Capital markets have captured an increasing share of the aircraft financing market over the last 10 years.
Introduction
Aircraft Asset Backed Securitisations (ABS) have been a feature of the capital markets arena over that time, with a peak in Aircraft ABS reached in 2019.
An Aircraft ABS uses a Special Purpose Vehicle (SPV) to purchase aircraft, typically sourced from the books of an existing lessor) with the SPV holding the rights to lease payments to airlines. The SPV finances the purchase of the aircraft through the issuance of tranched Notes to investors.
Higher-rated Senior Notes attract less interest and less risk while the lower-rated Equity tranche retains the greatest risk and potential rewards. Equity Notes are normally held initially by the Originator (leasing company) and they may, on occasion, act as Servicer, thus retaining an ongoing relationship with airlines.
Investors had been attracted to the asset class as they were receiving an attractive yield relative to other asset classes whilst the underlying credits, airlines, performed strongly. All of that changed in recent years.
Recent Risks
Covid has had a dramatic impact on the airline industry and on Aircraft ABS. With the grounding of many aircraft in 2020/21 the aircraft leasing industry suffered an incredibly challenging environment.
Successive COVID travel restrictions resulted in lease rental deferrals, changing fixed lease rentals to power-by-the-hour for some existing lessees, deferrals of maintenance reserves and lower lease income from switches of aircraft out of defaulted lessees to new lessees; all resulting in a dramatic reduction in income for Aircraft ABS.
Some employed the use of liquidity facilities to make interest payments to investors while many principal payments were suspended through lack of cash through the waterfall. However, Aircraft ABS, by their design, are able to absorb these losses and the structures themselves remained intact.
The invasion of Ukraine by Russia caused further turmoil within the industry. Many aircraft trapped in Russia were held by Aircraft ABS. Rating agencies downgraded many tranches of Aircraft ABS during that time and the issuance of new ABS dried up.
Outlook
The airline industry has had a dramatic turnaround in fortunes in the last year. Many airlines have recorded passenger numbers back to pre-pandemic levels. To meet demand airlines are returning aircraft back into service. Lease rentals are being paid and the cash-flow within many ABS are back in a healthy state. So airline credits are improving, aircraft residual values are better and investors are seeing continuing interest and a resumption principal payments. Rating agencies have recently upgraded ratings on many senior tranches of ABS structures. Whilst risks are still pertinent, including oil prices, higher interest rates, geopolitical conflicts and airline defaults Aircraft ABS still represent an investment opportunity worth considering.
To find out more about Aircraft ABS, please get in touch with Mohammad Zia, based in our Dublin office.
