After a record year for aviation finance in 2021, the increased cost of capital came as a shock to many seeking to raise funds in 2022. As well as being more expensive, capital also became accessible toward the end of the year. Inflation has been steadily rising since countries began to exit pandemic lockdown measures but spiked following the Russian invasion of Ukraine and continued to rise until the fourth quarter of the year when oil prices started to cool slightly. Central banks reacted to curb inflation by increasing interest rates in steeper increments than markets had expected.
At the end of 2022, interest rates in the US were 4.5%, in the EU rates rose to 2%, while the UK Bank of England interest rate finished the year at 3.5%. The consensus is that further rate rises are expected for 2023 while inflation is being brought back under control. Goldman Sachs predicts that the short end of the interest rate curve will be as high as 5-5.25% but could increase further should rising inflation threaten to push the US into recession. The EU and UK are expected to fall into a shallow recession this year but interest rates in both regions are expected to continue upward. The market is predicting that the Bank of England base rate will rise above 4% in early 2023 and as high as 4.6% by July 2023. Rate rises in the Eurozone are expected but in smaller increments.
Even though interest rates are now rising and at their highest level since the global financial crisis in 2008, at between 4-5% they still remain very low when viewed over a longer time horizon (see chart).
Although rate rises were expected, the real issue concerning investors has been the flat and inverted yield curve – which tracks the gap between long-term and short-term government borrowing rates – that often is a harbinger of a recession. In the US, a so-called “yield-curve inversion” occurred in April 2022 for the first time since 2019. The chart below shows that the US Yield Curve remains inverted for short, mid, and long-term maturities.
“Concerned that interest rates are rising very quickly, colleagues in our macroeconomic forecasting area are focused on the shape of the yield curve,” said Goldman Sachs’ Greg Lee. “On the short end of the curve, rates are expected to be 5%-plus, the unknown is where whether the long end of the curve will continue to be inverted around the low 4%. We are watching developments very carefully since an inverted curve is a relatively negative signal in terms of the demand for capital.”
Lease rates are expected to rise, with many lessors already indicating an uptick (see Chapter Three-The Age of Leasing), but it will take some time for them to catch up with rising interest rates to return that equilibrium with the debt markets.
For the aviation sector, rising interest rates and the increased cost of debt will – and indeed need to – feed into lease rates eventually but there is always a delay due to the long-term nature of the aircraft lease products.
Lee says that although some lessors will be able to cope with rising interest rates, others may struggle. “Lessors with a capital structure based on a stacked maturity schedule over a five or seven-year period would only need to refinance one seventh of their debt stack in any given year, which is a good pattern to follow alongside strong capital allocation and a good liability management strategy,” he says. “The problem for lessors that have too much debt coming due at once with longterm rates, is that if they are not hedged appropriately, they could get caught out where the return on equity implied by the lease rates is not generating a sufficient return for their shareholders.”
Hedging is a sound financial tool used to flatten out interest rate rises and, until the volatility ends and the rate rises stop or become more predictable, this will become a more feasible solution for many more companies. Vinodh Srinivasan, Managing Director, Co- Head of the Structured Credit Group at Mizuho, notes that it is the volatility which is pushing out credit spreads for aviation issuers. “Because investors have uncertainty around what the Fed might do with regards to rates, they’re building in a cushion into the credit spread, which is then unfairly penalising the issuers because it’s not reflective of what their true credit spreads should be,” he says. “It’s totally understandable from an investor perspective, but that’s just piling on a level of debt cost that’s unsustainable.”
AerCap’s Aengus Kelly agrees that without adequate hedges in place, certain lessors will be exposed to interest rate rises. “Lease rates increase with interest rates – and we have seen that happening over the past 10 months on new aircraft and it is almost instantaneous – on older aircraft there is generally a few months lag to catch up,” he says. “That’s a pretty small impact but interest rate rises also feed into your funding structure, for hedged businesses like AerCap, your exposure occurs when your liabilities mature. For example, if we have $5 million of liabilities maturing in a year, we will also have approximately $5million of assets repricing in that year to offset the interest risk. Companies that aren’t hedged will be in a very tight spot. Those that were playing the yield curve and funding the business with threemonth floating money, will inevitably be hurt badly.”
