Analysis: Why DVB's aviation exposure will increase
David Goring-Thomas, the new member of the board of managing directors responsible for the German bank’s aviation business, speaks to Airfinance Journal about his plans for the department and the bank’s recovery after declaring its first-ever loss in 2016.
Although the aviation industry is enjoying strong profits, the same cannot be said for the shipping industry, which has seen its profits go overboard since the 2008 financial crash.
German lenders, which provide about a quarter of the world’s $400 billion in shipping loans, were hit hardest by the global shipping crisis, caused by slowing trade and poorly timed investments in larger assets.
Frankfurt-based DVB Bank, bearing the weight of €11 billion ($11.5 billion) (as of 30 September 2016) in shipping loans, had been feeling the effects of the crisis for several years but these effects were particularly pronounced in 2016, when the bank posted a consolidated net loss of €27.3 million before taxes for the first nine months of the year.
This was the first time the company had recorded a loss since it became a transportation- specialised bank in 1998. Along with the persistent shipping crisis, the European Central Bank’s low-interest rate policy and the high costs spurred by banking regulation led to a poorer financial performance from DVB in 2016.
Continuation of good work
The year 2016 also saw changes in the bank’s board. David Goring-Thomas took the helm of its aviation division in early December after Bertrand Grabowski, the former bank director at DVB responsible for aviation, left to pursue other projects. Grabowski had been the face of the board of directors for aviation business at DVB Bank for a decade, and would be a tough act to follow.
Speaking to Airfinance Journal from DVB’s offices in the City of London just two weeks into his new role, Goring-Thomas plays down the impact of the bank’s overall results on the aviation business. He says his leadership style is different to Grabowski’s, but having worked closely with him for more than 11 years and worked at DVB for over 17 years, he looks to “continue his good work”.
“2015 was a disappointing profit, while 2016 will, as we have reported, be a low triple-digit loss,” says Goring-Thomas. “This significant loss has been mainly caused by the deep, long crisis in the shipping sector.”
He adds: “The majority of exposures in the shipping business causing impairments and losses at the bank were booked more than five years ago. If you look back with hindsight, there appears to have been an over-enthusiastic approach which has come back to haunt us.”
It is a case of continuing to manage those legacy exposures and, while some impact will be reflected in the bank’s budgeted numbers next year, Goring-Thomas expects a recovery in the 2017 financial year.
For the first nine months of 2016, DVB closed a total of 102 transactions generating €4.2 billion in new business volume compared with 137 transactions with a volume of €5 billion in the previous year’s corresponding period. Much of its aviation business is lessor-centric, with the bank closing a majority of more than 50 transactions a year with leasing companies.
Overall, the bank expects to book more than $3 billion of new loan business for its own account in aviation finance in 2016.
“At operating levels, excluding impairments, aviation, shipping and land transportation continue to produce healthy numbers,” says Goring-Thomas.
“We are able to demonstrate a robust performance across our divisions, and in new shipping cases the risk-reward is certainly accretive to the business. A bit tongue in cheek, but I would like to see more of this on the aviation side, which is currently under greater margin pressure.”
It is a good time to be underwriting new shipping business because the industry is at a low point.
The aviation-lending portfolio represents 34% of DVB Bank’s total credit volume, compared with shipping’s 47% share. Goring-Thomas says there has always been a desire at the bank to see the aviation proportion grow.
Opportunities during volatility
“We will see a tendency to a more balanced exposure in the future, but we tend to grow the aviation book more aggressively in times of greater volatility or uncertainty,” says Goring-
Thomas.
He adds that current market conditions are very competitive in the aviation sector. “We remain prudent and disciplined and will not over-lend in terms of loan advance payments or balloon profiles and resist covenant deteriorations.
“What we have seen over the past two years is an erosion of our net margin. That reflects where we are in the industry, and indeed liquidity cycle, and we would expect a turn in net margins and overall better opportunities as the cycles turn.”
Despite heading for a loss in 2016 at bank level, DVB retains the confidence of investors.
DVB Bank’s parent, DZ Bank, announced a capital injection in November, and Standard & Poor’s and Moody’s (the latter ratings are unsolicited and unsponsored) have each recently endorsed DVB Bank ratings, and as such Goring-Thomas does not see any changes in the cost of liquidity as a result of recent announcements.
As a lender, the bank has a close eye on the capital requirements.
Banks have until 2019 to meet Basel III, but it is clear that regulators are moving beyond the Basel III requirements and asking banks to meet even higher standards.
“There is a lot of speculation and its outcome. The reality is great opposition to the current proposals across the board, not only in our industry,” says Goring-Thomas.
“In the current proposal, for example, there is hardly any differentiation in terms of loss given default, between aircraft-backed secured lending and unsecured lending. This would take us back to the Basel I environment we were in. In fact, Basel I ratios continue to be ratios we need to observe,” he adds.
