Credit managers that embraced aircraft investing face uncertain future

By Andrew Hedlund

NEW YORK, April 7 (LPC) - In the years that followed the global financial crisis, private debt managers added myriad strategies to their product suite, including niche ones like aircraft investing, an industry now at the epicenter of the fallout from the coronavirus pandemic.

Attracted by higher investment returns during years of low-interest rates, some of the most prominent managers in private debt, including the Carlyle Group, KKR, and Apollo Global Management, found their way into the sector.

Aircraft leasing and aircraft asset-backed securities are the main investment strategies. The former is how airlines finance their airplanes, the latter a way for credit managers to finance aircraft acquisitions.

Returns for aircraft leasing can depend on the age and type of the planes. Younger, smaller airplanes return the least at 3-5%, and older, larger aircraft, the most at 10-12%, a survey by British aviation finance research firm Ishka found.

Aircraft ABS have different levels of debt varying in risk, and each level can return in excess of 2% more than comparable corporate bonds, according to a Guggenheim Partners research paper.

Capital has come from a variety of locations: Carlyle has dedicated private funds, while KKR has committed capital from its credit and infrastructure funds, in addition to its business development company (BDC), which Apollo has also done.

The unprecedented health crisis is forcing aircraft investors to address its most significant challenge in years. For the week of March 30, departures globally and in the US were down by almost one-half and one-quarter, respectively, according to air flight data tracker OAG. Demand was down around the world each week of February and March.

Fitch Ratings last month assigned a negative outlook for aircraft lessors, which had a stable outlook at the beginning of the year. Growing passenger traffic and strong liquidity positions contributed to the change.

“Fitch is concerned about near-term downside pressures for lessors given the significant reduction in travel demand, potential airline defaults, increased repossessions leading to impairments and less favorable capital markets access,” said Johann Juan, an analyst at the ratings firm whose coverage includes aircraft leasing, said in an interview.

Industry observers will closely monitor portfolio quality and the potential for impairments on aircraft values.

“Aircraft leasing’s growth subsequently compressed lease yields, which contributes to an increasingly smaller margin of safety for the sector,” said David Petu, a second Fitch analyst that covers aircraft leasing.

Carlyle acquired aircraft lessor Apollo Aviation Group - no relation to Apollo Global Management - in October 2018. The firm, now called Carlyle Aviation Partners, is raising its fifth private fund, targeting US$850m, according to a Pennsylvania state pension fund’s investment documents. It is aiming for an annual yield of 12.6%-14%.

Carlyle completed several ABS transactions in 2019 including a US$540m deal last fall that financed the acquisition of 29 aircraft. So far this year, the firm has completed one transaction.

Aviation fund structures are often long-term and can likely make it through the tough times, one aircraft leasing fund manager said. The ABS structures are “continuing to hold up well,” and the industry also has dry powder available to deploy once the atmosphere stabilizes, the manager said.

SOURCE OF CAPITAL

Separately, KKR announced a US$1bn commitment to Altavair Finance in January 2019, establishing a platform to acquire aircraft serviced by Altavair, a lessor of planes.

KKR aimed to be “prudent” on the financings, which included bank debt and aircraft ABS, of its Altavair acquisitions, one fund manager familiar with the matter said. That effort put the firm in a better position to ride out the crisis, he said.

Also, KKR’s BDC, FS KKR Capital Corp, has a joint venture with DVB Bank that owns 38 aircraft, according to a report from the fund. It also refinanced a portion of its debt with an ABS transaction in February, an S&P Global pre-sale report shows.

The US$2trn stimulus bill Congress passed last month could have little effect on the aircraft ABS market, despite containing billions of US dollars in support of the airline industry, said Patrick Wacker, a portfolio manager that invests in aircraft ABS at Insight Investment.

“The majority of these underlying (asset) pools (securing the transactions) are centered on smaller emerging market operators that are very unlikely to get bailed out,” he said.

The most significant portfolio positions for Apollo’s BDC, Apollo Investment Corp (AINV), are in aircraft lessor Merx Aviation. AINV’s investment in Merx comprises 12% of its portfolio, according to a March 26 letter to its stakeholders. Merx has a “well-diversified, high-quality fleet” that will allow it to “weather the current challenges,” AINV Chief Executive Officer Howard Widra wrote in the letter.

Apollo also purchased PK AirFinance, another aviation lending business, from GE Capital in December.

Representatives from Carlyle, KKR and Apollo, declined to comment.

Fallout from the coronavirus has put aircraft investors in uncharted waters. The pandemic represents the largest blow to the aircraft investing industry ever, Insight’s Wacker said.

“This is the biggest shock I’ve seen. This is much more severe than 9/11, this is much more severe than the financial crisis,” he said.

“The difference here is the financial crisis did not ground entire fleets of aircraft across nations. I think many of us are asking ourselves the question: will the US ground all non-essential airline travel? That was never a question that was asked in 2008.” (Reporting by Andrew Hedlund. Editing by Kristen Haunss and Michelle Sierra)