Muzinich & Co’s Alok Wadhawan, highlights how COVID-19 is likely to be a catalyst for investors seeking to access attractive opportunities in a relatively stable asset class.
Aviation finance, which is a specialist area of investment, has been in turmoil since the COVID-19 crisis erupted more than a year ago. The hit to commercial airlines and some private aviation has been dramatic. Where does this situation leave aviation finance, and what can be in store as and when the world tries to recover some sense of normality? A firm engaged in the space is Muzinich & Co, whose head of aviation finance, Alok Wadhawan, examines the subject.
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When the pandemic hit the western world in February 2020, we witnessed a dramatic fall in air-traffic demand. However, in our view, the repercussions of COVID-19 on aviation finance have created a once-in-a-lifetime opportunity, especially for new entrants wanting to invest for the longer-term and players who have been underweight the sector. Recently, the oldest aviation lessor, General Electric, sold its aviation leasing platform at 0.7 times net asset value. As a comparison, transactions pre-pandemic were typically executed between 1.25 to 1.5 times NAV, according to our estimates.
Historically, aircraft financing has been a stable, income-generating asset class providing investors with potentially attractive returns on a risk-adjusted basis. The asset class aims to provide downside protection to investors with its dual security of credit and assets (aircraft). Moreover, the yield on the senior secured aircraft investment in private markets is still attractive on a relative value basis to comparable investment grade bonds, although pricing has tightened after the global vaccine roll out and the anticipation of the global economic recovery.
Additionally, as air traffic demand is expected to improve and mirror the gradual growth in global GDP over the next few months, we believe that the long-term fundamentals of the industry continue to look attractive. Our positive outlook for the sector is underpinned by some of the following key themes.
Pent-up demand for domestic air travel
By the end of 2020, international travel demand was still a lot lower than the start of the year. However, domestic air travel was able to recover more rapidly; for example in Europe we witnessed a 70-80 per cent increase in domestic air travel demand during the summer months due to a drop in COVID-19 cases (1). In China, which was able to control the virus quicker than other countries, demand for air travel in November to December last year was higher than at the same time in 2019 (2). This trend was similar in Latin America (from December 2020 to March 2021), before the recent wave of COVID-19 hit the region (3).
This is largely because domestic travel does not require crossing borders and is more dependent on leisure. Whereas international or long-haul travel tends to rely more on business travel, which has been severely affected by the pandemic.
Government support and airline resilience
Although airline companies have greatly suffered from the COVID-19 crisis, with global airlines collectively predicted to record a total of $118 billion in losses in 2020, there have been very few bankruptcies (4). This is because airlines entered the pandemic with very good balance sheets, following ten years of record profitability.
Additionally, a total of approximately $225 billion of government support was provided to airlines, while in the US, airline carriers had access to capital markets, and were able to raise money from debt and equity from shareholders (5). As such, airlines have been able to survive through the pandemic because sufficient liquidity was provided by governments, shareholders and capital markets. Banks and lessors have also supported their clients throughout this difficult period.
Lack of competition
With limited funding available for a few airlines and a significant lack of competition in terms of capital going into the industry, we strongly believe that now is a good time to invest in the asset class. We continue to see opportunities with top-quality credits on new technology aircraft available at what we consider to be attractive prices. Compared with pre-COVID-19, we believe there is less competition for these opportunities, as a number of existing players are focusing on managing the risk of their existing portfolios.
This lack of demand from investors has shifted the bargaining power. While investors pre-pandemic were mostly price takers, they are now able to set their preferred terms, making the investment much more attractive.
-- Due to its structure, the aviation sector will take longer to fully recover compared with other industries, but that recovery is clearly in sight.
-- Competition in the private finance community has significantly reduced and is likely to remain the case for the next couple of years.
-- In our view, the next 12 to 24 months provides investors with a unique entry point into aircraft investing with a high degree of confidence and a margin of safety to those investments.
-- Aviation finance offers a “sub-class” of investment opportunities with strong credit quality and assets with the latest technology, which we believe can generate strong, stable and uncorrelated returns to mainstream asset classes and other alternative investments.
1 BofA Commercial Aerospace Tracker as of 9 March 2021.
4 International Air Transport Association (IATA) economic report March 2021.
About the author
Alok Wadhawan joined Muzinich in February 2020 and is the global head of aviation finance. He has 20 years of experience in structured finance and, prior to joining Muzinich, was head of aviation finance at Investec, a FTSE 250 investment bank. He worked for nearly 14 years at Investec and was one of the founding members of the aviation finance business. He was instrumental in building its aviation finance fund platform and; he also established aviation debt funds for institutional investors. Alok Wadhawan has extensive industry relationships across financial institutions, leasing companies, manufacturers and airlines and is a regular speaker at aviation conferences. He earned a bachelor of commerce (Hons) from Calcutta University and is a qualified Chartered Accountant, MBA (Finance), qualifying in India.
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