APRIL 2015 | www.cit.com

China has been called the future of business aviation. With annual growth projections near 20 percent, industry experts were confident that an emerging market where big jets ruled was going to lead to industry-wide expansion. But several barriers are negatively effecting this growth. To what extent will these obstacles impact private aircraft sales in China?

Business Aviation in China – Enormous Potential, Serious Obstacles

Business Aviation in China – Enormous Potential, Serious Obstacles

2 APRIL 2015 | www.cit.com

The business aviation sector in China is very new. Private ownership of aircraft was not even legal until 2003. But by the end of 2009, Chinese officials were welcoming foreign investment in business aviation enterprises while praising private jet ownership.

As a result, fleets in the country have been growing at double-digit rates throughout the past five years. This expansion should continue, though the rate of growth has slowed. China is forecasted to become the world’s third largest region new aircraft deliveries over the next 20 years. According to industry reports, a total of 950 private aircraft purchases are expected between 2014 and 2023, with 1,275 further deliveries between 2024 and 2033.

An improving economy and a seemingly greater cultural acceptance of private jet ownership over the past decade has helped spur this expansion, and numerous predictions seem to indicate sustained growth for business aviation in China.

However, there has been a noticeable cooling of the market. Honeywell’s Global Business Aviation Forecast for 2015 cites disappointing growth figures and government austerity initiatives for a projected decline in sales. As a result, the total share of global demand over the next five years for Asia Pacific – with China as its hub - is only about three percent. This is off two full points from 2013 levels.

What are the reasons for this sudden decline? A cooling economy – the weakest in over two decades - is certainly a major factor. However, other elements must be considered, such as:

• Much of the airspace in China is controlled by the Air Force. Military leaders have taken a very restrictive approach to business aircraft and operators struggle to get flight plans approved. Pressure has been placed on the government to ease restrictions in this area but reform has been slow.

• The Chinese government has taken a more adversarial stance to displays of wealth – including corporate jet ownership. While executives insist that private jet ownership is necessary for conducting business, many Chinese look upon these aircraft as an ostentatious status symbol.

This white paper will consider three key reasons for a slowing of the growth in Chinese business aviation.

IntroductionContents3

5

6

7

Slowing Economy

Airspace and InfrastructureRestrictions

Changing Perceptions of Private Aircraft Ownership

Conclusion

Much of the boom in Chinese business aviation was provided by a rapidly expanding economy. However, this growth is slowing down. In 2014, China’s economy grew by 7.4 percent, its lowest rate since 1990. Real estate and heavy industry, like steel production, have contributed to a slowing of the national economy. Housing prices have been sliding and while the pace of the slump has begun to recede, new construction has also suffered.

China still enjoys an increasing amount of aircraft deliveries, but the number of private jets being put up for sale is also on the rise and is now into double digits (10.2 percent) according to a report by Corporate Jet Investor. This figure also suggests a slowdown in business aviation according to many brokers.

The cooling of economic growth is likely to be only a minor setback to the sector. Private jet ownership in

China is expected to increase sevenfold from 2012 to 2032 according to forecasts from Bombardier,

a Canadian aircraft manufacturer. The forecast also predicts that China will

account for nearly 10 percent of the worldwide business jet fleet in

2032. This compares to less than 2 percent in 2012.

This prediction conforms to the most recent Honeywell forecast – a standard guide for the business aviation industry.

Most Chinese aircraft owners cited in the report mention

economic uncertainty and fiscal austerity as negatively impacting their

buying decisions in 2015.

However, this is a temporary concern. Most forecasts still call for a strong recovery and continued economic growth within the country for the next decade.

3 APRIL 2015 | www.cit.com

A Slowing Economy

The People’s Bank of China is accelerating its effort to stimulate the Chinese economy with a series of recent moves. It decided in late 2014 to lower its one-year deposit rate and reduce the one-year lending rate.

In February 2015, the bank reduced the share of assets that commercial banks must hold as reserves. This is seen as a huge boon for financing and is particularly beneficial to private jet buyers since these aircraft typically require large initial investments.

“The People’s Bank of China will continue to implement a prudent monetary policy maintained to an appropriate degree, guide monetary credit and social financing to steady moderate growth, and promote the smooth operation of economic health,” declared the bank in an official statement.

“Survey findings from this

part of the world rely on a smaller base of operator

pools, and we do not believe the 2014 results represent any

long-term structural change in the region’s fundamental underlying growth drivers or commitment to

business aviation,”

-Brian Sill, President, Business and General Aviation, Honeywell Aerospace.

“We agree that the long term prospects remain very strong,” said Richard Koe, an analyst with WINGX Advance. “That’s because of fundamentals such as size of country, increase in number of very wealthy individuals, growth in trade and FDI, and planned investment in aviation infrastructure development.”

