Issuance of bonds backed by aircraft leases is booming as airlines turn to lessors to fill gaps in their fast-expanding fleets in response to falling energy prices and rising passenger traffic. They are increasingly booking the older, less fuel-efficient airplanes in lessor’s fleets, which can now be operated profitably.
Lessors are taking advantage of the demand to offload leases on aging fleets from their books through securitization, and using the proceeds to acquire newer-production models.
“If I were a top-tier leasing company, I would be selling these older aircraft because right now, fuel prices are incredibly low,” and older aircraft are at peak value, said Jonathan Goldstein, a partner at Pillsbury Winthrop Shaw Pittman and a longtime legal advisor in high-end aviation structured finance. “Three, four or five years down the line, one could extrapolate that conditions will change.”
Deutsche Bank and other firms expect to see between $5 billion and $10 billion of asset-backed transactions for aircraft lessors this year. That would build on the momentum from 2014 and 2015, when issuance the asset class exceeded $7 billion worth of deals over both years – levels previously not seen since the pre-financial crisis era of $7.6 billion in aircraft ABS securitizations from mid-2005 to 2008.
“Strong investor demand for aircraft exposure has prompted private and public investors to sponsor new entrants in the aircraft leasing sector that are buying aircraft to increase scale,” wrote Moody’s Investors Service analysts in a global airline industry sector report last month. “At the same time, airlines’ desire to more efficiently deploy capital will increase their demand for leased aircraft.”
Six leasing companies completed leasing deals totaling $3.7 billion in 2015, according to credit rating agency DBRS. One of the transactions was a $1.2 billion securities issuance by BBAM Aircraft Leasing last May that was the first billion-dollar plus aircraft ABS in over a decade. That deal was also noteworthy for weighted average age of 6.2 years on the underlying aircraft assets, making it one of the older vintage pools of recently rated aircraft ABS.
Prior to 2014, aircraft ABS had been largely dormant in the post-crisis era. Investors had been wary of the quality of large number of planes built in the late 1980s and early 1990s then nearing the end of what DBRS termed the “natural economic lifecycle.” (Approximately 40% of orders that are currently in place with Boeing and Airbus are to replace aging fleets approaching 30 years of service). During this time, aircraft lessors kept leases on their books, turning to more favorable financing conditions from banks and export credit agencies.
The market thawed in 2013, as companies like Avolon Aerospace Leasing and GE Capital Aviation Services kicked off a third-generation of aircraft ABS issuance.
With growing investor demand and commercial carriers improving in credit quality through mergers and operational efficiencies, the ABS market is in the third year of a comeback in which it now is expected to provide up to 40% of the financing for airlines’ expanding fleets in a $130 billion-a-year base market, according to DBRS.
“Some lessors are looking for attractive form of non-recourse financing [for plane purchases], while other lessors are looking for a way to sell portfolios and get aircraft off of their balance sheet,” explained Douglas Runte, a managing director at Deutsche and head of aviation debt research.
Runte notes that many lessors of second-generation ABS securitizations still have high utilization of their fleets that were collateralized in the mid-2000s. Goldstein points out that AerCap Holdings, a longtime issuer or lease-backed securities, still has healthy demand its 50 Boeing 767s aged between 12 and 21 years. “And they’re willing to lease these aircraft to less desirable credits at higher rent values,” he said.
“People ask me about the evolution in aircraft securitization,” said Tony Nocera, a managing director in commercial and non-traditional ABS for Kroll Bond Rating Agency. “While structures have evolved, it’s really more about the assets.”
ABS deals the last two years have strongly featured older, vintage aircraft that literally have been given a new lease on life thanks to lower fuel costs as well as passenger demand levels that make maintenance of the older fleets more feasible for operators.