The problem for lessors that have too much debt coming due at once with longterm rates, is that if they are not hedged appropriately, they could get caught out where the return on equity implied by the lease rates is not generating a sufficient return for their shareholders.
For CALC CEO Mike Poon, like many of his peers, maintaining a diverse funding strategy is critical, particularly during a downcycle. “Lessors may have different strategies but for CALC, our strategy is to maintain a diversification of funding sources,” says Poon. “We will try to maintain each of our funding sources; we maintain the channel and maintain a relationship with a different kind of funding or financing. CALC has long-established diversified onshore and offshore financing channels over the years. Poon adds that thanks to its diversified funding sources, CALC can also consider switching to RMB financing “when appropriate and favourable.”
The tense macroeconomic environment has served to increase the cost of funds for leasing companies and airlines alike. In 2021, top-tier leasing companies were able to raise five-year senior unsecured debt at an all-in rate of around 2-2.5%; today that number reaches 6% although it peaked above 7% in mid-2022. Airlines have been able to tap the commercial bank market for significant amounts of unsecured debt at what Lee describes as “decent levels” at around 200 basis points, whereas issuing in the capital markets would have been “a hundred, 150, and sometimes 200 basis points wide of those levels”.
The capital markets are a deep and renewable source of funding, which were being used increasingly by aviation companies with issuances peaking in 2019. The capital market also provided a lifeline for airlines and lessors during the pandemic, with record amounts of debt raised in 2020 and 2021. In 2022, the rising rate environment increased the cost of debt became unattractive and many companies pivoted back to the commercial banks for access to more efficient capital.
CHART 13: TOP TEN AIRCRAFT LESSORS (BY PORTFOLIO VALUE)
| AIRLINES | |||||||
|---|---|---|---|---|---|---|---|
| Date | Issuer | Size (m) | Tenor | Maturity | Rank | Spread to T/ MS | Coupon |
| 12-Jan-22 | Wizz Air | € 500 | 4 | Jan-26 | Senior Unsecured | MS+105 | 1.00% |
| 14-Jan-22 | Korean Air Lines | ¥30,000 | 3 | Jan-25 | Senior Unsecured | 0.45% | |
| 12-Jan-22 | Singapore Airlines | US$600 | 7 | Jan-29 | Senior Unsecured | 180 | 3.38% |
| 20-Jan-22 | VistaJet (Malta) | US$1000 | 8 | Feb-30 | Senior Unsecured | 461 | 6.38% |
| 20-Apr-22 | VistaJet (Malta) | US$500 | 5 | May-27 | Senior Unsecured | 526 | 7.88% |
| 18-May-22 | Air New Zealand | AUD 300 | 4 | May-26 | Senior Unsecured | 240 | 5.70% |
| 18-May-22 | Air New Zealand | AUD 250 | 7 | May-29 | Senior Unsecured | 300 | 6.50% |
| 10-Aug-22 | Allegiant | US$550 | 5 | Aug-27 | Senior Unsecured | 446 | 7.45% |
| 15-Sep-22 | Korean Air Lines | $300 | 3 | Sep-25 | Senior | 90 | 4.75% |
| 20-Oct-22 | Air New Zealand | NZ$100 | 5.5 | Apr-28 | Senior Unsecured | 190 | 6.61% |
| 11-Oct-22 | LATAM | US$450 | 5 | Oct-27 | Senior Unsecured | 1085 | 13.38% |
| 11-Oct-22 | LATAM | US$700 | 7 | Oct-29 | Senior Unsecured | 1094 | 13.38% |
| 09-Nov-22 | Spirit Airlines | US$600 | 3 | Sep-25 | Senior Unsecured | MS+405 | 8.00% |
| LESSORS | |||||||
|---|---|---|---|---|---|---|---|
| Date | Issuer | Size (m) | Tenor | Maturity | Rank | Spread | Coupon |
| 05-Jan-22 | Air Lease Corp | US$750 | 5 | Jan-27 | Senior Unsecured | MS+220 | 5.85% |
| 05-Jan-22 | Air Lease Corp | US$750 | 10 | Jan-32 | Senior Unsecured | MS+102 | 2.20% |
| 12-May-22 | BOC Aviation | US$300 | 5 | May-27 | 4.33% | ||
| 28-Nov-22 | Air Lease Corp | US$700 | 5 | Dec-27 | Senior Unsecured | MS+142 | 2.88% |
Greg Lee sees this as another step change for the sector: “In general the aviation sector had fed mostly on relationship bank lending but that really started to change in the early to mid- 2010s, cresting into 2020,” says Lee. “In the three to five years going into 2020, peaking in 2019, it was interesting to see investment grade leasing company paper starting to trade at levels that were much closer to a triple-B bond index. In fact, lessors were able to access the capital markets at much better rates than provided by the bank market. Now we’re seeing a reversion back to that period where the bank markets were more efficient.”
