Norwegian deal shows depth of turmoil in aviation finance

Norwegian Air’s nail-biting $1 billion debt-for-equity swap with bondholders and lessors on May 4 has given the struggling airline vital breathing room, allowing it to access up to an equivalent of $290 million of state-guaranteed loans.

But according to one prominent aviation banker, the deal will just delay the airline’s eventual demise, at best through a takeover.

Even before the coronavirus crisis, Norwegian’s future was in doubt, after years of aggressive growth as a long-haul budget airline. It has posted three consecutive years of losses.

With only seven of its planes now flying, why did creditors agree to the rescue instead of repossessing the aircraft that backed its funding?  

The obvious answer is that the devastating impact of the coronavirus on all airlines’ revenues meant that repossession was not a viable option, even for an operator as weak as Norwegian. It would have put a fleet of about 150 aircraft into a market in which the planes might have fetched only a fraction of the outstanding debt against them.

Forbearance is fine for a few months, but if passenger demand does not return rapidly, more repossessions are inevitable – accentuating the dip in asset values 

But Norwegian’s aggressive growth merely illustrates the problems of the wider boom in aviation finance during past decade and especially over past two years. Aviation asset-backed securities (ABS), many arranged by the big US private equity firms, have grown rapidly, in particular for lower-rated borrowers such as Norwegian.

Around the world, about two thirds of all aircraft financed by ABS structures are now grounded, according to UK aviation consultants IBA. So much for the diversification benefits of packaging risks in securitization structures.

Meanwhile, in the bank market, loan-to-value ratios going into the crisis were as high as 85%, albeit for safer credits than Norwegian. On the basis of less-bullish appraisal values on the aircraft, those ratios were above 95%, even before the coronavirus crisis, according to one aviation finance consultant working for German clients.

All this left market participants dangerously exposed, even to a relatively mild downturn. Now travel bans and lockdowns herald a shock that will be deeper and longer lasting than even the most bearish players could have imagined.

Leasing companies

Big leasing companies such as AerCap, Air Lease and Avolon have had to grant hundreds of millions of dollars of rent deferrals to airlines around the world. Even if some of them are doing sale and leaseback transactions for airlines that still own aircraft, their clients are at best taking on new planes only if they are contractually obliged.

The question is how long lessors, banks and creditors can wait. Forbearance is fine for a few months, but if passenger demand does not return rapidly, more repossessions are inevitable – accentuating the dip in asset values. 

Regulators are allowing banks more flexibility around when they must provision for credit losses, but planes are a depreciating asset, so loan-to-value ratios will rise the longer that the debt remains unpaid, and interest accrues. Another worry is the capacity of a zombie airline to properly maintain its leased planes.

Aviation attracted yield hunters in recent years because it was supposed to be safe. As in shipping, the vessels can be transported wherever there is demand. And unlike shipping – which enjoyed a similar financing bonanza before 2008 and a subsequent decade-long slump – just two companies, Airbus and Boeing, control most global production of aircraft.

The aviation finance industry, however, has never faced a global threat like this. After the 2001 terror attacks made people in the US and Europe fearful of air travel, for example, planes could be sent to Asia instead.

Now even Asian carriers – which have fuelled the industry’s growth recently – are due to see passenger demand drop by about 50% in 2020, according to the International Air Transport Association (IATA). Likely production cuts of about a third by Boeing and Airbus will not be enough to rebalance supply.

Delayed rebound

The biggest worry is what happens if the sector does not rebound in a few months or even years. International long-haul travel will recover last. This means the kind of wide-bodied planes used for inter-continental trips – including by Norwegian – will see the biggest hits to their value, even if some of them may get converted to cargo vessels.

According to Willie Walsh, chief executive of British Airways- and Iberia-owner International Airlines Group (IAG), passenger demand won’t recover to 2019 levels before 2023.

Even this assumption could be optimistic, though, if businesses become fundamentally less willing to send employees on trips, particularly long-haul ones.

As in banking, low growth and a lack of prior consolidation means European firms are worst off. Perhaps IAG will revisit the bid for Norwegian it considered in 2018. Whether national governments will let mergers happen in other cases, after they’ve spent money bailing out their airlines, is more questionable.

In the meantime, banks and investors who have lent against aircraft that are now superfluous will be forced to take losses. The French, Japanese and German Landesbanken – names such as Crédit Agricole, MUFG and NordLB – are among the most exposed.