The tipping point in the evolution of the aviation industry

Authored by Liberty Head of Continental Europe, Financial Risk Solutions, Alex Paton

Alex Paton explains that we could be at a tipping point in the evolution of the industry, and that Balthazar is providing an aircraft finance solution that is enabling sustainable change to happen.

Religious historians might know Balthazar as one of the three kings. Others may know it as a very large bottle of wine (12 litres to be precise). But those in the specialist world of aircraft financing will have their own, unique perspective.

For them, Balthazar is a supported aircraft finance solution, which provides loans to airlines and lessors for the purchase of Airbus aircraft. The finance solution is tailor-made to suit the needs of airlines, lessors and banks alike. As the industry works to meet sustainability goals – including the International Air Transport Association’s Net Zero by 2050 commitment and jurisdiction-specific initiatives such as the UK Net Zero strategy – the need for new generation, low-emission and sustainable aircraft is only set to grow.

The terms of each deal constructed under Balthazar are different – depending on a variety of factors including the profile of the purchasing airline/lessor and the type of aircraft. But environmental objectives are very much in the driving seat as some airline balance sheets improve and companies accelerate capital investments.

A renewed focus on sustainable finance

As the world emerges from the pandemic, air and passenger traffic demand is increasing. According to Airbus’s Global Market Forecast, air traffic will recover to 2019 levels between 2023 and 2025 and passenger traffic is expected to grow at 3.6% annually from 2019 to 2041.

There is a renewed determination among the financial community (lenders and their insurers) that more financial innovation should be targeted to support long-term sustainability and to accompany the industries in their endeavour to achieve global climate targets.

This ESG focus is shared by Airbus and its airline clients, many of whom are keen that airlines should become more sustainable and are working together with the aim of putting the sector on a flight path toward decarbonisation and CO2 emission reduction.

New plane technology means each generation of aircraft reduces emissions by 15-25%, according to experts. The switch to Sustainable Aviation Fuel (SAF) will help decarbonise air travel and also allow older aircraft types to continue operating by lowering their carbon footprint. All Airbus aircraft are already capable of using a blend of 50% SAF and their target is to have all new aircraft 100% SAF capable by 2030.

Building on developments in the aerospace industry, airlines are also exploring the potential of hydrogen fuels, battery technology and futuristic ‘e-fuels’ (produced by directly transforming green energy into a combustible liquid) in airplanes.

New generations of airplanes will be ready to accommodate these technologies when they become commercially available.

Net Zero doesn’t come cheap

But such developments don’t come cheap. Before recent fuel price spikes, SAF cost up to three times the price of regular kerosene. And ensuring that airlines have SAF-enabled fleets requires significant capital spend.

Currently only around 20% of today’s in service fleet are new generation aircraft, which creates a huge future growth opportunity as airlines retire, replace and upgrade their fleets. The debt funding requirement for a new generation aircraft is anywhere between US$50m to US$150m, depending on the model. During the pandemic, Airbus had to defer various deliveries which led to painful cuts in the production rates. With the majority of planes grounded, cashflow was in short supply. Many airlines required State support packages to survive. Now that the situation is improving, they are ready to invest in new generation planes which is key for them to remain competitive and to operate in a more sustainable way. But with credit ratings lowered during the pandemic, lending banks in various instances need the security of additional capacity to finance fleet replacement.

The Balthazar partnership (which includes Airbus, specialty broker Marsh SAS, Liberty, and three other insurers) delivered on existing financing commitments throughout the COVID crisis, focusing primarily on State owned or flag carrying airlines of strategic importance to their country. Now, as global investment in new aircraft is accelerating across the board, Balthazar is here to support the financing of new aircraft, and airlines in meeting their sustainability commitments.

Building back better

Since its inception in 2019, Balthazar has underwritten US$1.75bn of financing and completed 26 transactions, two of which have been written with innovative ESG commitments incorporated into the terms of the contracts to reward delivery against ESG targets, such as CO2 reduction.

The latest, agreed in December 2021, supported Air France to purchase its twelfth Airbus A350-900, the latest-generation aircraft that offers outstanding environmental performance. Sustainability performance targets selected for the transaction are focusing on the proportion of new-generation and fuel-efficient aircraft in Air France’s fleet and the future usage of SAF as part of Air France’s daily operations. It is one of the first sustainability-linked aircraft-secured term loans provided to an airline and was recently awarded Airline Economics’ Aviation 100 Sustainability Supported Finance Deal of the Year.

Partnership pays

Balthazar is a success story built on a close partnership between experts including Airbus, lending banks, insurers, Marsh, legal advisers, and aviation specialist consulting firm, IBA. It is designed to meet the needs of Airbus and its many clients – airlines in countries around the world with different aircraft and different financing requirements and lessors as well.

Balthazar’s approach, which accepts the aircraft as the collateral for the loan, relies on the residual value of the asset and the skills and experience of its partner IBA in repossession and remarketing of planes should a payment default arise.

The cover is tailored each time to reflect a range of risk factors including the credit risk of the airline, the sovereign risk in the territory where it is based, the value of the asset and its anticipated lifetime, and whether the airline is based in a jurisdiction subject to the Cape Town Convention. It is different to classic nonpayment insurance in that it provides coverage for up to 100% of the financing amount, rather than 90% or less, which is the norm in the insurance industry. In another departure from established practice, it also provides accelerated payout times.

The unique policy framework that we have set up addresses the individual needs of banks and airlines, which provides reasonable turnaround times and the ability to commit in advance. To date, in testament to the skills of the expert teams and the quality of the risk selection, there have been no defaults on the financing underwritten by Balthazar.

Future is bright

Although the Balthazar partnership is still relatively young, it has successfully established itself as an additional source of financing and an important tool for Airbus customers. The model is replicable and can and should inspire others. Innovative finance is needed to meet the environmental challenges we face, Balthazar is one part of the solution.