DBRS Morningstar’s Takeaways from ABS East 2022: Aircraft, Container Inventories Are Out of Balance

As part of its takeaways series, DBRS Morningstar is publishing several write-ups about pertinent topics discussed at IMN’s 2022 ABS East in Miami, an industry conference for the structured finance/asset-backed securities (ABS) sector. The supply and demand dynamic for new aircraft and container assets have seesawed since the pandemic. With flights grounded and online orders piling up, there were too many planes and too few containers. Now, the imbalance has flipped, specifically for containers, which are oversupplied, while supply of new technology aircraft is constrained by ongoing manufacturer production/supply-chain issues. Airlines clamor fuel-efficient and environmentally friendlier new technology aircraft to cost effectively meet air travel demand, which came back in full force over the summer for most of the world. In contrast, the shipping ports became less congested as global consumption slowed and supply challenges have started to subside in the past couple of months, resulting in lower freight demand and faster container turnaround rates thereby reducing the demand for spare containers.

FULL PLANES: NEW TECHNOLOGY AIRCRAFT UNDERSUPPLY, STRONG HEADWINDS A CONCERN
“Right now, we remain undersupplied,” said Yezdan Badrakhan, Managing Director and Head of Nonflow ABS at MUFG. His main concern with the supply and demand dynamic in aviation is the duopoly between Boeing and Airbus. These manufacturers can only produce so many units at a time and both face significant production delays. With limited supply available, airlines and leasing companies are “leaning in to acquire assets because they need the equipment,” he said. In his opinion, this competitive element is contributing to preventing low lease rates from shifting higher in step with the cost of financing. “[They] don’t reflect the current cost of capital, but they do reflect the available supply.”

DBRS Morningstar’s Hylton Heard, Senior Vice President, states that air travel demand ramped up to high historical levels in certain travel markets such as Europe and the U.S., approaching 2018−19 levels when travel was at its peak before the pandemic hit. “We clearly have all wanted to travel,” he said, adding that Europe was probably the busiest ever this summer. However, he highlighted several headwinds for the industry with two key risks being geopolitical risk and the global recession pressures. For the former, Heard highlighted the war in Ukraine, saying it only takes a spark for there to be spillover effects in Europe. Global recession pressures, such as inflation and rising interest rates, have elevated airline and lessor financing costs, which, along with high fuel costs and global labor shortages, negatively affected operating costs. Heard wondered if the airlines can absorb higher costs over the next year given that the industry is still recovering from the pandemic, which caused deep financial hardship. He pointed out that it doesn’t take much to push airlines into trouble given the ongoing recovery period, citing the recent 2022 Scandinavian Airlines (SAS) bankruptcy as an example.

Except mostly in China, Asian countries have recently opened their borders to international travel again, and they have started to see people travel locally and internationally in the region and abroad. While that will generate demand, a lot of traffic comes from China, according to Jing Xie, Director, Public Fixed Income, at Northwestern Mutual Investment Management Company. Overall, Xie believes this upcoming winter will be very tough for aviation, citing the skyrocketing heating costs across Europe, and thus consumers may not have extra cash to spend on travel.

Ali Ben Lmadani, Chief Executive Officer at ABL Aviation, has a more optimistic view. Though he acknowledged the industry’s challenges, he believes a fully open Asia will see travel ramp up quickly over 12 months, similar to what happened with Europe and America.

On the ABS side, performance has stabilized and improved for certain deals but not all. The majority of ABS transactions are still behind on paying scheduled note principal down the waterfall, with most only paying senior Class A note principal, and debt service coverage ratio triggers remain tripped. Heard noted that the 2021 vintage aircraft ABS deals are performing better than the pre-pandemic deals, not surprisingly as they benefited from improved global macroeconomic and aviation industry conditions along with stronger airline lessee credits and younger, in-demand aircraft driving stable performance metrics to date.

EMPTY BOXES: CONTAINER OVERSUPPLY
Unlike the aviation industry, the shipping industry caught on fire in late 2020 and throughout 2021. The result: a year ago, it cost $20,000 to transport a 40-foot container to New York from Asia, the highest it’s ever been, per Xavier Auge, Executive Director at Mizuho Americas. The industry added a record number of newly built shipping containers to meet a surging demand for consumer goods in North America and Europe and to compensate for slow throughput of the containers because of the pandemic-driven historically long delays at ports and logistical issues in the supply chain.

The industry has cooled off in the second half of 2022 and now has to deal with the meaningful oversupply of shipping containers. As of last week, the shipping cost for a container for the same route was $1,700, a massive drop year over year. “The shipping war as it is has already started,” said Auge, with competition among the shipping liners heating up as they to try to retain or grow market share. This massive drop in shipping costs is due to several factors including containers getting unstuck in the ports and making their way through the system, the addition of ship liner capacity, the recent easing of supply-chain issues, and importantly, a decline in demand for consumer goods.

The container leasing community is also doing its part to level out the oversupply. Badrakhan has heard leasing companies plan to limit their capital expenditures in the near to intermediate term.

Time will tell if the imbalance in both industries will sort itself out.

Written by Caitlin Veno

Notes:
For more information on aircraft and container ABS, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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