously low-interest rate environment. Depending on the remaining lease term, those assets may not get that upward bounce.

The wider trading environment has suffered from the manufacturer challenges, as larger lessors have delayed divesting plans as they are forced to wait on deliveries, and the hope is that this market can return to a greater level of efficiency over the course of 2023.

Lessors: the importance of scale

TL: In terms of movement among the top 20 aviation lessors in the world, who do you think are noteworthy movers either up or down? 

JOM: The significant mover last year was SMBC Aviation Capital, who completed the largest M&A deal of the year when they closed the acquisition of Goshawk in December. A near $7 billion transaction, it brings the enlarged group to over 700 aircraft and makes them the second-largest leasing group in the world.

Carlyle Aviation Partners also closed their acquisition of the AMCK portfolio last year. They are an example of a US private equity backed leasing group that has grown to significant scale in the last few years.

What is interesting about both the Goshawk and AMCK transactions is that they were platforms of significant size, with over 100 aircraft, that were absorbed into larger groups. It speaks to that overall point around the importance of scale. If you can’t get to investment grade status, with say a balance sheet north of $10 billion of assets, you could be a target for consolidation.

The prevailing wisdom coming out of this year’s interviews was that more consolidation was expected and that it is the medium size players that will be the more likely targets. We have seen in recent days that Standard Chartered have announced that their operating lease business is on the market, which supports this viewpoint.

There have been a couple of new entrants over the course of this year that clearly have big plans. AviLease is backed by the Saudi sovereign wealth fund, PIF, and they are looking to build out a significant platform and have a very experienced team assembled at the top. High Ridge, the US private equity backed group, has a number of ex-GECAS executives leading the way and it will be interesting to watch their growth over the coming year.

TL: Freight came to the rescue during the Covid-19 crisis, are those gains sustainable? Do you expect a leveling out of growth?

JOM: Freight has always been a spikey market, more prone to significant movements depending on how global commerce was performing. We did see a step change in growth as the pandemic hit and a boom in e-commerce followed.

That surge in demand has cooled somewhat, on foot of global economic challenges and the return of more widebody belly capacity into the market. However, it remains an attractive space, as reflected in both the order books of the manufacturers and in the challenges in obtaining passenger to freighter slots for conversion. There are mixed views as to whether there is a potential for oversupply to occur in the near term, but the broad consensus is that the step change in demand on the cargo side post-Covid will be materially sustained.

Start-ups, Ireland, and aviation

TL: Are you surprised at the number of aviation start-ups your report identifies? 

JOM: To be honest, not really. There is a very disrupted market, many incumbents have very stressed balance sheets. If you can come in and hit your mark operationally, there should be a great opportunity for you, given the demand pick-up we have spoken about.

That said, successfully running an airline business is incredibly difficult and the likelihood is that lots of those start-ups won’t be here in a few years’ time. That’s the nature of aviation though, airline failures are commonplace. Some years we see more than others, but it’s a fact of life in the industry,

TL: Where does Ireland sit competitively versus other geographies when competing for aircraft leasing investment?

JOM: We are still the market leaders. Ireland’s success comes down to talent, track record and the tax environment. The continued success is in large part down to a deep pool of local expertise that has developed in Ireland since the 1970s. This includes both highly experienced leasing groups in all facets of the business. from the C-suite, through marketing, finance, technical, legal and commercial teams. We also have a highly developed professional services infrastructure, which has grown here over decades, and which stands apart from competitor jurisdictions.

TL: From a policy perspective, is there more we could do to attract investment?

JOM: I spend a lot of my time talking to investors about why Ireland is the right place to be for aviation finance. We have a great story to tell, coming back to those talent, track record and tax points. The likes of Singapore and Hong Kong continue to push for market share, and we are also likely to see the emergence of challenges from the Middle East in the coming years as well.

I am optimistic about our continued place at the centre of the leasing world, but we need to appreciate we are talking about a mobile asset class and keeping that focus on developing talent and maintaining our general pro-business approach is critical to defending our world leading position. Given what our competitors can offer, a lower personal tax rate wouldn’t go amiss either, but I won’t hold my breath on that front.

The green agenda

TL: Of the dozens of aviation leaders you interviewed for this year’s reports, is there one or two insights or stories you would highlight?

JOM: I was lucky to have lots of interesting conversations with senior people across the industry and for those that have an interest in the sector, please do check out the videos as they really do give a good insight into aviation finance and the various respective businesses.

We struggle sometimes to get airlines to go on the record, so one chat I really enjoyed this year was with Conor McCarthy, founder of Emerald Airlines. A new post-Covid airline, they have had an interesting growth story over the last couple of years and they’re a great Irish business success story.

TL: ESG is an ever more important theme for the aviation industry. What are the key learnings from this year’s report in relation to SAF (Sustainable Aviation Fuel) and other green technologies?

JOM: The primary hope in the near term for carbon reduction in the sector is the increased use of SAF. However, there are significant challenges in terms of supply and cost. It’s an area that needs significant investment and also technological advancement in terms of developing synthetic SAF.

We have seen interesting partnerships being explored by some lessors in relation to SAF and a concerted and more joined up effort, across the entire sector, as well as from governments around the globe, is needed if SAF is to deliver anything close to what IATA (International Air Transport Association) hopes it will manage in the journey of carbon reduction. I’m reasonably sceptical on how much will be achieved in the next few years, but there aren’t many other immediate options. If governments are going to continue to legislate for the increased use of SAF by airlines, one would hope they will also start to better support its development and production.

Another angle on ESG that will be interesting to watch in the coming years is the impact that carbon emissions will play in aviation finance. In chatting to lessors, it’s clear that it is not currently materially impacting on their ability to raise funds. However, this agenda is clearly growing in importance, and it is reasonable to think that leasing groups which have newer technology, lower emission aircraft in their fleet will be able to gain a strategic advantage in attracting debt and equity investors in the near future. In fairness, most leasing groups are aware of this coming challenge and KPMG is working with a number of those groups now on the ESG strategies.

Click here to view the full Aviation Leaders Report 2023: New Horizon.

Further reading:

“As soon as restrictions lift, the pent-up demand is obvious and travel bounces back very strongly”

Battle-tested: Aviation’s terrible year, Dublin’s status, and the striking resilience of the aircraft lessors