The aircraft sector of the ABS market is still grasping at straws when it comes to mapping out its future and deciding on what changes should be implemented, panelists said at a recent gathering hosted by UBS. As a result, differences in valuations and rating methodologies offer structurally savvy investors opportunities for incremental yield in the tight credit environment.
Noting that aircraft ABS has underperformed expectations by three standard deviations, UBS director and aircraft ABS trader Mostafiz ShahMohammed told the up to 280 attendees that the likelihood of default of both primary and backup servicer was small and that, even if this changes, sources of value exist at the right price.
ShahMohammed recommends that investors analyze a transaction's structure rather than the credit of the underlying assets, urging that any potential buyers to be mindful of lease arrangements backing the deals and performance triggers embedded in each deal's structure.
The conference, which coincided with the publication of UBS' Framework for Evaluating Aircraft ABS research piece, also served as a platform for Shah Mohammed to tout a new pricing model UBS will soon release. An integral part of the model, according to ShahMohammed, is its basis on the difficult-to-gather lease-rate volatility.
From there an investor's decision should be based on the yield desired. For example, ShahMohammed broke down the outstanding aircraft lease ABS sector into five distinct investment opportunities.
The largest group available is first-pay senior amortizing notes, with roughly $5.1 billion outstanding. First-pay seniors typically offer a 9% to 13% yield, or up to 900 basis points over Libor, on a discount margin basis.
Second-pay seniors, totaling roughly $4 billion of the sector, are bonds that have stepped up, but have yet to pass that excess return to investors. These can offer 300 to 750 basis points over Libor in yield.
With just over $1 billion outstanding, amortizing subordinate notes will pay interest throughout the deal's life, according to UBS. These classes only accelerate upon erosion of senior class interest or "complete servicer default," meaning both primary and backup servicer default.
Bonds that look as though principal may already be lost fall into what UBS calls its I/O-like category, currently totaling $2.9 billion. Typically shorter duration subordinates offered at low dollar prices have been seen with returns approaching 3500 basis points over Libor. Using UBS' assumptions, investors should consider any principal repayment as gravy.
The most highly leveraged bonds in the sector are classified as PIK/default notes, which can offer yields in excess of 35% or 3500 basis points over Libor. The play with this class of bonds is that maintenance costs decline and cashflow recoveries may lead to eventual interest payments.