Despite a slight decline in activity during 2017, due to increased bank liquidity and airlines deleveraging, capital markets remain a vital source of financing for airlines and leasing companies.
Capital market deals accounted for 26% of the financing for all Boeing deliveries in 2017 to December, according to the US manufacturer’s latest Current Aircraft Financing Market Outlook.
Taking advantage of record low coupons, airlines and leasing companies had raised more than $61 billion in the capital markets over 2017 at the time of writing (7 December). Lessors accounted for 70% of capital markets deals by volume as they raised unsecured debt and financed their portfolios through asset-backed securities (ABS) transactions.
The past year was an active one for the ABS market, with 13 deals having closed at the time of writing, compared with eight in 2016. ABS markets are attractive to aircraft lessors for several reasons. Some use the product as an equity sale of assets, where they retain the right to manage the assets as a servicer but sell the equity to new investors. Other lessors use the structure for portfolio refinancing, where the lessor retains the equity in the aircraft.
Air Lease’s 2016 and 2017 Blackbird and Thunderbolt transactions are examples of when an issuer sells a portfolio of assets, but continues to act as the servicer. GECAS’s 2016 Labrador Aviation Finance transaction served a similar function, being the first deal of its type with equity placed in South Korea. Asset managers, private equity funds and hedge funds continue to buy the E-notes on these transactions.
“We have seen first-time investors coming in on every new ABS transaction,” says a New York-based capital markets banker. “New investors usually take time working through its credit approval process, and might not be in time for the first few deals shown to them, but eventually would invest in later deals.”
Not only has the market welcomed new investors; it has also hosted new assets that ABS investors were uncomfortable with only a few years ago. “There is more flexibility for ABS of mid-life aircraft, regional and turboprop aircraft and engines,” says Drew Fine, partner at Milbank. “ABS has also become a popular product for joint ventures. There are also more protections for investors, such as excess proceeds and single waterfall provisions.”
Another banker tells Airfinance Journal that three to four years ago, the advance rates for ABS deals were in the low 70 percentages and now they are in the mid-80s, showing that banks are now more comfortable with higher loan to value ratios.
The NYC-based capital markets banker agrees, saying that ABS now allows issuers to achieve better terms through higher advance rates and lower pricing than bank transactions, particularly for older collateral.
“The investor base for ABS has broadened significantly in the past year, as investors seeking incremental yield start investing in the space,” he says. “ABS financing facilitates aircraft portfolio sales better than other alternative financing, such as a bank loan.”
Tony Nocera, senior managing director, ABS, at Kroll Bond Rating Agency, which has rated 35 aircraft asset-backed securities transactions since 2013, says pricing was tighter on ABS deals over the past six months.
“We’re seeing repeat issuers, such as Castlelake, Apollo, even Aergen, with the HAIL transaction, which they’ve done as a second issuance,” he says. “There’s some new issuers to the market, like Sky Leasing, with the S-JETS deal, and Wing Capital Partners, with the WAVE deal, and Aergo with the Metal deal, so that’s another trend we’re seeing.”
He adds: “Newer companies to the ABS market are not all new companies either, some of them have been around a long time but they haven’t securitised, so they’ve entered this market for the first time.”
During 2017, ABS issues have refinanced warehouse facilities, refinanced de-levered bank facilities and facilitated portfolio sales.
However, some issuers have hinted that production line delays in new-technology aircraft, such as the Airbus A320neo, may halt future ABS deals.
John Plueger, chief executive officer of Air Lease, told Airfinance Journal in September that a follow-on transaction from the lessor’s $344.7 million Thunderbolt ABS would come later than expected because of production line issues that have delayed new aircraft deliveries.
Conversely, the capital markets banker believes product line delays may increase ABS deals. “Delays of the new-technology aircraft actually help to extend the timing of when the current-technology aircraft expect to be replaced by new-technology aircraft, which results in a better value curve of the current-technology aircraft.” In other words, there will be less depreciation on these aircraft than originally projected. With a better value curve, lessors can finance or sell current-technology aircraft at better
value, hence promoting ABS issuance.
Through 2017, ABS structures became more streamlined, so more deals were done and at a quicker rate. The banker says that the standard ABS deal now usually has a seven-year anticipated refinance date (including a full cash sweep, a pricing step up after seven year anticipated repayment date), one single waterfall (as opposed to separate waterfalls for i. monthly rental cash flow waterfall and ii. dispositions), a debt service coverage ratio test, a utilisation test, and end-of-lease payment pro rata repaying the debt.
The market is seeing consolidation of legal terms on these deals, meaning that lessors can access low pricing even if it is their first time tapping the market.