Business aviation executives agree with these forecasts and say demand for corporate jets in China has been rising. They are positive about long term prospects for the industry. “In the next 10 to 20 years China will become one of the biggest aircraft markets in the world,” predicts Diana Chou, Chairwoman of Jetcraft Asia. “One day it could be even larger than the US sector.”

4 APRIL 2015 | www.cit.com

Where do you see the Chinese business aviation market in 5 – 10 years?

We are confident that in the long term - certainly over the next 10 years - the prospects for the Chinese business aviation market are good. China’s large population, growing segment of high net worth individuals, high-growth companies and vast geography will propel an increase in business jets. In the short run (the next couple years), the market looks as though it will be tempered by decelerating economic growth and internal political pressures. But certainly the long term fundamentals for business look good. Is the economic slowdown a short term concern?

The key word here is “slowdown.” Any time an economy of China’s size slows, it is a concern for world economies and markets. And we are seeing the effects of this slowdown in energy and commodity prices. But it is important to note that China’s economy is not contracting. So, what we are seeing in China is not a recession. Rather, even if you cut the official growth statistics by half, you see an economy that is growing at a pace that would be envied by most other countries. Certainly there are notable pockets within the Chinese economy - such as real estate - where the effects of past overinvestment are being felt and where we would expect some pain going forward. But the macro theme in China is growth at a pace that is lower than the past but still good by world standards. Whether that reduced level of growth is a short or long term phenomenon (once the economy and the people adjust to a pace of growth that is lower than the past - but still good) we would argue that it is a more fundamentally sound and sustainable basis for the country’s future.

What is your view of financing in China?

CIT has been in China for 17 years, financing a wide variety of general equipment types as well as commercial aircraft. In recent years we have been financing business jets for Chinese entrepreneurs. This is the latest expansion of our lending activities in the country and the region. For sure, it is still by comparative standards a new market. The fact that many of the legal remedies available to financiers of business jets have not been tested in the courts is a consideration when making a loan or entering into a business jet lease in China. But in that sense China does not differ much from many other emerging markets. There are many regions in which the fact that legal remedies have not been tested is largely because there have been virtually no contentious defaults. So to that extent, financing business jets in China has all of the inherent risks (and rewards) that are seen in other developing economies worldwide.

Any thoughts on airspace/infrastructure issues?

We have seen sharp growth in the number of business jets deployed in and around China. It is encouraging to see the recent commitment from the government to change regulations that will open airspace. These changes will eventually promote faster growth in the general aviation business sectors - particularly the rotary wing and turboprop areas. Construction of additional airports and other infrastructure is still needed to support growth in aviation across China. The government certainly recognizes how infrastructure can impact macroeconomic growth – positively and negatively. We see this in the country’s commitment to building highways and high-speed rail service. In the past the commercial and general aviation industries have grown despite these headwinds. And the fact that government seems to be taking steps - however halting - to address these issues going forward, makes us feel that the long term potential for growth in China is good.

Q&A with Mike Kahmann, CIT Business Aircraft

Mike Kahmann is Managing Director & Group Head, CIT Business Aircraft Finance

China’s airspace is strictly controlled by the military. Starting in 2010-2011, Chinese officials put a greater emphasis on business aviation as a growth sector in the national economy. The Civil Aviation Authority of China’s (CAAC) Air Traffic Management Bureau has led efforts to free up access to air space and to ease congestion. The amount of airspace now free from military use is about 20 percent, which is actually an improvement over a few years earlier. Despite these gains, the military still keeps a tight grip on the availability of most of the national airspace.

In addition to airspace access, there is a related problem of flight plan restrictions. This makes it difficult for anybody wanting to get approvals to fly private aircraft in the country. But there have been some bright spots when it comes to the reform of flight plan restrictions. Five years ago, it took on average of between three to six days to get flight plans approved by the government. There was also a fee of $4,000.

The fee has since been waived for Chinese-registered aircraft and flight plans can now be filed up to six hours before a departure. But the restrictions and fees are still in place for foreign-registered aircraft. Moreover, the military often schedules air drills and weapons tests on short notice, disrupting both commercial and private aviation operations.

China also suffers from infrastructure problems that make it harder for business aviation. There is only one flight training school in the entire country, which contributes to a chronic shortage of pilots. There are less than 200 airports available to private aircraft in China. By comparison, the U.S. has more than 5,200 airports available to private aircraft. In addition, Chinese airports are only allowed to have one fixed base operator (FBO) at each facility.

The capital city of Beijing is the prime destination for most business travelers. However, it has only one major airport, which is already at capacity with commercial flights.

Private aircraft are granted only one slot per hour during peak traffic times.

There are plans for an additional airport in Beijing. In 2013, Chinese officials announced the

construction of a new airport with seven runways. It should be completed by

2018 though it is still unclear to what extent private owners will

be able to access the facility.

