Could you provide us an industry average and details on how the following matrices vary for Aircraft lessors specific to Indian Aviation Market:
a) Aircraft Lease Rate factor, Aircraft Lease terms
b) Operating margin
c) Maintenance reserves/ Return conditions
d) Operating expenses
e) Cost of funds
Aircraft Lease rate factor, Aircraft Lease terms: Types of Aircraft Leases There are primarily three types of Aircraft Leases: (i) ACMI (Aircraft, Crew, Maintenance, and Insurance), or the wet Aircraft Lease; (ii) dry Aircraft Lease; and (iii) damp Aircraft Lease.
A. Wet Aircraft Lease or ACMI - In the case of wet Aircraft Lease or ACMI, the lessor, or the company leasing out the Aircraft, supplies the crew, including pilots, mechanics, and flight attendants, as well as repAirs and insurance, to the lessee, or the company/Airline operator who takes the Aircraft on Aircraft Lease. The crew's wages are paid by the lessor, not the lessee. However, the lessee is responsible for the costs of petrol, parking, landing, and so on. If the plane is flying or not, the lessee must pay for the minimum promised block hours set by the lessor.
B. Dry Aircraft Lease-Dry Aircraft Leases do not require crew, repAirs, or insurance. A dry Aircraft Lease normally has a term of more than two years. There are two categories of dry Aircraft Leases: working and financing. An Aircraft is rented only for a limited amount of time relative to the entire life in the case of an operational Aircraft Lease. For example, if an Aircraft had a life expectancy of twenty (20) years, it will be Aircraft Leased for approximately eight (8) years. The lessee returns the Aircraft to the lessor at the close of the leasing term, and there is no way to purchase the Aircraft. A finance loan, on the other hand, is a long-term Aircraft Lease under which the lessee has the option to buy the Aircraft at the end of the leasing period.The Aircraft Lease payments are in excess of 90% of the market value of the Aircraft and the term of the Aircraft Lease is over 75% of the Aircraft’s usable life.
C. Damp Aircraft Lease - A damp Aircraft Lease is a wet Aircraft Lease under which the lessor pays repAirs and protection on the Aircraft it rents out but does not give a crew to the lessee. However, in order to provide initial instruction to the lessee's crew, the lessor can sometimes provide a teacher on board for a short period of time.
Operating Margin: The operating margin, also known as operating profit, operating profit margin, or return on sales, is a ratio which is used to measure how profitable a business is. The operating margin shows what percentage of revenue is left once a company accounts for costs of goods sold and operating expenses, but before interest and taxes – i.e., a company’s EBIT. The current operating profit margin for Air Aircraft Lease as of December 31, 2020 is 25.61%.
Operating margin for Air Aircraft Lease over last 10 years
Maintenance reserve/ reserve conditions: Maintenance reserves are payments made by the lessee to the lessor to accrue for those scheduled major maintenance events that require significant Aircraft grounding time and/or turn-around time for certain major component overhauls. Put another way, maintenance reserves are payments for maintenance utility1 consumed and can be expressed as follows for a particular maintenance event:
Mx Reserves = Mx Utility Consumed
OR
Mx Reserves = Full-Life Mx Value – Mx Utility Remaining
A Aircraft Lease agreement will specify what maintenance events are to be covered through payment of reserves and for which the lessee may draw down against the accrued amounts. Areas of maintenance typically covered by reserves are as follows:
o Airframe Heavy Structural Inspections
o Landing Gear Overhauls
o Engine Performance Restoration
o Engine Life Limited Parts (LLPs)
Auxiliary Power Unit (APU) Restoration
The contractual position relating to maintenance reserve is always a subject of intense negotiation. Many Airlines have sufficient credit stature that their prominence in the marketplace means they can reject paying maintenance reserves. On the other hand, lessors will show less flexibility for weaker credit lessees and require these operators to pay maintenance reserves.
Maintenance reserve payments are calculated on flight hour, flight cycle, and/or calendar basis and are usually paid on a monthly basis in arrears. Accumulated reserves are reimbursed (subject to limitations) after major maintenance events are completed.
Operating Expense: sometimes referred to as selling, general, and administrative (SG&A) Expenses, refers to expenses that a business incurs to function on a day-to-day basis. In other words, expenses from normal business operations. Costs of goods sold are not considered operating expenses, nor are capital expenditures. In case of lessor around 2/3 of the total cost are direct cost, while the remaining cost is indirect coat.
Csost of fund: The cost of long-term borrowing has increased in recent months due to regulatory changes and economic uncertainties. Another trend experienced by the industry is the decrease in LTV ratios. While it was possible to leverage assets up to 85%+ in the past, recent deals have been as low as 65% on certain narrow body assets which affects both funding scarcity and concern over residual value.
Airlines will need to be prepared for increased costs for new fleet acquisitions or even situations of costs increasing for existing financing.
A continued focus by Airlines on driving down operational costs in an era where the cost of a barrel of fuel in excess of $100 is the ‘new normal’ and with fuel now representing a third of total operating costs. This has driven the demand for new technology Aircraft with innovative improved composites and more fuel efficient engines.
