Manufacturer delivery delays are continuing to push up demand for leased aircraft, especially ahead of the busy summer season and leasing companies are reaping the benefits. Dublin-based aircraft lessor Avolon has reported strong demand for leased aircraft and has demonstrated its confidence in the sector with a recent commitment to order 40 737MAX aircraft.
Including the new order, Avolon’s total owned, managed and committed fleet is now 870 aircraft – the vast majority are new technology aircraft.
“Avolon benefitted from rising lease rates during the quarter as global passenger traffic continued to grow and the reopening of the Chinese market provided an important catalyst for increased travel in the region,” said Andy Cronin, chief executive of Avolon. “Demand for aircraft remains strong, with high levels of leasing activity and a continued shortage of aircraft. This is supporting residual values and driving demand for lease extensions from airlines unable to access new deliveries.”
The new MAX aircraft will boost the lessor’s orderbook to 252 new technology aircraft and push its delivery schedule out to 2030. “With strong demand for our new technology orderbook, and delivery slots at a premium, it strengthens and extends our delivery profile with Boeing,”
Cronin added. New aircraft orders are only one way that Avolon can grow its portfolio and it also acquires aircraft via sale and leaseback transactions with airlines, who globally have $90bn of new aircraft deliveries in 2023 to finance. With airlines still recovering to full capital strength, lessors remain an essential funding partner. “Increasingly, airlines are turning to lessors like us that are active in the sale-leaseback market to fund their new deliveries,” Andy Cronin told Airline Economics. “We do have targets for those sorts of acquisitions, but our prime focus is the long-term value in our allocation of capital. It is much more important for us to see real value in the rates at which we are deploying the incremental capital. But those flows of capital need to be balanced constantly on and off the balance sheet.”
Avolon has strong access to capital. At the end of March 2023, the lessor had total available funds of $5.5bn, including $403 million of unrestricted cash and $5.1bn in undrawn debt facilities. “We have very high liquidity levels compared to our peer group that allows us to deploy more capital and even retire debt at a low cost if we need to,” says Cronin.
Even with manufacturer delays, Avolon has over 75 aircraft expected to deliver by the end of 2024 and as a result has continued to raise funding at competitive levels. Prior to May 2023, Avolon consciously steered away from the capital markets during the past period of intense market volatility related mainly to the steep increase in interest rates that characterised the market at the end of 2022 and into the new year. “Last year, due to the large interest rate movements and volatility in bond spreads, we focused on funding the business via other sources rather than through unsecured capital. We are comfortably funded and are able to wait until those bond yields normalised and primary market issuance returns,” said Cronin in March 2023.
During the first quarter of this year, Avolon continued to raise funding in the bank market and executed a $810 million term financing facility maturing in 2030, with a syndicate of 10 banks.
As part of that broadening of funding sources, Avolon also completed its first Japanese Operating Lease with Call Option (JOLCO) financing working alongside ORIX Aviation.
“JOLCOs are a very cost-efficient financing tool for aircraft assets,” Cronin said. “With ORIX, we were able to position Avolon’s underlying leases on certain assets to be acceptable to that investor market. The scale of the JOLCO market is limited so I don’t see it becoming a wholesale part of our capital structure, but it does create diversification.”
With the partnership with ORIX Aviation – the equity underwriter on the JOLCO transaction – Avolon has a unique ability to tap into the JOLCO market and opens avenues for additional collaboration between the two businesses. From a broader market perspective, this innovative lessor JOLCO deal demonstrated that Japanese investors were regaining confidence in the aviation market again following the pandemic period where certain investments were impacted by the worldwide grounding of the fleet.
As a secured financing products, JOLCOs can create certain limitations for leasing companies due to operational restrictions on where the aircraft operate that can limit the ability to trade the aircraft down the line. “For certain areas of our portfolio, the JOLCO works well, and we are pleased to have opened a new channel in the financing markets but at our core we will remain a predominantly unsecured funded, investment-grade business,” confirms Cronin.
To that end, Avolon returned to the capital markets at the beginning of May with a five-year $750 million 6.375% senior secured notes issuance managed by joint book runners J.P. Morgan, BNP Paribas, Deutsche Bank Securities, Fifth Third Securities and MUFG, with the deal completing 37.5bps tighter than the initial price talk at launch.
