Since mid-December, KPMG’s head of aviation finance Joe O’Mara has interviewed dozens of leaders in the aviation industry. It has given him a broad and unique insight into a sector that is of significant importance to Ireland. Among the people he interviewed are Aengus Kelly, the chief executive of AerCap; Peter Barrett, chief executive of SMBC; Helane Becker, managing director of Cowen; Kieran Corr, global head of aviation finance with Standard Chartered and James Meyler, leader of Orix Aviation.

The views of these leaders have fed into the fifth Aviation Industry Leaders Report 2022: Recovery through Resilience published by KPMG in conjunction with Airline Economics. When I spoke to O’Mara last year, Covid-19 was only a year or so old. It was causing havoc in a sector reeling from the greatest exogenous shock it had ever endured, resulting in a sudden collapse in global air travel.

Two years in and the bottom seems to have been reached. The sector is moving rapidly towards recovery. Global airline losses in 2021 will come in at $51 billion, which is a huge sum but much less than the record $137 billion loss in 2020. In this wide-ranging interview, O’Mara talks about the challenges of 2021 and the outlook for 2022 and the years ahead. 

Tom Lyons (TL): We’re now almost two years into the Covid-19 crisis. What do you think is the outlook for the aviation leasing sector in 2022?

Joe O’Mara (JOM): I’m pretty bullish on this, Tom. While the pandemic has been extremely challenging for aircraft lessors, the crisis has highlighted the resilience of the leasing business model. Large scale, well-run lessors have expertly managed their own liquidity challenges and been essential partners in supporting their airline customers through the crisis. This support throughout the past two years has deepened and strengthened relationships between lessors and airlines. 

Airline balance sheets have been decimated by the pandemic and most airlines will be severely capital-constrained for the foreseeable future. As a result, lessors have taken on a greater importance in funding new deliveries. 

The long-posed question of whether the percentage of leased aircraft can break 50 per cent has been answered and the question now is how high that percentage may climb. Either through their own order books or via the sale and leaseback channel, close to 60 per cent of new deliveries were funded by lessors in 2021. The prevailing view coming out of our report was that this is a level that could be sustained over the longer term. 

TL: How has the Omicron variant impacted the industry so far? And how has that been different to earlier variants?

JOM: Over the course of 2021, it has been a case of two steps forward, one step back in terms of managing the challenges of variants of concern, both with respect to Delta and Omicron.

What is clear across the board is that once restrictions lift, there is a strong bounce back in travel numbers. Delta and more recently Omicron gave rise to additional restrictions which put a dent in the recovery. However, what has been encouraging from the Omicron perspective is that we are seeing a quicker reaction to removing restrictions. 

I was really pleased to see our Government be more proactive in dropping the test requirement for vaccinated travel earlier this month. That was just over four weeks after we brought in the requirement in the first place and a huge improvement on what we had seen previously. 

The fact is, and this is acknowledged by the World Health Organisation, travel bans are not effective in controlling the spread of the virus. Willie Walsh, the former IAG CEO and current Director General of the International Air Transport Association (IATA), hit the nail on the head when he stated that any restrictive measured should be properly coordinated and risk-assessed, and where deemed necessary, should be time-bound and regularly reviewed. 

Coming back to Omicron specifically, given the level of cases, the other clear challenge is in relation to staff shortages. We have seen this result in thousands of cancellations as airlines, like most other businesses around the world, cope with cases and close contact issues. Hopefully, this wave will be the quick burn that most are expecting and will ultimately be the beginning of the end. 

TL: Where do you expect net losses to come in at for the entire sector and when do you expect it to make a profit again?

JOM: From a financial perspective, 2021 will bring global airline losses of $51 billion. While a significant improvement on the $137 billion loss in 2020, it will still represent the second-highest loss on record. 

The return to profitability is harder to predict. IATA’s current expectation is that losses should reduce in 2022 to around the $12 billion mark, but so much of that is dependent on how the virus evolves and what that means in terms of travel restrictions. 

It is also imperative that the Asian Pacific market, where restrictions have been the most onerous, returns to some kind of normal. On the positive side, the US market has generally been the key driver of global profits and the current expectation is that this market will return to profit this year. 

“Most of the large aircraft lessors have remarkably still been posting profits, albeit reduced profits, since the outset of the crisis.”

TL: Losses in 2022 are big for the aviation sector but at least the numbers are moving in the right direction. What has the aviation finance industry been able to do to protect its own profitability and try to avoid losses? 

