Downgrades are expected to the credit ratings of airlines’ aircraft asset-backed securities (ABS) as they struggle to meet the challenges of COVID-19, according to leading aviation consultants IBA and Split Rock Aviation in a report today.
While senior tranches of aircraft ABS debt still hold an A rating for now, leading ratings agencies such as Standard and Poor’s and Fitch have them on a negative watch, and downgrades are expected.
Aircraft ABS servicers are already experiencing lease deferral requests from many or most of their lessees and are expecting to see significant non-payments in the coming months. Senior debt notes are expected to extend cash flows, and losses are likely in subordinate debt tranches, but formal defaults are not expected.
This is one of the many impacts of COVID-19 being felt by airlines and other aircraft investors, in an operating environment that has seen passenger operations shrink by 80% and IATA forecast that full year passenger revenues will drop by $252 billion compared to 2019.
Phil Seymour, President of IBA, says: “We expect COVID-19 to wipe one to two years of traffic growth off the previous airline industry forecasts. Despite unprecedented levels of government support, we believe the industry will not immediately bounce back when the effects of Coronavirus recede, and the looming downgrades to ABS and leasing company ratings are a clear indication of that.”
IBA forecast a sharp rise in aircraft lease ends throughout 2020 with lease end transactions outnumbering lease starts for the first time in 30 years. They forecast depressed aircraft trading activity overall with the exception of sale leasebacks which airlines will increase in an attempt to boost liquidity.
Clay Smith, Partner at Split Rock Aviation, says: “While the global airline industry is facing some of its darkest days, we believe that defaults on aircraft ABS are unlikely, it is very hard to default these structures. The current generation of ABS’s generally includes liquidity facilities that can cover up to nine months of payments before a default could be triggered.”
Aircraft lease rates and values are forecast to fall across all types throughout the remainder of 2020, with particular falls in older aircraft models which airlines may now seek to ground permanently in anticipation of a slow return in passenger demand.
This is set to drive a significant increase in premature/re-scheduled lease ends, and IBA and Split Rock are advising ABS investors to focus on the organisation and ability of aircraft owners and lessors to handle the additional workload from early returns, lease restructurings and remarketing. Key to this is their previous track record in managing economic cycles, aircraft transitions, negotiated lease restructurings and aircraft repossessions.
They are also encouraging investors to take an independent review of specific lessees and aircraft in each ABS portfolio, assessing exposure and risk individually, as each will vary.