Director, Conor Blake draws on discussion from our recent aviation finance webinar to highlight that, despite evident distress in the aviation market, there is cause for optimism as it presents opportunities to realise value.
The aviation sector has been particularly hard-hit by the Covid-19 pandemic. The closing of borders and cessation of international travel during the lockdown have presented both airlines and aircraft lessors with a set of extremely challenging circumstances.
The initial flood of requests for rent deferrals by airlines was a sign of significant distress and yet only provided a short-term remedy, an attempt to gain some breathing space.
Some airlines haven't made it – notable businesses going into administration include Virgin Australia and Avianca. In addition, some airlines, such as Lufthansa, TAP and Korean Air, took huge state bailouts as well as payments to furloughed staff. Even American Airlines took US$5bn under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
Now leasing companies are examining the credit profiles of their airline customers, noting in particular those that have government support, are financially strong and retain the backing of institutional shareholders.
This was an area that was highlighted by Dominic Pearson, a Partner at Watson Farley & Williams, in our recent webinar titled 'A New Focus for Aviation Financing'. Pearson says that airlines can be broadly split into three categories: at the extremes are those that will go bankrupt, as against those that will survive after three-to-six months of rent deferrals.
For him, the most interesting are those that comprise a middle category who may lease their entire fleet, may not have significant cash reserves and may not be getting cash support from their government, but whose business case is really strong. "It is these airlines that lessors are going to be keen to help find ways to survive the crisis," he says.
The routes navigated by airlines attempting to survive and restructure naturally varies. Investors in Norwegian Air Shuttle backed a US $1.2bn debt-for-equity swap in order to enable the low-cost airline to unlock a state rescue. CityJet took an examinership (the Irish equivalent of Chapter 11 bankruptcy) in order to give time for a scheme of arrangement to be formulated with the airline's creditors, while Virgin Australia went into voluntary administration.
Joe O'Mara, Head of Aviation Finance, Tax Partner, KPMG Ireland, remains optimistic, arguing that airline demand for finance is going to stay strong. "They have taken on huge amounts of additional debt during this time of tension and their need for leasing companies is only going to increase."
Indeed, Marie O'Brien, a Partner at A&L Goodbody, confidently predicts that the current crisis will "inform lots of financing structures going forward". For example, while she doesn't believe asset-backed securities business will come back before the end of the year, she is confident it will return, albeit with some modifications.
Moreover, if B-notes are downgraded to below investment grade and there is a fire sale by pension funds and insurance companies, Pearson is hopeful the gap will be filled by a different type of investor coming into the market. "It might be much less risk averse, maybe a little bit more aggressive, seeking really good yields, getting its pound of flesh in terms of a healthy discount off those B-notes."
He even thinks it possible that in the future "you may see more C or D tranches as that type of investor sticks around".
Such is the extent of distress in the market that many lessors themselves may have to raise funds or restructure in order to survive the seismic events created by Covid-19.
Regarding restructuring, Waypoint, a helicopter leasing company that went into Chapter 11 bankruptcy, provides a "cautionary tale", says O'Mara. Unwinding that sort of structure was incredibly complicated, very costly and effectively eroded value for the senior secured debt that it was looking to enforce.
For this reason, Marie O'Brien states: "A scheme of arrangement is an alternative approach, albeit you need a lot more buy-in from your creditors."
O'Mara even expects to see some consolidation among aircraft lessors. "I absolutely see an accelerated timeline for M&A in this space... I think you'll see in Q4 a push around that consolidation."
Opportunities for private equity
All the distress in the aviation sector, among both airlines and lessors, certainly creates opportunity and O'Mara points out that different types of investors are looking at the space. "You have those that are comfortable in the asset class that are sensing there is value there now and then you're seeing investors that specialise in distressed investment."
This is opening doors for private equity firms with plenty of spare funds to invest both in airlines and leasing companies. In April, Delta announced it was raising $3bn against a mix of slots, gates and routes at a number of US and European airports, which was later raised to $5bn due to strong investor demand. JetBlue followed Delta's example and pledged slots as collateral on a $750 million loan (originally $500 million) to strengthen its balance sheet.
A sure sign of longer-term market confidence in the sector was the recent raise by lessor AerCap. It initially went to issue $500 million unsecured but eventually raised $1.25bn and demand was so strong that it was ten-times oversubscribed.
The lesson is clear: experienced, well-funded players will be able to leverage strong relationships to make the most of the opportunities presented by this industry change.
For his part, Dominic Pearson is confident that current concerns will abate relatively soon. "I think the industry, particularly on the finance and legal side, will continue to innovate... In ten years' time we will look back and wonder what we were all worrying about. We will see a recovery in the next one-to-two years, that is my prediction," he concludes.
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Originally published by Ocorian, July 2020
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