The aircraft leasing market has proven its resilience during the past year and most importantly has demonstrated just how critical its support has been for the aviation industry throughout the pandemic period.
“The pandemic has shown that the leasing business is a good business,” says Aengus Kelly, CEO of AerCap. “Well-managed lessors with global platforms that are able to move assets around the world and manage the interactions with the customer base and manufacturers during times of great stress, have proven the resilience the aircraft leasing business, which is why we are seeing so much capital interested in the sector at the moment.”
Aircraft lessors have succeeded in navigating the challenges of the global pandemic, helping their customers through a very difficult operating environment. Lessors have supported their airline customers in myriad ways – from providing aircraft from their orderbooks, enabling airlines to defer their own orders to free, as well as combinations of sale-leasebacks and renegotiated leases to assist airline cashflow.
“Lessors have proven to be a bastion of capital,” says John Plueger, CEO of ALC. “As evidence of this shift, in 2021 lessors took delivery of 60% of all Boeing and Airbus aircraft orders combined, all placed under some form of lease, be it sale-leaseback, order book, finance lease. Clearly, the leasing component is a capital star of industry.”
“During this period of airline financial and balance sheet recovery, airlines have looked to leasing in a much more significant way, which I see continuing in 2022 and probably 2023 and beyond,” adds Plueger.
Rents & lease agreements
Rent deferrals spilled over from 2020 into early 2021 but began to taper off as airlines saw a return of demand in the summer. Lessors have continued to find innovative solutions for clients in order to ensure consistent cashflow.
Power-by-the-hour lease agreements have become more popular, especially with new airlines and airlines undergoing restructuring. The general consensus by lessors has been to leave aircraft with defaulting lessees using PBH agreements in order to ensure some degree of cashflow remains as aircraft are not as easy to place with other customers.
“Even as painful as it has been for us, the performance of the lessors throughout the crisis has demonstrated the resilience of the model and the diversification of customers and geography, which will continue to attract capital,” says Michael Inglese, chief executive officer of Aircastle.
Aircraft lessors went into the crisis already in a much stronger position than in previous downturns. “If you go back to the first Gulf War, there were ten top lessors, and nine of them were wiped out with only International Lease Finance Corporation (ILFC) surviving,” remembers Fred Browne, CEO of Aergo Capital.
“This time, lessors are much more resilient and robust, which reflects the fact they are so much stronger – the top 15 lessors are all backed by institutional money. Operating leasing is definitely here to stay and in my view it’s going to command 60% of the fleet over the next five years.”
During this period of airline financial and balance sheet recovery, airlines have looked to leasing in a much more significant way, which I see continuing in 2022 and probably 2023 and beyond.
Leasing market share
The aircraft leasing market has grown substantially over the course of the last several decades but the pandemic has accelerated the growth of the leased fleet. Airlines have embraced sale-leaseback transactions to monetise unencumbered assets in the frantic effort to raise liquidity in 2020 and into the first half of 2021.
There is some evidence that trend is slowing as airlines access to capital markets and bank debt returns but the expectation is for the share to remain at least at 50%, with some predicting an increase to as high as 60%.
“[Sale-leaseback deals] freed up a lot of capital, which has been great for the industry,” says Tim Myers, president of Boeing Capital. “Lessors have played a tremendously important role, providing support that has benefitted the entire industry. We think there will be a much more balanced recovery going forward.
There have been a number of new lessors set up that are backed by new private equity and hedge funds, which will strengthen the leasing market overall. The investment community really likes the lessor models and the investment grade lessors have performed extremely well throughout the pandemic and have put pressure on the rating agencies to upgrade their ratings. Overall, the lessor share of the market will stay in that 50% range and continue to be a major player going forward.”
For SMBC Aviation Capital’s Peter Barrett, the move to a greater share of the fleet was simply the natural evolution for the leasing sector. “I’ve always felt that the long-term secular trend was going to be for leasing to become the dominant tool for airlines to acquire aircraft and for good strategic reasons – including managing balance sheets, for fleet flexibility and the strategic development of their business,” he says.
“There are parallels with the hotel industry. Most hotels operators don’t own the assets, they’re focused on service delivery and execution of that operating product. COVID-19 has accelerated a long-term sector trend that aircraft ownership and aircraft operation will be seen as separate things.”
With airline balance sheets expected to remain under strain for the next year or two, and with airlines under pressure to operate more fuel-efficient fleets, the expectation is for leasing to continue to gain market share as leasing provides much-needed flexibility and capital in an uncertain market.
Lease or own
“The pandemic has clearly driven the leased fleet share well beyond 50% towards 60%,” observes Plueger. “It is difficult to predict whether that will be the maximum level or the steady state going forward. Born of necessity, the leased share will probably stay closer to 60% but airlines will want to continue to order their own aircraft – the industry depends upon it – so I would be personally surprised if the leased share went materially above 60%.”
There is a valid debate in the market considering just how much of the global fleet can be leased. Some take a similar view to Peter Barrett that it makes much more sense for airlines to lease than own their assets.
“I’ve never thought it made sense for any airline company to own aircraft but I understand why they do since as the largest buyer they get a good deal and will fly the planes for their full life,” says Cowen’s Becker. “When you think about the residual value risk, especially of late model aircraft, it makes more sense to let someone else own the aircraft.”
Greater lessor share
There are others – mainly the US carriers – that maintain owning aircraft has real benefits. “US airlines have traditionally owned their own aircraft because they can be efficiently financed in the EETC market and they also benefit from the tax depreciation,” noted one banker.
“The pandemic has required airlines to monetise all of their unencumbered assets but it remains unclear if that general shift to lessors will continue in a more stable operating environment and as airlines return to a more diversified financing strategy.”
Kieran Corr, Global Head of Aviation Finance at Standard Chartered, doubts that there will be a permanent shift in the long-term trend towards a greater lessor share of the market.
“Airlines use operating leases as a capacity and residual risk management tool, and to gain access to aircraft quickly and 100% financed,” he says. “While in the near term, there may be a larger percentage of operating leases, those fundamental reasons for leasing will cause the longer-term trend to remain the same. The percentage is hard to predict but it will be a very different story between the narrowbody and widebody market, because going forward there will be much lower lessor participation in the widebody space.”
Building versatile fleets
The most up-to-date data from Cirium shows that the number of leased widebody aircraft has been falling slowly from 2020 as troubled airlines return and retire certain assets.
Airlines have been encouraged to renew their fleets with the newest, most fuel-efficient aircraft to lower their carbon emissions – some have even been compelled to do so in return for government funding during the pandemic.
As a result, airlines have been busy both ordering new technology aircraft from the airframe manufacturers (OEMs) and have also turned to leasing companies for fleet renewal purposes as cashflow remains constrained due to the uncertain operating environment. As Cowen’s Becker notes: “Without the leasing industry, a lot of smaller airlines wouldn’t survive and most would not be able to meet their re-fleeting requirements.”
CDB Aviation’s CEO Patrick Hannigan expects the impact of the pandemic on airline fleet decisions to resonate for a long time: “While many of the world’s airlines grew their fleets through deliveries of new airplanes and often delayed airplane retirements to accommodate passenger demand over the past decade, the current market disruption will shape airline fleet strategies long into the future as airlines make decisions to renew their fleets and resume growth,” he says.
“Airlines will focus on building versatile fleets that provide future network flexibility, maximising capability while minimising risk, and improving efficiency and sustainability.”
The demand for re-fleeting with new technology aircraft – driven by a combination of the pandemic providing a good opportunity to rationalise fleets and phase out older equipment in conjunction with the move towards improving carbon emissions – has contributed to the popularity of leasing since many of the larger companies already had orderbook positions for attractive delivery dates.
