Covid-19 meant over a quarter of a trillion dollars in debt came into the airlines, and that’s not including the lessors that financed receivables, so another couple billion-plus from there, and that was just to get to the other side of the pandemic.

“Now compare that with just under $30 billion, and $50 billion free cash in the best year since the Wright brothers. It will take five years, at least, of the best year to delever back to where we were.”

Days later, Marathon Asset Management revealed an inaugural offering of secured notes collateralised by 15 narrowbody aircraft. The $303.7 million offering priced at 6.995% with a 61.1% loan-to-value ratio.

While such levels are hardly a surprise and reflect other transactions – Spirit Aero Systems issued a $900 million private offering at 9.375% in November – they are in stark contrast to those achieved in 2021. ALC issued its lowest coupon “ever and by far” attached to a $750 million unsecured note offering in January 2021, the lessor told Airfinance Journal at the time. The three-year deal priced at 0.70%.

A week earlier, Avolon issued a $1.5 billion unsecured bond. The $750 million five-year tranche priced at 2.125% with a 2.377% yield. The $750 million seven-year tranche priced at 2.75%. The yield was 2.946%.

Long Covid

The most recent update from Airfinance Journal’s The Lessor Analyst shows investment-grade lessors have $87 billion of unsecured bonds outstanding, of which $13 billion is scheduled for repayment in 2023. Non-investment-grade lessors will need to roll over a further $2 billion.

These refinancings will occur during a time of tighter capacity and with the US benchmark interest rate the highest it has been in 15 years. Also, markets expect the Federal Reserve to continue to raise rates in 2023, with the first hike set for February.

Airfinance Journal’s data indicates the average coupon per issuer of this maturing debt for investment grade lessors is between 2.50% and 5.00%. The overall average is 3.9%.

If the entire amount is refinanced at the same cost as ALC’s recent $700 million five-year bond, the additional interest cost per annum will be approximately $260 million. However, given the range of credit quality among the lessors, this cost would likely be higher.

This is important to note as most aircraft with lease agreements have fixed rentals, so lessors’ profitability and cash flow generation could be severely squeezed. Furthermore, long average lease terms are normally considered a positive but, in this context, are a negative as it delays the ability to increase rentals.

Conlon anticipates these bond maturities will result in higher spreads but from few sources. As such, opportunities are ripe for the LR Airfinance business.

There is a need for someone to step into that gap where the structured finance markets and ABS [asset-backed securitisation] deals have backed away. Also, we’ve seen commercial banks back away from the space given the reserve requirements they have to hold, and this compresses the returns they have,” says Conlon.

On the trading side, activity has stepped up, he notes. “We’re seeing many portfolios come to market,” he says. “And less now for a regular rebalancing of the portfolio.

There was a component of harvesting for gains, some exposure resetting and then recycling the capital for capital expenditure.

I think those priorities have flipped. It’s primarily a recycling of capital and less about exposure management and gain on sale. That’s just great if you can get it.”

High Ridge has no exposure issues as a start-up, allowing it to look “aggressively” at the “many opportunities” coming down the pipeline. Sources tell Airfinance Journal that the dearth of funding sources – stemming from dislocations in the ABS to fewer and more selective bank financings, some because of tighter ESG requirements – has not been seen since the financial crisis of 2007-08.

Given this retreat, will the lending side be the dominant business?

I don’t think we have a predisposed recipe. We can do both. It’s more about where the opportunities are,” says Conlon. “But I agree that debt opportunities are larger now than they used to be, although we surprisingly see a fair amount of lease opportunities.”

High Ridge’s LR Airfinance business enters the market as established entities, such as Castlelake, which recently partnered with insurance-backed platform ITASCA, step up their lending efforts.

It is certainly a space where we see attention coming in. We like our positioning and can go from investment grade to high yield. I think that’s a differentiator,” says Conlon. “We’re not trying to take yield capital and find investment-grade deals and then wedge it in there. The LR platform is a good mix of airline and investor clients.”

