Learning to Fly

Aviation sector appears on funds and advisors’ radar

By Laura Thompson (Laura@9fin.com)

This is an abridged version of an article published by 9fin on 12 February. For a copy of the original, with much more detail, and including data points, please contact sales@9fin.com

As the restructuring pipeline slows in the first quarter of 2021, attention has turned to the turbulence in the aircraft leasing market and their airline clients. It is a sector beleaguered by overcapacity and tumbling asset values, with 2019 traffic levels not expected until 2023 or 2024 “every airline” has the potential for restructuring, according to one aviation lawyer. 

Distressed debt traders are seeing increasing volumes of aviation debt flying across their desks. Several larger players such as AerCap and ALC retain access to issuance, but slots for smaller players are limited. Avation PLCs A&E transaction announcement, however, could provide a flight plan for others and remove the fear of flying.

Finding information and gaining an understanding of the market is frequently more trouble than it is worth. Aircraft values and lease rates are tightly guarded secrets in the aviation sector and have only become more obscure as the pandemic raged on. Not only did abrupt overcapacity tank rentals, but lessors have also been offering case-by-case rental relief since March 2020, making an easy approximation of an aircraft type’s value or lease rate even trickier. 

Deferred pain

Since March 2020, lessors have been generous with rent deferrals – a generosity that one airline restructuring source scorns as “kicking the can down the road”. Airlines are lobbying for more substantial aid, usually in the form of rental waivers with a lease extension as a carrot for leasing companies facing low demand for their jets. 

Power-by-the-hour (PBH) contracts, in which airlines only pay proportional to flight hours, also proliferated in 2020, with some large airline groups in restructuring (Lion Air Group, Aeromexico, Norwegian Air Shuttle) pushing these carrier-friendly arrangements through the courts. 

Meanwhile, lessor-to-lessor trading activity has all but dried up as carriers grapple with sudden excess capacity, largely only reaching out to lessors for sale-leasebacks to shore up liquidity. Alongside that, the airline credits underlying lessor ABS structures and the asset values locked into their LTV ratios continue to spiral. 

This is not to say that clouds are on the horizon for all lessors. Many of aircraft leasing’s biggest players have either easy access to the IG US capital markets (AerCap, ALC) or strong shareholder support (Aircastle, SMBC AC) to see them through. 

Crucially, governments around the world have splurged on support for their airlines, mitigating much of the damage that sector could have faced in 2020. State aid has now become the key watch aid for many airline’s viability. The proliferation of sale-leasebacks through 2020 and beyond will also help shift aircraft ownership towards lessors long-term.

Two lessors, however, have caught the distressed investor’s attention: regional giant Nordic Aviation Capital (NAC), who is expected to need further relief in April after a June 2020 debt standstill expires, and Fly Leasing, whose balance sheet is bloated by high levels of secured debt.

Nordic Aviation Capital forbearance round two

NAC, the world’s largest regional aircraft lessor and fifth largest lessor, is the name on everybody’s lips. It is expected to need further forbearance from lenders as deferred amortisation and interest payments come due from 15th April following last year’s standstill on $6bn of debt.

NAC has a high exposure to some of the most distressed aircraft assets whose rates have collapsed, meaning LTV ratios are elevated. With the entire fleet granted as security under the previous agreement, the aircraft lessor may need more substantive support from its sponsor EQT to keep creditors onside.

Ahead of an anticipated restructuring, NAC private placement bondholders recently appointed Houlihan Lokey and Akin Gump as advisors, with the company relying on previous advisors: Rothschild & Co, Clifford Chance and McCann Fitzgerald.

For more insight, our recent article on NAC is available here.

Fly Leasing debt at high altitude 

Another lessor on the long-term radar is Fly Leasing (Fly). Last month, the Irish Times reported that Fly had appointed Goldman Sachs to advise with a potential sale. The publicly-listed Irish lessor booked a $8.1 million loss in Q3 2020, having collected just 53% of pre-deferral contracted rents in Q3 – low compared to public peers ALC and AerCap, who collected around 80%. 

Most importantly, Fly has a relatively high level of secured debt – 70.8% of total debt as of Q3 2020 versus 33% (AerCap) and 2% (ALC) – which restricts cash flow from associated rentals. 

Good news for Fly is that 86% of its fleet by number and 67% by book value are A320 and 737 family aircraft, powerhouses of the sky that will not struggle to find operators or operations. Current generation is still enjoying a boon from the MAX grounding and A320neo delivery delays. 

However, its 86 aircraft fleet has an average age of 8.3-year and lease term is 4.9-years, which according to S&P compares less favourably to other lessors, which have 5-8 years and over six years, respectively. 