John Plueger referred to the trend for airlines to defer their own deliveries to take advantage of lessors’ earlier delivery positions and off-balance sheet access to newer technology aircraft. But for airlines without an orderbook, lower production rates for new narrowbody aircraft will leave them with little alternative other than to turn to lessors with orderbooks.
Air Lease Corporation order
Air Lease Corporation made a sizeable order (LOI) in November 2021 for 111 aircraft – 25 A220-300s, 55 A321neos, 20 A321XLRs, four A330neos and seven A350Fs – as it continued to see demand build even while the world continued to react to new coronavirus variants of concern.
“We have clearly seen a resurgence in traffic led primarily domestically within geographies and continents, which has fuelled a significantly increased demand for new single-aisle aircraft,” says Plueger. “That strong demand is one of the reasons why we placed our recent order with Airbus, which was for almost all single-aisle aircraft that also included seven A350 freighters for the first time.”
Importance of lessors to OEMs
With their increased market prominence, aircraft lessors are arguably even more important customers for the OEMs, a factor they recognise.
“The pandemic it has enabled lessors to divert some of their financing requirements from speculative orders into supporting the sale-leaseback market initially to provide the liquidity. That allowed us to readjust our skylines with the lessors going forward as airlines work to manage their fleets and determine the most efficient way for them to come out of the pandemic,” says Boeing’s Myers.
“Lessors continue to be extremely important to the OEM for both the single-aisle, twin-aisle and freighter market. The OEMs and the lessors need continue to partner going forward to ensure the right kind of balance. The OEM’s job is to continue to look at the supply-demand economics in the marketplace, and to make sure that we’re working together with all of our customers.”
Lessors & OEM deliveries
Paul Meijers, EVP – Commercial Aircraft Leasing, Trading & Financing, Airbus, notes that even pre-pandemic leasing companies were financing more than 50% of OEM deliveries. “That figure has increased further over the past two years and lessors will continue to account for the major share of our deliveries,” he says.
“There is a lot of new capital flowing into the leasing space, with new players backed by private equity that are developing their portfolios. We see a lot of appetite for growth in the leasing markets, which we expect to continue to develop over the next year.”
|CHART 13: TOP TEN AIRCRAFT LESSORS (BY PORTFOLIO VALUE)|
|Manager||TP||RJ||SA||TA||Total Portfolio||On Order||Est Portfolio Value ($mn)||Current Rank|
|SMBC Aviation Capital||469||59||528||199||17,216||2|
|Air Lease Corporation||2||354||116||472||304||17,023||3|
|Aviation Capital Group||340||15||355||47||8,473||8|
Source: Ascend by Cirium
Although most lessors have a realistic view of their buying power with the OEMs, even the largest lessor doesn’t see any meaningful shift in the relationship between OEMs and lessors.
“Everybody says they get a great deal with the OEMs, but they don’t,” says AerCap’s Kelly. “The airlines might get a lower price initially than some of lessors, but then the OEMs will stack the order so that they know the airlines will have to come back and defer airplanes and then they’ll reprice them and hold onto their PDPs. The OEMs certainly have a greater appreciation for the necessity of lessors – lessors are now buying over 50% of all the aircraft the OEMs produce – but there are only a few customers they care about.
All they care about from the lessors from an order perspective is that they can pay for the aircraft and lease the aircraft. Many lessors struggle with the placement task particularly on widebodies but what really separates lessors in the eyes of the OEM is if they have the market power to influence airline fleet decisions and the timing of these decisions.”
“The OEMs certainly have a greater appreciation overall for the leasing industry but what’s more likely to happen is that we will probably see the price that lessors and airlines pay for assets close significantly,” adds Kelly. “We’re seeing the gap narrowing already.”
Standard Chartered’s Corr agrees that there will not be a shift in relations between lessors and OEMs. “The bigger players have always had some influence on what the OEMs are developing but I don’t see a future where lessors gain such a predominant voice that suddenly Boeing and Airbus will only produce a plain vanilla A320 Neo in max density forcing airlines to find some other way to differentiate their product to passengers.”
Aviation Capital Group (ACG) has had a long partnership with the OEMs and CEO Thomas Baker sees that continuing for the foreseeable future. “We have demonstrated to the OEMs throughout the pandemic that we are strategic partners and that working together is all our interests,” he says.
“They have constraints, they’ve got challenges, and demanding customers that they need to please, and sometimes we have to compete for their affection. But there is a path forward so long as they can deliver aircraft on time.”
Baker expects lessors to place more direct OEM orders in the future to gain access to new technology assets. “I think you’ll see bifurcation on this issue with a number of large global lessors that are seeking to grow through multiple channels, which have access to capital and confident in their ability to secure financing,” he says.
“Those lessors will continue to grow their orderbooks over time, particularly with new technology aircraft. And then there is a whole bunch of smaller lessors, without flexible corporate level access to capital that need to fund through secured vehicles or warehouses or fund on a match asset or match funding basis.
Orderbooks are tougher for those players. But you will start to see a number of lessors with the capability and the confidence to grow their order books. And the rest will focus on the sale-leaseback channel.”
ACG grew its orderbook in December 2021 with an order for 40 A320neo Family aircraft, of which five are A321XLRs, as well as signing a Memorandum of Understanding (MoU) with Airbus for 20 A220s.
With this order ACG is supporting the recently launched multi-million dollar ESG fund initiative by Airbus that will contribute towards investment into sustainable aviation development projects.
We have demonstrated to the OEMs throughout the pandemic that we are strategic partners and that working together is all our interests. They have constraints, they’ve got challenges, and demanding customers that they need to please... there is a path forward so long as they can deliver aircraft on time.
|CHART 14: TOP 30 LEASING COMPANIES (RANKED BY NUMBER OF AIRCRAFT)|
|Manager||Total Portfolio||On Order||Est Portfolio Value ($mn)||Current Rank|
|SMBC Aviation Capital||528||199||17,216||3|
|Nordic Aviation Capital||483||70||3,867||4|
|Air Lease Corporation||472||304||17,023||5|
|Aviation Capital Group||355||47||8,473||10|
|Carlyle Aviation Partners (inc. AMCK Aviation)||326 (459)||(20)||4,314 (7,070)||11 (6)|
|AVIC International Leasing||200||5,932||17|
|Jackson Square Aviation||198||22||6,456||18|
|Boeing Capital Corp||172||23||1,100||21|
|China Aircraft Leasing Company||156||263||3,396||22|
|Cargo Aircraft Management||127||1,698||26|
|CMB Financial Leasing||127||3,783||27|
|Standard Chartered Aviation Finance||122||2,905||28|
|CCB Financial Leasing||115||50||3,610||29|
|GTLK - State Transport Leasing Company||112||58||1,755||30|
Source: Ascend by Cirium
Mergers and acquisitions (M&A) activity has characterised the aircraft leasing market in 2021. AerCap announced its definitive agreement with General Electric to acquire 100% of GE Capital Aviation Services (GECAS) for a total value of approximately $30bn in March 2021. AerCap’s acquisition of GECAS has changed the dynamic of the aircraft leasing market. Dubbed a super lessor, with a fleet of close to 1,970 aircraft, AerCap now towers above the rest of the leasing sector.
Importance of scale
“You have one huge lessor now and then everybody else,” notes Becker, who adds that scale is important because it provides a unique insight of the market. “AerCap and Avolon have proven that it makes sense to be big. They get the first call and they know everybody, they know where aircraft are, they know how to get aircraft. They also don’t play in the lower quality sale-leaseback market as they tend to deal more with the OEMs.”