With new deliveries coming on stream and airlines once again ordering aircraft to secure their growth trajectories – specifically airlines in China and India – the aviation industry recovery is well on its way to 2019 levels despite the macroeconomic challenges.
Avolon reported a slight dip in lease revenue for the first quarter to $599 million compared to $658 million a year ago, with net income rising to $56 million compared to a loss of $182 million a year ago, which included the impairment and write-off of aircraft in Russia. Avolon booked $310 million operating cashflow in the latest quarter compared to $320 million in the prior-year period.
Cronin is bullish about the full year outlook for 2023 having started the year on a positive note with the reopening of the China market, which had an immediate impact on traffic statistics. He notes though that although airlines can show an immediate impact on the bottom line, lessors tend to show that Covid bounce some months later: “The best thing about aircraft leasing businesses is that they are so stable; the worst thing about this business is that it is so stable,” says Cronin. “In the same way that lessors didn’t have an immediate drop in profits that airlines did through the Covid period, the impact was dampened. The same is true on the way out of the pandemic, there is a lag before the impact of the recovery and higher lease rates feed into the financial statements.”
Despite the significant financial impact of writing off its leased Russian fleet, Avolon remained profitable in the second half of 2022, which has continued into the first quarter. “Our portfolio was quite long emerging Asia, and we have seen a slower recovery both there and in China. Although only nine percent of our portfolio is in China, the lockdown of the Chinese market had a knock-on impact on Asian airline traffic. “About 40% of all Asian traffic levels originates or arrives in China – all of the major Asian economies are heavily reliant on China in terms of traffic flows. But our operating cash flow demonstrates the now improved payment performance of our airlines in Asia and around the world, which will only continue to increase as the recovery strengthens.”
There have been relatively few bankruptcies in relation to the scale of the crisis, and the market has also seen a record amount of start-up airlines being set up. Going forward, Cronin expects the aviation market to normalise over a short period of time and the company to return to a more “normal portfolio churn” of recovering aircraft from troubled airlines. “During the pandemic, lessors were more defensive about keeping aircraft in place but lessors have now become more assertive in recovering and redeploying their aircraft elsewhere in the globe.”
The higher, or as Cronin says, the more normal interest rate environment, may cause disruption to certain airline customers but for lessors the current situation is much more attuned to a long-term business like aircraft leasing. “The underwriting environment now for new business for us is much more consistent with our desired long-term returns than when we were when interest rates were at zero or heading to negative interest rates,” says Cronin.
With rising interest rates comes rising lease rates but a lack of capacity is also ticking lease rates upwards, which is good news for lessors. “Lease rates are increasing because of the scarcity of aircraft due to those aircraft that didn’t get produced during Covid and those that were retired. But it is also due to the rationalisation of some of the airlines and the lessors’ orderbooks as well as a reduction in the number of lessors due to consolidation.”
The leasing market has had its fair share of consolidation before and following the pandemic, and most market observers feel there are still some more deals to come. There are known lessors already in the market looking for buyers while some smaller players that no longer have access to the funding they had pre-pandemic are seeking to exit the market. The stall in the M&A market at the moment is a lag between sellers expected sale prices and what the market is prepared to pay. The upward march of interest rates and now with some concern in the banking market could change that dynamic and lead to more sales in the second half of the year. In the meantime, the trading market remains active driven again by the strong demand for aircraft.
“There has been a lot of trading activity earlier in the year, which we are pleased to see,” says Cronin. “But every buyer is using a different discount rate on the lease cash flows driven by the move in interest rates, which has had an impact on trading volumes. What we are seeing is confidence return to the market, and all the residual values and lease rate assumptions strengthen as appraiser move up values.”
Avolon is well known for its young, new technology fleet – the average fleet age is just 6.3 years – but like any lessor with a large aircraft portfolio, it has options for older aircraft in its fleet other than trading out older assets. The team has invested heavily in an A330 cargo conversion programme.
In October 2021, Avolon became a launch customer for IAI’s A330-300 passenger-to-freighter (P2F) programme for 30 conversions slots between 2025 and 2028.