Cash and equity financing by Airlines has not been as popular in the recent past. The primary reason for this is the necessity for Airlines to have reasonable cash buffers to cover normal operations and be able to deal with unusual situations (e.g. volcanic eruptions, earthquakes, SARS) which put significant strain on the business.
The Basel accords are the global regulatory framework which aims for more resilient banks and banking systems through harmonised capital adequacy requirements. The new Basel III changes will be enforced gradually from 2013. For Airlines, the effect of Basel III could translate into higher loan pricing as banks pass on higher liquidity costs. It is hard to quantify its specific impact precisely as lending rates are an interplay of bank risk costs, liquidity costs, access to currencies.As a result, Airlines may have to cope with increased loan pricing and a more challenging funding environment.
2.) What is typical cost structure and profitability for an Aircraft lessor?
Ans: Aircraft lessor is a firm that provides physical planes on rent, rather than them buying a plan by themselves.
An Airline would not have to pay the total cost of an Aircraft ( for example a brand new A380 costs $444 million, a Aircraft Lease significantly less so). leasing Airlines buy so many Aircraft that they get them up to 70% off from manufacturers. There can be different costs for different types of Aircraft Lease:
• Dry Aircraft Lease: In this type, the lessor provides the only Aircraft to the Airline.
• Wet Aircraft Lease: In this type, the Aircraft comes with fuel, crew, insurance and operations as well.
• Damp Aircraft Lease: In this type, some services between crew and maintenance are provided.
Profitability:
Extra money left on the top after reducing the cost from revenue is the profit. For a leasing company to make a profit, it must manage its risk and exposure. Following are some income stream for the lessor:
• Airline Aircraft Leases: By rent out a plane for a Aircraft Lease starting from five to fifteen years
• Airline sales: After completes its useful life with an Airline leasing company, they can sell on the plane. Now they are more like houses than luxury car. They do not depreciate quickly if maintained correctly.
• Part sales: if they can't sell the plane, they can break it down into spare parts. some parts are rare and useful and can be sold at a high price.
Following are some risks involved:
• Cost of Airline: The first cost is the cost of the Aircraft itself; they must require a high capital.
• Asset recovery: If after lending an Aircraft lessee become bankrupt then the lessor has to pay to recover the asset.
• Currency conversion: Because these Aircraft Leases are over 5-15 years at a time, leasing agencies need to account for different currencies. If they lent to a country’s Airline that suffered an economic crisis, they might be left short.
3.) What is the typical transaction structure in leasing an Aircraft? Who are the key stakeholders in the transaction?
Following are some typical transaction structures in leasing an Aircraft:
• Secured Loan (Commercial bank finance): It is a basic kind of loan in which, the lender makes a loan to the Airline or leasing company to purchase an Aircraft. The loan is secured by the mortgage or any other security interest over the Aircraft. The Airline or leasing company owns the Aircraft and have full rights to operate it and Aircraft Lease it to any other party. here a diagram to explain further:
• Operating Aircraft Lease: In an operating Aircraft Lease, there is no transfer of ownership. Ownership remains with the lessor. hence, all the risk and rewards incidents remain with the ownership of the Aircraft. It includes "dry Aircraft Lease" and "wet Aircraft Lease".
• Finance Aircraft Lease or capital Aircraft Lease: In this Aircraft Lease structure an owner or lessor buys an Aircraft from manufacturer which it Aircraft Leases to an Airline or any other lessee. Following is the detail structure:
Rent payments return all or substantially all of the purchase price.
The lessee is required (or at least expected) to purchase Aircraft at the end of the term.
• Leveraged Aircraft Lease: A leveraged Aircraft Lease is similar to a finance Aircraft Lease except that in these transactions, lenders provide the owner or lessor (typically an owner trust owned by equity investors, also known as owner participants) with loans to cover a portion (typically 70% to 85%) of the acquisition cost of the Aircraft being purchased from the manufacturer. The balance of the Aircraft’s acquisition cost is provided by the owner participants. The owner trustee uses the Aircraft Lease payments it receives to repay the loans. The obligations of the owner or the lessor under the loan agreement are secured by:
A first priority lien on the Aircraft and related assets.
Its rights to receive payment from the lessee under the Aircraft Lease
• Sales Aircraft Leaseback: In this kind of Aircraft Lease, an Airline sale its used Aircraft or its right to purchase a new Aircraft from manufacturer to leasing company. This Aircraft Lease used when an Airline needs flexibility or need to raise capital.
• ECA loans: ECA loans are provided to promote exports of Aircrafts by ensuring that the Aircrafts are going to be purchased by foreign buyers. ECA can make either a direct loan or guarantee loan by another lender.
An ECA financing transaction may be structured either as an:
Airline leasing transaction. In this structure:
A foreign owner or lessor buys an Aircraft from a manufacturer with the proceeds of an ECA direct loan or an ECA guaranteed loan;
The foreign owner or lessor Aircraft Leases the Aircraft to an Airline or lessee pursuant to a finance Aircraft Lease (see Finance or Capital Aircraft Lease); and
The rent payments the Airline or lessee makes under the finance Aircraft Lease are used to repay the ECA direct loan or the ECA guaranteed loan.