Scale and its importance is an oftdebated concept in aircraft leasing but none more so than in 2021. As head of the world’s largest lessor, AerCap CEO Aengus Kelly, sees the tremendous benefits such scale brings to the business.
“In any space you have the innovator, the imitator and blithering incompetents,” he says. “We will continue to see a general consolidation trend; the benefits of scale are just too important. [Those benefits are realised] with the airlines, with the MRO shops, the engine MROs, with the engine manufacturers... and if you don’t have extremely competent people in the business, managing the metal and the engines, you can lose an awful lot of money very quickly.
Generally speaking, with scale you just tend to have better people, more people, and you have better access and more leverage with suppliers.”
Large vs small
Kelly views consolidation as a positive move for the leasing industry, which he says has been a “fragmented industry for too long”. With AerCap and GECAS, followed by Carlyle Aviation Partners’ acquisition of FLY Leasing and then AMCK Aviation (in addition to the finalisation of the widely rumoured SMBC Aviation Capital’s acquisition of Goshawk and Falko’s sale), the past 12 months have been the busiest year for M&A in the leasing sector since AerCap acquired ILFC.
Kelly foresees a “snowball effect” as lessors viewing these latest consolidation deals will worry about being left behind and becoming less competitive. “There will always be room for start-ups, and smaller players who are very good at what they do,” Kelly notes, but warns that the days of smaller leasing entities trying to serve all markets are numbered.
Carlyle Aviation Partners
“Smaller lessors will need to focus on an area of expertise because the larger companies will only get bigger.” One such enlarged company is Carlyle Aviation Partners, which grew rapidly from its foundation as Apollo Aviation founded by Robert Korn and Bill Hoffman just after 9/11 to a mid-sized institutional asset manager, which was sold to Carlyle Group in 2018.
The team has continued to grow the platform, implementing its decision to evolve from a mid-to-endof- life lessor into a full-service aviation finance platform, which it has achieved with the acquisition of FLY Leasing and now an agreement to acquire AMCK.
“Throughout our 20 years in operation, we have always looked at thoughtful opportunities to grow the business,” says Korn. “We believe that scale is important, and being able to offer a broader range of financing solutions to our industry partners should allow us to better compete on behalf of our investors.”
Carlyle Aviation Partners completed its acquisition of Fly Leasing (FLY) in August 2021, although the deal was first announced in April. Under the terms of the agreement, FLY shareholders received $17.05 per share in cash, representing a total equity valuation of approximately $520m.
The total enterprise value of the transaction is approximately $2.36bn. FLY’s portfolio of 84 aircraft and seven engines is on lease to 37 airlines in 22 countries. The per share cash consideration represented a premium of approximately 29% to FLY’s closing price on March 26, 2021.
AerCap’s twice in a generation deal
When AerCap’s acquisition of International Lease Finance Corporation closed in 2014, Aengus Kelly, CEO of AerCap, described the purchase of ILFC as a “once-in-ageneration opportunity”, noting that the last time an opportunity of that size arose was when GE bought several hundred airplanes from GPA, which effectively started GECAS. With the acquisition of GECAS, AerCap has repeated that success.
AerCap-GECAS negotiations were at their height in December 2020 when the industry was still reeling from the impact of the virus and COVID-19 vaccination programmes were still in their infancy. Despite the tense environment, AerCap was able to secure a bridge financing facility for $23bn, which was fully underwritten by Goldman Sachs and Citi. For Kelly, securing this financing was absolutely key to closing the acquisition of GECAS.
“You need to make sure that you are in a position where you don’t have to go to the capital markets,” says Kelly. “Similar to ILFC, and with GE, there’s no way that either of those transactions would have happened if we didn’t have the committed funding in place.”
The bridge financing agreement was negotiated in tandem with the GECAS acquisition negotiations. “Citi and Goldman underwrote the whole facility in full themselves because we wouldn’t allow them to syndicate it prior to closing because we didn’t want anyone to know what was happening,” shares Kelly. “ And so they took it on the best part of $12 billion each themselves. We had to pay a lot of money for that on the day we signed the transaction, but it is what allowed us to close the deal.”
Citi and Morgan Stanley acted as financial advisors to AerCap for the GECAS transaction. PJT Partners LP, Goldman Sachs, and Evercore acted as financial advisors to GE.
Cravath, Swaine & Moore, McCann FitzGerald and Nauta Dutilh acted as legal advisors to AerCap, with KPMG acting as tax advisers. Paul, Weiss, Rifkind, Wharton & Garrison, Clifford Chance and A&L Goodbody acted as legal advisors to GE.
There are few companies in the aviation sector that could have executed a deal of this magnitude. As a public company, AerCap was able to leverage its position to structure a transaction that involved cash and shares, which in a downturn scenario, sweetens the deal for the seller.
Under the terms of the deal, AerCap acquired $34bn of GECAS net assets, paying GE $24bn in cash, $1bn in AerCap notes and/or cash upon closing, and 111.5 million ordinary shares, which was equivalent to approximately 46% ownership of the combined company with a market value of approximately $6 billion on March 9, 2021.
GE has already witnessed the upside in the deal structure, since its 46% equity stake in AerCap was valued at approximately $6.6 billion as of October 29, with further upside potential since GE’s shares in the new company are subject to a staggered lockup period allowing GE to dispose of a third of its stake after nine months post close, a third after 12 months, and the entirety of its stake after 15 months.
This financing strategy was copied from AerCap’s successful acquisition of ILFC in 2014, but it was first used when AerCap acquired Genesis in 2009. “One of the biggest advantages of being a public company is that you have an acquisition currency.
In 2009, when we acquired Genesis, which was a listed company, there was another cash bidder, but the Genesis Board realised that if they sold for cash their shareholders would have locked in their losses in the middle of the financial crisis, so we offered them stock to provide some upside to shareholders.”
It was a similar story with ILFC, says Kelly: “I said to Robert Benmosche the CEO of AIG that there was going to be a recovery and explained that although on paper there is a significant day one loss, with a large shareholding in AerCap, AIG would be able to benefit from the return to travel.
With Larry Culp, the CEO of GE, it was the same playbook. GE is the largest engine manufacturer in the world and so had a wide lens on the aviation business so he could also see that a recovery was coming and that this deal was an opportunity to effectively reverse engineer an IPO of GECAS and have a way to play the up cycle in aviation.”
Although a large proportion of the GECAS transaction was settled with AerCap shares, the company still needed to raise an eye-watering amount of debt to meet the $24bn cash portion and refinance the expensive bridge facility.
For Kelly, the incredible response to the debt offering was not only a great endorsement of AerCap by the capital markets. Banks also showed that the market had tremendous confidence in the sector.
Following the closure of the GECAS transaction, AerCap now has a portfolio of over 2,000 aircraft, over 900 engines and over 300 helicopters, as well as an order book of approximately 450 new technology aircraft.
New technology aircraft represent approximately 56% of the combined inservice fleet, which is expected to grow to approximately 75% in 2024. The combined company serves approximately 300 customers around the world and is now the largest customer of Airbus and Boeing. Such scale has led to AerCap being labelled as a super lessor.
The combination of AerCap and GECAS has created a best-in-class aircraft trading platform with deep market insight and relationships, which combined have sold on average over $5 billion of assets per year over the past four years.
AerCap and GECAS have already started on the lengthy journey to integrate the two companies. “We are focused on making sure that all of our people understand the objectives and the culture of the business. We’ve never had a parent; there’s no 1-800 Billion phone number for us, we are on our own.
But this is what has driven us forward. For now, we are making sure that our way of doing things is instilled throughout the business, and then the rest will look after itself,” notes Kelly.
