PE funds and new lessors help drive recent aircraft trading

Lessors state that a wave of capital from new and existing investors is driving down margins, particularly for sale/leasebacks, but has also helped resuscitate the trading of leased aircraft. Private equity firms, and a variety of specialist funds and money managers, have been notably active in the aircraft leasing and financing sector since the onset of the pandemic.

This month, KKR invested a further $40 million in preferred equity in Jet Edge International, a private jet charter business. The investment manager partnered with asset manager Altavair in 2019 and more recently was behind the launch of specialist aircraft lender Av Airfinance in June. Griffin Global Asset Management (Griffin) is another example of a recent PE-backed aircraft lessor. Griffin’s founder and CEO, Ryan McKenna, partnered with Bain Capital to launch the platform in January 2020. This month the firm announced an order for five new 737 MAX 8s. Speaking with Ishka in January, McKenna stressed Griffin’s flexibility and willingness to invest in a wide range of aircraft leasing and financing opportunities.

The management teams of Ares Private Equity Group and Vmo pulled together $500 million in initial equity capital when launching Vmo Aircraft Leasing in January 2021. The two entities have been an active investor in distressed and restructured aircraft debt (including Norwegian’s 2016-1 EETC and LATAM’s 2015-1 EETC) and have been hiring several senior leasing executives -including most recently Marilyn Gan as its head of Asia-Pacific. Ishka notes several aircraft finance and leasing funds established before 2020 have also ramped up aircraft bidding activity after investors approached them with new mandates.

“There’s no secret. In an ultra-low interest environment, PE funds have been seeking to deploy capital to help boost returns and aircraft leasing has offered an interesting opportunity, especially during disrupted market conditions. We have seen several funds that had previously invested as seed capital for leasing platforms, that then exited that business, and have now come back to the space,” explains, Jim Bell, London Partner and Global Aviation Sector co-head at Watson Farley & Williams.

“PE funds cover a wide range of investors; all of whom have different ambitions and exit strategies for these new aviation investments and platforms. They are also extremely open in their approach and will offer both operating leasing and financing to meet their customer’s needs. What has probably taken some lessors by surprise during 2021 is just how robust investor appetite has been for the sector,” he adds.

 

The interest in recent lessor portfolio trades

 

There may be more competition from funds and asset managers, but it is generally channelled towards specific types of deals and airline credits, confides one lessor. Many funds are favouring the sale/leaseback market to acquire new aircraft on long leases where returns have become “incredibly skinny”, confides one exasperated lessor. Other funds have been bidding aggressively on portfolios of leased aircraft. April and May this year saw a flurry of leased portfolios hit the market (see Insights: ‘Trading update: Bocomm reviews off-shore portfolio bids, Castlelake sells Delta 737s’ and ‘Trading update: Avolon signs LOIs for 12 aircraft, GECAS returns with revised portfolio’). Sources indicate the resumption of the ABS market in 2021 helped both inform the types of portfolios being offered as well as boost investor confidence in acquiring assets.

“A lot of this is being driven by US-based funds with access to cheap debt. We saw a lot of people swarm to these portfolios which were almost being assembled for this new group of buyers who tended to have quite strict mandates. They need good long-term leases and good credits. They’re kind of agnostic as to whether this is current-gen or new-gen. They just need to get products. It's a bit of use it or lose it mentality for some,” explained one European lessor earlier in the summer.

He estimated that many US funds were probably able to obtain sub-5% debt in the first half of the year and that many funds have a 6% or 7% equity return hurdle on average. “So people are kind of getting all in return of 6% or 7% and that's before they charge the fees to the platforms. I'm also aware of some funds out there promising a 15% average return on good quality midlife [aircraft] deals or on current-gen deals, which we know is not possible if you're going to actually win the deals unless you're dealing with naked aircraft, or dealing with tricky credits, or being super aggressive on your residuals, which I think is what might be happening. The recent portfolios we see now with strong credits and younger assets are probably generating single-digit unlevered returns of between 3%-6% but that’s based on our underwriting.”