DVB is actively lobbying with its own regulator, also providing data together with other members of the Aviation Working Group “The data we and the other banks provide clearly demonstrate that some of the current proposals are flawed. Nevertheless, the final outcome remains uncertain, and new regulations would only take effect from 2021- 2025,” he adds.
Banking on pensions
Although the industry is seeing an increasing amount of new fi nancing sources, notably from pension and insurance funds, Goring-Thomas does not see a link between the insurgence of
non-bank financing and current and upcoming bank regulation such as Basel III and Basel IV.
“Personally, I don’t think that there’s necessarily a link here. It’s just a trend, and I think that trend will continue for insurance and pension fund interest in aviation, more specifically aircraft assets, because of the nature of the assets, and the long-term and stable cash flows that they generate.”
Goring-Thomas believes the trend is here to stay but also recognises that Basel IV could shift the balance of sources of aircraft financing. He adds that this shift is “an assumed development”nand his bank has been working to “embrace that development”.
DVB Bank also has been entering new markets to keep up with changes in the aviation finance landscape. In the fourth quarter of 2016, the bank closed its first debt fund initiative, raising $400 million. The deal was with a German asset manager and German pension provider where DVB is sourcing aircraft finance senior loans. The senior loans can be for airlines for lessors.
“This development is strategic for us and we expect the activity in our debt fund business to grow because it is very complementary to what we do today. We’re not the largest bank, so unlike some of our competitors, we can’t write a billion-dollar cheque for a big leasing company.”
Goring-Thomas adds that future debt fund initiatives implemented by the bank will most likely not cover predelivery payments financing for end-of-life transactions, but instead “anything in the middle”. He adds that Investec Bank has also been active in this area. DVB looks to double, at least, the scale of this activity in 2017.
Goring-Thomas adds that the model could be replicated in other jurisdictions.
“This particular initiative is with German partners,” he says, “but we see a lot of inward interest and this is based upon the reputation we have. There may well be opportunities to grow the activity with our current partners, but we fully expect there will also be opportunities for other initiatives with other investors.”
New players
Those investors could potentially come from Asia. “There’s strong interest from China and Japan,” he says. “There’s increasing interest from Japanese regional banks, and we’ll try and embrace that. That’s more on the senior debt initially but we are also seeing interest in the equity business as well.”
Goring-Thomas notes that the Korean market seems to be maturing. “There still seems to be plenty of appetite but it seems more informed, and with a more disciplined approach, compared to some of the transactions that have been written in the past.”
He adds that his colleagues in Singapore speak about new Chinese leasing companies coming to DVB interested in buying aircraft “almost every week”.
Goring-Thomas says: “I assume the investor money backing the likes of Accipiter and Goshawk is fairly long-term and here to stay. The US private equity firms and hedge funds have typically been less predictable and have generally followed where they can get the best yield.”
Historically, DVB has benefited from periods of volatility, attracting more business when other competitors have left the market. The bank also finds financing opportunities with some of the newer entrants, as they will initially require a better understanding of assets than the more established names.
The DVB Bank aviation platform has four main commercial pillars: structured lending, investment management, asset management and advisory, each supported by a specialised research group. DVB’s asset management team has grown steadily, from three employees in 2007 to more than 20 in 2016. It has more than 170 aircraft under management.
The bank’s aviation investment management team, Deucalion Aviation Funds, manages more than 130 aircraft. DVB is the asset manager for the majority of the aircraft under investment
management by Deucalion, which is a fund management business with the majority of the equity provided by institutional investors but with DVB having a minority investment in every
transaction.
With a team of only four, DVB’s other commercial pillar, its advisory business, is much smaller than its asset management business or Deucalion, but that has not stopped it from being one of the most active DVB teams in recent months. The team has worked with the likes of
LOT Polish Airlines, Royal Jordanian and Air Cote D’Ivoire on commercial transactions.
Goring-Thomas says: “The situations where we are typically pretty strong are when the airline is considering which way to go – whether it’s into the commercial market, the export credit market, if available, or sale and leaseback, and we’ll help them with that assessment. Then, once they complete that assessment, we’ll help them execute the relevant fund raising.”
To return to profit in 2017, Goring-Thomas says the bank will need to continue to manage proactively the work out cases, especially on the shipping side of the business.
“The work out cases won’t solely be in shipping and off shore; we’ll have the odd transaction pop up every now and then on the aviation side, or elsewhere,” he says. "I think the interesting thing at the moment is that, as aviation board member and also board member responsible for land transport, I can complain about margins right now. That’s a reflection of the current state of those industries – more competition, more liquidity available – but I think we’re definitely going to see some good opportunities in the shipping space.”
Goring-Thomas says that the prospects in 2017 still look positive for airlines, but perhaps not to the level of 2016. He adds that there are always markets or airlines that can pose individual challenges.
“In general, we wish for a bit more volatility. Bertrand described the situation at the moment as ‘the perfect reverse storm’, but there are some signs that that storm will change."