For Carlyle Aviation, the attraction was the portfolio, which had very few widebodies to remarket, and it was acquired at an approximate 30% discount to book value of the portfolio that had already been impaired.
CK Asset Holdings confirmed on December 23 that it had agreed to sell its portfolio of 125 aircraft managed by AMCK Aviation (previously Accipiter) to an entity managed by an affiliate of Carlyle Group for $4.28bn. The transaction also includes an order book for 20 Airbus narrowbody aircraft.
The transaction is expected to close in the second quarter of 2022, pending regulatory approvals. Goldman Sachs is leading the acquisition financing for the transaction. Milbank is acting as legal counsel to the Carlyle Aviation Partners managed investment vehicle with Kirkland & Ellis advising on the formation of entity acquiring the portfolio.
Carlyle Aviation Partners had three active platforms at the beginning of 2021. A dedicated pre-delivery payment (PDP) financing platform, a young aircraft leasing strategy, and a mid-life leasing strategy.
“The FLY acquisition fit very well into our mid-life leasing strategy,” says Korn. “We viewed it as a ready-built portfolio that had very similar attributes to what we might have historically constructed from five or six smaller transactions with other lessors/traders, so it was a very efficient way to acquire assets.
AMCK was a little different. We believe it’s a very good portfolio that had been thoughtfully constructed by CK and the management team, and has performed well during the pandemic. When we were initially shown the opportunity, we knew these were assets we wanted to manage and had confidence we could create value from them. We were pleased to partner with one of our current investors to underwrite the opportunity.
Reason for sale
In a notice to the stock exchange in December, CK Asset noted that the reason for the sale was due to the “paradigm shift in the aircraft leasing sector” where the “risk and return dynamic has become volatile and unpredictable”, which the industry has mitigated by increased consolidation, mergers and acquisitions.
Adding that following the internal consolidation of its aircraft leasing business, CK Asset considered it an “opportune time to exit the aircraft leasing sector” allowing the company to “unlock the underlying value of its aircraft portfolio and realise a satisfactory gain”.
CK Asset confirmed that its aggregate profit from the sale would be approximately US$170m, which would be utilise for general corporate purposes. In the video interview with Airline Economics and KPMG, Robert Korn noted that CK Asset as an investor in multiple industries, decided they could achieve better results with their capital outside of aviation.
He says: “From our standpoint, they created a fantastic portfolio that we and our investors are very excited about.”
Carlyle Aviation’s acquisition spree, once closed, will catapult the company solidly into the top ten largest leasing companies ranked by number of aircraft. The sale of Goshawk is also expected to close shortly, with SMBC Aviation Capital rumoured to be the prime bidder for that portfolio. Should this deal close successfully, SMBC Aviation Capital would become the second largest lessor by portfolio size and a total value.
With the sale of regional aircraft lessor Falko also believed to be in its final stages, further consolidation is likely heading into 2022 and beyond, mainly characterised by large portfolios with large-scale platform sales unlikely save for in a distressed scenario.
For ALC’s Plueger, although consolidation in the leasing market is increasing, it is being balanced with new entrants into the space: “There is new capital coming into the space from a variety of sources, and from some of the bigger private equity names, which has continued,” he says.
“So while some of the faint of heart investors have exited, there is this phenomena where there is more consolidation, but at the same time new capital in entering the marketplace. That has always been the case over the past 10 years. Some 10 or 15 years ago many of the Chinese lessors were just entering the space, so the situation now is really nothing new.
Those coming into the space want to capture the recovery they see ahead. They want to be in on the initial phases, which is understandable. This has given other lessors pause that perhaps they might want to grow a little bit more, have a bigger scale.”
DAE Capital, which bought AWAS in 2017, has always been in favour of inorganic growth, and CEO Firoz Tarapore expects the larger leasing companies to continue to grow. “Scale continues to be defined upward,” he says. “To manage the more pronounced and complex risks that we see today and which were highlighted over the past 21 months, there’s no such thing as too much capital to the extent we can use that to further provide the stability that our clients need… particularly as they re-fleet and regrow their business.”
Tarapore adds that it is the reliability of counterparties that has proven to be very important to airlines during this period of uncertainty – they need to know lessors can deliver on their promises, and from that perspective he agrees that size is of consequence.
“The top 10 lessors are probably going to get bigger as a group because other than the two at the very top, there is still scale headroom that is quite material relative to the current size of number two to number 10,” he says.
We believe that scale is important, and being able to offer a broader range of financing solutions to our industry partners should allow us to better compete on behalf of our investors.
For SKY Leasing, a relatively new and mid-sized leasing company, CEO Austin Wiley agrees that scale is important when dealing with the airlines to be able to negotiate large portfolio deals but adds that these are not the preserve of the top lessors, noting that SKY has closed a 10-aircraft deal with a single airline in 2021.
“The consolidation of lessors like AerCap and GECAS will force some reflection amongst the top 10 or top 20 lessors, but we should not necessarily expect a material amount of consolidation to follow. The shareholders across the top 20 lessors are very stable, they’re happy with their businesses, and it doesn’t seem like there is a need to grow beyond what is organically available in the market.”
Growing the books
The lack of significant sellers will limit the scale of consolidation in the leasing market as ORIX Aviation’s James Meyler explains: “While there is certainly a strong appetite for consolidation and for growth especially in the top 15 lessors, there are actually very few sellers in the top 15; almost all of them are trying to grow their book,” he says.
As a result Meyler expects acquisitions of smaller portfolios by the larger lessors to continue due to opportunistic sales or changes in business strategies that would allow some of those top lessors to grow their book. “I think all of them would love to buy a big lessor but there’s very limited availability for that.”
Meyler expects the top leasing companies to grow their books in the short-term at a pace the mid-table lessors may struggle to match. “I can see the top two to five lessors reaching a thousand aircraft in the short term,” says Meyler.
New leasing companies
“Whether that’s through acquisitions of other platforms or quite possibly just through the aggressive acquisition of assets. Although we have a very competitive space right now, as most of the airlines start to get back on stream, probably from 2023 onwards, and their order streams are back flowing at full capacity, many airlines will move to the sale-leaseback channel either for existing aircraft in their fleet or for new order deliveries.
That is going to be the big opportunity for some of the lessors to move at scale with a house and without an M&A transaction.”
“For leasing companies with portfolios of around 300-500 aircraft, it may not be sustainable for them to acquire enough aircraft organically to retain their position at the top of the table, since the leading lessors below AerCap, Avolon and SMBC Aviation Capital continue to grow their books towards 1,000, competitors would need to double their fleet every five years to just hold their position in the leasing space,” adds Meyler.
Even though many lessors expect consolidation to continue, they also expect the aircraft leasing sector to expand as even more new leasing companies enter into the market.
“Lessors don’t need a $10bn-plus fleet size to participate in these multiaircraft sale-leasebacks,” says SKY’s Wiley. “And airlines don’t want to be overly reliant on any one lessor so they can ask for help if they need to restructure. If anything, what we’ve seen over the last three to five years is more leasing companies and platforms emerge rather than less.”
Further down the leasing ranking table are the medium-sized lessors and asset managers that thrived during the boom years but some of which have suffered the most during the pandemic as restructuring airlines tend to opt to return aircraft to their smaller leasing counterparties to lean on assistance from their larger lessors.
Heading into the recovery over the next two years, in order to remain competitive, these sorts of lessors will be facing a tough fight for deals with such large lessors dominating the market. That competitive pressure, warns Becker, may result in those companies taking larger risks.
“[The smaller lessors] are going to fall behind and so will have to take on more risk, which means lesser quality on credit,” she says. “This is a sort of a catch-22 situation because they will take more risk with whom they place their aircraft, which means charging a higher rate to cover their higher cost of capital. But because most airlines are still struggling financially, they won’t be able to afford a higher rate.”
