Aviation Finance: Five Key Trends to Understand in the Aviation Industry
Contributed by the Vinson & Elkins Aviation Finance Team, including Niels Jensen, David Berkery, Demi Hueth, Kim Dalrymple, and Coral O’Connor
After a two-year hiatus due to the pandemic, the Airline Economics and AirFinance Journal conferences returned to Dublin this month. The conferences were well-attended and there was optimism in the air among the many key players, including investors, suppliers, and manufacturers.
Throughout the course of both events we listened to dozens of panellists and convened with multiple stakeholders who shared their views. What we consistently heard were remarks on the proven resilience of the aviation industry and predicted better times ahead, while still urging that lessors, airlines and investors exercise caution in light of lessons learned. Here are five key themes that emerged over the course of the two weeks:
- The Return of the ABS: While the capital markets have been quiet thus far in 2022 due to a number of factors, including the ongoing Ukraine/Russia conflict and the continued increase in interest rates, the successful closing of GJC’s business jet ABS is a positive sign and issuances of ABS secured by operating leases of commercial aircraft are expected to return in the near term. ABS deals coming to market now are likely to feature “pristine” portfolios focusing on in-demand aircraft types and low risk jurisdictions. Rating agencies have grown more comfortable with less portfolio diversity provided that the lessee credits are strong. Other structural changes are most likely around LTVs and amortization profiles, but largely the ABS structure has stood the test of COVID and Ukraine/Russia without the need for radical overhaul. E Note transactions are likely to lag debt issuances and will hinge on finding the right balance between investors’ return expectations and asset valuations driven by lease-rate factors.
- ESG: The “E” in ESG remains a hot topic, but no easy solutions present themselves. Solutions for operators are likely to start with carbon offsets, then increasingly incorporate use of SAF as supply increase and costs come down, and eventually eVTOLs may be utilized for lower capacity, short-haul transport (subject to air traffic permitting it). Already, the modernization of fleets and other corporate initiatives by industry participants have helped reduce the sector’s carbon footprint, and a consensus emerged that the industry needs to do more to communicate these efforts and improvements to stakeholders—including investors and regulators. Equity investors appear to be more insistent than debt investors on including ESG solutions, however concrete KPIs and industry-wide standards have yet to emerge and market incentives remain murky.
- Emergence of Alternate Capital Sources: Diversifying funding channels continues to be a priority for lessors as interest rates rise and as a slew of COVID-delayed deliveries create a need for new capital. Private equity’s presence is ever-expanding and private equity firms, which are not subject to the same capital adequacy requirements as traditional bank lenders, have introduced additional competition in the debt markets. Especially while traditional lenders adopted a “wait and see” approach, these alternate capitol providers have demonstrated a willingness and ability to step in and meet financing requirements. Investor appetite for aviation investments remains very strong and investors of all types reported that they have more capital to deploy than there are suitable investments. In the current competitive environment, investors have placed a premium on origination capabilities and certainty of execution in addition to pricing and returns. Distressed lenders have also entered the sector. While some lessors and airlines view this development with concern, some capital providers argue that distressed investors have a role to play in the market (as they do in many other industries), especially as a buyer of last resort for those looking to exit a sinking investment.
- Potential Consolidation: Several conference panellists predicted that further consolidation in the industry is likely, noting that even small mistakes or isolated incidents can have catastrophic consequences for smaller lessors. Panellists noted that, for less specialized lessors, there will be advantages in scale, while others identified orderbooks as a potential reason to pursue an acquisition until lease rate factors improve to reflect a higher interest environment, this is likely to remain an attractive avenue.
- Uptick in Aircraft Trading and Increased Lease Rates: Industry players remain bullish that the trading market will experience a meaningful increase in the next three years, particularly as a slow ABS market in Q1 of 2022 made it difficult for a number of lessors to move assets off their books in anticipation of new deliveries. Lessors were bullish that increases in passenger numbers would allow them to pass on some of their increased costs to customers noting the accommodations made by lessors to airlines during the peak of the pandemic.
The general consensus from the conferences is that the industry has been put to the test by a number of historical pressures in a short period of time – perhaps more so than at any point before. Between COVID, Ukraine/Russia (see our recent article on this topic), rising interest rates with lagging lease rates, fuel price increases, and climate change pressures, the ability to adapt will be even more important for industry participants.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.