The post-COVID resurgence in demand for air travel is worsening tight aircraft supplies, especially in Asia-Pacific. Forced to extend leases on existing aircraft, airline operators in the region are facing escalating lease prices, which is helping to create tighter spreads on aviation ABS deals, even at the senior level.
The number of aircraft in service in the Asia-Pacific region now exceeds the number of aircraft in-service from May 2019, while the regional number of aircraft in storage is also at pre-pandemic levels, Deutsche Bank explained in its recent report, "Asia air traffic rebound drives aircraft demand upwards."
Aircraft production had slowed down considerably during the pandemic and deliveries of new aircraft are still subject to delays.
"The transition to higher [lease] rates was slow initially in 2022 but started to pick up further in 2023. This has been driven by the overall global demand for aircraft and ongoing tight supply of both new and used planes, along with rising interest rates," said Hylton Heard, a senior vice president of structured credit at DBRS Morningstar.
What this means for aviation ABS, according to Guggenheim Securities, is that secondary market spreads on post-COVID senior, 'A'-rated notes have tightened into the mid-high 200s, from the low-mid 300s where they were at year-end 2022, according to Michael Liu, a managing director of structured products trading at Guggenheim Securities.
"B tranches with BBB ratings from these deals have also tightened from the mid-500s into the mid-high 400s," Liu said.
Spread movement is also a matter of supply and demand, affected by low aviation ABS issuance. Liu said that consequently investors are seeking senior tranches in the secondary market.
"Given uncertainties in the sector, higher yields, and a shift to more conservative structures, we expect new issue commercial aircraft deals to remain focused on placing seniors to investors, with issuers likely retaining the mezzanine and equity portions of the stack," he said.
Investor preference for senior tranches compounds another issue: diminished issuance activity. Year to date, the aircraft ABS sector has produced only one new issuance. That is a clear drop from just three new aircraft ABS transactions in 2022, and it is eclipsed by the 15 deals that got done in 2021.
"Investors are wanting to see wider spreads. But the aviation ABS market has not necessarily been able to cater for that, which is why there has been a lack of issuance," said Peter Walter, director of asset management at U.K.-based aviation consultancy IBA. "They need to wait for a pool of assets with higher lease rates relative to the current market."
New debt issuance is not likely to get a boost from new aircraft leases, because of the nature of their structure, according to industry sources. Since aviation leases are long term, it will take some time for higher lease rates to generate ABS income.
"We aren't forecasting an increase in ABS issuances until mid to late 2024 and then a return to good levels of issuance in early 2025," Walter said.
In terms of ABS credit Fitch Ratings says it expects aircraft ABS ratings to stabilize this year, but tempers that positive outlook, saying the process is likely to be slow. After unprecedented stress over the past few years, aircraft lease performance is improving, airline credit quality is strengthening, and aircraft values and lease rates are increasing for many aircraft types, the ratings agency said in a February 2023 research note.
"Airline credit improved notably in 2022, and we see this trend continuing in 2023, although at a more gradual pace with airlines facing a number of challenges," Fitch said.
