Since the fourth quarter of last year, ABS market participants have been predicting a “handful” of aircraft ABS to take off at the start of 2021. Running out of other means to fund themselves, aircraft lessors began talks with banks about pushing deals through the ABS pipeline as early as January. However, very few believed that issuers could get something done, given the grim prospects for the sector.
By October 2020, just one aircraft ABS deal, from Global Jet Capital, had been priced since the pandemic hit in March, but the deal was not considered a barometer for broader investor sentiment thanks to its unconventional portfolio mix. Even in January when Castlelake began marketing a deal, no one expected investor reception to be so exuberant.
But Castlelake Aircraft Securitization Trust 2021-1 was oversubscribed 11 to 12 times and exceeded initial pricing expectations. On January 20, the ‘A’ notes were priced with a coupon of 3.47% and the ‘B’ notes were priced with a coupon of 6.66%.
“The Castlelake outcome woke up a fair amount of issuers and investors and showed that the market is open,” said Greg Byrnes, CFO of specialist financier White Oak Aviation. “I’d be surprised if we don’t see at least five to 10 deals get priced in 2021.”
The transaction was “far more tilted” in favour of the investors and offered ample protection, which was a big selling point, sources who participated in the deal said.
Moreover, the collateral pool and the credits were high quality, consisting of young assets with long lease terms and high quality obligors, including the likes of Delta Airlines, said Evan Carruthers, Castlelake’s co-founder and chief information officer. The modifications gave investors the comfort to buy into the structure despite the pandemic, he added.
Castlelake hopes to execute at least one additional aircraft ABS over the course of 2021, the company told GlobalCapital.
“The Castlelake deal was surprising to me and many observers in the space and paves the way for one or two more commercial aircraft deals this half of the year,” said an executive at an aviation consulting firm. “My takeaway is that the strength of the ABS market overall has been a rising tide for most ABS deals, even esoteric ones.”
Global Jet Capital is following that deal with a refinancing, which began marketing on Tuesday.
Sluggish recovery
As much as sellers of ABS may be excited about unearthing such investor appetite, the credit metrics of the air travel industry still look grim. In the US, passenger traffic is nowhere near healthy levels. Europe is in a worse state, with strict lockdown measures in a number of countries preventing or discouraging travel.
Scheduled flights in the UK, for example, were 90.4% down year-on-year for the week of February 22, according to data from the Official Airline Guide (OAG), an international air travel data provider.
Several sources described the recovery of air travel as “gradual” at best, but the disconnect between ABS investor exuberance and the credit backdrop is odd, though not unreasonable, sources said.
Ever since vaccines injected hope into credit markets, ABS investors began turning their focus to aircraft as an attractive long-term recovery trade. No matter what current passenger traffic numbers show now, ABS investors are more focused on the long term.
The rollout of vaccines has dispelled a lot of uncertainty and set a more defined schedule for when a recovery may be complete — a timeframe of around two to three years.
“We are not expecting cash flows within aircraft ABS deals to return to pre-Covid levels in the next three to six months. We know it’s going to be a gradual recovery,” said Dan Kosinski, ABS and CLO sector manager for Medalist Partners. “But we are investing with the view that two to three years down the road we will see travel return, and aircraft ABS is a good way to play that recovery trade in the long term.”
For example, investors see upside in purchasing BB rated bonds trading at prices of 50-70 now rather than waiting to buy them when the timing of the recovery is more certain.
The upside in aircraft ABS offers was something “you just can’t find anywhere else”, a source said.
The securitization market has lagged equity and corporate credit in the recovery and, within ABS, aircraft has lagged even further behind, compared with asset classes such as data centres or marketplace loans.
“Investors have warmed to the space,” said Carruthers. “I think that has more to do with the fact that investment grade and high yield are trading at historical tights, so investors are rotating into sectors that still have relative incremental yield. We believe that investors have increased awareness of servicer performance — only the best servicers will get access — and will only accept higher quality pools and credits.”
A premium economy
Indeed, sources believe the ability to issue will be restricted to a small number of sponsors similar to Castlelake — those who have the capability and willingness to retain equity. Before Covid-19, the equity was sold to third parties in 60%-70% of aircraft ABS.
Although the primary market has sprung back to life, it is too early to expect demand for ‘E’ notes to recover as well.
“There are no signs at the minute of any deal being done that includes an equity tranche,” said an aircraft ABS issuer whose last deal was priced in 2019. “So what that means for us is it is still effectively a closed market from an issuance perspective because we have no mandate to retain the equity in the deals we sell.”
In fact, such issuers can get cheap financing elsewhere, including the secured or unsecured corporate credit markets.