Mounting risks for aircraft lease ABS from coronavirus outbreak
The "hell or high water" nature of aircraft leasing contracts will, for now, keep lessors insulated from the economic harm the coronavirus outbreak is having on the global airlines they do business with.
But there's no escaping the potential impact that might arise from a prolonged period of infections, resulting in long-term travel restrictions that could force a series of airline bankrutptcies, researchers of aircraft lease securitizations are reporting.
"There should not be an immediate threat to lessor utilization rates and cash flows for aircraft lessors and ABS transactions," Fitch Ratings said in a report last week. "However, a pandemic will start affecting lessors if there are elevated airline bankruptcies, or if air travel is suspended for a prolonged period of time."
In a report released last Friday, Wells Fargo ABS analysts said they did not expect “an immediate cashflow effect” on aircraft leasing companies and their securitizations, “as the lessees should continue to pay on the leases” during the anticipated grounding of air traffic in China and other areas of the Asia-Pacific region.
“However, if the health emergency continues, Asia-Pacific airlines – particularly those without government support – could face financial difficulties, with could then lead to aircraft coming off lease unexpectedly," the Wells report stated.
As the financial pressure mounts on airlines, leasing firms could be faced with revenue interruption, declining asset values of their airplanes, and perhaps even the inability to deliver or repossess aircraft from airlines in nations with air-travel bans.
“Coronavirus is having a sharp effect on the financial health of airlines in the region,” said Douglas Runte, head of transportation debt research at Deutsche Bank. “To the extent those airlines experience financial challenges and delay or end payments on associated leases, aircraft ABS with exposure to those airlines would be affected.”
Fears of a pandemic spooked global markets Monday; the Dow Jones index fell 3.56% and the S&P 500 fell 3.35% after news of a jump in coronavirus cases in South Korea and Italy. Bloomberg reported the worldwide infection count surpassed 80,000 and the death toll climbed further in China (2,663), where the outbreak originated from the city of Wuhan in the Hubei province.
Most analysts are using aviation industry experiences with previous pandemics, particularly SARS in 2003, as a benchmark for the potential impact of the Wuhan coronavirus. When the SARS outbreak was at its most severe, the percentage of stored narrow-body aircraft globally climbed to 12.4% at the start of 2003, before peaking and then ending at 11.09% at the end of 2003, according to a Deutsche Bank outlook from late January.
“If the trough is both later and deeper for traffic than what we saw with SARS, the concern for both airlines and aircraft ABS gets heightened,” Runte said.
Aircraft lessors are protected from events like the coronavirus travel restrictions because of the long-term leases that govern airlines' use of leased commercial planes. The leases "require maintaining lease payments even with a reduction in revenue passenger miles. Lessors can also defer orderbook deliveries and reduce capital expenditures in the event of a temporary reduction in demand," Fitch's report stated.
"However, a pandemic will start affecting lessors if there are elevated airline bankruptcies, if air travel is suspended for a prolonged period of time, if a ban of air traffic to a specific country creates a problem for aircraft lessors to repossess and redeploy aircraft to other regions or if airlines start refusing new aircraft deliveries."
About 54 countries, including the United States, have implemented coronavirus-related travel restrictions to China and the Asia-Pacific region, according to a Feb. 13 update from the International Air Transport Association. The IATA reported last week that its initial assessment of the travel impact shows a potential 13% annual decline in Asia-Pacific air travel in 2020 - a year that originally had a forecast of a 4.8% hike in passenger demand.
"In that scenario, that would translate into a $27.8 billion revenue loss in 2020 for carriers in the Asia-Pacific region—the bulk of which would be borne by carriers registered in China, with $12.8 billion lost in the China domestic market alone," according to a Feb. 20 IATA news release.
The Asia-Pacific region accounts for 35% of global passenger air travel, compared with 27% for Europe and 22% for North America.
Deutsche Bank estimated that 46 outstanding aircraft ABS deals had aircraft leases to airlines in the Asia-Pacific region, where many carriers are not financially strong to make huge upfront investments in buying planes for new routes.
“The potential impact will vary dramatically by airline,” Runte said. “Different airlines have different degrees of financial health. Some were struggling prior to the revelation of the coronavirus, so those are the ones potentially most at risk.”
The possibility a global air traffic slowdown would dampen the currently high demand for midlife and end-of-life aircraft, according to Fitch, and negatively affect secondary markets and residual values. "That would result in potential losses from aircraft trading, lower lease rates for new leases for aircraft lessors active in this space and weaker performance for ABS transactions," Fitch's report stated.