Avation gets more runway

The troubled Singapore-based leasing platform appears to have averted an emergency landing with an amend-and-extend agreement with unsecured bondholders lengthening its runway. In return, holders get a seat upgrade from additional guarantees and security, plus some mileage perks from warrants to equity. But while the Asian market has recovered faster, a number of notable customer failures have created turbulence for Avation, with aircraft prices and lease rates continuing to fall and leverage approaching double-digits.  

Aircraft leasing sources claim this lessor has been “limping” on for a while, dragged down by exposure to such floundering airlines as Garuda Indonesia and a rough fleet mix: nearly half the lessor’s aircraft are ATR 72s, which have been plagued by whole fleet retirements and overproduction.

On February 9, 2021 Avation announced an amend-and-extend agreement with bondholders representing 76% of its 6.5% unsecured notes due May 2021. Under the agreement the notes will be extended to October 31, 2026, with the 6.5% cash interest rate retained, with an additional 1.75% cash or at the Company’s option, an additional 2.5% PIK coupon. The bonds are callable at 103 until 18-months from completion, then at 106 until October 2024, stepping down to 104.5 until October 2025 and callable at par thereafter. 

The bonds will now sit behind $466.6m of secured debt amortisation and $263.4m of balloon payments in the maturity queue – with $284.7m due before June 2022.

The company said: “it expects to refinance or extend the balloon payments prior to maturity and has commenced discussions with financing providers who have been supportive in providing accommodation and relief thus far.”

Dash from Regions

NAC has a particularly high exposure to one of regional aviation’s most distressed assets: the De Havilland Canada Dash 8 Q400, whose largest operator, UK regional carrier Flybe, folded in February 2020. 

More generally, buyside sources describe regional aircraft leasing as a “niche within a niche” – and a niche that has been suffering. Regional airlines, enjoying markedly less state support than their international peers and being dropped by feeder carriers, have tumbled into bankruptcy and restructuring at disproportionate rates to long-haul carriers. 

Carriers including Ravn Air Group, Trans State Airlines, Compass Airlines and LWG shuttered up shop last year under the strain of the pandemic. Others, like Alaska’s Ravn Air Group and Ireland’s CityJet, muscled through the court system and have resumed operations.

Regional leasing sources say, thanks to the pandemic, access to bank funding has become more strained than their non-regional competitors profess. Despite expectations that regional traffic will return quicker than long-haul, banks are increasingly weary of signing on regional aircraft debt, with LTVs on loans funding aircraft acquisition now up around 80% versus 70% in 2019, some regional aircraft lessors say. The sector also missed out on a flood of Chinese investment that buoyed non-regional leasing in the years prior to the Covid-19 crisis.

Airlines: A year of emergency landings

Non-regional airlines have not, of course, escaped the pandemic’s grasp. Airlines, already a capital-intensive business skimming by on slim margins, have been some of Covid-19’s highest profile casualties. 

In 2020 alone we saw at least 32 airlines or airline groups either reach for restructuring or close up shop entirely. Just in 2021 so far, along with MAB, South Korean carrier Eastar Jet went into receivership after being ditched by potential purchaser Jeju Air, and long embattled Chinese leviathan HNA Group crumbled into restructuring, putting its golden goose, Hainan Airlines, on the table for investors.

This domino falling of airlines last year has, however, handed them a lot of power in negotiations with lessors. Always looking to avoid a grounded aircraft, “in many cases, lessors can’t push back too hard,” said one aviation lawyer. “The question is what the banks backing the lessors are willing to put up with.”

Aviation restructuring sources say upcoming debt maturities are less important in the current climate than operational costs. “For [signs of stress for] airlines, keep an eye out for employee disputes or unpaid fuel bills,” said one aviation lawyer. One such airline, Mexico’s Interjet, has been grounded multiple times in the past few months as it could not meet its fuel bills. 

Another clear warning sign, the aviation lawyer said, is court cases from leasing companies. During the pandemic, lessors have been particularly aggressive in attempting to reach agreements with trouble airline credits in their ABS portfolios, a second aviation lawyer said. 

ABS issues have typically been used as a way for leasing companies to shuffle undesirable aircraft (usually due to age) or lessees off their books. 

With fleet cuts a favourite of carriers in restructuring, investors should keep an eye on lessors with heavy exposure to airlines in the following tables: (list of airlines and their status is removed from the abridged version).

Aircraft: Controlled descent

The final layer in understanding a lessor’s credit is their fleet. Generally, the largest lessors will skew towards current-technology and new-technology narrowbody aircraft (aircraft with one aisle between the seats) and trade to keep their fleet at the age of a toddler. 

All aircraft values – expecting maybe freighters – have been hit by the pandemic, but some were in tailspin even before Covid, particularly four-engine jets and some regional jets. Excluding aircraft no longer in production or largely already awaiting their fates in the deserts, watch out for lessors with a lot of the following on their books: (distressed aircraft lists and valuations omitted in abridged version)