Leasing company transaction. In this structure:
A foreign leasing company buys an Aircraft from a manufacturer with the proceeds of an ECA direct loan or an ECA guaranteed loan
The foreign leasing company often Aircraft Leases the Aircraft to another entity (the lessee or sublessor), typically an affiliate or subsidiary of the leasing company which further Aircraft Leases the Aircraft to the Airline or sublessee under an operating Aircraft Lease (see Operating or True Aircraft Lease)
The rent payments the Airline or sublessee makes under the operating Aircraft Lease are used to repay the ECA direct loan or the ECA guaranteed loan
Stakeholders involve in different types of transactions:
• Secured loan: Manufacturer, Airline/leasing company, lender
• Operating Aircraft Lease: Manufacturer, Airline/leasing company, lender
• Financing Aircraft Lease: Manufacturer, Airline/leasing company, lender, participate beneficiary
• Leverage Aircraft Lease: Manufacturer, Airline/leasing company, lender, participate beneficiary, lender
• Sales Aircraft Lease back: Manufacturer, Airline/leasing company, lender
• ECA: Manufacturer, owner participant, owner/lessor, Airline/lessee, ECA, ECA lender
4.) What are the key entry barriers and competitive intensity in Indian Aircraft leasing market?
Ans: Following are the key entry barriers and competitive intensity in Indian Aircraft leasing market:
• Huge initial cost involve: The biggest barrier for the industry is that it involves a huge initial capital to purchase and maintain the Aircraft, and provide other rental services:
Aircraft purchasing cost
Direct operating expenses:
Fuel and oil
Maintenance cost
Handing fees
Crew expense
Passenger and cargo expenses
Indirect operating expenses:
Flight crew pay
Cabin crew pay
Maintenance labour
Handling cost
Overhead: Overhead cost for accounting and other administrative expenses
• Loss due to client’s loss: If after provide Aircraft on Aircraft Lease, client gets bankrupt. In this situation to recover our asset we have to pay money.
• Currency conversion: Because these Aircraft Leases are over 5-15 years at a time, leasing agencies need to account for different currencies. If they lent to a country’s Airline that suffered an economic crisis, they might be left short.
5.) How prevalent are Aircraft repossession by lessor? How does it impact the Aircraft value and Aircraft profitability?
Ans: Repossession can be done in the following cases:
• Expiry of its term
• Default in payment by the lessee
• The bankruptcy of the lessee
Expiry of its term: This situation is depending upon the type of Aircraft Lease provided. In the case of the financial Aircraft Lease, there is no need for repossession of the Aircraft. lessee purchases the Aircraft after the end of its Aircraft Lease period. In the case of operating, Aircraft Lease repossession can be at the end of its period. But generally, companies used financing Aircraft Lease.
Default in payment by the lessee: In this case, the lessor has a right to repossess its asset, but in case the lessee tries to stop him physically he can't take it. Then he has only one option to opt legal route to recover its assets. He can file a lawsuit against the lessee and ask to start the procedure of bankruptcy.
The bankruptcy of the lessee: In the case lessee got bankrupt, now lessor has a right to recover its asset as per the bank's procedure.
Aircraft value and its profitability doesn’t have any impact if proper records are maintained by the lessor. Because if there is records left for the Aircraft it becomes value less.
6.) What are key considerations in an asset selection and portfolio management for Aircraft lessor?
Ans: Following are the consideration in an asset’s selection:
• Investment horizon
• Risk tolerance
• Diversification
• Costs/Expenses
• Investment vehicle
• Rebalancing
• Guidance
Portfolio of an Aircraft lessor:
• Aircraft Lease technical negotiations
• Management of Aircraft physical delivery and redelivery and lessee contractual compliance
• Periodic monitoring of Aircraft utilisation and maintenance status and lessee technical obligations
• Administration of lessee commercial, operational and insurance obligations including control of Aircraft Lease rent, reserves and other receivables
• Appraisals and trading-based valuations
• Asset repossession, including Aircraft valuation, records management, deficiency claims and Aircraft recovery & Storage
7.) Why the leading global players like Aercap and SMBC aviation capital have very small presence in the Indian market?
Ans: India has a huge demand for Aircraft Leased Aircraft, but we have a very presence of lessors in the country. Many of the leading brands have a presence in single-digit number. Indian operators have outstanding orders for a total of 958 new Aircraft at 17-Oct-2018, led by IndiGo's 415 orders, according to the CAPA Fleet Database.
Commercial Aircraft orders in India by the operators
Typically, this is either because no operator has yet been identified (the order could be thought of as speculative), or because the lessor and/or operator do not yet wish to reveal the operator's identity for commercial reasons. A related point is that orders placed by operators often end up as lessor-owned following sale and Aircraft Leaseback transactions.
Bhawana Aggarwal [MBA IIM-s]
Manager FinTech
AirCrews Aviation Pvt. Ltd.
Bhawana@Air-Aviator.com
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