There was the sense that prior to the pandemic, the investment grade leasing sector had matured and companies had demonstrated their stability relative to airlines. However, the global pandemic and particularly the Russian seizure of leased aircraft have served to reverse those years of hard work. “Aviation is being penalised based on its recent history of severe pandemic crisis and the Russian invasion of Ukraine,” says Lee.
“The capital markets have assumed that the aviation sector is volatile and cyclical in nature and so have priced in a risk premium in addition to the fundamental sector risk. The equity markets are also ascribing a lower valuation multiple to the sector. You can see that in the way that airlines trade – not on their price equity but more on an enterprise value (EV)-to-cash flow or EV-to-Ebitda. In general, airline multiples have traded lower than other comparable businesses in a larger corporate bonds or corporate equity index.”
Issuance of even the most liquid capital markets product – investment grade, senior unsecured, non-amortising bonds – has been limited during 2022. Wizz Air kicked of airline issuance in January 2022 with a €500 million 1.000% four-year Reg only bond offering at midswaps+105bps. This early issuance attracted an orderbook in excess of €3.3bn and achieved the lowest coupon for an airline issuance in the post-pandemic period. Singapore Airlines (SIA) also issued into the US dollar bond market at the start of the year with an offering for $600million 3.375% seven-year Reg-S senior fixed rate notes due 2029. There have been more airline issuances last year (see Debt Capital Markets Issuance 2022 table) but pricing has widened as the headwinds build up over the year, but lessor issuance has been considerably reduced.
Boeing was noticeably absent from the capital markets in 2022 but this was unsurprising considering the huge sums it has raised over the past two years in this channel at very low rates and with long tenors. Brian West, CFO of Boeing, commented in November at an investor conference that the company has “no plans to raise any kind of capital from either the debt or the equity markets. We don’t need to. As we close this year, we expect to have around $17bn of cash on hand, that’s between $7bn and $9bn higher than historical baselines.”
Investment grade lessors often issue in this market once a quarter in a normal year, or once a year in large quantities – $1bn issuances became common the pre-pandemic period. But for the few companies that entered the market, they found that pricing was much higher by the second quarter. Air Lease Corporation (ALC) came to market twice in 2022 – once in January, ahead of the rapid change in monetary policy, with $1.5bn of 2.200% five-year and 2.875% 10-year senior unsecured notes; and once again in late November with $700 million 5.85% five-year senior unsecured medium-term notes (coupled with a $400 million fiveyear unsecured term loan that closed in December).
Although ALC has been able to tap into the bond markets, the two issuances were well timed – one just ahead of the tightening of monetary policy in February and the other closer to the end of the year when the markets began to show signs of easing. Speaking to Airline Economics and KPMG in New York in October, chief executive of ALC, John Plueger, commented: “Classically we have tapped into the public bond markets for the vast majority all of our funding and quite successfully. And we will continue to do so but now is also a time when we can use other resources – such as the $7 billion unsecured bank facility with very attractive financing that runs out for several years, which remains largely unfunded. In recent months, several banks have approached us with offers for more term loans and other banking products, which we will evaluate.”
