This week, over 2,000 of the world’s aviation leaders arrived in Dublin for the back-to-back Airline Economics and Global Airfinance Conferences. Ireland has long been a global leader in aviation leasing with nine of the world’s top 25 firms headquartered here. 

On top of this, all of the top 25 own assets or have platforms based in Ireland in an industry that supports over 5,000 highly-paid jobs. 

It is flat-out time for 37-year old Joe O’Mara who is head of aviation financing and leasing at KPMG. 

We meet in O’Mara’s office in Dublin’s docklands where he is prepared to give readers of The Currency his insights into The Aviation Industry Leaders Report 2020 – Steering the Super-cycle report. 

The report, which is published annually, draws upon interviews with some of the biggest names in the aviation industry including Aengus Kelly (AerCap), John Slattery (Embraer), Peter Barrett (SMBC Aviation Capital), Ruth Kelly (Goshawk) and David Butler (Stellwagen). 

O’Mara tells me that KPMG traces its interest in the sector back to Tony Ryan’s GPA, which pioneered the industry globally. “Dublin is the centre for excellence for aviation leasing in KPMG,” O’Mara said. 

His firm he said had a team of 150 people working in the aviation sector from audit to tax to advisory. 

“We are the largest professional services firm in aviation. Our roots go back to retired partner Pat O’Brien who started working in the sector in the 1970s. We’ve been in this industry since the beginning,” O’Mara said. 

He added that 2019 was the tenth consecutive year of global airline profitability. 

It is an industry that has historically experienced cycles, so O’Mara cautions that continued growth can never be taken for granted.  

In a wide-ranging interview, O’Mara discusses the big themes emerging in the aviation industry from this new report, what headwinds lie ahead, and what to expect in 2020.  

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Tom Lyons: What are the big themes that emerged in 2019 that can be seen in this new report?

Joe O’Mara: The aviation sector performed strongly in 2019, global airline profits were the fifth highest on record at nearly $26 billion. For a normally cyclical sector, this represents the tenth consecutive year of profits and is an unprecedented run. IATA (International Air Transport Association) expects this super-cycle to continue in 2020.

The oil price and interest rate environments have been a big factor in this performance. Oil makes up over 20 per cent of airline operating costs and it has been relatively stable over the last 12 months, hovering around the $60-70 per barrel level. Airlines have also never had better access to cheap money, either on the financing or leasing side.

This notwithstanding, the consensus of the industry leaders interviewed for our report is that the cycle has peaked, and a slow downturn has commenced. While the headline figures for 2019 are positive, they represent a decline from 2018 where profits stood at $27.3 billion. Growth in passenger air travel has also fallen from 7.4 per cent in 2018 to 4.2 per cent in 2019.

TL: What is the outlook for aviation finance?

JOM: In the context of aviation finance, the overall outlook remains broadly positive. In a world where air travel is expected to grow, where significant capital is needed to fund aircraft deliveries, and where the percentage of leased aircraft continues to trend upwards towards 50 per cent, lessors are well placed to continue to thrive. The total amount required to fund the delivery of new commercial aircraft over the next five years is estimated at over $800 billion. While there has not been a significant amount of M&A during 2019, we have seen minority interests being converted into 100 per cent shareholdings for large-scale lessors like ACG and Aircastle. Capital certainly continues to flood into the sector.

There is also a belief that, while competition remains fierce amongst lessors, pricing is rationalising somewhat. Deal origination has become increasingly challenging in recent years, with new entrants chasing business and winning bids for transactions with ultra-low lease rates or few or light return conditions. Over the last year, there have been less new entrants and some newer players (including several Chinese leasing companies) who have not been able to achieve sufficient scale and withdrawn from the leasing market. Airlines are placing more weight on deal execution and this has been a positive for more established lessors.

TL: What trends are you seeing in terms of aircraft leasing and capital?

JOM: While the number of publicly-listed lessors is small and decreasing, given Aircastle moved private in 2019, aircraft leasing continues to become more mainstream and there is greater market confidence in the business model. This can be seen from the increased number of aircraft lessors that have achieved investment-grade status, with unsecured funding now representing more than two thirds of the debt being raised by aircraft lessors. 