Aircraft securitization debuted in the 1990s and the market has been cyclical. It provides a key source of capital for fleet owners of commercial airlines, corporate and regional jets and turboprops, but has often struggled with weak credit quality in airline customer base. These deals are complex; they require the input of ratings agencies and aircraft appraisers, and assessments of investor demands, making securitization impractical for all but the larger-size portfolios. “The average deal size is going to be at least several hundred million dollars,” said Runte.
Securitization also competes with financing from banks export agency credit (EAC) as well as issuance of enhanced equipment trust certificates, which are bonds issued by airlines collateralized by the planes being purchased. But banks are less keen on finance the leasing or acquisition of older plans, and the support of EACs (most notably in the U.S. Import-Export Bank’s dwindling support for Boeing’s international deliveries, accounting for only 11% in 2015).
The increased demand for older aircraft is making securitization more attractive, however, especially for those approaching the end of what DRBS calls a plane’s “natural economic lifecycle,” when excessive maintenance costs make it more practical to scrap them for parts.
The ongoing high utilization and lease income from AerCap’s Aircraft Lease Securitization 2007-1 – one of four that AerCap has issued – prompted Moody’s to put the deal’s ‘Aa3’-rated class G-3 certificates under review for a potential upgrade in January. (Pre-crisis securitizations will typically have higher ratings than more recent portfolios, since pre-2008 vintage included insurance wraps to enhance ratings. More recent issues are stand-alone ‘A’-rated portfolios without insurance backing).
Improved profitability and credit ratings of the airlines (Delta Airlines was upgraded from junk status by Moody’s in February) have also aided the business of lessors, which face less counterparty risk of default and repossession. “This makes lessors’ lives a lot happier,” said Runte. “The thing you don’t want to have to do as a lessor is have a forced or unplanned repossession of an aircraft. It can be difficult, it can be time consuming, it can be expensive, and it can take a long time to find a new home.”
Low fuel costs over the last two years have made extending leases on older fleets more feasible for airlines, but analysts and players in this esoteric ABS sector hesitate to ascribe the ascent of aircraft-related securitizations primarily to lower oil prices. Increased passenger demand, alongside an extended backlog of orders for new plane deliveries from Boeing and Airbus, are perhaps bigger factors for the one, two or even three-year lease extensions airlines are seeking for older ABS-owned aircraft.
“I don’t think you can attribute the increase in the transactions, both in the ABS and [enhanced equipment trust certificates] space... due to favorable fuel prices today specifically. It’s just one of several factors,” said Goldstein.
“Perhaps at the margin,” oil prices have had an impact, adds Deutsche’s Runte. “I think the bigger drivers are fundamentals that have already long been in place.”
Chief among those is passenger traffic, said Runte. According to the International Air Transport Association (IATA), revenue per passenger growth is projected at 6.9%, compared to 6.5% growth in 2015 and 6% in 2014.
“Combine that with strong growth in passenger demand,” of 7.1%, Runte said, “parked aircraft is low, utilization of existing fleets is high, and it creates stronger demand for aircraft, both new and older.”
In addition, expected rising interest rates could make the floating-rate leasing costs associated with the planes more attractive for ABS securitizers, who issue fixed-rate notes.
The surge in interest from investors, as well as the growing variety of ages in the securitized fleets, has prompted structural changes in ABS deals. The traditional monoline, A-rated single-tranche deals are giving way to multi-class series of notes.
BBAM’s ECAF 1 Ltd. trust issued $1.2 billion in 25-year notes last year via two tranches of notes backed by the leasing receivables of tier 1 commercial Airbus and Boeing aircraft. AWAS Aviation Capital also used Class A and Class B notes in 2015 to finance the purchase of a fleet of 30 aircraft being leased in 14 countries. Castlelake Aviation placed three tranches of notes in its $713.2 million CLAS 2015-1 transaction, after splitting its previous $515.5 million CLAS 2014-1 into a two tranches of notes.
“In the mid-2000s, you had deals that were single-tranche transactions that were wrapped by monoline transactions,” said Kroll’s Nocera. “The fleets were newer and structures were a little simpler than today.”