Over the last 20 years, passenger demand for global air travel has risen at an annual rate of 4.7% – or 1.5 times global economic growth over that period.
But in just the last five years, annual growth in passenger demand has topped 5%-6% as emerging markets and low fuel prices continue to support growth in the commercial airline industry.
That in turn has led to rapid growth in demand for aircraft, and in particular for leased planes that allow airline operators worldwide to fill routes and build fleets quickly and economically. Many of the new aircraft lessors that have sprung up to help them do this are turning to the asset-backed market for financing.
Volume has grown from just $1.7 billion in 2013 to $4.6 billion last year, according to Moody’s Investors Service.
Increasingly, these transactions are being structured to give lessors more flexibility in terms of both the types of collateral and the ability to actively trade aircraft. As a result, transactions more accurately reflect lesssors’ fleets. Many now finance mid-life and older aircraft, which have become more economical to operate as a result of low fuel prices.
And in February, Elix Aviation Capital completed the first deal backed entirely by turboprops, aircraft with turbine engines that drive a propeller, rather than jet engines. Patrick McShane, a managing director and commercial ABS analyst at Kroll Bond Rating Agency, which rated the $411 million transaction, believes that it portends an expansion in such niche-style assets. Market demand is growing and investors are becoming more comfortable with the lease performance and collateral attributes of specialty aircraft.
“It’s hard to say when or how often the frequency of these deals might happen, but nonetheless I can say that over the past three years we have seen a variety of new issuances,” said Patrick McShane, a managing director and commercial ABS analyst with Kroll. “We would anticipate seeing the continuation of this trend in 2017.”
Only one other deal rated by Kroll, sponsored by Castlelake Aircraft in 2014, has included a significant share of turboprop planes (about 33% of the pool).
Turboprops are noisier and offer a less comfortable ride than jets, but they operate more efficiently at lower speeds, making them a better fit for emerging travel markets like India or small island nations like Indonesia, according to Chris Damianos, the senior vice president of specialty markets for GE Capital Aviation Services (GCAS).
“Some of these routes aren’t suitable for a 150-passenger jet,” Damianos said. “You need a 75-foot turboprop to serve them economically, matching the capacity to demand.”
He notes that airlines in Indonesia do not have the facilities or the economies of scale to shuttle commercial jets between its major islands. (Indonesia happens to top the list of nations in expected passenger growth for internal travel through 2035, according to statistics from the International Air Transport Association).
In the last few years, the number of turboprops in service has risen to over 4,200 worldwide, according to Damianos. The two turboprop manufacturers, Canada’s Bombardier and France’s ATR, regularly report strong sales and order pipelines. (Bombardier reported that it delivered more than 1,200 new turboprops in 2016, and had 34 on back-order in the fourth quarter.)
As in the commercial jet space, demand for turboprops is outpacing supply, according to Kroll. That provides the opportunity for companies like Elix, owned by Oaktree Capital Management, that have amassed inventories that can be used to immediately fulfill operators’ needs.
Nordic Aviation Capital, another lessor with a large fleet of turboprops, has not issued a publicly rated securitization, though it does service a pair of 2014 transactions that it inherited from its acquisition last year of two regional jet leasing specialists. Those two deals, the $691.5 million Aldus Trust Leasing Aircraft Securitization Series 2014-1 (through Aldus Aviation) and the $513.2 million Eagle I Limited, Series 2014-1 (from Jetscape Aviation) are themselves unusual in that they are backed entirely by smaller, 70-120 seat regional jets manufactured by Brazil’s Embraer (known as “E-Jets”, which have been in service since 2004).
Like turboprops, E-Jets provide airlines with fleet flexibility and fuel-efficient alternatives to the small narrowbody aircraft that have traditionally served the market for sub-130 seat passenger planes. In its presale report for the Eagle I deal, Kroll described the collateral as “attractive leasing assets” due to an expanding global operator base and the ongoing “right-sizing” of this segment of the market.
Small lessors acquiring turboprops and E-Jets are “just not going to be able to get financing as efficient as the traditional bank financing methods, so they access ABS,” said Peter Manofsky, a director of U.S. ABS analysis for Fitch Ratings.
While deals backed by turboprops and E-Jets are still relatively rare, it has become common to issues deals backed by older aircraft, which are staying in service longer due to low fuel prices and fleet demands. Nine of the 18 public aircraft lease securitizations completed since 2014 were backed predominantly by this type of aircraft, according to Moody’s Investors Service.
These fleets are also low cost to obtain, and can also generate higher cash flow and asset yields relative to their low asset values. “Obviously with lower ratings overall and a slightly more esoteric nature of the collateral, I can see getting higher yield on the notes. That’s something I think the investors like,” said Manofsky.
In addition to new types of collater, there have been structures changes to deals, such as variations in handling of maintenance reserves and end of lease payments, as well as asset trades.
“There’s definitely been more flexibility added into the transaction structure to allow the lessor/servicer more flexibility in trading in and out of aircraft when they see the opportunity to do so,” Manofsky said. “It allows the servicer to trade out of an aircraft where they see softening demand, and [replace it with] one that’s going to be a better piece of collateral for that pool going forward.”
The demand for aircraft, specialty or otherwise, has led to consolidation among lessors, though this may be slowing simply due to the dwindling number of potential acquisitions.
In addition to Nordic’s deals for Aldus and Jetscape, AerCap Holdings of The Netherlands purchased the aircraft leasing business of American International Group for $7.6 billion in 2014. More recently, CIT sold its commercial air leasing business to the Avalon unit of Chinese conglomerate HNA Group in October 2016.
While these bigger operators are less dependent on securitization for low-cost funding, they do issue asset-backeds on an opportunistic basis, and to sell aircraft portfolios.
“Lessor M&A activity will slow down once these recent lessor acquisitions have been digested,” said Fitch Ratings’ senior director Hylton Heard. “There are just not as many names out there for sale, bar one or two still on the block.”