COVID-19 has had a tremendous effect on the aviation industry. In the months since the W.H.O declared COVID-19 a pandemic, there has been a negative impact on airline share prices, air travel, airline workforce, and liquidity of operators and lessors generally. In addition to the more apparent issues facing the aviation industry, there has also been a flurry of activity behind the scenes. Operators, lessors, and financiers are realigning to salvage ongoing lease and financing arrangements in light of reduced operator liquidity.
Despite the disruption brought on by the pandemic, aircraft lease rentals have remained payable because aircraft leases are hell or high-water agreements; i.e., rentals are to be paid by airline lessees/operators irrespective of circumstances. Carve-outs in a hell or high-water clause would typically include scenarios where there is a total loss of the aircraft but rarely risks related to pandemics.
Additionally, force majeure clauses (which are quite rare in aircraft lease agreements, but which could be available as a relief by operation of law) would not give airline operators an automatic exit from obligations under lease or finance obligations. It could be quite challenging, as a matter of fact, for an obligor to equate a difficulty in the performance of its duties due to the pandemic to an impossibility to perform due to an intervening (force majeure) event.
Below are a few emerging trends in aviation finance and lease, in the face of decreased liquidity brought on by an unavoidable dip in demand for air travel:
- Rent holidays: A number of airline operators have approached or are currently negotiating standstill agreements with their lessors. An upshot of these standstill agreements is inevitably the effect a standstill would have on financing arrangements, particularly if same would result in a cross-default. This notwithstanding, it would appear that the trend is to embrace rescheduling negotiations by lessors and financiers who are unwilling to terminate leases or take enforcement action where there have been defaults and cross-defaults under current arrangements.
- Sale and leasebacks: Some lessors are undertaking sale-leaseback transactions with airline operators, where the aircraft is being repurchased by the lessor; and leased back to the airline operator. This appears to be the trend with unencumbered aircraft and with lessors who are not facing liquidity issues and can acquire aircraft unconstrained in these unprecedented times. This approach is beneficial to both parties, as the airline operators would gain liquidity and the lessors could regain ownership of aircraft assets at lower than usual prices.
- Predelivery payments (PDPs): PDPs are usually paid to manufacturers several years before the delivery of new aircraft, and manufacturers typically deliver on an agreed schedule. With delivery schedules hanging in the balance, PDP financing has been affected, with several financiers facing possible payment defaults from airline operators. Typically in a default-by-an-operator situation, a financier would probably step-in, pay the remainder of the PDPs and then take delivery of the aircraft. With reduced liquidity, this may not be an attractive option for lenders. As such, it is expected that these step-in terms are likely to be re-negotiated by parties.
- MAE/MAC clauses: Material adverse change/material adverse effect clauses are inevitably becoming heavily negotiated. Parties are increasingly negotiating to include risks related to general economic conditions, natural disasters, and now specifically, pandemics. This is particularly the case where drawdown or deliveries are heavily reliant on the non-occurrence of MAE / MAC events.
- Information undertakings: Loss of income by the operators has resulted in financial covenants and ratios being tested. As such, operators are paying keen attention to the information undertakings in their transaction documents and informing counterparties where there is likely to be a breach of a financial covenant; and in some cases, requesting for financial ratios to be adjusted accordingly to take into account current market conditions.
- Private equity: There appears to be an increased interest in the aviation sector from investors who are able to purchase interests in aircraft assets at a lower than usual cost. Additionally, the pandemic has presented an opportunity for private equity firms who focus on distressed investments to acquire interests in airline operators and leasing companies that are facing liquidity issues.
- Government bailouts: Another trend during this pandemic has been for some governments to provide low-interest loans and grants to the aviation industry to cover payroll and, in some cases, working capital needs. The United States of America granted a USD 50 billion bailout package to several airlines through its CARES Act, Payroll Support Program. The United Kingdom, through its Coronavirus Corporate Financing Facility, provided GBP 3.075 Billion to the transportation sector (including aviation). The Dutch and French government provided EUR 3.4 billion in state-backed loans to Air France-KLM, and the German government provided a EUR 9 billion bailout to Lufthansa.
In the current environment, it is difficult to anticipate or predict what the attitude of the market will be towards acquiring and leasing new aircraft (or financing these acquisitions) in the next few months. Arguably, the closure of airspace and low traveler confidence has had a domino effect in the aviation industry. For lessors, the ability to acquire new aircraft hangs in the balance. At the same time, for lessees, the loss of income from decreased air travel has had an undeniable effect on leasing and financing arrangements.
Arguably, government support coupled with re-opening air spaces and increased traveler confidence could return air travel to pre-pandemic volumes. This, in turn, could aid the airline operators to regain income, which would consequently assist those operators and lessors with liquidity issues to meet their various obligations under their current leasing and financing arrangements.