The capital markets have also continued to provide significant levels of secured debt funding, with the volume of asset-backed securitisation (ABS) transactions reaching record levels, with 18 ABS transactions closing during 2019, with a value of $9.87bn. The ABS market is seen by lessors as an efficient form of debt refinancing and/or aircraft fleet disposition (whilst retaining a servicing function for the leased aircraft), which is crucial to many lessors’ business model. The growth in ABS transactions is in part driven by developments in typical ABS structures, whereby the equity portion of the securitisation is now more tradable than it has been in the past, with greater transparency of information. This has encouraged new players to enter the aviation market through holding relatively minor equity stakes in ABS vehicles. There is a significant secondary effect to this, whereby there is an expectation for further capital inflow in the future as those new entrants gain comfort and experience in the aviation finance sector through initial relatively small investments in an ABS product.

There has also been a trend towards the establishment of joint ventures between new investors and established lessors seeking to capitalise on the healthy levels of liquidity flowing into the sector. This allows new investors to join with an experienced partner and an established platform, which can be considerably more efficient than seeking to grow out a new platform from a blank canvas. Joint-venture arrangements can also be attractive to aircraft lessors who retain significant servicing income earning potential whilst limiting their capital requirements. The management of conflicts of interest, particularly in the event of aircraft disposals, is of paramount importance in ensuring the continued success of joint-venture arrangements. 

TL: What impact are the problems of the Boeing 737 Max having on the sector?

JOM: The grounding of the Boeing 737 Max is significantly distorting the market, both for airlines and lessors, and it has the potential to cause even further disruption in 2020. Boeing has now suspended production of the aircraft and there remains no clear line of sight as to when it will return to service. The situation is unprecedented. Over 80 airlines have taken delivery of 385 Max aircraft, which are not currently in use, and there are in the region of another 400 aircraft currently held in storage by Boeing.

In the short term, the unavailability of the Max has had a positive impact for some lessors as it has increased demand for older aircraft, with airlines looking to fill the void left in their schedules by the grounding. However, for larger-scale lessors (such as AerCap and SMBC), who had expected to take delivery of new Max aircraft and place them on lease in 2019, there has been a negative impact on earnings. The longer the aircraft is out of service, the greater impact it will have on airlines (particularly if it impacts on the 2020 summer season) and if this leads to financial difficulties for airlines, there will be a knock-on adverse impact on the entire aircraft leasing community. 

TL: What about concerns about climate change and carbon emissions?

JOM: Aviation accounts for only about 2 per cent of the global total of net carbon emissions. But the climate change agenda is having an ever-increasing impact on the aviation sector. ‘Flight shame’, the imposition of environmental-related taxes and the increased environmental, social and governance (ESG) focus of investors are real concerns for the industry. To the extent that climate change concerns result in people flying less or it diminishes appetite for investing in aviation, this will clearly have a negative impact on aviation finance.

While improvements are being made through new aircraft technology efficiencies and significant investment is being made into cleaner alternative fuel sources, the sector as a whole (including manufacturers, airlines and lessors) need to better promote these technical innovations, as well as highlighting the social and economic benefits that air travel brings. This will be a continued area of focus for the foreseeable future. 

TL: Are you concerned about trade wars or a global economic slowdown?

JOM: The growth in air travel has, over the long term, broadly followed a two-time multiple of global GDP growth. Any slowdown in the macroeconomy will have a negative impact on the aviation sector. Factors such as the ongoing global trade disputes between the US and China, and to a lesser extent Brexit, are contributing to a slowdown in global GDP growth. This has been a contributing factor in global air traffic growth dropping from 7.4 per cent in 2018 to 4.2 per cent in 2019. Furthermore, fuel costs make up over 20 per cent of airline operating costs. While oil prices have been relatively stable for the last number of years, they were over $100 a barrel as recently as 2014. To the extent that geopolitical concerns, such as the current situation between the US and Iran, cause increased volatility in the price of oil, this could adversely impact airline profitability and, by extension, aviation finance as well.  