Among airlines, the enhanced equipment trust certificates (EETC) market is seeing an increase in non-US investors participating, as well as ongoing demand from several airlines. Five EETCs closed in 2017, the same number as 2016, according to Airfinance Journal’s Deal Tracker.
All the deals that closed in 2017 were for US airlines, apart from a $719.2 million EETC launched by Air Canada in December. The deal was secured against a pool of 13 aircraft, comprising nine new Boeing 737 Max 8s and four 787-9s.
“The US airlines who have traditionally issued the most EETCs have generally been extremely profitable resulting in less need to raise financing,” says Milbank’s Fine.
“It is in part because of the robustness of the market and the strength of the US carriers post-consolidations,” adds the capital markets banker. “For example, Delta is able to fund at attractive rates in the unsecured market and American and United have less need for cash.”
EETCs for airlines outside the US price much wider than US airline EETCs. Often, non-US airlines can access cheaper financing than EETCs through Japanese operating leases with call options, tax leases, sale and leasebacks and bank loans.
Although 2016 saw Norwegian price a $349 million EETC, the airline’s pricing was higher than the US airlines that issued that year: the European carrier obtained a coupon of 4.87%, compared with 3.10% and 4.38% from United and American Airlines respectively. There were no European airline EETCs in 2017.
Unsecured and private placements
The majority of the top 10 lessors took advantage of the low interest rate environment and locked in low-priced unsecured funding in 2017. Deals have been used to fund aircraft acquisitions, for general corporate purposes and to help acquire other leasing companies in M&A transactions.
Some of the highlights of the year include DAE Capital issuing $2.3 billion in unsecured paper to help it acquire AWAS in August, with pricing between 4% and 5%.
Michael Halaby, head of aviation/land transport debt origination EMEA at Deutsche Bank, tells Airfinance Journal: “We’ve seen increasing interest from borrowers to access the unsecured bond markets given the attractive spreads available relative to secured bank margins. Indeed, we see some borrowers’ margins in bank debt flat to unsecured bond issuance.
“Normally, we expect secured
There has also been some activity in the European unsecured markets. Ryanair returned to the eurobond market for the third time in February via a six-year offering, which priced at 1.125% – one of the major deals of the year. Lessors also tapped the eurobond markets in 2017. For example, Russian-owned but Dublin-based lessor GTLK Europe priced a $500 million eurobond on the Irish stock exchange in June at 5.125% a year.
On the unsecured side, aviation companies are increasingly interested in the schuldschein (SSD), a privately placed and unlisted bilateral loan instrument usually governed by German law. After issuing its debut Schuldschein in 2016 and becoming the first aircraft lessor to tap this market, raising $95 million, Goshawk dived in again in October. Nordic Aviation Capital also raised its first Schuldschein in late 2017, with Investec acting as the lead arranger.
Halaby adds: “I expect SSD to be a serious contender for airlines and lessors provided the market continues to perform. No direct secured SSD has been completed to our knowledge but we expect those trades will come. “The issue is getting issuers comfortable on execution risk as they are used to fully underwritten secured bank deals. SSD is popular for borrowers seeking euros – as well as US dollar and sterling – given the larger investor base. It is crucial to recognise that the SSD market is not a purely German product; we see a number of deals for international borrowers attracting global investor demand.”
Despite the recent flurry of activity in European capital markets, one capital markets banker is dubious about them opening further anytime soon.
“An aircraft is still primarily a US dollar asset. Rating agencies penalise non-USD currency issuance due to asset recovery analysis. We expect aircraft to trade more in euro (and renminbi for that matter) at some point – but it will take time.”
Over 2017, the private placement market saw deals from issuers including Goshawk, Jackson Square Aviation and SAS.
“US private placements – both secured and unsecured – offer issuers who previously depended on secured bank loans and the like to diversify their borrowing base and maturity profile,” says Halaby. “The limiter to the number of private placements is more due to issuers who are not yet entirely comfortable with the best efforts nature of deals, which typify capital markets transactions versus underwritten bank trades.”
He adds: “Many investors now have portfolio managers and analysts as well as the infrastructure necessary to invest in any number of airlines and aviation lessors. The more credits they see, the more they can amortise that cost over a wider range. The private nature of the market allows borrowers to access capital under the radar.”
As aviation becomes a more recognised, better understood and relatively stable asset class, yield-hungry investors continue to invest selectively across a variety of debt products. Along with this, a favourable interest rate and long-term financing environment has made the capital markets attractive for leasing companies, as well as airlines that have high credit ratings.
It looks likely that capital markets will remain buoyant in 2018 as a source of capital for airlines and lessors. However, this assumes that several variables remain favourable, including oil prices, GDP growth, air travel demand and the financial outlook of lessors and airlines.