Demand for Narrowbody Aircraft Exceeds the Available Supply
Outside of Asia, summer travel has seen a large recovery and this has coincided with a large uptick in demand for narrowbody aircraft by both airlines and lessors. Many airlines and lessors used the Covid-induced travel downturn as an opportunity to turnover their fleets to favor newer, more fuel-efficient aircraft. Delivery delays from Airbus and Boeing have meant that this process has not always gone to plan and many commentators believe there is a looming shortage of narrowbody aircraft. This supply constraint, along with an overall increase in interest rates, has already led to an increase in lease rates (especially for narrowbody aircraft) and we expect that this trend will continue.
Capital Markets – A Game of Wait and See
ABS
Capital markets debt activity has been quiet for the majority of 2022. Only two ABS deals have gone to market since Russia invaded Ukraine on February 24th and with higher base rates (the U.S. Federal Reserve has already raised rates by 225 bps in 2022 and the European Central Bank raised rates for the first time since 2011) and spreads remaining high, lessors have been hesitant to test the ABS market.
However there are signs that the ABS market could be rebounding. Many lessors were able to extend the maturities on their warehouses and also took advantage of other financing sources (including an emerging private credit market) to weather the pandemic. Those solutions were largely designed to be temporary though, and lessors will need to look for new sources of financing. The increase in portfolio trading and the desire of some lessors to load-up on next gen narrowbody aircraft (including via delayed deliveries from the hot 2020-2021 sale and leaseback market) may exacerbate the need for cash on hand.
Many expect that the ABS market will open up if the next transaction to launch prices at rates favorable to sponsors. With financing costs increasing overall, rates that six months ago may have seemed unpalatable may be looking more attractive to lessors by the day, and in particular to those who need to finance large portfolio acquisitions. ABS portfolios that reflect the recent rise in lease rates, or were hedged against interest rate risk, and contain a mix of stable credits in “safe” jurisdictions will likely still appeal to investors sitting at the top of the waterfall, but down waterfall investors may remain elusive.
ABS equity issuances are largely expected to lag debt issuances, further delaying the return of the ABS as a disposition tool.
EETC
The EETC market has also been quiet. Airlines (especially those based in the United States) were able to mount large liquidity raises in 2020 and 2021. Combined with a recovery in domestic air traffic and a delay in new deliveries from the OEMs (see below), they have had sufficient cash on hand for short-term expenditures. That aside, there may be a bounce back in the EETC market as early as Q4 2022. Many airlines expect their capital expenditures to rise in 2023, in part because the OEMs will eventually catchup on their delivery schedules. (Any upcoming debt maturities will only increase the need to have cash on hand.) Airlines will undoubtedly search for the cheapest available sources of financing to fund these outlays, and as a result we may see a continued emphasis on sale and leaseback transactions, as well as an uptick in finance leases. The EETC market will remain attractive to rated airlines with large orderbooks, particularly in the US and other tested jurisdictions.
Additional Airline Restructurings on the Horizon?
While there’s industry-wide confidence that traffic will only continue to grow long term, which airlines will be around to benefit from that is a subject of much debate. Increased fuel costs, higher costs of borrowing, increased interest rates, inflationary pressures on wages, supplies and parts, continuing lockdowns in Asia and the slow recovery of business travel are all cause for concern. For non-US airlines in particular, rising fuel costs have been exacerbated by the increasing strength of the US dollar, which further drives up costs. Other US dollar‑denominated expenses such as financing debt service and aircraft rents are easier to predict but still contribute to the problem.
Stricter Regulatory Environment on the Horizon – Changes to SEC Disclosure Rules on Climate Impact
On March 21, 2022, the United States Securities and Exchange Commission (the “SEC”) proposed new rules that, if adopted, would require public companies to provide detailed reporting of their climate-related risks (including financial impacts), related governance and strategy, emissions, and net-zero transition plans (the “Proposed Rule”).
The Proposed Rule would apply to U.S. public companies as well as foreign private issuers (as defined by the SEC), and would require disclosures (often subject to officer certification) in periodic reports and Securities Act or Exchange Act registration statements, as well as in connection with initial public offerings and merger proxies. Additionally, many of the requirements of the Proposed Rule would entail companies making forward-looking statements as they would be required to project the risk of climate issues, and in some instances estimate the impact of those issues over the short, medium, and long term. Crucially for the aviation industry, the Proposed Rule would require companies to report on progress towards publicly announced climate goals. What effect this will have on the “Net Zero by 2050” commitments made by numerous US airlines and leasing companies remains to be seen.
The SEC has indicated that it hopes to release a final rule by the end of this year, December 2022, however when the rule would go into effect is uncertain. Litigation over the final rule is all but certain and courts have the power to stop a rule from going into effect, either during a lawsuit, or following a successful challenge to a rule, meaning that any litigation will likely cause a delay in implementation. Regardless, companies should begin to consider how they will comply with climate disclosure rules now and there are numerous steps that they can take to be better prepared for any eventual requirement and the additional liability it will bring.
For more detail on the specific disclosure requirements and steps that companies can take to engage with the SEC and prepare to comply with the climate disclosure rules when they are finalized, please see https://www.velaw.com/insights/proposed-sec-climate-disclosures-an-overview-of-the-proposed-rule-and-what-companies-need-to-do-now/.
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