Special Report - Opportunities in Aircraft Leasing
About 30% of the world’s aircraft are owned by leasing companies and there are several reasons why most observers expect the number to increase.
Most obviously, lease rates have come down sharply in recent years, particularly for larger aircraft. With interest rates remaining low, they will continue to be attractive for some time.
Additionally, the financial market is only just recovering its lending strength for purchases. “When the funding market became dislocated last year, we saw a huge demand for sale and leasebacks,” says Robert Martin, Managing Director and CEO of BOC Aviation. “From December 2008 to February 2009, we committed to 45 aircraft via sale and leasebacks that total $2.5 billion.”
Sale and leasebacks have advantages for both airline and leasing company. The former improves cash flow while the latter avoids pre-delivery payments and additional costs.
Martin says speed is now an essential requirement for leasing companies. On 10 December 2008, Southwest approached BOC Aviation to gauge its appetite for the sale and leaseback of 10 new Boeing 737s. “Less than two weeks later, we owned five out of the 10 aircraft,” says Martin. “By the end of the first week in January 2009, BOC Aviation had 10 aircraft on 12–16 year operating leases with Southwest.”
Proving the continuing emergence of leasing companies, Singapore-based BOC Aviation has acquired $14 billion worth of aircraft to date. It finances its purchases based on internal resources, supplemented by external financing obtained from a group of 42 banks, export-credit agency guaranteed debt, the Singapore bond market and its parent company, Bank of China.
Other factors in favor of the leasing market include the delays in delivering both Airbus and Boeing aircraft, which have also resulted in airlines having to lease aircraft as an interim measure.
However, growth in the leasing market will have to overcome a number of challenges. The global downturn led to a sharp rise in parked aircraft, for example, meaning there are still aircraft in the system. This has further dampened leasing rates meaning specialist companies are finding it hard to increase their charges.
There is also increased competition from the airlines themselves. The host of aircraft that many airlines ordered during the boom years of 2007/8 could lead to surplus. “This results in them leasing the aircraft out to other airlines and regions at low market rates to undercut the companies specialized in aircraft leasing such as GECAS and ILFC,” says Max Sukkhasantikul, a Consulting Analyst with the Frost & Sullivan Aerospace & Defense Practice.
Sukkhasantikul also notes airlines are increasingly interested in procuring their own assets as a range of financing options become available: “which may seem more viable in some cases than leasing an aircraft from a leasing company.”
And it may be that the market is shrinking even further as leasing companies look increasingly to more creditworthy airlines. Limiting their downside in such uncertain economic times also means lessors are looking to raise the security deposit and the maintenance reserve.
Despite this, leasing companies are generally posting strong profit margins, a trend that looks set to continue.
Leasing in a nutshell
There are a variety of leasing options. Operating leases come in wet and dry varieties, wet meaning the aircraft comes complete with a crew. Generally, operating leases are short term. So, aside from the obvious benefits in reduced outlay, a lease means airlines can access the latest aircraft, which can be critical in such a competitive, dynamic market.
Normally, airlines pay a deposit as part of the leasing agreement, but they do not tie up huge amounts of capital in pre-delivery payments (PDPs). Different accounting rules around the world mean the leased aircraft is treated in different ways but essentially airlines can’t raise capital against it.
Finance leasing, however, allows an airline to view the leased aircraft as an asset. It usually comes with the option to buy the aircraft at the end of the leasing agreement and gives an airline ownership rights if the lease payments are a sufficiently high proportion of the aircraft’s full value. Lessors are happy with the deal, too, as it can give them significant tax deductions.
Sale and leaseback is becoming especially popular. An airline simply sells its aircraft and then immediately leases it back. For example, Jet Airways has received proposals for the sale and leaseback of 10 Boeing 737s from a selection of leasing companies, according to Jet Airways’ Vice President of Commercial Strategy and Investor Relations, K. G. Vishwanath. He has confirmed the airline intends to sell and lease back 20 of its 737s soon.
And if there is a problem with any leasing deal, the Irish High Court has become the international centre for aircraft leasing disputes. It will mediate on all related matters regardless of the originating country. The agreement forms part of the Cape Town Convention.
Confidence in the Cape Town convention
The Cape Town Convention is crucial to new aircraft financing. The Convention came into effect in March 2006. Its original eight signatories (Ethiopia, Ireland, Malaysia, Nigeria, Oman, Panama, Pakistan and the United States) have been joined by many others, including the European Union and China.
In essence, the Convention standardizes transactions involving mobile property. “Cross-border deals are complicated by the variety of approaches by local legal systems to security and title reservation rights, which either do not protect lenders in the event of default or are unpredictable,” says Louise Mor, an Asset Finance Associate at White & Case in the Energy, Infrastructure, Projects and Asset Finance Group. “The Convention aims to reduce creditors’ uncertainty by providing secure and readily enforceable rights in aircraft, consistent across all states which have ratified the Convention.” This means borrowers can raise funds more cheaply if they are located in a country which has ratified the Cape Town Convention.
Savings to the airlines are a key benefit of the Convention. “New Zealand is currently considering whether to accede to the Convention, and a New Zealand treasury report has put the savings to the aviation industry in New Zealand alone over the next five years at anywhere between $13 million and $233 million (NZD18–325 million),” says Mor. “The bottom end being the potential savings from reduced Export Credit Agency (ECA) premiums, and the top end being the potential savings from lower interest rates.” IATA estimates savings from the Cape Town Convention could run into billions of dollars.
From an airline point of view, the more countries that ratify the Protocol the better. Progress was slow but it now appears to be accelerating. “There are currently 35 states which have ratified the Convention, with the Convention coming into force in four of those countries in 2010 so far,” Mor informs. “The momentum of the ratification process does not seem to be diminishing.”
Special Report - Aircraft Financing