Valuing Aircraft Asset-Backed Securities (ABS)

Deconstructing the ABS Structure

Aircraft asset-backed securities (ABS) are complex financial instruments that are backed by a portfolio of aircraft leases. To value these securities, it is first necessary to understand their structure. A typical aircraft ABS will have multiple tranches of debt, each with a different level of seniority and a different credit rating. The most senior tranche will have the first claim on the cash flows from the underlying leases and will therefore have the highest credit rating and the lowest yield. The most junior tranche, or equity tranche, will have the last claim on the cash flows and will therefore have the lowest credit rating and the highest potential return.

Analyzing the Underlying Collateral

The value of an aircraft ABS is ultimately derived from the value of the underlying collateral—the aircraft themselves. Therefore, a thorough analysis of the collateral pool is the first step in the valuation process. This analysis should include:

• Aircraft Type and Age: The mix of aircraft types and ages in the portfolio will have a significant impact on its value. A portfolio of new, in-demand aircraft will be more valuable than a portfolio of older, less popular models.
• Lessee Credit Quality: The credit quality of the airlines that are leasing the aircraft is another key factor. A portfolio of leases to strong, investment-grade airlines will be more valuable than a portfolio of leases to weaker, unrated carriers.
• Lease Terms: The remaining term of the leases in the portfolio will also affect its value. A portfolio with long-term leases to strong credits will be more valuable than a portfolio with short-term leases.

Forecasting Cash Flows

Once the collateral has been analyzed, the next step is to forecast the cash flows that will be generated by the portfolio. This involves forecasting the lease payments that will be received from the airlines, as well as the residual value of the aircraft at the end of their leases. The cash flow forecast should also take into account any potential defaults by the airlines.

Applying a Discount Rate

The final step in the valuation process is to apply a discount rate to the forecasted cash flows. The discount rate should reflect the riskiness of the cash flows. A higher discount rate should be used for a riskier portfolio. The appropriate discount rate will depend on a number of factors, including the credit rating of the ABS tranche being valued, the current level of interest rates, and the investor's own risk appetite.

A Holistic Approach

Valuing an aircraft ABS is a complex process that requires a deep understanding of the aviation industry, as well as a sophisticated knowledge of structured finance. It is not a task that can be performed with a simple spreadsheet. A robust valuation will require a holistic approach that combines a thorough analysis of the underlying collateral with a rigorous cash flow forecast and a thoughtful application of the appropriate discount rate.