The resilience demonstrated by the commercial aviation sector to recover as strongly as it has from the impact of the Covid pandemic and subsequent market challenges has been remarkable. The pick-up in air traffic demand that began in 2021 has continued, albeit in a non-linear fashion. Figures from the International Air Transport Association (IATA) note that total traffic in October 2022 was almost 45% up on the same period in 2021 (and at 74% of pre-pandemic levels in 2019). That increase can largely be attributed to growth in international travel, which was more than 100% up on the same period in 2021. Whilst the strong demand for air travel continues, the industry continues to face a challenging mix of economic, geopolitical and environmental uncertainties.
From an aircraft leasing and financing perspective, despite such challenges, we have seen strong positive trends in transactional and investment activity in recent months. This is of course based on the fact that the fundamentals of the industry remain strong: leased aircraft are a tangible asset class with a contracted revenue stream and a disciplined (and currently constrained) supply. More than half of the world's commercial aircraft are owned or managed by aircraft leasing companies and in 2021, lessors took delivery of 60% of all orders from the OEMs. Today, more than $100 billion of the world's leased aircraft assets are leased out of Ireland.
As access to the traditional ABS market continues to be challenging given the chilling effect of rising interest rates on new issuances, airlines and lessors have been pursuing innovative financing solutions to manage upcoming debt maturities. As a result, we have seen an uptick in privately-placed deals in recent months. While private debt investors may be more expensive, private placements can be advantageous for issuers in a number of ways particularly in the context of the current market conditions. As private investors will often have an opportunity to carry out a closer level of due diligence on a portfolio, there can be greater flexibility to negotiate more bespoke terms and structures. Critically, the faster turnaround times involved in private placements where issuers are dealing with a smaller pool of investors can significantly reduce execution risk which can be of key importance given the current interest rate volatility.
A recent example which Walkers advised on is the US$303.7 million MAST 2022-1 and MAST 2022-1 USA privately placed ABS, backed by funds managed by Marathon Asset Management and serviced by Airborne Capital Limited. The portfolio comprises 15 commercial jet aircraft with 10 different lessees based in nine countries. The Walkers legal teams were led in Ireland by partner Killian McSharry with assistance from of counsel Caitlín Friel and associates Róisín O'Connor and Diana Pacheco; and in the Cayman Islands by partner Sarah Humpleby with assistance from associates Hannah Hawkins, Kulraj Badhesha and Alexandra Franklin. Led by Fiona de Lacy and Gennie Bigord, Walkers Professional Services, in both Ireland and Cayman, provided fiduciary and cash management services throughout the warehouse phase of the transaction and will continue to provide fiduciary services throughout the life of the ABS and Walkers Professional Services also acts as Managing Agent for the ABS. Walkers worked with Clifford Chance (London and New York) together with Vedder Price (Chicago), O'Melveny & Myers and Baker Botts (New York) on what has been an important transaction for the aviation sector which could lead the way on further private placement activity in 2023 in the absence of traditional ABS issuances.
Lease Rate Factors
The conference circuit in recent months has seen much discussion around the need for lease rate factors to rise in line with interest rates in order to attract investors back to the ABS market and bring activity back to pre-pandemic or even 2021 levels (the value of ABS deals is understood to be $1.1bn for 2022 compared to $9.2bn in 2021). Recent industry commentary suggests we might now be seeing some movement in this regard. Some lessors are noting that lease rates are moving upwards for both new and used aircraft in response to the undersupply of aircraft in the market, rising interest rates and the withdrawal of certain lessors from the market, particularly in Asia.
From an airline perspective, as interest rates rise they will have to be more careful about how capital is deployed. In a rising rate environment, capital costs will increase and borrowing capacity for some airlines will become more challenging, making aircraft ownership difficult. Accordingly, airlines may have to accept a situation where more experienced lessors take the upper hand in the negotiation of more lessor friendly lease yields and return conditions.
Notwithstanding this, for lessors, given usual lease tenures of eight to twelve years, the impact of the increasing lease yields will be reasonably limited in the short to medium term as typically only 15% to 20% of a lessor's fleet comes up for lease renewal annually. With lessors expected to be facing bond maturities totalling $15 billion in 2023 according to industry analysts, many will need to grapple with the challenge of reconciling the higher cost of their refinancing options backed by lower yielding historic leases. As we look forward to 2023, we are likely to see returns for lessors impacted as they need to use a combination of amendments and extensions of current financing arrangements at higher rates, bridge finance, alternative lenders and further private placement deals. This impact on returns may also drive further divestment of portfolios by lessors, in part or entirely.
Alternative Lending Solutions
As many of the mid-tier lessors and airlines have been unable to access bank funding to modernise their fleets and finance order books, aviation-focused alternative lenders and credit funds have become increasingly big players in the commercial aviation lending market. Lenders like Ashland Place, Muzinich, Castlelake and Volofin have been carving out a strong niche in the non-recourse lending market. These funds can be nimble and often more flexible in terms of financing older assets as they are not subject to the same regulatory requirements as traditional banks. While banks may be able to offer lower margins given their lower funding costs, this is not the whole picture. Looking at the overall structure of a deal, alternative lenders can often offer more compelling terms with more flexibility to offer larger balloon repayments than banks, thereby giving borrowers more cash flow during the term of the financing. These alternative lenders are currently providing fast and flexible capital financing solutions for lessors and providing much needed liquidity to the market. We have seen funds with large amounts of institutional capital they are keen to deploy on sizeable transactions, often competing directly with traditional aviation banks. The availability of such diversity of funding sources for lessors and airlines is to be welcomed and clearly demonstrates the confidence that investors have with respect to opportunities for real long-term value in the commercial aviation sector.
