The repercussions of COVID 19 on the aviation industry are severe as most of the world’s commercial aircraft remain on the ground months into the crisis. Those most affected financially include airlines, banks, lessors and investors.
Airlines obtain aircraft through a variety of means. Some are bought directly for cash, more are financed through bank loans or capital markets debt, and others are leased from aircraft leasing companies. For the lessors, the situation is pretty much the same – they can buy aircraft for cash, finance them through bank loans or capital markets debt, or in fact through Aircraft ABS – of which there are currently around 50 in issue globally.
In an Aircraft ABS, Classes of Notes are issued to investors and listed on a stock exchange. The A-Note is the highest ranked tranche of an ABS or other structured financial product, and during bankruptcy, default, or other credit proceedings, an A-Note is senior to other Notes, such as B-Notes, or C-Notes. Indeed, the riskiest are the Equity (E) Notes, but as E-Notes have the highest risk they also have highest potential return.
The total ticket sizes for ABS range between USD 300m to 600m, with each comprising a mix of 15 to 25 aircraft on balance sheets, and deriving income from lease rentals. Lease income is used to pay fees and expenses, aircraft maintenance and interest and principal repayments to the Noteholders. The day-to-day operations are managed by a Servicer which is a specialist company that liaises with lessors, airlines, maintenance companies, legal and professional support and investors.
With the recent upheaval in global air travel due to COVID 19, most commercial aircraft are grounded and airlines are struggling to keep solvent. This has had knock-on implications for Aircraft ABS. While some airlines are still making their contractual lease payments, a significant proportion of ABS lessees have negotiated temporary rent deferrals that range from three months to sometimes six or even nine months. Other airlines have not even bothered negotiating and are simply not paying.
The effect of reduced lease income from airlines coming into ABS structures has had the following consequences:
- Downgrades to the Notes from rating agencies
- Some ABS Notes trading the secondary market at distressed prices
- Increased use of liquidity facilities in some ABS
- Some defaults on interest and / or principal payments to Noteholders.
The short to medium term outlook for the airline industry in general is bleak, with some predicting that global aviation travel will not reach pre-COVID 19 levels until 2023. Therefore it is likely that there will be some consolidation within the airline industry between now and then. Even if airlines do start flying again, it is expected that lease rates will be at much lower levels.
Unless airlines start flying soon, (and there are signs that airlines in south east Asia as well as in Europe are looking to increase the number of flights in the coming weeks), with reasonable load factors to finance lease rates owed to ABS, then liquidity could become a major problem in ABS structures.
Over the coming months we will also see significant differentiation between ABS issuances, where the underlying credit make up, aircraft type and abilities of the Servicer to navigate these tricky times, will result in some issuances being more “beaten up” than others.