Air travel has plummeted since the outbreak of the Covid-19 pandemic, and it is increasingly likely that lower airline demand will be the "new normal" for quite some time. Even if a vaccine is developed successfully and widely distributed, it is unlikely to spark an immediate restoration of airlines' and plane manufacturers' fortunes.
The airline industry is bracing for years of pain ahead, and setting up additional sources of private liquidity to finance leasing is a part of that. A growing number of asset managers have been more than happy to oblige.
The hunt for yield continues
Asset managers have been moving up the capital stack for years in search of yield. Globally, monetary policy has helped amplify this trend as the reticence of central banks to tighten monetary policy in the decade following the Great Financial Crisis has kept borrowing cheap and yields low. Consequently, even supposedly conservative pools of capital, such as pension funds and university endowments, have piled ever deeper into private credit in their hunt for yield.
When Covid-19 hit, it seemed as if these moves would come back to haunt these institutions, but the Federal Reserve's unprecedented interventions this year prevented a serious reckoning. As a result, rather than de-risk as they would during a normal recessionary event, many institutions have instead expanded their exposure to high-yield private credit. Aviation leasing represents the latest frontier of these intrepid yield-hunters.
Even the most conservative pools of capital have been lured by the siren song of aviation leasing. In July, the New York State Common Retirement Fund, the third largest public pension fund in the nation, announced a $150 million allocation to closed-end aviation assets fund managed by Castlelake Aviation. On Oct. 19, bond market titan PIMCO also joined the fray, announcing plans to team up with GE Capital Aviation Services, a subsidiary of General Electric Co. (GE), to fund up to $3 billion in aircraft financing.
An opportunity to deploy capital
In past articles for GuruFocus, I have discussed the Trump administration's bailout of the airline industry and its impact on the near-term outlook for players such as Southwest Airlines Co. (LUV). Despite these generous federal bailouts, airline companies are still in serious trouble as their cash burn continues to drain their weakened balance sheets. Influential voices within the industry have already started begging for more government cash, while others have begun to turn increasingly to alternative private sources of financing that have stepped up to meet their needs.
Aircraft leasing has a long history, and its enduring popularity with airlines will be obvious to anyone with experience in a capital-intensive, often cyclical industry. Compared to owning aircraft outright, leasing offers airlines considerably more flexibility. It is often more economical and financially efficient for airlines.
While the leasing market is looking a bit crowded, the need for leasing and refinancing is set to grow as airlines face pressure on their balance sheets. Existing aircraft leasing companies have been joined by new entrants eager to meet the airline industry's seemingly insatiable appetite.
Until next time
The hunt for yield has dragged capital allocators into aircraft leasing funds like never before, which has exposed more passive investors than ever to the asset class. Yet, even before the outbreak of Covid-19 stopped air travel in its tracks, there were mounting signs of oversupply and overcapacity in the passenger aircraft market. The pandemic has made this problem even worse.
Given the precarious state of the industry, I am dubious whether a bet on aircraft financing can actually pay off for these institutions or their beneficiaries.
Disclosure: No positions.
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