Some middle-sized lessors have been able to capitalise on the many sale-leaseback opportunities, having entered the pandemic period with little or no exposure, and with deep cash reserves. Such companies include SKY Leasing, Aergo Capital and Bain Capital’s Griffin Asset Management.
Aergo Capital is navigating the current crisis from the strong position. Back in 2017, the team began to position the business for a downturn it was expecting following the elongated growth cycle the aviation industry had enjoyed for more than a decade. When alternative investment manager CarVal invested in Aergo in 2014, the company rapidly increased its portfolio to 80 aircraft worth approximately $1.5bn. By the time the pandemic hit, Aergo had reduced its portfolio from approximately 80 aircraft to just 20.
As a result of that prudent planning, Aergo reduced its exposure to the wave of defaults in the marketplace following the early impact of the pandemic crisis, which has resulted in it having a significant amount of capital to deploy and more time to consider new opportunities.
“We’re more like a boutique lessor; we’re very opportunistic,” says Fred Browne, CEO of Aergo Capital. “We look for value deals, rather than being pigeonholed in one particular niche, we’ve looked right across the whole spectrum of the aviation market and have financed new narrowbodies including Neos and MAXs but we have also found value in some widebodies and turboprops.”
Aergo Capital has also recently launched a structured products division, which Browne states would not have been possible in the pre-pandemic period. “With such stress in the aviation market, Aergo is very well placed to finally launch a structured products division, which would have been much more difficult in the benign decade leading up to the crisis,” says Browne.
“This sort of business needs stress; it needs opportunity; it needs experienced people; and it needs capital.”
With secure backing from CarVal, an experienced management team led by David Power – who headed up ORIX Aviation for more than 15 years until late 2018 – Aergo’s Structured Assets Products was formed to capitalise on the opportunities presented by the stressed environment.
“We were expecting a downturn in the market but we have now been pitched the greatest one ever, so ironically, it’s been a perfect opportunity for us to set up this division,” says Browne.
Our airline customers have performed really well. We continue to see great opportunities with that customer base and have actively expanded this year, particularly in Latin America, where we’ve been able to partner with a number of airlines, as part of their restructuring process coming out of bankruptcy.
“This kind of capital plus fee-earning investment banking style business complements the pure leasing business as its very accretive, it contributes greatly towards platform costs and market relevance and redefines our business – it’s a great business to tack on to a traditional leasing and trading business,” he says.
Aergo has subsequently invested serious resources in building an effective platform to capitalise on the opportunities created during a downturn. Power has wasted no time in originating new business and closed his first deal for the structured products division upon joining the company in September 2020, involving the reconfiguration of an 737-800 for an innovative alternative use; also acquiring and financing of one 2006-vintage A321-200 aircraft from Global Knafaim Leasing.
The aircraft was sold with an existing operating lease to British Airways, financed by Volofin Capital Management. Since then the team has executed on $2bn in assets.
Castlelake’s Aviation Lending Program
More lessors have been willing to step up as lenders for their clients as airline demand for liquidity increased. Castlelake set up a debt fund in a bid to provide more capital solutions to its leasing clients. Castlelake’s Aviation Lending Program, set up at the end of 2020, was created to leverage the leasing platform’s existing airline and investor relationships to provide financing solutions for aircraft buyers, utilising mezzanine, senior secured and high loan-to-value (LTV) financing.
The program was dubbed a “natural extension” of the company’s longstanding investment strategy in aviation but it is also highly opportunistic and mindful of airlines need for funding, which will only increase as aircraft deliveries ramp up once more.
SKY Leasing also entered the crisis on a positive footing having closed its first aircraft leasing fund in October 2019 with a $300m equity investment from M&G Investments (M&G) and closed a $600m warehouse debt facility in January 2020.
As result, SKY headed into the pandemic without having deployed any capital and with zero exposure. Capitalising on the opportunities presented by the crisis period, SKY has increased its portfolio with new and young to mid-life aircraft with approximately $2.5bn in value, with ambitions to increase that figure annually by $1-1.5bn.
“We were fortunate to be able to select the airlines and the opportunities we wanted to pursue without much of a legacy fleet pre-COVID,” says SKY CEO Austin Wiley.
“Our thesis at that time was that airlines with large domestic markets and with exposure to short-haul and leisure traffic were going to perform the best during this crisis and ultimately recover the quickest in 2021. We’ve largely seen that play out. And so our airline customers have performed really well. We continue to see great opportunities with that customer base and have actively expanded this year, particularly in Latin America, where we’ve been able to partner with a number of airlines, as part of their restructuring process coming out of bankruptcy.”
Griffin Global Asset Management
Griffin Global Asset Management – formed as a long-term strategic partnership with Bain Capital Credit to create an aviation leasing and asset management platform – has also been very fortunate in that it wasn’t exposed to any restructuring having set up only shortly before the pandemic period.
Led by Ryan McKenna, Griffin has evolved quickly from its initial deal with Virgin Atlantic in January 2021 with a sale-leaseback transaction for two 787s to securing a $1bn warehouse funding facility structured by Goldman Sachs for Palisade Aviation, a joint venture between Griffin and Bain Capital Credit, that included innovations to provide maximum flexibility to offer airline partners a variety of financing solutions.
The company also placed its first direct OEM order for five new Boeing 737- 8s, which is only a stepping stone to bigger things, according to McKenna, who has spent many months analysing opportunities for investment in strong established carriers but also for startup airlines, especially in the low-cost and ultra-low-cost segment.
“Going forward, we think they’re disruptive to incumbents and there certainly is a demand at that level of the leisure market, to get to their destination in as cost effective of a way as possible,” he says. “And so we’ve really spent a lot of time trying to support carriers that fit that profile throughout the pandemic, which we will continue.”
COVID-19 has led to lots of hedge funds and venture capitalists entering the industry, thinking that they can do some business very quickly, but they forget that we are in the business of relationships.
While some lessors have been aided by timing more than anything else with the pandemic period coinciding perfectly with the closure of their initial fund raising, existing lessors and smaller asset managers have been managing their exposures and finding ways to both serve their customers but also keep those cashflows moving. ABL Aviation is one such company. The team, led by CEO Ali Ben Lmandi, have worked hard to both restructure existing leases and financing structures as well as raising fresh equity with new joint venture partners.
In November 2021, ABL Aviation announced the creation of a joint venture with new equity partner, alternative investment manager, Ellington Management Group, to invest in commercial aviation assets. The two companies formed the first blind mid-life aircraft investment pool in the post-pandemic period with a strong commitment from Ellington to invest up to $800m in aircraft assets.
The JV was arranged by Mizuho, which led the successful search for a new equity partner for ABL Aviation that builds on its strategic partnerships already held in Japan.
The new venture allows for flexibility across asset types, asset age, duration, structures and jurisdictions. ABL Aviation will act as servicer and manager for all aircraft, while Ellington will provide financial and strategic support.
Formed in 2014, ABL Aviation’s main vision was to create an independent asset management platform led by three differentiating principles: innovation, efficiency, and global presence.
As an independent manager, ABL Aviation was able to be adaptative and flow with the cycle. The company was originally focused on mid-life aircraft and high yielding investments, but market conditions forced Ben Lmadani to re-define that strategy and in 2018 switched to the new aircraft segment following the execution of an exclusive partnership with a financial institution in Japan, which provided $1 billion of asset value in permanent capital for JOL and JOLCO transactions.
The new venture with Ellington, an alternative investment manager, enables ABL Aviation to opportunistically deploy capital outside of the Japanese market and again consider mid-life assets.
