Aviation credit markets grappling with Boeing 737 MAX
The grounding of Boeing 737 MAX jets continued to reverberate through the aviation credit markets Wednesday, as the U.S. bowed to pressure and grounded Boeing MAX 737 aircraft.
The decision, announced by President Trump, means that the aircraft involved in a deadly crash in Ethiopia on Sunday are now grounded worldwide. Canada had announced a similar move earlier in the day.
Credit market participants are now contemplating the possibility that the discovery of a systemic issue with the aircraft could result in their being grounded for an extended period of time, which could result in material delays in the delivery of aircraft on order and even significant order cancellations.
"The Boeing 737 MAX could be a concern throughout the aviation credit sector for much of 2019," Fitch Rating said in a statement issued mid-afternoon. The rating agency said it was premature to take credit ratings action until there are final conclusions about the Ethiopian Airlines crash and another crash by a Boeing 737 MAX operated by Lion Air in October.
The most immediate impact is on Boeing; Fitch said the company's credit profile (it's currently rated A with a stable outlook) could weaken in a worst-case scenario. But there would also be pressure on Boeing customers, many of whom finance new aircraft like the 737 MAX using enhanced equipment trust certificates, or EETCs, a kind of sale-and-leaseback financing. There are a total of 37 737 MAX aircraft, 34 of which have been delivered, in five outstanding EETC issues, according to Deutsche Bank.
Most recently, United Airlines priced $1.01 billion in equipment notes in January that finance the delivery of 25 planes, including nine Boeing 737 MAX 9 planes representing 28% of the total value of the portfolio.
Other outstanding EETCs have even higher exposure, as high as 58% for a $301 million transaction completed by Air Canada in February 2018 that is secured by one new Boeing 787-9 and four Boeing 737 MAX 8.
However, EETC investors are pretty well insulated from the impact of the grounding of these planes, according to Deutsche Bank. In a report published Tuesday, Douglas Runte, an aircraft debt analyst and managing director at Deutsche, said these deals have several indenture provisions that insulate investors from the financial impact of regulatory action.
For aircraft already delivered, EETC indenture language requires principal and interest payments to continue for outstanding EETC issues “regardless of the operating status of the aircraft” or until a loss is declared, when a par call on the notes would occur, the report states. EETC agreements also establish the steps for an airline to return a plane deemed not flightworthy, usually a six-month time frame during which EETC payments also continue (airlines can delay this return schedule up to two years if its working toward introducing the plane into service).
An airplane returned to a manufacturer would be followed by a pro rata call of the EETC deal at par to refund certificate investors, the report states.
Even for the 4,596 of MAX jets on back order awaiting delivery, regulatory and transactional protections will also limit exposure for airlines and aircraft lease/EETC investors in the event of a long-term grounding or an actual ban of the jet. It is “inconceivable that an airline would accept delivery of an aircraft that could not be flown,” the report states. “In the event that scheduled delivery had to be delayed, the indenture provisions allow for some period of time between the original expected delivery date of the aircraft and when it is ultimately delivered.”
Runte says it’s "highly likely" that the 737 MAX aircraft will eventually return to service, however.
“Aircraft types have been grounded in the past and modifications mandated from the DC-10 in 1979 to the 787 in 2013, but there are no instances we know of in the last 50 years where a mainline, western-built commercial aircraft type has been permanently grounded," the report states. "One would likely need to go back to the 1950s and the ill-fated de Havilland Comet to find an example of a jet aircraft whose design was found to be so compromised that a substantial fleet of aircraft needed to be permanently retired.”
While aircraft lessors own almost 40% of the global fleet of commercial passenger jets in use, to date none of them have financed a 737 MAX in the asset-backed market, according to Deutsche Bank. That’s unsurprising, since this model has only been delivered since 2017. “The typical aircraft ABS collateral pool consists of aircraft that are not newly delivered (and quite old),” the report states.
Fitch, DBRS and Kroll Bond Rating Agency all confirmed that none of the aircraft lease ABS that they rate have 737 MAX jets as collateral.
In its statement, Fitch said that the effect of the groundings on aircraft secured debt transactions would likely be mixed, with deals containing the MAX potentially coming under pressure, offset by higher valuations for alternate narrow-body models needed to replace the MAX.
Fitch does not expect the MAX will have a material effect on aircraft lessors it rates, however.
U.S. airlines have already announced a rejuggling of their fleets. United Airlines issued a statement that it's grounding 14 aircraft, which account for 40 flights a day. It will use spare aircraft and rebook customers, and American Airlines said it is parking 24 Max 8s used on 85 flights a day (out of 6,700 daily departures in its system).
The mass production of newer planes such as the Boeing 737 MAX has put pressure on leasing companies to upgrade their fleets. That pressure may now be lessened, at least temporarily. “Airbus and Boeing have launched several new aircraft types in recent years,” AerCap, the world's largest lessor of passenger aircraft, said in a regulatory filing last week. “The development of these new types and variants of such new types could decrease the desirability of the older types and variants and thereby increase the supply of the older types. This increase in supply could, in turn, reduce both future residual values and lease rates” of AerCap’s fleet of 962 owned aircraft.
With an oversupply, AerCap’s ability to finance aircraft purchases could be “negatively affected,” resulting in a higher cost of funds, which could “materially and adversely affect our financial results,” the report stated.