Following Russia’s invasion of Ukraine, certain lessors and banks, particularly those involved in ABS deals, noted a hesitation to take on additional Chinese exposure because of a similar situation potentially occurring in Taiwan. Even though China ended its stringent zero-Covid policy, the current rapid spread of Covid-19 in the country means it faces economic headwinds. The IMF indicates that China’s annual growth will likely be at or below global growth for the first time in 40 years. Still, High Ridge is open to business in the region.

People are a little gun-shy after Russia. Most didn’t see that coming, so people are now underwriting downside scenarios they probably wouldn’t have underwritten before. And then there is some decoupling with the West that’s certainly driving some attention,” he says. “There may be limited interest in the near term, but I’m an optimist. We’re thoughtful about the region, not necessarily cautious, and we’re looking at some opportunities now.”

He would not be drawn on details but says “bespoke opportunities” are under review as opposed to large portfolios.

Take the loan

Lessors financed more than 60% of all new aircraft deliveries since the beginning of 2020, based on Airfinance Journal’s data, and Conlon expects lessors to continue taking on a more significant financing role. He says this is “evolving” how aviation exposure is managed.

It’s increasingly complex for a single balance sheet to own multiple billions of dollars of aviation exposure efficiently. It’s possible, and we’ve seen it in the past, but it is pretty unique,” he says.

“It works best if you are a big industrial that generates a lot of cash, like GE, or an insurance company that generates a lot of investable cash, like AIG,” adds Conlon.

A managed money model makes better sense. “It is efficient for an experienced team to focus on originating and managing assets and team with someone who is very efficient at raising capital. That’s the natural progression of our space, and the market has been heading in this direction for some time,” he says.

Understanding this shift in management direction made PIMCO the right business partner, adds Conlon.

The difference between High Ridge and the others is that we are the platform owners. This is the first time PIMCO has invested in a platform. They have deals with GECAS, Gilead and Navigator, but this is truly a platform, and we can do multiple product strategies on both the lease and the debt sides.”

No doubt, scale has always been important for lessors, especially for raising capital efficiently. It has arguably become more so following the sale of the world’s largest leasing company to Aercap.

However, certain lessor leaders disagree.

In an interview with Airfinance Journal following Aercap’s takeover of GECAS, Firoz Tarapore, the DAE CEO, clarified that, while he thought the largest aviation merger was a “fantastic deal” for both parties, diseconomies of scale remained a worry.

There are some legitimate questions about whether our business has real diseconomies of scale. Only time will tell if 2,000-plus aircraft is too big to create the right economic returns for the capital they deploy or the risk they take by deploying capital,” he said.

Meanwhile, SMBC Aviation Capital’s CEO, Peter Barrett, said scale is essential “to get to investment-grade ratings” and the right cost of capital. “But do you need to be $50 billion or $30 billion? I think that brings some challenges before it brings some opportunity,” he added.

According to Conlon, High Ridge will aim for the double-digit mark.

Eventually, we need to be close to $10 [billion] to have some scale on a long-term basis, and I’m talking between debt and leases. That feels like the right neighbourhood,” he says. “But we don’t have to be there in 18 months. We have time.”

However, High Ridge could end up bigger.

I think it is fine to do so, but it is not necessary to reach $35 [billion] to be relevant,” he says. “And any company that is that size, it was a long road to get there.”

But High Ridge will not achieve scale through speculative orders.

To make that work [speculative purchase], you need three things: a price that you’re comfortable with to compensate for committing the capital on the forward risk; some view of scarcity and asset availability; and, finally, you need to have the product people want with the ability to adjust.

“Looking at that model now, our view is that we don’t see those three things lining up right now to justify the deployment of capital. We can certainly do a new orderbook, but I don’t see it as an investable thesis in today’s market,” says Conlon.