The business of relationships
To date, ABL Aviation has completed 43 aircraft transactions totalling more than $2.5 billion of capital deployed for major airlines including Lufthansa, Delta, Pegasus, EVA Air, EL AL and Wizz Air since its inception, 11 of which have been in the past 12 months.
ABL Aviation has continued to serve its customers throughout the pandemic period but Ben Lmadani notes that some banking relationships have been strained during this time. The global pandemic has demonstrated clearly that the commercial aviation industry is a relationship business, which Ben Lmadani has always understood.
“People forget we’re in a business of relationships,” he says. “COVID-19 has led to lots of hedge funds and venture capitalists entering the industry, thinking that they can do some business very quickly, but they forget that we are in the business of relationships.
As a young company, ABL Aviation works very hard to build and maintain those relationships. Relationships are built in good times and bad times, but people are going to remember who failed them in the bad times.”
Waves of liquidity are entering the aviation market at all angles from the top of the market, focused on new technology assets, right down to the bottom to the mid-life and end-of-life assets, providing both equity and debt.
“Between 2014 and 2020 a lot of new capital entered the sector,” notes AerCap’s Kelly. “Some has done well; some has not. Those that thought it was a spread business probably have not done well, and will probably exit the market. But those who understood the risks in the business and worked with competent teams and platforms and that are committing additional capital to the space have done well and that trend will continue.”
The sale-leaseback market
The already overheated market has become even more competitive as the recovery has begun, as new money is entering the market, and especially since the supply of new aircraft remains constrained both due to lower production rates and the fallout from the problems the OEMs have been experiencing with certain aircraft types.
Although the MAX is now flying and performing well by all accounts, the issues with the 787s are lingering and causing some disruption in the market – to Airbus and the A350’s benefit.
The sale-leaseback market – which had been notoriously overheated pre-pandemic with lease rate factors rumoured to have dropped to extremely low levels of 0.4 – enjoyed a brief renaissance of sensible margins immediately post pandemic in 2020. However, that began to taper off in 2021 when more competitors entered the market eager to gain market share quickly with good credits.
There has been a bounce back in demand and as a consequence the sale and leaseback activity in 2021 has been the most competitive environment we’ve ever been in, with lease rate factors again falling to ultralow levels.
“The market is reacting to the supply and demand dynamics that we’re dealing with right now,” notes SKY’s Wiley. “Both manufacturers are producing significantly below pre-COVID levels, with essentially the same or potentially even more dollars chasing those reduced deliveries coupled with historically low borrowing rates, it’s natural that there would be pressure on pricing as a result.”
Wiley expects the spreads to remain healthy especially as the quality of the airlines that continue to take aircraft must be taken into consideration. “In our view, the issues around low lease rate factors will probably get resolved over the next 12 to 18 months,” he says. “Both the manufacturers are increasing their production rates, which will naturally bring more supply, more opportunities in the market and create a better supply demand dynamic.”
One aviation banker views this market dynamic as a positive for cash-strapped airlines, commenting: “Tier 1 airlines with new technology narrowbodies will get very low rents -between 0.5 and 0.6%. New technology widebodies will attract higher lease factors due to longer recovery for international long haul.
However, airlines could get classic widebodies capacity from lessors desperate to place some returned aircraft at low rents. When inflation kicks in, we expected the lease rents for new technology aircraft to increase with a delay upon renewal of leases.”
The sale of GECAS has removed GE from the engine leasing market, which formed part of GE’s plan to break up the company into three global public companies focused on aviation, healthcare, and energy.
Tom Barrett, CEO of Engine Lease Finance (ELF) notes that there are now fewer competitors in the engine space but it remains hugely competitive: “We have really tough competitors in the space, all of which are very well capitalised, wellfunded, well-resourced and anxious to grow,” he says.
“There has been a bounce back in demand and as a consequence the sale and leaseback activity in 2021 has been the most competitive environment we’ve ever been in, with lease rate factors again falling to ultra-low levels.”
Private equity funding
Existing mid-sized lessors remain under pressure from the multiple startup platforms that have been created with private equity funding over the past few years.
Most recent examples include Vmo Aircraft Leasing, set up by industry veterans Bob Brown – the former CEO of Vx Capital – and Vx co-founding partner Will Hudson with colleague Sean Sullivan, backed by fund managed by Ares Management Corporation; as well as investment fund, FitzWalter Capital Partners, which says that it is committed to building a leasing platform and acquiring aircraft at a time when the industry is going through a difficult time.
Private equity-led entities, new to the aviation space, have been criticised for the use of more aggressive tactics uncommon in the aviation industry, buying up debt to take control of distressed assets in such a way that is detrimental to junior investors.
Investment funds have a very different view. In distressed scenarios, these companies claim to be providing much needed liquidity and enabling senior lenders to exit difficult situations rather than remain bogged down in lengthy and costly restructuring negotiations with lessees.
SKY’s Wiley comments more positively on the uptick in new lenders entering the space, which he says are looking to fill the void left by the traditional bank lenders that have left the space due to regulatory or risk management factors.
“They have provided a nice complement to what the capital markets or the unsecured lending market have to offer but that product is a bit narrow today relative to where it will be three or five years down the road.
Certainly when we talk to our institutional investors, there’s an increasing interest in playing in multiple parts of the capital stack. What’s exciting to us is that we can provide potential solutions for such investors by effectively tranching these transactions within their portfolios.”
Aircraft leasing debt markets mature
The sheer scale of corporate debt issued by aircraft leasing companies over the pandemic period – aided considerably of course by the $21bn AerCap issuance – has ensured that the aircraft leasing sector is a situation that viewed as a niche market by investors, a situation that is only improving.
“This is not a cottage industry anymore,” says Srinivasan. “There’s been a sea change between how aircraft leasing was viewed post and pre- Global Financial Crisis. It is now a very well followed, very well tracked sector.
If you look at aircraft lead leasing as a function of the unsecured market, now there are multiple players that have been constantly tapping that market. You’re seeing a lot of equity research on the public companies there. You’re seeing a lot of debt research on the unsecured issuers. This is a very mature industry right now.”
In October 21, AerCap successfully refinanced the $23bn bridge facility provided by Citi and Goldman Sachs for the acquisition of GECAS with an immense $21bn multi-tranched debt offering, which was phenomenally well received as the deal generated $74bn of demand from more than 400 investors around the world.
AerCap’s $21bn funding package comprised a number of senior notes offerings in varying tenors: $1.75bn two-year 1.15% notes; $3.25bn threeyear 1.65% notes; $1bn 1.75% threeyear notes; $3.75bn 2.45% five-year notes; $3.75bn 3.00% seven-year notes; $4bn 3.30% senior notes due 2032; $1.5bn 3.40% senior notes due 2033; and $1.5bn 3.85% senior notes due 2041.
The package also contained $500m two-year floating rate senior notes. The bonds were rated Baa3 / BBB / BBB- by Moody’s, S&P and Fitch, respectively. The 2032 notes represented the first senior unsecured 20-year bond issuance by an aircraft lessor.
On November 1, 2021, AerCap closed $1bn 1.899% senior notes due 2025, which were issued to a subsidiary of GE. AerCap also closed a $2bn secured term loan issued by indirect subsidiary Setanta Aircraft Leasing DAC (Setanta) and in addition, on November 2, completed a $2bn seven-year term loan B, which priced at Libor plus 200 basis points (bps), with a zero Libor floor and an original issue discount of 99.75.
The $21bn funding package raised in excess of $76bn in orders at the virtual roadshow, which demonstrates the enormous interest in the deal and the company, but also speaks to the maturity of the sector.