“What we are not seeing is many funds acquiring any naked aircraft or single engines – often because their equity or debt mandates preclude them from placing those aircraft in those vehicles. Those funds that have bought naked aircraft have had to deploy equity because debt for naked aircraft is still nearly impossible to obtain,” he adds.

 

Permanent vs transitory capital
 

At first glance, private equity might seem an odd choice for aircraft leasing and financing, given the propensity for PE to seek to maximise returns over relatively short-term horizons compared to insurance or pensions funds. Most new aircraft leases and loans have historically been around 10 to 12 years.

But several private equity firms have invested and built leasing platforms that are now permanent fixtures within the aviation finance and leasing landscape, such as Avolon and Elix. Castlelake is a PE investor that has built an aircraft asset management and leasing business. Evan Carruthers, Castlelake’s chief investment officer and co-founder, explains that the distress caused by the Covid-19 crisis to the aviation sector has attracted PE and alternative capital to niche asset classes like aircraft leasing where they sense outsized returns are achievable. Many aircraft investments that were “arguably priced to perfection” before the crisis have been forced to reprice, explains Carruthers. But the risk for transitory capital is that it is very difficult to time the market to ensure outsized returns. Unexpected events such as 9/11 or Covid, or the global financial crisis, inevitably impact investor returns, he adds. To counter that, a longer-term view of the market helps manage these unexpected events.

“Our philosophy is you need to be an ingrained, embedded participant in the space with a large infrastructure that allows you to navigate the risks in the industry. Jumping in and jumping out with a passive investing approach… we don't think that works long-term. I think that the graveyard is full of private equity-funded aircraft leasing businesses that got their timing wrong, or perhaps didn't have the appropriate infrastructure required to work their way through a crisis,” explains Carruthers. 

While several PE funds have been actively investing in the leasing platforms themselves or developing a platform from scratch, many are still investing in aircraft directly via dedicated third-party asset managers. In January, Kennedy Lewis Investment Management, a credit manager, agreed to put forward $500 million in equity investment to create a new $1.5-billion aircraft leasing platform, KLA Aviation Finance (KLA), alongside Arena Aviation Capital, an established aircraft asset manager. KLA’s initial focus will be to acquire young and new leased narrowbody aircraft.

Speaking with Ishka, Arena CEO Patrick den Elzen states that the benefit of having multiple investors has been the freedom to source aircraft opportunities. “There are certain PE funds that have invested in aircraft where the teams that are working for those PE funds saw big opportunities last year. Some were able to respond while others were not because within that PE firm senior management were not interested in making a hard asset investment, they were interested in investing in EETCs or ABS paper or real estate or something completely different. So, you have a beautiful team, you see wonderful opportunities, but you just don't get the mandate from your senior management to act on it, whereas we were completely free and could find that particular pocket of capital that was ready and able to move.”

The Ishka View
 

Aircraft leasing returns have notably compressed in 2021 as more investors and capital continue to chase a relatively small number of deals. Ishka’s regular series on sale/leasebacks has been tracking how quickly lease rate factors have dropped in the space of 12 months.  It is also hard to predict how sticky some of the capital currently available might be for aircraft leasing if returns continue to drop.

However, several new PE-backed aircraft leasing funds and asset managers are likely to become a permanent fixture in the aviation finance landscape, especially for investors looking for longer-dated returns. Several funds are still looking for shorter-term distressed opportunities. More lessors may be forced to take impairments on aircraft or seek a solution for aircraft coming out of formal and informal restructurings. Investors speaking to Ishka have been surprised, however, by the relatively limited amount of distress in the space to date. Some predict that more leasing platforms could come under stress as they balance the need to service debt with reduced lessee revenues, others are unsure, and question how much further distress there will be in the sector. 

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