Plueger goes on to stress the importance of demonstrating to investors, rating agencies and the market the company’s “broad depth of funding sources” and its lack of dependency on a single or few sources of financing. He notes that it was the perfect time to deepen the company’s banking relationships. “We have always funded in the public markets and we will continue to do so, but there’s no gun to my head to do that right now. We can use this period as a chance to expand our debt portfolio, maybe additionally through bank means – the Middle East is a huge source of potential funding capability today, for example.”
ALC also has the advantage of a skilled treasury team that, as Plueger says, is “spectacular at maximising ALC’s position in debt funding”.
We have always funded in the public markets and we will continue to do so, but there’s no gun to my head to do that right now. We can use this period as a chance to expand our debt portfolio, maybe additionally through bank means.
AerCap has been a prolific issuer in the bond market but didn’t go to market at all in 2022 but the lessor did raise $4.5bn outside of the capital markets with compelling pricing. “There are other forms of financing besides the bond market,” says Kelly. “Many debt investors have a glass half full mentality but they witnessed the worst possible stress the industry could have. The world stopped flying. It doesn’t get any worse for aviation or for any business when there is no revenue coming in but the demand for aircraft rapidly recovered as did the demand for AerCaps bonds, demonstrating the durability of AerCap and the aircraft leasing industry.”
BOC Aviation chief executive officer, Robert Martin, speaking in Singapore in November, said that although the lessor was a major issuer in the corporate bond market, he has also seen a renewed strength in the commercial bank debt sector. “We have 50 banks in our banking group,” he said. “We just closed a $500 million facility in that market rather than using the corporate bond market where secondary rates have been pushed up by the rise in interest rates.”
There is a core group of aviation banks that have been steadfast supporters of the industry throughout the many cycles over the decades. But in recent years, bank regulation has served to increase their cost of capital and in some cases reduced their capacity for aviation debt. Over the past year, airlines and lessors have leaned heavily on their banking relationships to raise financing at a more efficient rate than the capital markets.
However, this may only be sustainable for the very top tier credits and those with those all-important existing banking relationships, and then financing may only for certain assets since many banks are moving toward imposing more sustainable financing goals with a focus on new technology only. Even with a stunted recovery, growth predictions for the industry show that passenger demand will exceed capacity in 2023.
The industry needs new aircraft, and once those productions delays are ironed out, the industry will also require the return of a more sustainable and plentiful source of capital. “The bank market is not a regenerating market; the amount of capacity that you can get from the bank market is relatively fixed. Once you tap it, it will take some time before it can regenerate,” says Lee. “The bond markets are a much deeper and regenerating source of capital.”
The bond markets may provide a deeper pool of capital but investment grade lessors have been able to tap into the bank market, particularly SMBC Aviation Capital, which raised US$2.54bn five-year syndicated facility to partially fund its acquisition of Goshawk that closed successfully at the very end of 2022 (more on this in Chapter Three-The Age of Leasing).
The SMBC Aviation Capital financing comprised a $1,830 million term loan and a $710 million revolving credit facility – upsized from a base size of $1.5bn on the back of strong investor interest despite the volatile market. The deal attracted 32 banks in total – 20 of which are new relationship banks for SMBC Aviation Capital. This was the largest funding transaction in the aircraft leasing sector in 2022 and one of the largest ever unsecured banking loan transactions conducted by a lessor in the Asia loan market. Citi and New Zealand Banking Group acted as joint global coordinators to a syndicate of Asia-Pacific, European and North American lenders.
Other significant bank transactions in 2022 include JetBlue’s $3.5bn 364- day senior secured bridge acquisition facility to fund its bid for Spirit Airlines, the Apollo-led consortium’s $1.9bn financing for its acquisition of Atlas Air, and LATAM’s debtor-in-possession-toexit financing that comprised a $1.1bn Term Loan B facility in addition to the $11.15bn senior notes piece.
