Aviation debt: Resilience, rates and the return of ABS

November 29, 2024

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Robust demand for aircraft and the retreat of banks from the aviation debt market are creating opportunities for alternative lenders and their investors, as Alok Wadhawan and Brian Lau explain.

Resilience and a robust aircraft financing environment have been defining features of the aviation sector in 2024. This is creating opportunities in aviation debt, but prudent selection and deal structuring remain essential for investors.

Demand for passenger and cargo services are at historically high levels, despite cost-of-living concerns. In fact, total passenger demand rose 7.1% year-on-year in September 2024, an all-time high for the month. That trend is expected to continue, with the latest data indicating a 7.4% year-on year rise in ticket sales during October and November.¹

Similarly, air cargo demand increased 9.4% year-on-year, the 14th consecutive month of growth.²

At a sector level, strong cargo and passenger demand have helped airlines continue to generate healthy profits in 2024,³ despite OEM (original equipment manufacturer) supply issues, cost pressures and capacity constraints. In our view, the industry is well-equipped to withstand financial stress due to extensive efforts to strengthen balance sheets after COVID-19.⁴

No let up in aircraft demand, despite backlogs

In terms of new aircraft supply, Boeing has a backlog worth US$511 billion, with over 5,400 commercial airplanes yet to be delivered.⁵  Airbus’ backlog, meanwhile, was almost 9,000 at the end of September.⁶ Recent delivery timelines for new airplanes have been unusually stretched due to supply chain issues, with Boeing delivering 291 aircraft in the first three quarters of 2024, while Airbus delivered 497, well short of gross order levels.⁷

This supply-demand imbalance could persist for several years, perhaps decades, meaning existing aircraft in service will continue to play a vital role in global fleets. This should help ensure the stability of both current market and residual aircraft values, a positive for senior aviation debt, where aircraft are included as collateral in many transactions to provide capital protection for investors.

Rise of alternative lenders

Another significant trend in 2024 has been the continued retreat of banks from aviation finance, driven by regulatory changes and capital constraints. This year has seen major lenders, including a German bank, either sell outright or substantially reduce their aviation lending books.⁸

This is presenting opportunities for alternative lenders. Our own aviation finance business saw a 20% increase in assets under management in Q3 alone, reflecting growing appetite for debt from non-bank lenders. This year, we have provided senior debt financing to international flag carriers and major airlines in the US, Europe and the Middle East, as well as to global lessors.

These deals are collateralised by modern, popular aircraft. The focus on covenants and capital protection — bolstered by the value of the aircraft itself — should offer additional comfort for investors. Due to less competition, lenders can also exert greater control over deal terms, structure and the underlying assets.

Even if rates continue to fall, we believe risk-adjusted returns on aviation debt will remain attractive due to the retreat of banks and stronger recovery rates compared to corporate bonds with similar ratings.⁹ Based on our experience and analysis of the market, credit spreads on individual transactions are 100-150 basis points wider than historical levels. Recent volatility in interest rates could also provide aviation debt investors with an opportunity to lock-in higher rates for longer-duration loans before the rate-cutting cycle continues.

Return of aviation ABS

Signs of a recovery in aviation asset-backed securities (ABS) has been another noteworthy development in 2024. The market had been largely dormant since COVID-19, compounded by geopolitical tensions and a sluggish global economic recovery, with a near-freeze in new issuance in 2022 and 2023. This year, six new ABS transactions have been issued, with coupons ranging from just over 5% on senior tranches to 7.5% on junior tranches.¹⁰

Nevertheless, a full recovery could take time. Historically, lessors used ABS as a mechanism to offload the most junior tranches, or “E” notes, which represent equity interest. However, investor appetite for lower-rated tranches is unclear. Issuance may also be impacted by what happens to interest rates after the new US administration takes office in January.

Consequently, we expect private markets will continue to provide the main source of financing for the sector over the medium term.

What next?

Looking ahead, robust demand for aircraft-related financing and the exit of banks could fuel opportunities for alternative lenders.

For investors, a disciplined approach, with a focus on loans to stable credits and high-quality aircraft as collateral, could provide a compelling opportunity.

 

References

1. The International Air Transport Association, ‘Passenger Demand Reaches September All-Time High,’ October 31, 2024
2. The International Air Transport Association, ‘‘September Saw 9.4% Growth for Air Cargo,’ October 31, 2024
3. Bureau of Transportation, ‘US Airlines gain $3.8 billion in second quarter 2024, a decrease from second quarter 2023,’ September 20, 2024
4. McKinsey & Company, ‘Aviation value chain: Strong recovery brings profitability into view,’ November 1, 2024
5. Boeing, ‘Third quarter results,’ October 23, 2024
6. Airbus, ‘Airbus reports Nine-Month 2024 results,’ October 30, 2024
7. Flightplan, ‘Airbus and Boeing Report September 2024 Commercial Aircraft Orders and Deliveries,’ October 21, 2024
8. NORD/LB, ‘NORD/LB decides to terminate aircraft financing,’ June 17, 2024
9. Kroll Bond Rating Agency, ‘EETC Resilience: Updated Historical Recoveries Through Pandemic and Beyond’, as of November 29, 2023. Most recent available data used.
10. Cirium Aviation Analytics, ‘The US Market Overview: Aircraft ABS,’ October 17, 2024

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of November 2024 and may change without notice.

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