It is staggering that any aviation company has been able to attract $76bn of interest. The industry has matured so much as the financial markets become more and more comfortable with aircraft as a very investible asset.
“The investor response was testament to the AerCap business model, the transaction, but also to the entire industry – it is staggering that any aviation company has been able to attract $76bn of interest. The industry has matured so much as the financial markets become more and more comfortable with aircraft as a very investible asset,” says AerCap’s Kelly, “particularly when it’s well managed by a very competent asset manager.”
Although the bulk of the funds raised were in the unsecured market, as per AerCap’s wishes, the company saw massive demand for its secured debt as well – combined AerCap’s fund raising attracted in excess of $85bn in demand.
The volume of debt on offer served to attract new investors into the aircraft leasing market and aviation in general. The hope is that they will stay and serve to expand the investor pool for the entire market.
“Because the deal was so big, it showed up in all of the indices and so was seen by more money managers than previous aircraft lessor deals,” says one investment banker.
“If you’re a money manager and you didn’t buy this bond and it performs well, you may underperform the market for the year simply because it was so big. A lot of accounts showed up for this deal that don’t usually show up in leasing. Hopefully, the deal performs well and brings those new investors in this deal into other aircraft leasing transactions.”
The unsecured corporate debt market remained wide open for aircraft lessors during the pandemic, reopened by AerCap and BOC Aviation in mid- 2020, and remains very active heading into 2022.
The market for investment-grade-rated lessors is very robust. During 2021, ALC raised more than $3.6bn in senior unsecured debt via its medium-term note programme – at incredibly low rates ($750m MTNs due 2024 issued in the first quarter of 2021 priced at a record low of 0.70%) – and has steadily increased its unsecured revolving credit facility throughout the year from $6.4bn to $6.8bn.
ALC also issued its first MTN bond of the year in January 2022 raising $1.5bn with $750m 2.20% senior unsecured MTNs due 2027 and $750m 2.875% senior unsecured MTNs due 2032.
Regardless of rising interest rates and the inflationary environment, ALC’s John Plueger remains confident that the capital markets will remain open and a robust source of capital going forward.
“Certainly for the first quarter or two of 2022, that robust capital will still be available through the investment grade market,” he says. “ALC’s strategy has always been from day one to maintain strong investment grade ratings, which has served us very well during this pandemic. And during a time when others started to struggle for financing.”
“If an increase in interest rates comes with inflation, those that have the highest rated balance sheets are going to still enjoy the lowest cost of debt,” adds Plueger.
“Generally speaking, if you look back over history, an inflationary environment tends to be good news for lessors because higher interest rates and higher inflation tends to bias a purchase decision versus a lease decision slightly in favour of leasing since capital is still scarce and the cost of money rises. I feel pretty good about the future, and we will have a very good debt capital market to support the growth in our business new aircraft deliveries for the foreseeable future.”
AerCap and ALC were not alone in accessing the unsecured markets in significant ways and at very attractive rates. Investment grade lessors including DAE, SMBC Aviation Capital, BOC Aviation, Aircastle, Aviation Capital Group, and Avolon all had successful bond raises during 2021, with over $32bn being raised by lessors during 2021.
The quantum raised and the interest rate spreads achieved by each of these investment grade lessors highlight both the confidence the investment community has in the leasing model and also speaks to the maturity of aviation as an investible asset class.
Even as we move into a rising interest rate environment, there is a widely held belief in the lessor community that there will be a continued ability to obtain attractive spreads on unsecured debt for largescale, well-run leasing platforms.
An inflationary environment tends to be good news for lessors because higher interest rates and higher inflation tends to bias a purchase decision versus a lease decision slightly in favour of leasing since capital is still scarce and the cost of money rises.
Lessors are frequent traders of aircraft assets – primary the larger, young portfolio-focused companies selling off older assets into the mid-life leasing sector. The COVID-19 pandemic put the brakes on aircraft sales in the early days of the crisis as aircraft were grounded. However, aircraft trading started to pick up again in early 2021. “[The trading market] is very robust, says AerCap’s Kelly. “We’ve seen very strong interest in assets we’ve been selling over the course of 2021.
At the end of 2020 into the first half of 2021, buyers focused on narrowbody assets that were on long-term lease. But we are seeing that migrate as buyers realise that the aircraft leasing industry is a crucial part of the infrastructure of the airlines and because we have seen a huge fall off in deliveries of aircraft from the two OEMs.
The educated buyers are certainly seeing the demand over the next several years for existing technology assets. And we’re certainly seeing good pricing coming back as we look to sell assets. The market turned a bit faster than I thought; the price of assets started to rise in the second half of last year and we certainly saw significant price increases on the new tech side, and on the narrowbody demand for A320s and 737s, followed recently in the 787 and A350 market, the more desirable of widebody assets and the A330 Neo.
The prices of those assets are moving upward. I’m confident that we will see a market for 777s and the A330s and as we go through this year, we’ll see movement in the right direction too, because we can see what’s happening on the engine side.”
Engine lessor, ELF’s Barrett, notes that he is very interested to find out AerCap’s engine leasing strategy following its acquisition of an interest in Shannon Engine Support (SES), which leases spare engines for CFM International, through a new joint venture signed with Safran in November 2021.
SES is now a 50/50 joint company between AerCap and Safran. Barrett is poised for any opportunities that may fall out of the GEEL/SES acquisition but highlights the limited numbers of dedicated engine lessors, which traditionally is a much more difficult space for new investors to enter because it requires much more technical expertise than the new aircraft leasing space. “It’s unlikely there will be much M&A in the engine space,” he says.
“One OEM has determined to exit the engine leasing market and it remains to be seen what how other OEM/other lessors strategies will evolve.”
SMBC Aviation Capital is also witnessing a very strong trading environment. “We are seeing strong bids on the trading side at the moment,” says CEO Peter Barrett. “We are receiving attractive offers, particularly for younger technology aircraft, both Neos and Ceos and MAXs and NGs, which are relatively young narrowbody aircraft. We have a wide variety of buyers, not just the ABS-type of buyers, but investors generally have a strong interest in the types of aircraft that we own.”
Other lessors have commented that the trading environment remains difficult in that there are many buyers seeking to purchase assets but they are simply not available – at least not at pre-COVID volumes – due to the larger lessors receiving fewer new aircraft due to production delays and deferred orders, but also because many have been reluctant to trade while asset values remain low.
Deliveries to pick up
“There’s a general view Omicron may delay progress by a number of months, but we still take a view that we will see significantly more trading in 2022,” says Seraph’s CEO David Butler.
“There are several lessors that have done very well from focusing on specific types of midlife assets and the opportunities there and there’s also a natural attrition from the leasing platforms, which are constantly upgrading their customer base and the aircraft type to retain a young, fuel-efficient fleet. We absolutely expect to see more opportunities around the midlife space this year.”
ALC’s John Plueger agrees that the larger lessors will start to ramp up their trading activities this year: “The large lessors haven’t taken on new aircraft at the pace they would have expected to and so haven’t had to sell at the pace they would normally,” he says.
“That’s all coming to a head in 2022. Deliveries will pick up and the large lessors will have to start selling again to start-up aircraft lessors or established midlife buyers, or they may tap the ABS market. You’re probably going to see a combination of both.”
There’s a general view Omicron may delay progress by a number of months, but we still take a view that we will see significantly more trading in 2022. There are several lessors that have done very well from focusing on specific types of midlife assets and the opportunities there and there’s also a natural attrition from the leasing platforms, which are constantly upgrading their customer base and the aircraft type to retain a young, fuel-efficient fleet. We absolutely expect to see more opportunities around the midlife space this year.