JetBlue’s bridge facility – led by joint global coordinators Goldman Sachs and BoA that were also bridge lenders with BNP Paribas, Credit Suisse, Credit Agricole-CIB, Natixis and SMBC – is secured by the TrueBlue loyalty programme along with certain slots, JetBlue’s brand as well as certain aircraft and engines. The flexible facility, priced at SOFR+300bps with a 50bps step up every 90 days, allows for subsequent take-out financings (including loans and debt securities) based on the most efficient markets and collateral at the specific time.
Structured secured debt products have become a favoured avenue for aircraft financing over the past decade, but none more so than Enhanced Equipment Trust Certificates (EETC), which first appeared in the late 1990s and have continued to evolve. EETCs have always been an efficient way for airlines to finance new aircraft deliveries. But the rising interest rate environment coupled with the drop in demand for new funding since airlines raised record volumes of liquidity during the pandemic using other means, effectively reduced the airline EETC channel in 2022. Some deals have closed, however.
In March, Sun Country closed a $188.277 million EETC in two classes of notes on a private placement basis, arranged by structuring agent and lead placement agent Goldman Sachs. The $142.83 million nine-year A notes have an LTV of 55%, a WAL of 5.1 years and priced with a 4.84% coupon and UST+270bps, while the $45.447 million seven-year B notes have a 72.5% LTV, 4.2 WAL and priced at 5.75% with a spread to treasuries of +360bps. The notes are secured on an all-737-800 portfolio with an average age of 11 years. The transaction is reported to have been well received by investors, achieving a blended cost of 5% in a volatile market.
Vista Global, under VistaJet Malta Finance, raised $287.5 million through an EETC offered in two classes comprising $250.5 million A notes and $37 million C notes. The notes were secured on a portfolio of 17 business jets and despite the market volatility in August, Vista achieved a blended coupon across both classes of notes of 7.14%. Citi was the sole structuring agent on the deal.
In September a new issuer came to the EETC market when WheelsUp priced its inaugural transaction a $270 million single Class A tranche at 12.00%, which was secured on a large portfolio of 134 corporate jets.
IAG-owned airlines, British Airways (BA) and Iberia, both utilised the EETC market in 2022 using sustainability linked structures joined with Japanese Operating Lease with Call Options. BA has used a similar structure in 2021 but now both airlines have raised financing using this product.
In April, Iberia entered the market with a $322.987 million sustainability linked EETC with JOLCOs to finance five aircraft – three A320neos and two A350- 900s – that comprised two tranches: a $260 million Class A notes, with a 13.7 year tenor and 57.4% LTV; and a $62.987 million 102. Year and 71.2% LTV Class B notes. Under the sustainability structure, the certificates are tied to a pre-determined fuel efficiency target of 69.0 gCO2/pkm for the FYE 2025.
Should the airline fail to reach this target, the coupons of both classes will increase by 25bps. This transaction, arranged by JPMorgan, was the first sustainability linked EETC to be funded in the private placement market. BA followed with a similar private deal, arranged by Citi, raising $299.57 million to fund two new A320neos and two new A350-1000s again using a single A tranche, with an LTV about 70%, WAL of 8.2 years and a 13-year tenor.
US carriers are notably absent from the EETC market but as mentioned they have been using available cash to purchase aircraft thanks to their very substantial cash positions. Helane Becker recalls that United CFO Gerry Laderman commented at the 2022 Airline Economics Growth Frontiers Dublin conference that he was in the process of writing checks to pay cash to buy aircraft which he has never done before. In December, he reiterated this point following the airline’s bumper order for 100 787s, and exercised options for 44 737 MAX aircraft to arrive between 2024 and 2026 and 56 more of the MAX planes in 2027-28. “We will have the luxury of actually using our own cash flow to pay for these aircraft or finance them to the extent that we find capital markets financing attractive,” Laderman said on a media call.
United ended the third quarter of 2022 with over $20bn of liquidity, including an undrawn $1.75bn revolving credit facility. Speaking on an earnings call in October, Laderman notes that such a high liquidity cushion allows the airline to “maintain flexibility as we meet the uncertainties that remain in our industry”. United paid for almost all of its aircraft delivered in 2022. Laderman noted that “every aircraft purchased for cash today increases our pool of unencumbered assets, which further protects our future”.