Investment Grade Lessors
Whilst traditional aviation lenders may have reduced appetite to lend at the mid-tier lessor level, it is certainly a different proposition at investment-grade level. Walkers recently advised Citigroup Global Markets Asia Limited and New Zealand Banking Group Limited as Joint Global Coordinators to a syndicate of Asia-Pacific, European and North American lenders in a US$1.7 billion five-year syndicated facility to SMBC Aviation Capital. The financing included a greenshoe option and comprised a $1,294 million term loan and a $431 million revolving credit facility which generated strong interest across the global banking market resulting in terms reflecting SMBC Aviation Capital's status as one of the highest rated, investment grade aircraft lessors. Six of the 13 banks which entered the transaction were providing financing to the company for the first time.
Additionally, in late November, Air Lease Corporation (ALC) announced the pricing of its public offering of $700.0 million aggregate principal amount of 5.85% senior unsecured medium-term notes due December 15, 2027 which was closely followed by the closing of a new $400.0 million unsecured term loan facility in December for ALC. Again these transactions clearly demonstrate the confidence within the global banking and capital markets with respect to the aviation sector.
Another significant aviation investment trend in recent years has been the increased number of large private equity firms establishing new aviation lending (as noted above) and leasing platforms, either alone or by way of strategic joint ventures with both experienced and newly established leasing and aircraft investment management companies. These new platforms are providing fast and flexible capital solutions to aviation sector borrowers and assembling large portfolios of aviation assets across all areas of aviation leasing, including passenger and freight aircraft, engines and helicopters availing of current distressed and impaired values in certain aspects of the market. The Walkers Global Asset Finance Group has advised on the establishment and financing of a significant number of award-winning joint ventures including the US$3 billion Gilead Aviation platform serviced by Aercap and the ST Engineering/Temasek cargo conversion platform (known as Juniper).
Aviation investment platforms are typically established using unregulated investment vehicles such as Irish trading companies or Section 110 companies as well as the tried and tested Cayman Islands incorporated Irish tax resident vehicle which combines the flexibility of Cayman corporate law with the benefits of the Irish tax regime. We have though seen an increasing interest in the use of Irish regulated fund structures such as an Irelands most popular investment fund the Irish Collective Investment Vehicle (ICAV) as aviation investment platforms.
An ICAV is a tax neutral investment vehicle regulated by the Central Bank of Ireland that can be used as the joint venture or holding company for the aircraft owning entities leasing the aircraft within the platform. An ICAV structure provides investors with a very tax efficient investment vehicle which is fully regulated under the AIFMD or UCITS regulations, making it very attractive from an investor protection perspective. As an Irish regulated fund, the Central Bank requires that an ICAV must have a majority of Irish residents on the board and its administrators and depository must also be located in Ireland which provides strong support to the Irish substance positon of the platform. Many private equity funds active in the aviation space will already commonly use ICAVs for other investment strategies, so using ICAVs to hold their aviation investments can be a very efficient and robust structure in which their clients are comfortable investing.
With the increased participation of private equity in the commercial aviation lending market, we are seeing greater interest in the securitisation of portfolios of aviation loans using collateralised loan obligations (CLO) technology. The emergence of aviation loan CLOs is a welcome development offering investors further ways to diversify their portfolios and providing private equity sponsors with an additional avenue to raise further funding or to finance an exit from their investment in order to distribute profits to their clients.
With the trajectory of air traffic demand and the prospect of the interest rate environment settling in the coming months, we expect increased levels of stability will return to the market. As a result, with greater levels of funding becoming available to lessors and airlines the industry can look forward to a continuing increase in new deal activity.
Walkers understand that appropriate structuring will be key and having market leading advisors to provide dedicated support for both the establishment and ongoing operation of a transaction will also be of critical importance. Our extensive experience together with our global network makes Walkers perfectly placed to provide the specialist teams required as the market recovery continues. For advice or further information, please reach out to any one of our experts listed below or your usual Walkers contact.
Walkers provides legal and professional services to the world's leading financial institutions and companies. With a global presence spanning the Americas, Europe, the Middle East and Asia we provide accessible advice on the jurisdictions of Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey, Ireland and Jersey.
Our cross-office multi-disciplinary asset finance legal team has advised on a number of award winning and first of their kind transactions including the Thunderbolt, JOL Air and AASET asset backed securitisations as well as the establishment of many new leasing platforms including PIMCO/GECAS JV, Dunas Capital, Lease Corporation International/SMFL and Stratos. The global team maintains deep relationships with leading market participants in this space, including financial institutions, lessors, fund managers, airlines and arrangers and can additionally provide Bermuda, BVI, Guernsey and Jersey law advice on a broad range of aircraft finance transactions.
Walkers Professional Services (WPS) has a dedicated asset finance director bench and professional services team located in primarily in Cayman, Dubai and Ireland allowing for full time zone coverage to Walkers' clients. Each director has been handpicked on the basis of their industry experience and background.
The fiduciary team consists of professionals with legal, accounting and tax backgrounds who have extensive knowledge of different financing and leasing structures. WPS' highly trained team works closely with Walkers' legal team and is well equipped and resourced to support clients throughout the life of a deal and to respond quickly to requests and transaction demands.
Leveraging the depth and experience of its accounting and transaction management team, WPS also provides managing agent services for ABS transactions, thereby ensuring a full service offering for an ABS transaction from Walkers.
Originally Published by Airline Economics Finance and Leasing Guide January 2023.
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