Capital Markets on Autopilot? Post-Pandemic Turns for Aviation Finance

The aircraft finance market, where the provision of capital to airlines and leasing companies takes place so that they can purchase (or refinance) commercial aircraft, has proven both delicate and responsive to global developments. The aviation industry initially experienced substantial growth due to increasing international travel, which created a significant need for aircraft financing solutions. Investors showed strong confidence in the value and sustainability of aviation asset-backed securities on the market, and airlines took advantage of favorable interest rates to secure bonds, benefitting from a low-risk environment that underscored the sector’s resilience.

A favored financing tool in the aviation sector has been Aircraft-Backed Securities (“ABS”), which are backed by the value of the aircraft themselves and in the case of leasing companies, the value of the rental contracts, particularly through Enhanced Equipment Trust Certificates (EETCs). These asset-backed instruments allow airlines to finance aircraft acquisitions by structuring debt secured against their aircraft assets, which brings tax advantages and opens a unique asset class. EETCs offer investors the opportunity to gain exposure to aviation assets while benefiting from structured security and creating a win-win for airlines seeking capital and investors looking for diversified, yield-bearing assets in the aviation market.

The high intrinsic value of aviation assets has made the sector particularly well-suited to leasing by creating a dynamic environment where leasing companies play a significant role in easing the burden on the capital of airlines. Through sale-leaseback transactions, airlines have been able to sell aircraft to lessors and lease them back to preserve liquidity. This approach allows airlines to maintain operational flexibility and allocate resources more efficiently while lessors enjoy a stable, asset-backed investment in the industry. The leasing model has become essential to aviation financing, offering financial relief and strategic agility.

The Covid Era

In a sector marked by high-value assets, substantial financing needs, and intricate capital market transactions, the aviation industry seemed well-positioned for growth—until the COVID-19 pandemic. The pandemic revealed just how precarious this triangle of dependency could be. When travel restrictions and health concerns emerged, passenger demand plummeted, resulting in a drastic revenue decline for airlines worldwide.

This sudden drop in revenue forced airlines into heavy borrowing to cover operational costs, leading to significant debt accumulation. Leasing companies faced challenges as airlines sought to renegotiate terms or defer payments to stay solvent. Consequently, capital markets for aviation financing grew risk-averse, as heightened airline debt and uncertainty surrounding demand recovery led to more conservative valuations and stricter credit terms. Due to the reduced investor confidence and market liquidity, ABS experienced a significant decline in value, and asset values for aircraft dropped. This led to lower lease rates and impairments in collateral value for many lenders​.

After the Storm: Post-COVID Skies for Asset-backed securities

As travel restrictions eased and global air traffic volumes began to recover, a steady and robust comeback was expected. However, the recovery of capital markets' role in aviation financing has not followed a consistent path since COVID-19. This situation highlighted that the sector's stability may be more fragile than anticipated despite the high asset values typically associated with aviation finance. External economic factors such as geopolitical uncertainties and market volatility have demonstrated that high asset values do not necessarily guarantee resilience in the aviation finance landscape​.

In 2021, the aviation finance sector saw a promising resurgence, with relatively more issuances. This rebound was attributed to low interest rates and tighter credit spreads, which created a favorable environment for capital markets to support airlines' financing needs as they began to recover from the pandemic's impact. However, major rating agencies also continued to factor pandemic-era losses into their assessments of aviation assets, sometimes adopting more stringent criteria.

This positive trend, however, did not persist into 2022, which experienced a significant decline in aviation-backed securities (ABS) issuances, dropping to just three for the year. This downturn was primarily influenced by the geopolitical turmoil resulting from the Russian invasion of Ukraine and the rapid rise in interest rates due to the COVID-related inflation. The ensuing sanctions and heightened geopolitical risks dampened investor confidence given the downgrading of aviation-related ABS.

In 2023, while high interest rates created a cautious approach of no aircraft ABS issuances, ABS transactions were stronger than in previous years. This is likely attributable to global air traffic returning to almost 2019 levels, despite the reduction in the number of aircraft in 2023 due to dispositions such as sales, leasebacks, and repossessions. In February 2024, global air traffic levels exceeded pre-pandemic figures, marking a milestone in the aviation sector's recovery. This resurgence in air travel and the 2024 issuances of ABS indicate a strong comeback for the aircraft ABS market.

Conclusion

The post-pandemic landscape of aviation financing reflects a complex interplay of recovery and caution. While the sector demonstrated resilience with a rebound in global air traffic surpassing pre-COVID levels, the path back to capital market stability has not been straightforward. The initial resurgence of ABS in 2021, supported by favorable economic conditions, provided a glimpse of recovery potential. However, subsequent geopolitical events and rising interest rates significantly curtailed this enthusiasm, resulting in a sharp decline in ABS issuances in 2022 and a cautious approach in 2023. As of today, the promising uptick in air travel and renewed ABS activity indicate a pathway to recovery, yet investor sentiment remains tempered by broader economic uncertainties and political dynamics.

Eser Ozgur is an exchange student at Columbia Law School and LL.M. (Corporation Law) candidate at NYU School of Law, where she also serves as a Graduate Editor for the NYU Journal of Law & Business. Prior to her studies at NYU, she worked as an Associate in the Capital Markets and Banking & Finance departments at Paksoy Attorney Partnership, which was recognized as the top-tier firm of Turkey by IFLR. She also interned at Dentons and Çakmak Attorney Partnership (formerly White & Case). She completed her undergraduate studies at Bilkent University, along with one-year study abroad program at KU Leuven in Belgium.