Becker says that having the novel ability to purchase aircraft with their own cash is “true for most airlines” particularly those in the US with very substantial cash positions. “They are using cash and taking penalties to pay down debt speedily,” she says. “Instead of refinancing their debt, they’re using their cash to work down the debt. As interest rates start to stabilise, airlines will return to financing and use those unencumbered assets to pay down debt.”
United and other airlines have the ability to pay down some or most of their outstanding debt raised during the pandemic at par, which will help them to pay down debt and restore their balance sheets. “In the current rate environment, it is a tremendous benefit to have the flexibility to prepay debt, continue to pay cash for new aircraft or access the financing markets opportunistically for new aircraft deliveries,” said Laderman.
Although EETCs are mostly suited to airline finance, lessors have used the structure in the past. Over the past two years, however, more and more leasing companies have been using the structure in the private placement market. EETCs are being used by lessors that have several aircraft on lease to a single top tier airline to leverage the credit worthiness of the lessee. BBAM has been a frequent issuer – closing one deal in July 2022 that financed four narrowbody aircraft but is believed to have closed 5/6 deals. Avenue Capital (which issued the Stellar 2021-1 Aircraft ABS in 2021) and Castlelake are known to have closed similar transactions.
The repricing of sector risk also seeped into the asset backed securitisation (ABS) market for aviation assets, effectively freezing the market. The decade-long low interest rate environment had caused ABS issuance to steadily rise from 2013, peaking in 2019 with a record 18 deals closing with a total value of almost $10bn. In 2022 only three deals closed. Global Jet Capital closed its sixth ABS transaction in May. The $609.96 million BJETS 2022-1, secured on a portfolio of business jets, was offered in three tranches: $512.8 million A notes, $60.3 million B notes and a $35.8 million C tranche. The blended spread was 253bps over treasuries. Deutsche Bank, Citi, Bank of America, TCG and KKR were structuring agents on the deal.
This environment feels very similar to when we first came to market in 2014 when the pricing was very similar.
In June, Carlyle Aviation issued an ABS transaction under its AASET moniker led by structuring agent and lead left bookrunner Goldman Sachs. However, the $522.464 million was issued as a single senior A tranche with a 6.00% coupon and 350bps spread to treasuries. CEO Robert Korn explains that a B tranche will hopefully follow. “This environment feels very similar to when we first came to market in 2014 when the pricing was very similar. We had managed to issue a B note but we struggled and we didn’t even try to issue a C tranche,” he told Joe O’Mara in New York in October. “This time around Goldman Sachs developed a very unique structure for the A tranche, which we issued, and we ultimately expect as the markets become more constructive to be able to issue a follow-on B tranche.”
The transaction featured a unique uni-tranche structure that optimised the Class A leverage with a more defensive liability mix, increased ongoing liquidity, and other debt friendly structural features, including an improved covenant package, including a higher utilization trigger (90%) and a monthly collections test (85%), as well as increased pay down upon disposition of assets (110%).
Airborne Capital was the final issuer in the ABS space in 2022 with a $303.7 Marathon Asset Management transaction (MAST 2022-1) formed of single A tranche of senior notes, secured by a portfolio of 15 narrowbody aircraft. Mizuho was the sole structuring agent and sole placement agent.
The notes were rated A- by KBRA, with an initial loan-to-value (LTV) ratio of 61.1%. The notes are listed but the deal was privately placed. The A notes priced just below 7% with a +300bps spread – a great achievement in a market environment where secondary market aircraft ABS paper was trading at alltime highs of around +400bps spread and during a time when there was no market for a widely distributed deal.
During this transaction process, Ramki Sundaram, chief executive officer of Airborne Capital, gained a clear perspective on the investor mindset from discussions with investors. “There are two aspects to the market – firstly, there is clearly lower liquidity with more focus on relative value, crowding out demand for esoteric aviation ABS issuances.
Secondly, increased market risk has driven higher uncertainty of issuance pricing, driven by the last dollar that comes in from those smaller investors,” he says. “The larger players in the market do have intrinsic appetite but they also have the ability to be selective in terms of the kinds of transactions they consider.”
