The operating lease bastion, only recently seeming to be impregnable, faces the prospect of being breached as more lessees seek changes to existing leases compounded by the inability to trade out of assets as revenues falter and levels of return fall into single digits – or even lower.
Even though the aviation industry is recovering from the April depths of the Covid Event, the market remains extremely fragile. Some 60 percent of flights have been restored but load factors remain low on many flights and seating capacities have been reduced as operators utilize smaller aircraft or actually block or remove seats. Even in the U.S. only 61 percent of flights have been restored with 17,242 commercial flights (including freighters) taking place on the 9th August versus the 28,502 of the 14th February. JetBlue will continue to block the middle seat on Airbus aircraft and the aisle seat on E190s until mid October reducing the maximum load factor at a stroke.
The issue for lessors and the wider aviation market is that the Covid Event cannot be compared to the Yom Kippur War, the Iran-Iraq War, the First Gulf War, 2001, SARS, the Financial Crisis. This event is much more aviation related with a complex recovery process. April 2020 may have been the deepest part of the Covid Event for aviation but the effect of the virus was always expected to present aviation with difficulties due to the Mexican Wave nature of the pandemic and the inability to snap back to normality even with a vaccine. Airlines have not only found it difficult to actually operate aircraft due to medical restrictions imposed by various countries and provinces, but also experienced problems in persuading travelers to return to the skies. Business people are loath to travel partly because of company policy and the risk of litigation and leisure travelers are concerned that they may have to quarantine on return. The very nature of the pandemic means that borders can open and close with little notice. The British Government imposed a quarantine on passengers returning from Spain in a matter of hours. Airlines that had geared up for a return on the Spanish market – the principal destination for British vacationers – had to cancel flights at considerable expense and loss of essential revenue. There now exists a reluctance to book international travel given the uncertainty. The Asian operators were among the first to experience an improvement but this optimism has now foundered as expectations of a rapid recovery in terms of traffic have not materialized to the extent envisaged resulting in considerable losses. Long haul travel continues to be particularly adversely affected as operators are loath to add destinations that may be closed in an instant. Those operators without a domestic market are particularly impacted. In late July United Airlines expected that the recovery would only equate to half that of 2019 at least until a vaccine was in widespread use and assume effective treatment, possibly late 2021. The airline expected that the recovery will improve to fifty percent before remaining at this level. In contrast to American, United has been more cautious in adding back capacity and aims to have 35 percent capacity by the end of the third quarter compared to 2019. Some 61 of the airlines B757s are not expected to return to service.
The Covid Event was always expected to be a multifaceted process with long term consequences than a singular occurrence that would be shrugged off. The effect on the leasing market is therefore not to see a single surge in deferrals and rent reductions but to see a constancy in such requests as a V shaped recovery has failed to emerge. As expenses have continued to exceed revenues and traffic has not recovered, operators have contracted operations with many now having to ask lessors for far greater assistance for perhaps longer than both lessor and lessee expected. Many major airlines have announced significant fleet contractions. Some four months have elapsed since the April depths but only now is Aeromexico seeking major fleet changes with the renegotiation of leases and the possible delay or cancellation of its MAX order. Lessors leasing to Aeromexico include SMBC, Avolon, Goshawk, Jackson Square, Carlyle Aviation Partners, DAE Capital, ALC, BBAM, Aercap, FGL.
Air Lease Corporation indicated in early August that it had granted 59 percent of its customers lease deferrals due to the pressure on airline revenues. Despite this, ALC increase second quarter revenues to $521 million, an increase of 10.6 percent compared to the same quarter of 2019. Most of the lease deferrals were to be repaid over a short term and within twelve months with lease extensions also agreed. This method of allowing some breathing space for lessees was replicated by other lessors. The nature of the Covid Event means however, that the process continues and that further deferrals may be required as traffic fails to return and as revenues falter. Deferrals already made may therefore have to be revisited and new ones considered. As of early July DAE stated that 29 rent deferral requests had been agreed with an additional 28 rent deferral requests being considered. DAE expected to provide additional assistance to lessees. As of early June Aercap had agreed to defer $450 million worth of rent. Avolon has also agreed deferrals of rents. In its earnings call for its first half results Aercap stated “At the end of June, our deferral balance was $430 million, which is equivalent to roughly 9% of our annual revenues. …….Obviously, there are some customers who have filed for bankruptcy in the last number of months, which should be no surprise to anyone, given the level of disruption in the industry. But that doesn’t automatically mean we will have the aircraft returned. In many cases, we expect the aircraft to stay in place after the airlines emerge from bankruptcy. In other cases, we will take aircraft back, but I expect this to be manageable for a platform of AerCap’s size.” For Avolon the lease revenue collection rate for the first half of 2020 was 68 percent with two thirds of the collection shortfall being related to deferral arrangements. During the second quarter of 2020 12 of Avolon’s customers were due to start repayments at the scheduled expiry of their deferral arrangements but five lessees fell into arrears or sought another extension.
This failure to start lease repayments and for new deferrals to take place will be the norm for lessors for another twelve months. The issue for lessors will be whether to repossess aircraft. More likely further concessions will be agreed as placing aircraft will be difficult, at least at pre Covid lease rentals with any new lessees vulnerable to changes in operations due to Covid. The second half of 2020 will therefore likely see an increase in the number of lease deferrals as operators appreciate that revenues will not recover as quickly as might have been expected. The lessors will have little ability to sell assets except at a considerable loss of book value. The sale and leaseback market may provide some opportunities for the more secure operators, but this will involve the lessors spending valuable capital at a time when the cash needs to be preserved as rental income may have fallen by a third. The market is recovering but the aviation industry and therefore the lessors, will still experience on going problems. This may see some consolidation among the lessors. Competition to place the unwanted aircraft, particularly the widebodies, will intensify and cause further problems for lessors as lease rentals remain weaker for longer than expected. Yet, in perhaps two years, the surviving lessors should be enjoying considerable improvement not least because this downturn is so severe.