Elevated aircraft asset backed security credit risk, and residual cash flow challenges stemming from the COVID-19 pandemic will continue to defer the recovery of commercial air traffic to pre-pandemic levels, according to DBRS Morningstar analysts.
“The general view is that Aircraft ABS is having medium to high credit risk. More specifically, we see significantly more risk in the subordinate tranches, and in the equity tranches in these transactions,” said Mark Hirshorn, a senior vice president of U.S. ABS global structured finance at DBRS Morningstar.
Aircraft ABS is the only sector with a negative rating outlook, said Stephanie Mah, a senior vice president of structured finance research at DBRS Morningstar during a webinar discussing the rating agency’s 2022 outlook for U.S. commercial ABS. The spread of the omicron variant and inflationary pressures due to rising energy prices and supply chain disruptions led The International Monetary Fund to reduce its 2022 U.S. GDP projections by 1.2 percentage points to 4%, Mah said. This matters when measuring performance expectations “for asset classes where commercial based obligors are the source of transaction repayment cash flows.”
Despite the revitalization that happened, in 2021 especially when the summer leisure travel picked up, business travel has not resumed anywhere near pre-pandemic levels, she said. The aircraft sector continues to deal with omicron-related travel restrictions, thousands of canceled flights and staffing issues.
Airline ABS risk and deal structures
The aircraft ABS debt market has been reasonably resilient since issuance rebounded in 2021 after almost shutting down in 2020, Hirshorn said. Pure aircraft ABS, exclusive of business jets and engine deals done in 2021, amounted to 11 transactions totaling $7.5 billion, he said, driven by operators with good credit who were able to take advantage of the low financing rates for the longer term.
During the past couple of years DBRS inflation assumptions for aircraft values that also affect cash inflows, were at or near zero percent. Currently increased inflation and interest rates likely will lead to higher aircraft sales proceeds, Hirshorn said, meaning “more cash and better protections for existing transactions.”
Underlined obligors tend to perform better as well on average first and second tier airlines, he added, but credit deterioration in pre-2020 transactions that include third tier airlines, for instance, will continue to struggle with cash flows.
Recent transactions have benefited from greater collateral diversity, often adding next–generation, newer narrow–body and freighter aircrafts, Hirshorn said. Transactions including wide body and old narrow body aircraft, however, feature accelerated depreciation rates alongside weak disposition and fewer buyers.
Nonetheless, aircraft ABS is off to a good start this year, he said.
“We have seen the addition of a number of different deal structures primarily in the private market,” including secured loans by aircraft lessors and owners, a trend expected to continue in 2022.
Passenger traffic & storage trends
Air travel fundamentals are also improving, adding to the better beginning for 2022. Air traffic had rebounded to at least 80% of the pre-pandemic levels, according to analysts. They warn, however, that business travel may never return to pre–2020 levels, especially international, long–route, leisure and business travel. This could create capacity pressures on the number and value of aircrafts deemed necessary.
Pre-pandemic, global storage rates were at or below 10%, according to DBRS. After 2020 the overall rate leveled at 60%, Hirshorn said, then fell to 25%-27% for wide body and 20% for narrow body aircrafts, which are more suitable for long-route travel.
The 737 MAX Boeing was up to 100% grounded pre–pandemic until 2021, he said, but currently has a 20%-25% storage rate, compared to 10% for the most attractive narrow body aircrafts. Similarly, wide body aircraft grounding rates vary from 35%-37% due to multiple factors.
Aircraft valuations
Such factors pressure the current market value (CMV) and the base value (BV) of aircraft. CMVs at 100% or above represent a strong market while CMVs under 100% indicate a less liquid market, he said. Freighter CMVs are north of 100% because throughout the pandemic consumer demand for e-commerce, supply chain issues and port delays kept freighter aircrafts busy.
In 2020 and 2021, value reductions reached 50% in some cases, yet more attractive aircraft values had stabilized, Hirshorn said. He also sees the recent Spirit-Frontier Airlines merger announcement as a sign of industry normalization.