Sundaram notes that the main themes from investors is their concern over the quality of the assets in the ABS portfolio and the quality of the servicer. “Pre-Covid the size of the servicer was more important than the quality of assets, but this has changed with the quality of assets now as important, if not more important than the servicer. The quality of the service, rather than its size, has also gained importance.”
Mizuho’s Srinivasan, who structured the MAST ABS, explained how the macroenvironment impacted the ABS product during 2022. “The Federal Reserve was pumping money into the system because of COVID – behaving the same way that they did during the global financial crisis – which kept interest rates low into 2021,” he says.
“Almost every investment grade lessor issued as much unsecured debt as they could in that environment, so they are set for a while, and then the ABS issuers also all issued debt-only deals without equity notes, so there were no portfolio sales. In 2022 rates have gone up, which means that the five-year rates used for the aircraft ABS structures that were 150bps in 2021 are now 450bps.
Credit spreads that were about 150bps have now widened to 350, which adds another 200bps to the 300bps interest rate rise, equating to a 5% increase in debt issuance cost in the aircraft ABS world. The lease cashflows cannot support the same amount of leverage seen in 2021 under the new interest rates and yields.”
These increases have effectively tripled the cost of an aircraft ABS transaction in six months. With the accepted lag between interest rate rises and lease rates, it will still be some time before the product becomes more attractive relative to cashflows. “Lease rates are sticky and they haven’t yet moved up to adjust creating a limbo situation where any ABS issuance would reduce leverage,” says Srinivasan.
The challenge today is that many ... outstanding portfolios now appear to have real cashflow issues. With some 20-40% of the aircraft off lease in certain structures, we believe that some trust has been lost in this marketplace.
The lack of affordable ABS channel for aircraft finance has led to a substantial increase in the number of warehouse facilities provided by commercial banks, many quasi-structured facilities that serve as a stop-gap solution to the capital markets.
Many of the deals mandated in 2021 for 2022 issuance in the ABS market had to be repackaged for warehouse deals, however those warehouses will eventually need to be refinanced more efficiently once rates level off. “Many warehouses were refinanced in 2021 so those will have availability into 2024 so there is no urgent need to refinance right now,” says Srinivasan.
“Typical warehouses comprise two or three-year revolving capital facility and a three or four-year amortising period that features a step-up in pricing. By the time the step-up pricing kicks in it will be into 2024. If the interest rates stay high for that long and there are no other products that make sense at the time, then there will be a squeeze. But I don’t see that happening as banks and alternative lenders are being very supportive, lending at 200bps – they see this as an opportunity to step up for their clients.”
The lack of ABS debt has also impacted the trading environment since it has become a major supporter of portfolio and aircraft sales since it can provide nonrecourse debt to the purchases. Srinivasan notes: “Without certainty of how much leverage you can achieve over the long term and the cost, its creating uncertainty with the buyers over what they can afford to pay for aircraft – that could vary quite dramatically, and it is absolutely affecting the trading environment.”
Certain frequent ABS issuers have been required to construct new sources of funding. Castlelake’s business model used to be heavily focused on refinancing in the ABS market but has currently pivoted to alternative options.
“We believe we were the largest issuer and servicer in the aviation ABS market and we believe we are still the largest servicer today,” said Joe McConnell, Deputy Co-Chief Investment Officer at Castlelake in conversation with KPMG’s Joe O’Mara in December. “It was an attractive financing tool for a long time and would still be today if the debt was appropriately priced.”
McConnell notes that pre-pandemic there was a rush of capital into aviation as many start-up leasing companies entered the sector with a lot of money to spend, which he believes led to a loosening of underwriting standards. “We believe that incentives became misaligned in many cases, with very small teams managing large pools of aircraft,” says McConnell.
“When all of the aircraft were on lease, some investors felt there was no need for a large technical or servicing team. The pandemic changed that and exposed many of the flaws we saw developing over 2018 and 2019. The challenge today is that many of those outstanding portfolios now appear to have real cashflow issues.
