“Portfolios will have to be less risky, both in terms of the airlines that lease the aircraft in the securitization, but also the countries they’re based in.”
It’s hard to overstate the amount of turbulence experienced by the aviation finance market over the last three years.
After a banner 2019, when asset-backed securitizations —a key source of capital for many aircraft leasing companies — hit a record high of $10.4 billion, Covid effectively shut down the market in 2020. Deal volume soared again in 2021, with transaction volume reaching $8.3 billion. Then the war in Ukraine dealt aviation finance another blow, stranding hundreds of commercial aircraft and tempering the appetite of issuers and investors.
“It was an unprecedented loss event that happened basically overnight,” said Vinson & Elkins partner David Berkery. “A lot of people took a step back.”
Berkery and his fellow V&E partner Niels Jensen have witnessed these market gyrations first-hand. Both acclaimed aviation lawyers who previously worked together at Milbank, Jensen and Berkery joined V&E in January to establish an aviation finance practice. The duo and their team represent aircraft leasing companies, airlines, financial institutions, and private equity investors in aircraft financings, acquisitions, and leasing transactions.
Jensen and Berkery recently sat down with V&E+ and shared four key trends impacting the aviation finance market. Here’s what they had to say.
Asset-backed securitizations are primed for a comeback
While the war in Ukraine, as well as rising interest rates, have slowed down capital markets, the recent closing of a $609 million asset-backed securitization by Global Jet Capital (GJC) was the first sign that issuances secured by the operating leases of commercial aircraft may return in the near-term.
“With one commercial jet portfolio pricing and a number of other deals ready to go, investor appetite and the interest rate environment are going to drive issuance volume in 2022,” Jensen said.
“ABS remains a very attractive, long-term financing product for leasing companies, if they can find the right portfolio to securitize,” Berkery added.
But investors are taking lessons from the war in Ukraine and will seek to lower their risk. Issuers will face pressure to assemble portfolios featuring in-demand aircraft that operate in low-risk jurisdictions, while loan-to-value ratios are expected to fall. At the same time, the higher interest rate environment means the cost of debt will go up.
“Portfolios will have to be less risky, both in terms of the airlines that lease the aircraft in the securitization, but also the countries they’re based in,” Berkery said.
Alternative lending is establishing itself as a viable source of capital
As traditional lenders have pulled back from the sector, private equity-backed alternative lenders — which don’t have the same capital requirements as banks — have been stepping in to fill the void.
“There are now greater numbers of capital providers in the space who have more flexibility in how and what they finance,” Jensen said.
Among the areas, alternative lenders have targeted is the conversion of passenger aircraft into cargo aircraft that are subsequently leased to retail and courier companies. These conversions require months of work during which aircraft leasing companies don’t receive any revenue.
“That’s something that traditional banks have found very difficult to finance,” Berkery said. “Whereas alternative lenders can step in and say, ‘Okay, we can finance that type of asset and go interest-only during the period that you’re not leased to either an airline or a courier service, but then we’ll step up your payment obligations once you’ve placed the aircraft on lease.’”
Investors’ focus on ESG will intensify
Investors have long pressured the aviation industry to reduce carbon emissions and those efforts will only grow stronger.
While aviation contributes around 2.5% of global carbon emissions, and the industry has made progress in reducing its carbon footprint, that message has failed to reach stakeholders.
As aircraft leasing companies face mounting scrutiny, they will need to clearly articulate their ESG plans to investors. “Investors are asking more questions before making investments as to what people’s strategies are and how they intend to move the industry toward its target of carbon neutrality by 2050,” Berkery said. “It’s no longer acceptable for a lessor to have no climate action plan.”
Consolidation buzz is in the air
AerCap Holdings’ (AerCap) 2021 acquisition of GE Capital Aviation Services (GECAS) will likely pave the way for additional M&A activity in the sector. The AerCap/GECAS tie-up brought together the No. 1 and No. 2 aircraft leasing companies creating a behemoth with a portfolio of more than over 2,000 aircraft, far overshadowing the current No. 2.
AerCap has significantly improved its leverage with manufacturers, investors, and the airlines, putting its rivals at a disadvantage.
“Operationally and from a cost perspective, you have certain advantages,” Jensen said. “If you’re a large, stable, creditworthy entity, you can raise cheaper financing. You’ve got more negotiating leverage with manufacturers. You have relationships with more airlines, you have a larger network. So, when an airline doesn’t pay you and you get an aircraft back, you might more easily be able to redeploy it elsewhere.”
“There’s an expectation that competitors will be forced to take action,” Berkery added. “Some of the mid-size leasing companies will have to eat — or be eaten.”