New aircraft don’t come cheap. The average price of a new Airbus 320neo last year was $110 million (€101 million) while a Boeing 737 Max-8 was even more expensive at $121 million. These are not the kind of purchases a company can fund out of petty cash. Alternative sources of finance must be found to augment whatever cash reserves are available.
According to Prof John Cotter of the UCD School of Business, there are two principal ways for airlines to finance their fleets. “The first is by going to the capital markets to borrow to buy aircraft and the second is to go to a leasing company which purchases the aircraft and rents it to the airline.”
That latter option has been growing in popularity over the years and it is estimated that more than 50 per cent of all commercial aircraft in service around the world are leased.
Leasing can offer significant advantages over direct ownership. “Many airlines don’t want depreciating assets with fixed costs on their balance sheets,” Cotter says. “They want to rent the asset and use it rather than own it. The projections are that leasing’s share of the market will increase further. The leasing companies have good investment grade credit ratings and can borrow at pretty low rates to buy aircraft.”
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David McGovern, partner and head of aviation and asset finance at Mason Hayes & Curran, also points out that leasing not only reduces the initial financial outlay for the airline, but it also places the long-term ownership risk with the lessor.
Leasing can also be very suitable for airlines with lower credit ratings that might have difficulty in accessing the capital markets to borrow for aircraft acquisition.
“It is very airline-dependent,” adds Joe O’Mara, head of aviation finance with KPMG. “Most US airlines have the benefits of being able to raise funding in the capital markets, as do some larger players. For most other airlines, they will utilise the traditional aviation banks, as well as structured products such as enhanced equipment trust certificate (EETC) funding.”
An EETC is a structure where a trust is set up to purchase aircraft and other assets that are leased to an airline. Investors in the EETC receive a share in the leasing payments made by the airline over a defined period. Ownership of the aircraft typically passes to the airline once the debt is satisfied at the end of the leasing period.
Flexibility
“The pandemic highlighted the benefits of leasing in providing flexibility to airlines and showing that they could work closely with lessors over the course of the crisis in helping airlines manage their liquidity challenges,” O’Mara says. “The leasing sector, along with the various government supports that were provided, was crucial in ensuring that many airlines were able to survive the past couple of years. We see and hear from our clients about how the pandemic brought lessors closer to their airline customers. Given the majority of leased aircraft are owned out of Ireland, that is a great positive for our economy.”
Despite rising interest rates and tightening credit availability, McGovern doesn’t believe the balance of funding sources is likely to change significantly. “I suspect the mix will remain broadly similar,” he says. “While it will be more expensive for airlines to raise debt directly from commercial lenders, lease rentals will reflect the same rise in interest rates as leasing companies will seek to pass their borrowing costs on to airlines. Globally, it is more expensive to borrow than it was a year ago. These costs will ultimately be passed on to airlines if they require additional aircraft to meet rising demand.”
Of course, the leasing companies also need to raise funds to purchase aircraft. “Larger investment grade leasing groups can access unsecured funding from the capital markets at very attractive rates,” says O’Mara. “Over the course of 2021, leasing companies very sensibly raised over $36 billion in the US bond markets at rates which on average were around 2 per cent. There were fewer issuances in 2022 given the level of liquidity that was raised the previous year, but it is a market those larger lessors will return to in 2023.”
The asset-backed securitisation (ABS) market is another important financing tool for the leasing sector. Asset-backed securities involve a company bundling a number of aircraft leases together into a product which is then sold on to investors who share in the lease income over a specified period of time. This allows the lessors to refinance borrowings and purchase more aircraft with the proceeds.
“The ABS market came back very strongly in 2021 with over $9 billion in funding raised by leasing groups, but the general ABS market was challenging in 2022, not just for aviation,” says O’Mara. “As such, we saw less than $2 billion raised in 2022. It will be interesting to see how that market comes back in 2023. It is an important financing option for leasing groups.”
Some of them have their own sources of finance. “Certain leasing companies are affiliated with commercial banks, and they would obtain the majority of their funding internally,” McGovern says. “The majority, however, would seek to access the full array of options available including private equity investment, debt and capital markets.”
Other sources are coming into play as well. “The traditional aviation banks are still active in the market, and we have also seen an increase in non-traditional lending platforms,” O’Mara notes. “These alternative lenders have generally been US private equity backed and highlight the attractiveness of the sector as investors look to play in different areas of the capital stack of leasing groups. We expect this trend to continue into the near future.”
Shifting market conditions may change that, however. “There has been greater risk in the last few years due to Covid restrictions, the war in eastern Europe and so on,” says Cotter. “Some private equity funds might have decided that the aviation finance market is a bit too risky, but others might decide that there are higher returns to be made from that increased risk.”
One door closes and another opens. Finance might be more expensive and a little bit harder to come by for some companies, but it appears there will be no shortage to fund aircraft purchases now and in the future.