Current consensus has been that larger aircraft leasing companies should have the resources and shareholder support to survive the downturn, but that this will not necessarily be the case for the next tier of leasing companies.
However, if countries start seeing a second spike of infections, or airline passenger demand fails to pick up for a significant period, leading to more airline failures or greater demands on forbearance, even the larger aircraft leasing companies' capacity to survive may be in question.
According to Fitch, aircraft leasing companies report that nearly 90% of airlines have been unable to make lease payments and have had to request rent deferrals. Lessors are also dealing with increased lease defaults and lower lease renewals.
The resulting reduction of cashflows, together with an increased anxiety about when counterparties might resume honouring obligations, is creating significant stress for aircraft leasing companies.
How long is this sustainable? Forbearance may be possible for a few more months. But without a sharp upturn in passenger demand for the airlines, many aircraft leasing companies may find they are breaching covenants or facing their own liquidity crisis and have little room for manoeuvre. This is especially true for those with weaker liquidity positions or large debt maturities due.
Typically, in times of financial strain, lessors and lenders agree with carriers to take back some of the planes leased out or enforce security to reclaim them. But in the current situation, repossession is not always a viable option.
An increase in aircraft repossessions reduces residual values, resulting in impairment charges for the aircraft leasing companies and financiers. Lessors risk not being able to re-lease the planes and there are substantial costs associated with storing planes that are not flying.
Lessors and bondholders are finding themselves in a position where they have no choice but to rescue ailing airlines as repossession would put aircraft into a market where the planes would fetch only a fraction of the outstanding debt against them.
How long can this last? Lessors and lenders cannot subsidise airlines forever, and without a rebound in passenger numbers, many will face unsustainable pressure.
The aircraft leasing company space has arguably been due for consolidation for a while, and the current crisis is likely to drive an increase of M&A in the sector.
According to BOC Aviation CEO, Robert Martin, consolidation will be driven by the wider strategies of the parent company, who may want to dispose of non-core operations. A good example is AIG selling ILFC after the last financial crisis.
In addition, Mr Martin believes that airline-owned leasing companies will not survive the downturn: "This is a financial business and the airlines will retreat to their core business during this period"1. Indeed, this trend had already begun, with AirAsia and Norwegian’s leasing arms being disposed of over the past year.
Financial requirements will be another key driver of consolidation. Lessors who have large debt maturities coming due at a time when refinancing options are limited can often find themselves forced into a restructuring with their lenders, which could, in-turn lead to a consolidation in the market.
There have been many new entrants into the market over the past 5-10 years, especially in Asia, which has become a centre of gravity for the aircraft leasing industry.
Many will not have experience in managing the risks involved in the full life-cycle of an aircraft and this will be the first downturn they have experienced. In addition, the Asian airline industry is relatively fragmented, and this crisis has widened the gap between the stronger and weaker carriers, many of whom will not survive.
Consolidation is inevitable, but will lessors be forced to exit the market now, sustaining significant losses, or will they be able to hold on until prices recover?
Attracted by higher investment returns, many private debt funds have invested heavily in aviation asset-backed securities (ABS) transactions. These have exploded over the past few years, especially for lower-rated borrowers and smaller emerging market operators. Unlike a traditional leasing company that can add additional assets, ABS vehicles do not have that option. There are very-real concerns about whether these ABS structures will hold up in the current environment.
Over 60% of all aircraft around the world financed by ABS structures are now grounded, according to UK aviation consultants, IBA. This compares to 52% of the global passenger fleet, indicating that aircraft within current ABS portfolios are less active than the global fleet average2.
This contributes to huge cashflow pressures within aircraft ABS structures, as they face both payment holidays and unforeseen maintenance costs linked to the grounding, which have not been planned or modelled. Structures with high exposure to wide-body or older aircraft, and deals that have a high number of plans coming off lease in the next 12 months are particularly vulnerable.
These are unchartered waters for aircraft investors, and ABS structures will continue to suffer in the short to medium term. Rigorous cash management is essential, together with accurate modelling for unforeseen costs and active engagement with lessees.
Those leasing companies that are well prepared to weather this period may be able to take advantage of the low prices in the market by purchasing assets at attractive prices and increasing their market share.
There may also be new entrants to the aircraft leasing market. If new players are able to purchase spare capacity at rock-bottom valuations, is there a risk they will build businesses by undercutting existing lessors’ pricing models? How many leasing companies could withstand such competitive pressure at this time?
Given all the headwinds currently facing the market, aircraft lessors, their lenders and financers of ABS will be faced with challenging situations as the financial year progresses and should think about whether they have the right internal capacity, knowledge and experience to have the inevitable difficult conversations that lie ahead.
For more information, contact Andy Charters