JOM: Most of the large aircraft lessors have remarkably still been posting profits, albeit reduced profits, since the outset of the crisis. The huge levels of airline government support have been helpful in providing a buffer to lessors, but they also came into this crisis off the back of the longest-running growth cycle aviation had seen. The confidence that leasing maintained with the financial markets was also key, as it has meant continued access to cheap capital. 

At KPMG we work with pretty much all of the large leasing groups. In 2020 we spent a lot of time helping clients manage the crisis, through complicated lease restructurings and significant debt raises. What we have seen since the start of 2021 is really interesting projects focusing on growth and increased profitability, whether it is large capital markets deals, significant M&A activity or helping new entrants establish new leasing platforms in Ireland. 

TL: The report notes the number of airlines that went bust or restructured in 2021. There are not too many well-known airlines in there – do you expect the number of airlines going bust to fall again in 2022?

JOM: It is true that widescale airline failures have continued to be prevented and this is in large part due to the huge levels of government support provided, which now exceeds $240 billion since the onset of the crisis. 

While there are those that question how long these supports can continue, the strategic importance of air travel, both from a commercial and social perspective, is what has driven this remarkable level of support. While the pandemic’s impact may persist, this fundamental fact remains. As such, I do not expect to see a huge spike in airlines going out of business.

However, airline failures, in both bad times and good, have been a fact of life within the sector. Running an airline is extremely challenging and successful airlines require operational excellence. It almost seems quaint discussing issues like oil price and interest rate volatility given the challenges of Covid-19, but these key metrics will return to prominence as airlines continue to ramp up activities in line with the recovery. Coupled with rising labour costs and ongoing supply chain issues, ramping up activity will be challenging for many.   

TL: Are you worried about what impact this support will have long-term – as a lot of it will have to be repaid eventually?

JOM: It depends a little on the nature of the support. Any loans or equity injections will, at least in theory, need to be repaid. A lot of the support has been in wage subsidies which likely won’t be required to be paid back. 

I agree though that the level of support will clearly have knock-on effects. 

One aspect is fleet focus, as we have seen some of the government supports come with green strings, some explicit, some implicit. As such, there will be an increased focus by airlines on moving to newer technology, more environmentally friendly aircraft. 

Another is the positive impact it could have for lessors. That need to re-fleet will require capital, which for airlines emerging from the crisis will be in scarce supply. As such, the attractiveness of the leasing channel will likely continue to increase. 

TL: What do you expect to happen to passenger numbers in 2022?

JOM: The recovery in air travel has been material but it has also been geographically disparate. Global passenger numbers grew by almost 30 per cent to 2.3 billion in 2021, however, this remains just over half of 2019’s 4.5 billion air travellers. 

The International Air Transport Association’s current expectation is that we will see almost 50 per cent growth in 2022 to 3.4 billion travellers, but that it will be 2024 before the figures return to 2019 levels. 

TL: To what extent is short-haul driving most of the recovery? When do you expect long-haul to rebound?

JOM: For now, short-haul is where it is at. This recovery has been primarily driven by large domestic markets including the likes of the US, China, Russia, Brazil. In the latter half of last year, we saw a recovery in the European market in line with the introduction of the EU vaccine passport, but you could argue that this market shares a lot of traits with other large domestic markets. 

What was interesting on the long-haul side is that the reopening of transatlantic travel in November led to an immediate and meaningful return for that market. Again, it all highlights that once restrictions are lifted, the pent-up demand is significant. 

As I mentioned above, the Asia Pacific market continues to be the area causing most concern, where stringent travel restrictions have resulted in traffic levels remaining up to 70 per cent below 2019 levels. It will be interesting to see how the almost zero-Covid strategies that have been employed on that side of the globe adapt to the transmissibility of Omicron. You would hope there comes an acceptance that severe travel restrictions are not the way forward.

TL: How do you see consolidation in the sector?

JOM: The pandemic has not really driven a significant amount in the airline sector. That may still come once it becomes clearer who will emerge in the best shape from this crisis, but it is worth noting that previous downturns had driven significant airline consolidation, particularly in the US and Europe.

On the aircraft leasing side, previous downturns have also driven consolidation and it was not a surprise to see material M&A activity in 2021. However, the remarkable AerCap $30 billion acquisition of GECAS, bringing together the two largest players in the market and creating a super-sized leasing group, came as a shock to most. The fallout from that transaction will be interesting to observe, both in terms of what wider market activity it may drive and in relation to the questions it raises around the importance of scale. 

