Demand for narrow-body aircraft exceeds available supply
Outside of Asia, summer travel has seen a strong recovery and this has coincided with a surge in demand for narrow-body aircraft from airlines and rental companies. Many airlines and lessors have used the Covid-induced slowdown in travel as an opportunity to renew their fleets to favor newer, more fuel-efficient planes. 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 narrow-body aircraft. This supply constraint, coupled with an overall increase in interest rates, has already resulted in increased leasing rates (especially for narrow-body aircraft) and we expect this trend to continue.
Capital Markets – A Game of Waiting and Seeing
abs
Debt activity in capital markets has been quiet for most of 2022. Only two ABS deals have come to market since Russia invaded Ukraine on February 24e and with higher base rates (the US Federal Reserve has already raised rates by 225 basis points in 2022 and the European Central Bank raised rates for the first time since 2011) and spreads remaining high, lenders have hesitated to test the ABS market.
However, there are some signs that the ABS market could rebound. Many lessors were able to extend their warehouse maturities and also took advantage of other sources of funding (including an emerging private credit market) to weather the pandemic. However, these solutions were largely designed to be temporary and donors will have to seek new sources of funding. The increase in portfolio transactions and the desire of some lessors to load on the next-generation narrowbody aircraft (including via delayed deliveries from the 2020-2021 hot sale and leaseback market) may exacerbate the need for cash.
Many expect the ABS market to open if the next trade launches prices at sponsor-friendly rates. With the overall increase in financing costs, rates that perhaps six months ago seemed unsustainable may look more attractive to day-to-day lenders, and especially those who need to finance large portfolio acquisitions. ABS portfolios that reflect the recent rise in rental rates or that have been hedged against interest rate risk and that contain a mix of stable credits in “safe” jurisdictions will likely continue to attract investors sitting at the top of the cascade, but cascade investors may remain elusive.
ABS equity issuances are expected to largely delay debt issuances, further delaying the return of ABS as a disposal tool.
ETC
The EETC market was also quiet. Airlines (especially those based in the US) have been able to mount significant cash increases in 2020 and 2021. Combined with a recovery in domestic air traffic and a delay in new deliveries from OEMs (see below) , they had enough cash on hand for short-term expenses. That aside, there could be a rebound in the EETC market as early as Q4 2022. Many airlines expect their capital expenditures to increase in 2023, in part because OEMs eventually catch up delivery delays. (Any upcoming debt maturities will only increase the need for cash.) Airlines will no doubt seek the cheapest sources of financing available to fund these expenses, and as a result, we may see a continued emphasis on sale and leaseback transactions, as well as an increase in finance leases. The EETC market will remain attractive for rated airlines with large order books, particularly in the US and other tested jurisdictions.
More airline restructurings on the horizon?
Although the industry as a whole is convinced that traffic will only continue to grow in the long term, there is much debate about which airlines will be there to benefit. Rising fuel costs, rising borrowing costs, rising interest rates, inflationary pressures on wages, supplies and parts, continued lockdowns in Asia, and the slow resumption of international travel. are matters of concern. For non-US airlines in particular, rising fuel costs have been exacerbated by the growing strength of the US dollar, which is pushing costs even higher. Other expenses denominated in US dollars, such as debt service financing and aircraft rents, are easier to predict, but still contribute to the problem.
Tougher 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 reports on their climate-related risks (including financial impacts), 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 executive certification) in periodic reports and registration statements under under the Securities Act or the Exchange Act, and in connection with IPOs and merger proxies. Additionally, many of the requirements of the proposed rule would require companies to make forward-looking statements, as they would be required to project the risk of weather-related issues and, in some cases, estimate the impact of those issues in the short, medium and long term. . Crucially for the aviation industry, the proposed rule would require companies to report on progress toward publicly announced climate goals. It remains to be seen what effect this will have on the “Net Zero by 2050” commitments made by many US airlines and leasing companies.
The SEC has indicated that it hopes to issue a final rule by the end of this year, December 2022, but the effective date of the rule is uncertain. Disputes over the final rule are almost certain, and the courts have the power to prevent a rule from taking effect, either during a trial or following a successful challenge to a rule, which means that any disputes will likely cause a delay in implementation. Either way, companies should start thinking about how they are going to comply with climate disclosure rules now and there are many steps they can take to be better prepared for any potential requirements and liability. extra it will entail.
For more details on specific disclosure requirements and steps companies can take to engage with the SEC and prepare to comply with 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-businesses-need-to-do-now/.