TL: The report lists 28 airlines that ceased operations in 2019…

JOM: Yes, airline bankruptcies have also seen an uptick in 2019. Significant airlines such as Thomas Cook and Jet Airways are amongst the failures. This supports the view that airline credit risk is clearly increasing, with some airlines addressing capacity issues and reducing growth plans heading into 2020. Having said that, lessors have proven quite effective over the course of 2019 in repossessing aircraft, undertaking any necessary maintenance and getting the aircraft on a new lease in quite a short space of time – the demand driven by the unavailability of the Max has likely been a factor here as well.

“Aircraft are a mobile asset class, and the likes of Singapore and Hong Kong are constantly looking to challenge Ireland for market share.”

TL: How concerned should Ireland be about competition from Hong Kong and Singapore?

JOM: Aircraft are a mobile asset class, and the likes of Singapore and Hong Kong are constantly looking to challenge Ireland for market share. We have a great position as the global leader in aircraft leasing. The biggest aircraft leasing companies in the world are headquartered in Ireland, with the key decision-makers based here. That doesn’t happen often in Ireland and we can’t take that position for granted. We have a positive domestic tax environment for aircraft leasing companies in Ireland, with the 12.5 per cent corporation tax rate and tax depreciation over eight years for aircraft purchases. However, the Singapore regime can offer broadly the same domestic benefits and the relatively new Hong Kong tax regime potentially offers a lower effective tax rate than both jurisdictions. 

TL: What are the key differences between Ireland and Hong Kong and Singapore?

JOM: What is advantageous to Ireland is that our tax system is transparent and reasonably straight-forward. If you set up a substantive leasing company here, your effective tax rate should be about 12.5 per cent. More importantly, when it comes to aircraft leasing, we have a best-in-class international tax treaty network and the lead-in period for Singapore or Hong Kong to develop a comparable treaty network would be many years, if they ever did get there. 

The Singapore regime is concessionary and time-limited, and thus lacks certainty. When you are dealing with balance sheets of such magnitude, that is a significant drawback and, coupled with their weak treaty network, it is part of the reason why it has not significantly challenged Ireland for market share. The Hong Kong regime is only in place since 2017 and it has not gained great traction in the market, again in part due to their limited treaty network. It also remains to be seen what the ramifications of the recent political turmoil will be.

However, both Singapore and Hong Kong can offer personal tax rates in the high teens and also give you closer proximity to the Asian customer and investor base, which are of critical importance in this sector. Ireland can’t compete on either of these fronts, so it remains key that we continue to build out on the local aviation finance talent pool, which has built up in Ireland since the 1970s and is supported by a highly developed professional infrastructure.

There have been positive developments on this front with the UCD’s Masters in Aviation Finance, of which KPMG was a founding sponsor and which has gone from strength to strength. It is also great to see the work that the Irish Aviation Student’s Association is doing in educating second and third level students about how rewarding a career in aviation can be. When people join this industry they rarely leave. Attracting the best talent in the first instance into the sector is critical in keeping Ireland where it is today.

TL: What predictions in 2020 would you make from knowing the industry, reading the report and analysing the responses from so many leaders in the sector?

JOM: We’ve covered a lot of these already, but one area where aviation finance has generally lagged is leveraging from advances in technology. In particular, the trading of aircraft, which forms a key part of an aircraft leasing company’s business, is broadly conducted in the same manner as it was in the 1980s. To address this, the Global Aircraft Trading System (GATS) is aiming to radically improve the trading of aircraft between lessors, through the introduction of an electronic trading platform developed by the Aviation Working Group (AWG).

AWG members are very supportive of the program and the benefits to all stakeholders, including airlines, are evident. At present, the requirement for lease novations represents a significant drag on resource for both airlines and lessors, but this lease novation process should become much more streamlined in a GATS environment. In theory, this should bring about more liquidity in the aircraft trading market, which should translate to more supply and lower lease rate factors for airlines. The GATS platform is due to launch by the end of the first quarter of 2020. 

Read more on aviation finance:

• Domhnal Slattery: “Are we a nation of storytellers anymore? Our history says we should be. But we have lost our way”
• Aengus Kelly: “If the US tax rates had been what they are today, would AerCap have moved? Probably not”