A promising development is the proposed Superior Aviation Town, a private facility built by Superior Aviation Group that will be devoted entirely to business aviation. Located just south of Beijing, the project will

include a 7,800-foot (2,400 meters) hard-surface

runway, taxiways, three FBOs, helicopter pads and aircraft

parking areas. Superior Aviation Town is scheduled to be completed

in 2020 though final approvals are still pending from the Chinese government.

5 APRIL 2015 | www.cit.com

“Air space restrictions are the number one

restriction in our view. Essentially it comes down to

military (PLA) control. That has eased a little, with some low level

airspace freed up the last 2 years. Also it’s now easier to get flight permits, at least for locally registered operators.

But airspace reform is still very partial (remains 80% restricted). In this

respect China will never resemble the US market.”

-Richard Koe, Managing Director,

WINGX Advance

Changing Perceptions of Private Aircraft

6 APRIL 2015 | www.cit.com

Changing Perceptions of Private Aircraft

Unlike the U.S., where business aviation is seen as a necessity for commercial activity, private jets in China are still viewed as an ostentatious status symbol according to Alud Davies, editor of Corporate Jet Investor. “Changing the attitude of China towards the real value of business aviation is proving to be hard work, with the general public still believing that business jets are simply play things for the rich. And there is undoubtedly an element of truth in that.”

In fact, Chinese billionaires often think of their jets much like their yachts and use them for parties and gambling trips, notes Davies.

Many Chinese executives prefer expensive, wide-body jets as the aircraft are still considered vehicles for entertaining clients, friends and partners, even as they are used for business.

But as Chinese companies started to expand overseas, executives began to appreciate business aviation for more tangible benefits. Simply put, more Chinese executives need to fly on a regular basis to Australia, Europe or the United States.

“Many of our clients bought their own private jets so they could have more flexibility regarding where to fly to and when to fly,” said Jenny Lau of Sino Jet Management. “Jets are more than just something to show off their wealth -

they are a key transportation means.”

But recently the government has frowned upon private jet ownership and there

may be a backlash against business aviation. President Xi Jinping

launched austerity measures upon taking office in November 2012. His reforms were primarily directed at China’s wealthy elite and its state-owned companies, with the stated goal of reducing graft and corruption.

“This is a problem and we don’t see it going away in the short term,”

states Koe. “China is only at the beginning of a major reform program.

Also the anti-corruption drive appears to be the personal crusade of Xi Jingping, and

he’s only just started his term in office.”

It remains to be seen to what extent these measures will have a harmful long-term impact upon the sector.

According to Forbes, China

had 242 billionaires in 2014, up from 168 in 2013.

For comparison, there are 492 billionaires in the United States.

The list of Chinese billionaires includes Alibaba’s Jack Ma who is the country’s richest person with

a net worth of $19.5 billion. The top 100 richest Chinese billionaires are now worth

a combined $376 billion.

7 APRIL 2015 | www.cit.com

ConclusionAll forecasts indicate a steadily expanding pool of private aircraft owners in China. There are currently 377 private jets in China, with an additional 344 Chinese-registered aircraft located around the globe according to industry analysts. This is a relatively small number given the increasing amount of high net worth individuals in the country. Indeed, there are only slightly more jets than there are billionaires in the nation. For comparison, there are over 15,000 private aircraft in the U.S. with only about 250 more billionaires than China. Brokers and other business aviation executives have good reason for optimism in the growth of this sector.

However, short term issues have arisen which, if not addressed, could endanger or at least limit this growth potential.

An economic slowdown, lack of airspace, limited infrastructure and changing attitudes to wealth and private jet ownership have contributed to a slowing of growth in this sector. How Chinese officials react to these issues will have a tremendous impact upon the nation’s business aviation industry in both the short and long term. These effects will also be felt by the global business aviation industry which sees China as perhaps the major region for future growth.

“For the last few years China has been the star of Asia and viewed as ‘the next big thing’ in business aviation. And with good reason.

From 2013 to 2014 Asia’s total fleet grew by 6 percent. China is the major player in this region and has the largest fleet. But to put this into a global perspective, China remains outside the world’s ‘top 10’ countries by business fleet. The U.S. leads by far with Brazil – another emerging market - in the number two spot with 1,635 aircrafts. France rounds out the top ten list with 410 so China is still slightly behind the top nations.

That being said, China’s market is quickly maturing – not only in terms of infrastructure, but also in aircraft type. Although enthusiasm for the market remains high, most economic indicators point to a recent slowdown in China’s economy. It will be interesting to see if this trend towards maturity continues or whether China simply stalls.”

-Nick Klenske, Editor, FlyCorporate

8 APRIL 2015 | www.cit.com

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