The larger lessors have been incredibly successful in raising funds from the capital markets and from their strong parents, which has enabled them to support their airline customers throughout the crisis. Investment grade lessors have been the most successful, raising enormous amounts of debt at historically low levels despite the ongoing pandemic crisis.
“Investment grade lessors have been relying on the unsecured debt market, and they have all taken advantage of the rate environment over the last 12 to 15 months to reset their longer-term debt,” says Vinodh Srinivasan, managing director, co-head of the Structured Credit Group, Mizuho. “If interest rates start to rise, lease rates often follow with a lag. But so long as the debt maturities are still further out, the lessors will see a net benefit.”
Non-investment grade asset managers too have been incredibly successful at raising funds from various sources including access to warehouse capital and the asset-backed securitisation (ABS) market for more permanent financing, which has returned to full strength much faster than anyone initially expected.
“Even in that post-COVID market, ABS deals are pricing a good 100 basis points inside of the best deals pre- COVID,” says Srinivasan, “so everybody’s taking advantage of the real interest rate environment.”
ABS market recovery
In February 2020, aviation ABS issuance screeched to a complete halt along with the world’s air traffic as governments reacted to the COVID-19 outbreak. The belief was that the market would remain shuttered for some time until the post-pandemic recovery was well underway.
However, the world had barely opened up following the worst of the global lockdown period, when the ABS market woke up in early 2021 and roared back into life throughout the year, gaining in size and scale. By December 2021, annual aviation ABS issuance had reached 14 deals with a total volume in excess of $8.5bn.
The speed with which the ABS market recovered surprised almost everyone. “The ABS recovery has been much quicker than expected after having been shut down for much of 2020, so its return was really a pleasant surprise in 2021,” shares Mizuho’s Srinivasan, who has operated extensively in the ABS market for several years.
“But if you take a big step back, perhaps it was predictable given that the Fed was pumping all that money into the sector and there is a wall of money looking for yield. Aircraft ABS deals actually provide a better yield than other ABS issuances such as auto and credit card assets. Those deals are pricing at sub-1%, with many aircraft deals pricing closer to 2.5%.”
Since the first tentative ABS deals return in early 2021 with Castlelake’s CLAST 2021-1 in January 2021, there have been a further 13 deals issued with the structures evolving throughout the year.
A number of structural enhancements were introduced in the immediate post-COVID period ABS transactions to provide additional protection for the debtholders who were extremely cautious in the early part of the year.
One of the foremost structural additions was the shortening of the debt service coverage ratio (DSCR) – the measurement of the available cash flow to pay current debt obligations – from six months to three months.
“The DSCR becomes much more reactive to any triggers in the structure and the DSCR kicks in faster should there be any interruption to the cashflows,” explains Serge Gabovich, Managing Director at Mizuho. “This was introduced post pandemic since investors felt it took too long for the DSCR to trip in previous transactions when losses began to filter through as a result of the air travel restrictions.”
The sense is that this shorter DSCR is a structural change that is likely to remain even as the issuing environment continues to improve as air travel recovers to 2019 levels. “This feature has been included in almost every ABS issuance in 2021; investors like it and there is no reason to change it so it will likely remain in the ABS structure going forward,” says Gabovich.
Minimum aircraft test
Another significant structure change has been the introduction of the minimum aircraft test. “The inclusion of the minimum aircraft test has been driven by the rating agencies and is another feature that we think is here to stay,” notes Gabovich.
The test sets the minimum number of aircraft for any secured aircraft pool and once portfolio drops below a certain number, the transaction goes into full cash sweep. “This feature was introduced because as the pandemic developed, there were a number of deals where aircraft couldn’t be delivered into them and the portfolios ended up with too few aircraft, which lost diversification and ultimately needed to be rapidly downgraded, even if the debtholders were repaid large chunks of their initial investment,” explains Gabovich.
Another new feature has been the collections test, which assesses the percentage of the funds collected that would trigger certain protective features if it was too low. Gabovich doubts that this feature is here to stay since the collections test has been slowly disappearing from the latest ABS deals that have come to market.
ABS transactions have always featured a liquidity facility, typically sized around nine months of senior note interest. Post pandemic, some facilities have increased to provide coverage for up to 18 months to ensure that there is enough liquidity available in difficult situations without causing any defaults.
“While this is a protective and helpful feature, we don’t think that it’s necessary to include such a large liquidity facility going forward and it is likely to disappear,” predicts Gabovich.
“Generally, for post-pandemic transactions, we have seen the cash security deposit accounts being funded with more cash than they have been prior to the pandemic,” he adds. “That aspect may continue while the industry remains in recovery but it is likely to be loosened over time because this overfunding is an additional drag on capital in exchange for added peace of mind.”
C Note reserve account
Another new feature has been the enhancement made to the C Note reserve account. “Prior to the pandemic, the account was typically funded once with a fixed amount to prevent the Notes from PIKing, since investors don’t like Notes that are designed to PIK and not pay timely interest,” says Gabovich.
“The reserve was set up for this reason but in the latest wave of deals, the cash reserve also replenishes. We think that this feature may remain in the near term especially given how fundamentally the lower rated classes were impacted by the pandemic.”
SKY came to market with an ABS in May, the $663m SLAM 2021-1, which consisted of two series of notes: $592.4m A notes priced at 2.434% and $70.7m of B notes priced at 3.422%.
The notes were secured on a portfolio of 16 aircraft valued at approximately $885m. An affiliate of SKY acquired the E Notes of SLAM. SKY used the proceeds for the transaction to refinance its existing warehouse debt financing facility.
“We were very happy with the result,” says SKY’s Wiley. “We saw a very significant demand for well-constructed portfolios in the first quarter. Post- COVID the biggest change has been that investors are differentiating on the quality of the portfolio in terms of the pricing – even when they have the same manager. That's a really healthy development because it will allow for more market participants to choose what kind of risks they’re willing to take within these ABS structures.”
KBRA’s Riggi was not too surprised that the ABS market rebounded as rapidly as it has, mainly due to the “wall of refinancing” that was due and the general importance of the market to aircraft lessors.
She points to the changes in structures as a positive move for the industry and also applauds the first CLO-type ABS issuance from Stonepeak and Bellinger – SALT 2021- 1 – as a positive development for the product type and the industry.
“The ABS deals that came to market had more conservative structures,” she says. “There are now ABS deals secured on much younger aircraft, with much longer lease terms remaining. There are even some loan deals that are kind of like mini-CLOs structures, which are simpler. Perhaps lessons were learned from the crisis but there’s still a place for older aircraft.”
E Note ABS
One aviation banker does not believe any E Note ABS deals will be sold so long as Omicron or other variants are a threat for the airline industry. “We are watching the current performance of the ABS on the sub notes, for midlife aircraft, and power-by-the-hour agreements.”
Griffin’s Ryan McKenna, who helped launch the tradeable E Note ABS product while he worked with ALC, sees no problem with the product and expects it to return. “I think there are no issues with the E Note market,” he says.
“If there are performing portfolios, the E Note market will be ready to roll the same way as the credit side. I see no structural problems on either side; it’s really a question of getting the airlines back healthy and on normal payment schedules, according to the lease documents. If you showed up to the market in January with you know, a portfolio that was performing, I think the E Note market would be ready to accept it with open arms.”
Mizuho’s Srinivasan agrees and maintains that the E Note market has never really closed. Srinivasan and his team recently closed the first tradeable E Note ABS transaction for the first time in some months in the shipping sector with the $275m marine container-backed portfolio sale for Buss Global Management.
The $85m E Note was marketed to a mix of investors including traditional E Note buyers across the aviation space. With the success of this deal and interest from aviation buyers, the Mizuho team are confident the product type will return in 2022.
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