A Recovery in Aircraft ABS Appears To Be Taking Flight

We believe fundamentals in the aircraft industry are in the midst of a strong recovery. Global passenger demand increased dramatically over the past year as COVID-19 restrictions loosened and consumers satisfied their urge to travel. However, continued production bottlenecks have hampered new aircraft deliveries. The low supply and high demand for planes have driven a pickup in aircraft values and leasing income. Read on to learn why we think aircraft asset-backed securities (ABS)[i] are positioned to take flight.

A one-two punch from COVID-19 and the Russia-Ukraine war

From 2020 to 2022, the aircraft leasing industry faced an incredibly challenging environment from the successive blows of COVID travel restrictions and Russia’s invasion of Ukraine, which stranded more than 500 aircraft in Russia, 59 of which were held in aircraft ABS transactions.[ii]

Rating agencies have downgraded several aircraft ABS bonds since 2020 due to deteriorating asset performance caused by travel disruption and the Russian aircraft seizures. Investors became extremely bearish on fundamentals in the aircraft sector and ABS bonds traded at significant price discounts in the secondary market. Even in the primary market, demand dried up, with almost no new issuance following the Russian invasion. It’s not surprising that many investors remain scarred by two consecutive hits to the aircraft leasing industry. As a result, we think investors have been slow to embrace the fundamental improvements in the aviation sector, which is reflected in continued wide spreads in seasoned ABS bonds.

Liftoff in air travel demand

The chart below illustrates how quickly global air traffic has bounced back, evidence that the pandemic did not cause long-term damage to air travel demand. With COVID travel restrictions lifted, worldwide passenger traffic in March 2023 increased by 52.4% year over year and is on track to return to pre-COVID levels by the end of 2023.[iii] To meet growing travel demand, airlines are returning previously stored planes back into service, extending terms of existing aircraft leases and paying higher rates for new leases. We expect these factors to help boost collateral performance of aircraft ABS.

Capacity still grounded

While aircraft demand has been increasing, the supply of new engines and planes remains constrained. During the height of the pandemic in 2020, original equipment manufacturers (OEMs) and their suppliers reduced production and furloughed employees. As fears of the virus subsided, aircraft demand ramped back up but supply did not. Staffing shortages, regulatory scrutiny and engine related issues caused supply chain issues that resulted in far fewer aircraft deliveries than the OEMs had planned. Though OEMs are working to improve capacity and increase production, we expect delivery delays to persist for years beyond 2023. With a shortage of new aircraft and engines for purchase, airlines have increased demand for leased aircraft and are willing to pay higher lease rates, which we view as a positive tailwind for aircraft ABS collateral.

Resilience and potential opportunity in aircraft ABS

We expect aircraft ABS collateral to benefit from the positive demand and supply technicals in the aircraft leasing space, which will likely continue over the next three to five years. While aircraft ABS are exposed to geopolitical conflicts, volatile oil prices, airline defaults and other idiosyncratic risks, senior bonds have shown resilience through the one-two punch of COVID and the Russia-Ukraine war. We think aircraft ABS deals issued before the pandemic offer the best relative value given their lower dollar prices and potential upside from plane dispositions,[iv] deal redemptions and insurance claim recoveries on confiscated Russian aircraft. Given the complexity of aircraft ABS, a careful analysis of deal collateral, structures, and servicers is warranted. That said, we think aircraft ABS can offer potential opportunity for investors with expertise in the sector.

WRITTEN BY:

Vinnie Zhang, CFA, Senior Research Analyst

David Rittner, CFA, Investment Strategist

[i] Aircraft ABS are bonds backed by aircraft on lease to a diversified pool of global airlines.

[ii] Source: Deutsche Bank Aviation Debt Research.

[iii] Source: International Air Transport Association (IATA). (https://www.iata.org/en/pressroom/2023-releases/2023-05-04-01/)

[iv] Plane disposition means any sale, transfer or other disposition of any aircraft (or an interest therein.

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Market conditions are extremely fluid and change frequently