The recent drop in the price of oil has completely changed the outlook of the transportation industry. The price of crude oil fell about 70% from mid-2014 to early 2016, from $105 a barrel to about $32. There has been a slight climb this year, but oil remains at a low price – $43 a barrel on the Nasdaq as
went to press.
Sustained low-fuel prices have been a blessing for most airlines, with operating costs falling. Also, the more expensive – yet fuel-efficient – newer technology aircraft are not as economically advantageous, meaning that airlines can fly cheaper and older aircraft for a better price than they could have previously.
But not everyone is benefiting from low prices. Countries whose economies rely heavily on oil are worse off than before. One of those regions is the Middle East, where some banks are cautious about liquidity drying up.
A report from Moody’s investors service, released in March, indicates that banks in the Gulf Corporation Council (GCC) were likely to experience challenges in providing regional liquidity because of sustained low oil prices.
“Lower oil revenues are driving tightening of liquidity in the GCC, with overall deposit growth slowing down significantly to around 3% in 2015 from around 10% in 2014,” says Nitish Bhojnagarwala, an assistant vice-president at the ratings agency. “Moreover, liquid asset buffers are broadly expected to decline by around 20% across the region over 2016,” he adds.
GCC economies are heavily dependent on oil for revenues and macroeconomic growth, with revenues from oil and gas accounting for at least 80% of total revenues (apart from UAE and Qatar, which have diversified their economies and reduced their reliance on oil and gas). Governments in the GCC play a major role in their domestic banking sectors, often being simultaneously the biggest borrowers, depositors and shareholders.
The Moody’s report proposes that falls in oil and energy revenues in the GCC will likely reduce sovereign deposits in banks and eventually reduce state support for the bank systems involved. This reduction in support is driving up funding prices from domestic banks, increasing their overall cost of funds and reducing profitability.
The Middle East’s favourable geographic location makes it a good place to run an airline. According to Boeing’s 2015 Current Market Outlook, air traffic to and from the Middle East has grown at a compound rate of 9.9% a year over the past five years. But with sustained lower prices causing banks in the region to slow down, airlines may have to look elsewhere to finance their aircraft.
One senior banker, who works regularly with the Gulf airlines, tells Airfinance Journal that less long-term liquidity is available in the Middle East for airlines because of sustained low oil prices. He adds that airlines which look at using regional banks to fund their aircraft need to look at new sources of funding, as aviation may not be a “top priority” because many aircraft deals require longer-term liquidity.
Some bankers believe that despite liquidity drying up, aviation financing from banks in the Middle East is still available. However Bertrand Dehouck, head of aviation Europe, Middle East and Africa at BNP Paribas, believes the low price has had an impact on regional liquidity.
“I think it already has had a knock-on effect,” he says, adding “that said, nothing dramatic, but we’re certainly seeing some form of retrenching of the local banks. For the right deals or with the right certainly, they are much more selective.
“Is it negative? It should be viewed more as a normalisation of that market. It’s certainly is less of an easy path for the local airlines to find liquidity, but liquidity is still plentiful for the good credits.”
Investec Aviation’s co-head agrees. Alok Wadhawan tells Airfinance Journal: “Liquidity has obviously gone down from what it was last year. There is still liquidity, but at a higher cost. The liquidity hasn’t disappeared.”
"Liquidity has been affected due to the sustained run of low oil prices resulting an increase of US dollar funding costs for the banks that is being reflected in a moderate widening of spreads. Although solid names are still able to access the debt markets,” says Ahsen Rajput, deputy managing director Middle East, Africa and South Asia, Boeing Capital.
Wadhawan adds: “If you want to borrow money from the Middle East now, the banks will still lend to you, but they will charge you a higher interest. So it’s not competitive, but the liquidity is still very much there. The cost has gone up.”
Some of the larger Gulf airlines, such as Emirates, Etihad and Qatar Airways, do not just rely on Middle Eastern banks to finance their aircraft and are able to source financing from the international banks and capital markets. If liquidity costs go up, they will have access to financing from other parts of the world.
This year, Dubai-based carrier Emirates tapped the German and Japanese markets to fund incoming Airbus A380s, which are often considered as niche assets because of the expense of financing them. In April, Abu Dhabi-based carrier Etihad agreed to finance two of its incoming Boeing 787-9 aircraft through Japanese operating leases.
Smaller carriers, which may not be able to get access to international financing, often will turn to leasing companies to finance their aircraft, whether through traditional operating leases or sale and leasebacks.
However, there have been some instances when carriers smaller than the big three Gulf airlines have obtained financing. Having only started operations in 2009, flydubai raised $500 million through a sukuk bond in 2014. The deal provided a highly cost-effective unsecured funding source for flydubai, pricing at a profit rate of 3.776%, equivalent to 200 basis points over five-year US dollar midswaps.
But smaller airlines in the region may need to look elsewhere for financing.
“They are relying more on the lessor financing rather than the airline financing, and lessors again tend to be able to access their financing internationally,” says Wadhawan. “So, at this point in time, I don’t think it has any impact on Middle Eastern airlines. If it carries on, it could mean the cost of financing goes up, but that’s too early to say at this point.”
According to the report, banks in countries such as Oman and Qatar are taking the biggest hit from the lower oil prices, because of a high vulnerability in liquidity and the funding structures of banks from the two countries. In Oman, government fiscal pressures have resulted in a decrease in capability and willingness to support its banking system. Although Qatar is projected to deliver strong, nonoil-related economic growth in 2016, by continued investment in infrastructure, Moody’s notes that local banks have experienced “a significant slowdown in overall deposit growth”, with it falling from above 20% in 2012-13 to 6% over 2015.
A senior aviation banker based in Oman, who did not want to be named, says that the funding costs of local Omani banks have increased by 35%, and even then the availability of the US dollar in the region is tight. Despite this, Bank Muscat recently provided 100% Sharia compliant lease financing to Oman Air on two 787s, meaning that the liquidity is still there for the right deals.
Another aviation banker based in Dubai has seen surprisingly strong demand from local banks to do aircraft deals in the Middle East.
“It is clear that not as much liquidity is available,” the banker tells Airfinance Journal. “It is certainly not available for the large infrastructure projects in the Middle East. But whether it’s available for their current clients – in this case the Gulf airlines – it doesn’t seem to me it has vanished for airlines like Emirates, Etihad, Air Arabia or flydubai. I think pricing may have changed – maybe the local banks will do slightly less – but it hasn’t gone away.”
He adds: “Surely the cost of liquidity would have gone up. Has it gone phenomenally up? I don’t get that sense either. What I do sense, though, is that many of these banks in the region were doing very silly things – 100% financing of A380s or just taking full deals themselves, etc, and I think they will act more rationally around those things now.”
Although BNP’s Dehouck believes that the fuel price has affected the industry, he thinks that airlines do not have much to worry about if they are looking at financing from the Middle East.
“Airline borrowing costs have been going back to more balanced levels when compared with other markets,” he says. “I don’t think borrowers are overly concerned. Prior to this, there was a bit of an oversupply of liquidity. The retrenching of local banks pushes back the supply level to a normal market.
“That said, between the low fuel price knock-on effect and the temporary gap in US export import bank and European export financing there is a slight risk of entering into an under-supplied market. If so, we would expect it to only be temporary, except if there was a marked credit deterioration – which we are not observing yet.”
Jack.Dutton@euromoneyplc.com
