Staying flexible enough to keep private ABS on the table
The benefits of private deals are becoming clearer as public ABS deals have been coming into the primary market up to 20 times oversubscribed over the past few months, a result of elevated demand from yield-hungry investors.
Demand has already started spilling over into private deals too, resulting in tighter spreads.
However, we still see three clear benefits in the private ABS market:
- Investors can more carefully structure security and collateral packages and facilitate private credit ratings
- Currently, credit spreads are still meaningfully wider than public deals of equivalent credit quality
- Investors can secure more sizeable allocations within deals
Furthermore, certain sectors that struggled at the start of the pandemic, such as aircraft deals, are re-emerging as potentially compelling recovery stories.
Aircraft ABS—a 2021 recovery story
Aviation was one of the most distressed sectors at the height of lockdown and border closures, but the primary aircraft ABS market has reopened strongly amid the resurgent economy.
New and improved structural protections
New aircraft deals issued since the start of the pandemic have better structural protections, reminiscent of how structures became more investor-friendly following the 2008 crisis.
New issuance now tends to include:
- three-month debt service coverage ratio triggers, versus the traditional six months in ‘legacy’ transactions
- minimum utilization triggers
- liquidity facilities
- higher quality underlying lessees
- greater exposure to North America (where domestic travel has recovered particularly strongly)
- longer-term leases
- newer aircraft models as collateral
Structural protections potentially make up for narrower spreads
As recent primary aircraft deals have been met with heavy demand, pricing has been at tighter spreads than legacy deals. For example, we have observed newer senior tranches trade in between ~140bp to ~160bp above swaps and subordinate tranches trade in the mid 200bps above swaps, versus +300bp to +350bp for legacy aircraft deals pre-COVID.
Nonetheless, on balance we still see new aircraft deals as more attractive than the legacy deals. Within legacy deals, investors are not provided clear insights into ongoing deferrals, modifications, extension or sales. We also expect relatively heavy secondary market aircraft supply later this year and early next year as operators and lessors attempt to streamline their fleets. As a result, valuations for certain aircraft types (that legacy deals are generally more exposed to) will potentially come under pressure.
Playing an uneven recovery in aircraft structures
Private deals: wider spreads and targeted exposure
Investors able to consider private aircraft deals can potentially benefit from a ~45bp to 50bp spread pick-up relative to public deals, depending on the sector, structure or collateral (Figure 1).
Table 1: Public and private aircraft ABS deals issued in Q2 compared1
|Public aircraft ABS deal||Private aircraft ABS deal|
|WAL||5 years||5 years|
|Current market spread||140bp||185bp|
Investors can also more easily target exposure. For example, we are seeing several private single operator deals, versus the traditional aircraft ABS structure with multiple underlying lessees.
Geography is key: reopening trajectories will vary
Global reopening efforts will be non-uniform and may even be volatile as countries and regions continue to move in and out of lockdown.
In the US, the vaccination drive has allowed domestic flights to resume with particularly high demand. Canada’s vaccination drive started slowly but the nation now has the highest vaccination rate of major economies, indicating a path to reopening. China has also seen domestic travel resume.
However, countries such as Brazil and India have been the global epicenter of cases in recent months. Other Asian economies, and even Australia, have recently had to enforce greater restrictions, indicating a slower return of travel within these regions.
Europe has seen mixed fortunes. Vaccinations have been strong in the UK and are accelerating in countries such as France, Germany and Spain, indicating a measure of ‘catch up’ with the US and China over the second half of the year. However, the spread of the ‘Delta variant’ indicates a cautious trajectory of border reopenings.
Collateral matters: be cautious on older and wide-body aircraft
Newer aircraft are potentially more attractive as collateral and are materially outperforming mid or late-life aircraft from a valuation perspective.
Newer aircraft are more operationally efficient, making for lower maintenance costs, which has become particularly important to operators as rising oil prices have pushed up fuel costs.
Narrow-body aircraft have also outperformed widebody collateral, as the former tends to be used for domestic travel and the latter for international flights. Certain widebody models, like the A330 and 777-300ERs, have seen valuations fall by 50% since the start of the pandemic.
Mid-to-late life widebody aircraft may even be increasingly retired given oversupply and the prohibitive expense of a transacting between operators (Figure 1).
Figure 1: Older aircraft increasingly grounded and may be retired by the end of the pandemic2
Accessing private debt sectors such as aircraft ABS
Investors can access the private ABS markets through club syndications as well as through direct relationships with borrowers (see Structured Insights: Esoteric Market Map).
Specialized ABS managers can tap multiple sourcing channels, create potentially more attractive deal structures with superior structural protections, influence funding timelines and coordinate private credit ratings from nationally recognized statistical rating organizations (NRSROs).
In these cases, we believe that specialized managers such as Insight can essentially act as an extension of an investor’s own internal investment teams, complementing their wider corporate and structured credit exposure by aiming to maximize the opportunity within their private debt allocations.
Shaheer Guirguis, CFA
Jeremy King, CAIA
Patrick Wacker CFA