The successful issuance last year by Ashland Place Finance of ASHLAND 2023-1, the aviation loan asset backed securitization (ABS), together with the engine ABS, WEST VII, issued by Willis gave glimmers of hope to aircraft lease ABS market participants. This year’s BJETS 2024-1 by Global Jet Capital marks a further significant development for the aviation finance sector, and although it comprises a mix of loans and leases for business jets, market participants cannot help but hope that it heralds a further indicator of a potential resurgence ahead for the commercial aircraft lease ABS market.

The aviation ABS market has faced significant headwinds during and since the COVID-19 pandemic and as a consequence of current global conflicts. The successive macro shocks of the pandemic and then Russia’s invasion of Ukraine, felt more acutely in aviation than in many other sectors, have led to a deterioration in asset performance and the consequent downgrade of a number of ABS transactions by the ratings agencies. Indeed, a significant number of the aircraft stranded in Russia were held in ABS structures. In addition, interest rate cuts have not yet materialized and the high swap costs coupled with the rising price of debt greatly contributed to the effective shutdown of the market, with the ensuing profitability challenges contributing to reduced aircraft trading volumes. These challenges led to investors becoming bearish on the aviation sector as a whole, with the primary ABS market effectively shut and with ABS notes trading at a significant discount in the secondary market.

Tailwinds for Recovery: Market Conditions Foster Optimism

The tide appears to be shifting, spurred on by increasing demand for commercial air travel set against continued production bottlenecks and supply chain challenges, which have contributed to a slow-down in new aircraft deliveries. This low supply and high demand environment has driven an increase in aircraft values and lease rates. Airlines have been returning stored aircraft to service, extending leases and accepting higher lease rates. Due to this resurgence, and other factors detailed below, the recovery and growth of the commercial aviation ABS market is on the horizon.

In particular, several key factors suggest an increasingly favorable environment for commercial aviation ABS:

  • Air Travel Resurgence: As noted, the global air travel industry has now experienced a robust recovery. As passenger volumes surge and indeed, in Q1 2024, have now exceeded pre-pandemic levels for the first time, and as airlines return to profitability, the risk profile associated with aircraft assets has improved, enhancing their appeal to investors. Airlines this year are expected to sustain their operating profitability seen in 2023, with demand forecast to be around 3% above 2019 levels.
  • Technological Advancements in Aircraft as lessors and airlines continue to modernize their fleet: Newer aircraft models boast superior fuel efficiency and require less maintenance, leading to more predictable cash flows for ABS structures backed by aviation assets. This will help investors in these ABS structures, particularly at the equity level, with a keen focus on environmental standards and compliance. While there are currently no universally adopted standards, market practice and appropriate benchmarks will emerge as the market further develops.
  • Changing rates: One of the big hampering factors will be what happens to underlying rates this year. If, as many expect, interest rates drop, this would help coupons and yields to drop, which would likely entice more issuances. However, even with a modest decrease in rates, increased funding costs with higher interest rates are seemingly here to stay. Any new deal may need to have a mixture of old and new aircraft assets to help boost the cash flows, given this increased cost of debt. Lease rates have gradually been increasing since the end of the pandemic to match this wider economic environment, and diversified funding channels have helped make new sources of capital available, particularly thanks to private equity.
  • Evolving Structural and Regulatory Landscape: Regulatory bodies are proactively implementing measures to streamline the ABS issuance process, aiming to reduce the associated time and cost burdens for originators. Rating agencies have become more accommodating of portfolios with less diversity, subject to the underlying credits being suitably robust. However, while the senior notes have been resilient notwithstanding the recent macro turbulence, we expect to see structural changes around LTV ratios and amortization profiles. This could pave the way for a more efficient market characterized by increased deal flow. More broadly, it is predicted that further consolidation in the industry is likely this year.

A Cautious Re-entry: Prioritizing Quality and Sustainability

While any public ABS right now is seen by many as a step in the right direction for the aviation market, and the recent deals have certainly been a positive development, it is impossible to ignore the different fundamentals of the business jet market compared to commercial aviation. A full-blown return of the commercial aircraft lease ABS market is likely to be a gradual process as investors maintain a cautious approach, seeking out deals with robust credits and meticulously designed risk mitigation features. However, we anticipate that the aircraft lease ABS will remain an attractive product and the performance of these initial post-pandemic deals will be closely monitored, shaping investor sentiment for future issuances.

Reed Smith Aviation

The Reed Smith global aviation team is made up of over 40 aviation practitioners spread across our offices in the United States, Europe and Asia.

Reed Smith Aviation ABS Team Key Contacts

Singapore

  • Simon Spells – Aviation Finance
  • Manoj Purush – Aviation Corporate

London

  • Richard Hakes – Aviation Finance
  • Simon Hugo – Asset Backed Securitization

New York

  • Trish O’Donnell – Asset Backed Securitization
  • Han Deng – Aviation Finance

Chicago

  • Gerard Martin – Asset Backed Securitization