A secret deal and the role of shares in the offer: How AerCap snapped up GECAS

In November 2021 AerCap completed the acquisition of GE Capital Aviation Services (GECAS) from GE in a seismic deal that involved $23 billion in cash, $1 billion of AerCap notes, and $111.5 million of AerCap shares. Afterwards, AerCap, which is headquartered in Dublin and led by Irishman Aengus Kelly (pictured), controlled a portfolio of over 2,000 aircraft, over 900 engines, over 300 helicopters and had an order book of 450 new aircraft.

It was an extraordinarily complex deal that, from an Irish perspective, reunited two companies that traced their roots back to Tony Ryan’s Guinness Peat Aviation business in Shannon. The Aviation Industry Leaders Report contains a detailed interview with Kelly about how this deal played out.

Kelly pulled the deal off in the middle of the crisis, securing a financing facility of $23 billion underwritten by Goldman Sachs and Citi. “Citi and Goldman underwrote the whole facility in full themselves because we wouldn’t allow them to syndicate it prior to closing because we didn’t want anyone to know what was happening,” Kelly reveals in the report. “And so they took it on, the best part of $12 billion each themselves. We had to pay a lot of money for that on the day we signed the transaction, but it is what allowed us to close the deal.”

The cash and shares offer was vital to the deal’s success. It was a financing strategy copied from AerCap’s successful acquisition of ILFC in 2014, that it first used when it bought Genesis in 2009. “One of the biggest advantages of being a public company is that you have an acquisition currency. In 2009, when we acquired Genesis, which was a listed company, there was another cash bidder, but the Genesis Board realised that if they sold for cash their shareholders would have locked in their losses in the middle of the financial crisis, so we offered them stock to provide some upside to shareholders.”

Kelly says AerCap and GECAS were working hard on integrating the two companies. “We are focused on making sure that all of our people understand the objectives and the culture of the business,” he says. “We’ve never had a parent; there’s no 1-800 Billion phone number for us, we are on our own. But this is what has driven us forward. For now, we are making sure that our way of doing things is instilled throughout the business, and then the rest will look after itself.” 

We’ve also seen the US private equity-backed Carlyle Aviation Partners, who has significant operations in Dublin, be very active in 2021, as they acquired the previously New York-listed FLY Leasing for over $500 million and in December announced an agreement to purchase the Irish-headquartered lessor AMCK for over $4 billion. 

In chatting with industry leaders for our report, there was consensus that more lessor consolidation is likely, but it was also acknowledged that ready sellers of large portfolios are not immediately obvious. Leasing companies tend to be profitable businesses that generate a significant amount of cash, you need a compelling reason to dispose of one. 

There is also an expectation that we will continue to see new entrants and indeed we already have seen some emerge since the outset of the crisis, mostly backed by US private equity. The challenge for those new entrants will be how they compete with established larger players, who may be able to access cheaper funds. These new entrants appreciate this challenge and will be looking for innovative ways to drive returns. 

The consolidation that occurred in 2021 has also resulted in some high-quality ambitious individuals seeking new opportunities. Given that those who join the leasing world rarely tend to leave it, we will be watching how this plays out in 2022 with interest, particularly given the continued flow of capital into the space.  

TL: There has been a big number of new challenger airlines launched in 2021. What impact has this had on the sector? Do you expect many of them won’t last?

JOM: Market disruption will always provide new opportunities. Dozens of new start-ups airlines have emerged, seeking to benefit from the recovery, without the financial scars of their more established competitors. Time will tell in relation to their relative success. Running a successful airline is complex and challenging. We know from past experience that many new entrants will falter. You would expect that those new entrants that are focused on low-cost and short-haul will be best placed to prosper.

TL: In terms of the top 30 leasing companies in the world, how many of them are now based in Ireland? And who have been the big movers up or down in 2021?

JOM: They pretty much all have significant operations here, Tom. The talent we have and the tax environment in Ireland mean it is a commercial imperative to have Irish operations. 

We also see that the larger players, including the likes of AerCap, Avolon, SMBC, are headquartered in Ireland, with their C-level teams residing here. 

I’ve been working in this sector since I started in KPMG 18 years ago and one of the reasons I love the space is that senior management are based here in Dublin or Shannon, so you could get to work hand-in-hand with the key decision-makers in what are massive-scale, global enterprises. 

