Alternative investment managers (Alt-IMs) have become increasingly active investors in the aircraft leasing industry as they seek to deploy capital into a growing sector that could provide attractive investment returns. However, Fitch Ratings notes the typically fixed-life nature of private-equity ownership can increase long-term strategic and financial uncertainty for owned aircraft lessors while the business's cyclicality and sensitivity to exogenous shocks exposes sponsors to heightened execution risk surrounding investment realization.
Investing in aircraft leasing is not a new concept for Alt-IMs and, in fact, many of the largest aircraft lessors today were at one time owned by private-equity sponsors. AerCap, now the second-largest aircraft lessor by managed fleet count, was purchased by Cerberus in 2005 and subsequently went public in 2006. Avolon, the third-largest lessor, was owned and formed by a consortium of sponsors in 2010 before going public in 2014. Recent media reports suggest that multiple Alt-IMs are eyeing GE Capital's $41 billion aircraft leasing business, GE Capital Aviation Services.
Still, Fitch believes that current aircraft leasing conditions are notably different than prior periods of elevated Alt-IM investment. Aircraft lessor credit fundamentals are solid, but Fitch is increasingly cautious given the growing prospect of a more challenging operating environment following a decade of low interest rates and largely benign economic conditions. The present environment is characterized by heightened competition pressuring lease yield and terms, and a greater number of lessors, including many not yet proven through a full economic cycle.
Alt-IMs continue to be attracted to aircraft leasing given strong return expectations and market forecasts of continued growth. According to the International Air Transport Association (IATA), revenue passenger kilometers (RPKs) are expected to grow 6 percent in 2019, which, while down from 8 percent in 2017 and 7.5 percent in 2016, remains above the 20-year annual growth rate. Additionally, airlines have increasingly elected to lease, rather than own, aircraft to increase operational and financial flexibility. According to Ascend, the percentage of global aircraft fleet under operating leases increased to 43 percent of the in-service fleet in 2017 from 20.4 percent in 1995.
However, investment performance could be challenged in the face of a deteriorating economic backdrop and the pace of Alt-IMs' new investments could slow until aircraft lessor valuations decline to more attractive levels. For example, in a stress scenario where more recent market aircraft leasing entrants seek to exit the space, private-equity sponsors could capitalize on their significant undeployed capital to facilitate industry consolidation.
Alt-IMs have invested in aviation finance assets in a variety of ways. Some view the industry as a longer-term strategic investment and have deployed capital through external management platforms and/or permanent capital vehicles. Apollo Investment Corporation (a business development company externally managed by Apollo Global Management) created Merx Aviation in September 2012. Last year, Carlyle acquired Apollo Aviation Group, which manages closed-end funds with 243 owned, managed or committed aircraft. If executed properly, these investments can provide Alt-IMs with a steadier source of fee income and potentially more flexibility to ride out cycles in the aircraft leasing industry.
See chart here.
Other investments include KKR's recent $1 billion capital commitment, primarily from its credit and infrastructure funds, to a joint venture with Altavair AirFinance to create a global portfolio of leased commercial aircraft. While this joint venture may exist for a number of years, fund-level investments generally have finite lives, which can lead to strategic and financial uncertainty as an investment nears the end of its hold period.
In assessing private equity-owned aircraft lessors, Fitch seeks to understand how the shorter-term investment horizon influences aircraft lessors' long-term operating strategy, risk appetite and leverage tolerance, among other considerations.