With some 20- 40% of the aircraft off lease in certain structures, we believe that some trust has been lost in this marketplace.” McConnell believes that distrust is continuing even into the recovery period demonstrated by the high price of secondary paper. He doesn’t see prices coming down until the performance of those portfolios improves.
“We saw some of these cracks form in 2020 and 2021, which is why we decided to establish Castlelake Aviation Limited in the fourth quarter of 2021,” he says. “It allows us to continue taking advantage of attractive opportunities on the buy side with the ability to fund assets through debt financing issued in the unsecured market, the Term Loan B, private placement, and recourse market.
We’re not dependent on the ABS market anymore and we feel confident about our debt funding and ability to continue deploying capital and finance it attractively.”
Castlelake also has the ability to lend via its recently established direct lending platform. “We have also developed a direct lending business, which we set up in 2020 in the middle of the pandemic; and we have now originated, purchased or committed approximately $5bn in direct lending capital,” says McConnell.
“This is typically senior secured investment grade risk to both airlines and leasing companies. We have also recently developed a reinsurance business that enables us to help airlines and leasing companies secure attractive financing rates by providing reinsurance products, as well as an aviation-focused credit opportunities business, which covers alternative assets including loyalty programmes, slot gates and routes, as well as exit financings for airlines.”
Alternative Lending
The contraction of the bank market and the freeze in the capital markets has created a temporary funding gap that in some places is being filled by alternative lenders that have recognised opportunities in the aviation sector. Castlelake Aviation is just one of a group of alternative lenders that have expanded their aviation portfolios over the past few years. others include: volofin, Valkyrie, Muzinich, Ashland Place, as well as more established players like PK AirFinance.
“We have seen instances where the bond markets shut down, where traditional investors haven’t been able to buy a certain security, and where the bank markets weren’t able to do something that was in the capital markets, when alternative lenders – usually private equity-backed credit funds – stepped up and were able to provide funds in significant size, and receiving very attractive yield for their efforts while filling an important role,” says Goldman Sach’s Greg Lee.
Jean Chedeville, Global Head of Aviation Finance, Natixis, views the addition of such alternative lenders or non-banking financial institutions (NBFI) as a complement to the aviation finance sector. “We are seeing NBFIs enter into the sector, which is something Alternative Lending that has been missing for a long time,” he told KPMG’s Joe O’Mara in an interview in Singapore in November.
“There have been a few Japanese and Korean alternative investors in aviation, but only a few and then only on very specific structured deals. Now we are seeing investors with background aviation knowledge because they a subset of leasing companies or a private equity firm that have already invested in aviation in different forms.
This is a plus for the sector. We don’t see them as competing against because they have a very different risk appetite and overall risk-return expectations. These investors will bridge the gap between what banks can do today and what the capital markets were offering until a few months ago.”
Chedeville describes Natixis has “product agnostic” and rather than push vanilla banking products to clients he would rather “add value” in his relationships. “A lot of lessors are struggling to find the right returns or to find the right deals mostly because their capital structure doesn’t work anymore and needs to be re-engineered. In this instance, working together with this type of investors makes a lot of sense.”
Evan Carruthers, Managing Partner and Chief Investment Officer at Castlelake comments that the “aviation industry provides ample opportunity for alternative lenders who really understand how to effectively structure and execute transactions and provide airlines and leasing companies with attractive debt financing. With this, we believe demand for creative financing solutions will remain high for many years, and the ability to provide tailored solutions is likely to differentiate industry participants.”
Although Chedeville notes that there were many investors entering the market to capitalise on the distress in the market, that attitude is now changing with investor seeking full flight platforms and he also notes the entry into the market of Middle East investors and sovereign wealth funds as they seek to reposition the region for the post-fossil fuel era.
Saudi Arabia’s Public Investment Fund (PIF) has been the most prolific investor out of the Middle East region. As part of the country’s Vision 2050 project, PIF has been investing in the Kingdom’s tourism industry, which include a new flag carrier, RIA, and a new leasing company, AviLease (see Chapter Three-The Age of Leasing for more on these developments with comments from AviLease CEO Ted O’Byrne).