In terms of the big movers, clearly, AerCap with the GECAS acquisition we spoke about has made the most striking move over the last 12 months, but we have seen many lessors continue to deploy huge amounts of capital in funding new transactions over the last year. About 60 per cent of all new deliveries by Airbus and Boeing were funded by aircraft leasing groups, and the vast majority of that funding was coming from Irish balance sheets.

TL: Tell me about how corporate debt has been used by aircraft lessors?

JOM: The capital markets have been incredibly receptive to aircraft lessors in 2021.

There is no greater evidence of the attractiveness of aircraft leasing than the $21 billion in unsecured funding in the capital markets that AerCap was able to raise in completing the GECAS transaction, a debt raise that was more than triply over-subscribed.  

AerCap was not alone in accessing the unsecured bond markets at very attractive rates. Investment-grade lessors including ACG, Aircastle, ALC, Avolon, BOCA Aviation, DAE and SMBC all had successful unsecured bond raises during 2021, with over $32 billion being raised by lessors during 2021. 

The quantum raised and the interest rate spreads achieved by each of these investment-grade lessors highlight both the confidence the investment community has in the leasing model and also speak to the maturity of aviation as an investible asset class. Even as we move towards a rising interest rate environment, there is a widely held belief in the lessor community that there will be a continued ability to obtain attractive spreads on unsecured debt for large-scale, well-run leasing platforms. 

The aviation Asset Backed Securitisation (ABS) market, which had become a key pillar of aviation finance, funding $10 billion of aircraft purchases in 2019, effectively shuttered in March 2020. Its return in 2021 was much hoped for but few foresaw how strong the market would come roaring back, funding over $8.5 billion in aircraft purchases. All of those ABS structures are based out of Ireland, so its prompt return is a welcome success story. 

TL: Air freight and cargo has received more coverage in this report than in previous years. Why is that and what are the key findings in the report?

JOM: The performance of cargo has been a significant positive during this crisis and there is a relatively widely held belief that the pandemic-driven surge in e-commerce has given rise to a sustainable step change for the cargo market. 

The cargo segment has its own unique challenges, including the availability of conversion slots, and it also saw its growth impacted by global supply chain issues last year.

But having long been subject to a reasonable degree of volatility, this potential step change is attracting both new investors and lessors to the space. 

"The 2050 net-zero target is hugely ambitious and will be a challenge for the sector to achieve."

TL: There is lots of talk about going net carbon zero by 2050 in the sector. Do you think this will realistically happen? What are the key trends emerging in relation to carbon change?

JOM: The 2050 net-zero target is hugely ambitious and will be a challenge for the sector to achieve. The threat posed by climate change continues to loom large over aviation and all stakeholders within the sector acknowledge and appreciate the need for immediate action. 

Flight shame, the imposition of environmental-related taxes and regulations, and the increased ESG focus of investors are real concerns for the industry. 

While aviation contributes around 2.5 per cent of global CO₂ emissions (a significant amount less than what the public generally perceives), its path to reducing its carbon footprint is less obvious than that of some other sectors.

The building blocks to reducing emissions include fleet renewal, improvements in operational efficiency, technological innovation, sustainable aviation fuels (SAF) and, in the near term, carbon offsetting. Some of these potential technological factors, such as hydrogen or electric-powered aircraft, are a long way from making any material impact. 

TL: When will sustainable aviation fuels become common?

JOM: There is clear industry consensus that the immediate focus should be on SAF, with IATA forecasting that it will be the primary driver of emission reductions over the next decade and beyond. 

However, there are key challenges relating to the current levels of SAF supply, as of today there is enough SAF being produced to cover about 2 per cent of the world’s flying, and its current price, which is more than three times that of jet fuel. 

There is momentum behind SAF but incentives are needed to attract more producers and investors to the space and governments need to play an active role in accelerating the demand for SAF. 

TL: Finally Joe, how do you see the next 12 months playing out?

JOM: In KPMG we are already seeing a significant pipeline of large-scale, really interesting transactions in the first quarter, which gives you a lot of optimism for where the sector is heading.

The last two years have been the most challenging time that aviation has ever faced, but the resilience of the entire sector has been remarkable. There’s a confidence that the worst is behind us and that a globalised vaccine rollout, coupled with a coordinated international effort in managing restrictions, will drive a recovery towards 2019 air travel levels. 

The key point I come back to is that as soon as restrictions lift, the pent-up demand is obvious and travel bounces back very strongly. Our appetite to travel has not been diminished by Covid. I firmly believe that the question is when, not if, a full recovery will take place. 

To read the full Aviation Industry Leaders Report 2022 click here.