“In 2025, we will see the induction of the cargo conversion market for our A330s,” says Andy Cronin, Avolon CEO. “We’ve seen the impact of that on demand for the 737-800. We are a firm believer in the A330 from a cargo conversion perspective because we think there simply isn’t an alternative to the 767 cargo aircraft and a replacement has to happen. We have taken a significant position with IAI for their conversion of the A330 on a multi-year program.”
Cronin believes that eCommerce is a permanent change to the global marketplace and believes that there will always be supply chain demand for fresh perishable goods that require air freight. “The move to twin engine widebodies, away from the four-engine aircraft, creates an opportunity for an increase in dedicated freighters. We see significant opportunities and a long-term shift in the market,” he says. “Over the past year, we had a cyclical high due to the all the supply chain disruptions. As all channels are moving much better now, some of the heat has gone out of that, but we never invest for the spot market today. We’re looking at the trend five years out, 10 years out, and 15 years out in terms of our expectations. We fundamentally believe that the freighter market is actually underserved by new capacity going in, which creates the opportunity for us to play in the conversion space in a material and significant way.”
The conversion programme is well under way and on target to deliver on time. Avolon is a firm believer in the medium and long-term prospects for the freighter, noting that the A330 converted freighters will offer 22% more volume and 17% more payload compared to the 767, which is the aircraft the A330 is effectively replacing. “We knew when we were taking on those cargo conversions that this was a three-to-five year bet on the freighter industry. The one enormous commonality air cargo has with aviation is its cyclicality. We always look to the medium and long-term trends when we’re making those kinds of capital allocation decisions. Even before the pandemic, those 767s were coming to the end of their useful lives and a replacement wave is imminent. Even without the eCommerce growth assumption, there is plenty of opportunity for this converted aircraft type.”
Avolon is well known for its commitment to driving a more sustainable aviation industry. The lessor was a first mover in the future aircraft tech sector, snapping up an investment in Vertical Aerospace realising the potential of its VX4 electric vertical takeoff and landing aircraft (eVTOL). Even more remarkable was the full placement of its 2021 order for up to 500 VX4 eVTOL zero emissions aircraft in April 2022.
Cronin views this “modest” investment in real future technology as a much more practical avenue for encouraging the decarbonisation of the sector than offsets for example. “We invested real cash in Vertical and we now have a first-mover advantage in these new modes of transportation that could flow around the world.”
Avolon didn’t set out to invest in eVTOLs, in fact when the team first set aside a pool of capital to invest in technology to further the decarbonisation of aviation, Cronin says that they “hadn’t even heard of an eVTOL at the time”. What the team was looking for was a practical way to contribute the decarbonisation journey without competing with the major airframe or engine manufacturers. “We wanted to use that capital in opportunities where we could dramatically accelerate the commercialisation of some of this technology through our global network of airline relationships,” he explains. “When we met Vertical, which had been developing this aircraft for a number of years, they were nowhere on commercialisation and we felt that what we were able to bring an effective litmus test by introducing that product our global network of airline clients and testing the reaction.”
The reaction was underestimated by Avolon – not only did the lessor place its orderbook but other airlines have placed orders and are investing in the development of the product and infrastructure alongside. “eVTOLs are never going to be a dominant feature in our portfolio,” admits Cronin, which as a commercial jet lessor is unsurprising, but he stresses again that for a small capital outlay, the company has created the opportunity to be “part of the flow of the development of this new mode of transport that potentially lead to benefits from upscaling some of this electrification into larger asset costs”.
Aside from the VX4, Avolon is also an active supporter of the broader industry move to upscale production and usage of sustainable aviation fuel (SAF). “The scale of capital required to evolve the development of SAF is way beyond what an aircraft lessor could contribute but Avolon is supporting SAF research in Ireland.” At the end of last year, Avolon partnered with Boeing, ORIX Aviation, SFS Ireland, and SkyNRG, to conduct a feasibility study into the production of SAF in Ireland.
The study, which will be completed this year, is being led by SFS Ireland and SkyNRG to identify market-level opportunities for an investable commercial-scale SAF production facility in Ireland. The partners claim that the planned growth of renewable energy sources in the country makes Ireland a potential location for SAF production.
“This is only a small part of how we can help to promote the use of SAF in the industry,” says Cronin, adding that Avolon will also be using its industry connections to help create more momentum behind the drive to upscale SAF production and usage in the industry.