Why new aircraft ABS deals will be 'very different' in 2021

Ishka hears rumours that at least one new aircraft ABS portfolio is being assembled for a potential Q1 2021 issuance, but aircraft ABS servicers and financiers warn new aircraft ABS deals will need to "evolve" to ensure investor support in 2021. 

One financier believes a new deal could occur as quickly as January or February 2021, while other sources familiar with the ABS market believe that the market is more likely to open in the first half of 2021. The consensus among sources is that it is not a question of if the aircraft ABS market will come back but when.

The aircraft ABS market has seen just one successful issuance since March for a securitisation backed by business aircraft, BJETS 2020-1, as the commercial aircraft ABS market has been effectively shut down since the Covid-19 pandemic erupted in Europe and the US. 

Existing aircraft ABS deals have been hit by declining cash flows and delinquent or deferred lease payments since the onset of the crisis, which has badly affected many of the junior and equity notes across many transactions. Between them, ratings agencies Kroll, S&P and Fitch downgraded the vast majority of notes and securities across the 48 transactions that constitute the aircraft ABS universe. By mid-August, Kroll highlighted that 35 transactions (63% of the aircraft ABS transactions rated by Kroll) had breached debt service coverage ratio (DSCR) triggers, causing rapid amortisation events (RAE). However, no aircraft ABS notes defaulted as a result of the crisis and the possibility of a deal defaulting remains remote due to the range of structural credit protections inherent in most aircraft ABS deals issued in the last five years (see Insight: 'How do Aircraft ABS structures perform if cash flows are reduced due to Covid-19?').

Evan Carruthers, a co-founder of Castlelake and one of the largest issuers and servicers for aircraft ABS, believes that, despite the "heightened sensitivity" around deploying capital in aviation, the aircraft ABS markets will ultimately open up and that it will be higher spreads will draw investors back to the space.

"What is likely to open the market up is a need for yield. The impact of investment-grade yields being back to basically historic tights should not be underestimated. We believe that for a lot of fixed-income buyers, the need for yield typically will lead to a lot of the esoteric ABS markets opening up," he argues.  
 

How new aircraft ABS may evolve: Lower LTVS, younger aircraft, and stronger airline credits

Carruthers, and other sources, believe that when the ABS market does open up it will be "in a very different way" compared to 2018 and 2019 with a focus on stronger airlines credits, lower LTVs, with a focus on just senior A and B debt tranches/notes and only open to certain servicers. This will be the case for at least the next six months.

"When it does open again, I think that there's going to be heightened sensitivity around the underlying servicers. There were a lot of subscale servicers that got ABS financing in 2018 and 2019 that I don't believe are going to have access to the market because there's an awareness around the risks associated with aircraft leasing and the infrastructure needed to manage through the COVID crisis," confirms Caruthers.

Crucially, sources argue that deals will need to have a lower leverage to reflect the greater risk now inherent across commercial aviation. In practice, sources speculate this might mean LTVs for A notes could drop to 60% or below to account for the higher default risk for airlines as revenues remain weak.  "If you look at the rating agencies and why they've downgraded everything one of the largest drivers is really the underlying airlines have all been downgraded, or most of them have. And so, when they run their stress models, they're running a higher incident of default and unless you're somehow mitigating that with a much higher lease payment, you just have to lower the leverage. It's a pretty simple starting point and it's going to be one of the more substantial differences," explains one financier.

The underlying collateral for new aircraft ABS is also expected be younger. One financier warns that investors will be less willing to buy "storied assets" – i.e. out of production or older assets that are likely to be less liquid and which will be harder to remarket in the event of a default. In theory, there is likely to be more of an emphasis on young new-technology single-aisle and twin-aisle aircraft. 

In addition, new aircraft ABS portfolios will need to include a better array of underlying credits who are seen as "proven payers", according to a separate source familiar with the market. 

"There's also going to be heightened awareness around the collateral pools and the credits," states Caruthers. "And I would say that the way that these deals got rated and the way that people thought about risk in 2018 and 2019 was to focus on lease term and diversification, but there was less emphasis around credit quality. Today there's more awareness around credit quality because everyone's looking at the market and saying: who are the survivors and who's going to fail?"
 

A and B notes and shorter DSCR triggers

New aircraft ABS deals are likely to only include A and B notes, explain financiers, as investors are less likely to chase C and E-notes. "The world of getting a C tranche done on an ABS or selling equity is gone for the foreseeable future," adds Caruthers. "Looking back, I think that market was dominated by people who were looking to sell pools of collateral into the market. They were looking to place A, B and C tranche debt, but they were also looking to sell equity to a third party." One banker agrees adding: "C notes I think are off the table now. I think it was just treated as equity. So, the real question boils down to that class B, and if can you find a class B buyer for that subordinated risk at a reasonable level right now."

But assessing where B notes might price is likely to be quite tricky. While pricing on the senior A notes for many aircraft ABS "snapped back" to around 90 cents on the dollar in the secondary market in September and October, pricing on the B notes in the secondary market has been more mixed, with several B notes currently trading in the 70s and 80s in November (see Insight: 'Ishka World Tour: Pricing on aircraft ABS A notes 'snap back''). . Taking that as a pricing guide for new deals would translate into double-digit yields for class B notes which would ultimately frustrate the economics of the deal for many potential issuers, who would likely need B to print at a few points higher than the A notes.

New aircraft ABS deals may need to include several structural changes to accommodate some of the challenges thrown at the structures by pressures emanating from the Covid crisis. One of the more likely changes is adapting the DSCR triggers from six to three months to make them more reactive to any disruption to expected cash flows. This has been particularly relevant in the current crisis where cash flows have been disrupted because of deferred rent agreements or due to an airline restructuring.

"There are no real mechanisms other than a lagging DSCR for rent deferrals," explains one financier. "If there's a non-agreed deferral, there's been pretty limited ability for the deals to react." Another source agrees and adds that shorter DSCR triggers will also help deals recover more quickly to escape rapid amortisation event when cash collections have improved. Ishka is aware of several deals that are still in rapid amortisation despite underlying rental collections improving.

The Ishka View
 

Investor confidence has been improving generally across aviation, thanks partly to the recent news on several Covid vaccines (See Insight:' Vaccine news help secured debt margins tighten for 'blue chip' airlines'). This bodes well for new aircraft ABS deals that may be waiting to enter into the market or for servicers thinking to refinance some of their older deals. Sources think that it will take some time for equity appetite to recover for new aircraft ABS deals. The most optimistic predictions speculating that some equity investors could return in the second half of 2021 while others wonder if equity will return at all in 2021 given the relatively small size of potential investors, many of whom will have issues around their existing exposure.

Some ABS servicers have been very actively acquiring aircraft during the crisis.  Ishka is aware that Castlelake has acquired over 40 aircraft in the last five months, including agreeing large sale/leasebacks with Delta. However, while there is certainly more confidence among the most senior noteholders for ABS debt, it will be interesting to see how aircraft ABS B notes continue to trade.

Aircraft ABS deals have seen a steady climb in rent collections since the summer (see Insight: Ishka World Tour: Pricing on aircraft ABS A notes 'snap back'). Leasing sources say that a rise of end of lease payments, as some leased aircraft see leases expire, may have helped the recent cash flow of some aircraft securitisations. If rental collections continue to hold steady or even improve, it will help servicers pitch investors for a new batch of aircraft ABS deals that could be coming in 2021.

 

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