Buying or leasing? That’s the question

Leasing of aircraft has taken a jump. Yet airlines prefer to buy them outright too. Richard Schuurman looks at the trends. Over the half a century of airliner leasing it has been a booming business. “In 1970 a half of one percent of the world’s fleet was leased. In 2017 this has grown to 39 percent and in 2018 to 41 percent”, says Boeing’s vice-president marketing commercial airplanes Randy Tinseth. “However, there are some regional differences. In the US 24 percent of all single-aisle aircraft is leased compared to 76 percent in Russia or even 80 percent in India. It reflects the financial situation of the airlines”. Those airlines with cash and resources prefer to buy, as owning aircraft adds the asset to their balance sheets. With a combined profit of $15,7Bln in 2017 US airlines are buyers more than leasers. On January 1, 2018, Delta Airlines had leased just 192 aircraft of its 856 strong fleet, United 215 out of 737 and American Airlines 411 out of 930. It’s the same at other cash-strong airlines: Lufthansa Group had 116 leased aircraft in a 728 fleet, International Airlines Group (IAG) 263 leased versus 283 owned. In January 1, 2018, Delta Airlines 856 strong fleet counted just 192 leased aircraft. (Delta Airlines) It’s slightly different at AirFrance/KLM, with 344 leased out of 545. The French/Dutch group takes a flexible approach: “In most cases, leasing aircraft is more expensive, but if you want fleet flexibility leasing is more attractive as you can add or drop capacity more easily”, an airline spokesperson says. It also depends on which financial options are around. Early 2018 KLM concluded a financial arrangement with the European Investment Bank (EIB) for the purchase of Embraers. “It’s an attractive loan or guarantee for €250Mln to renew the KLM Cityhopper fleet. The agreement with EIB allows us to diversify our financial arrangements, which secures our access to funds for fleet renewal in the future as well”. Ryanair is different again: of its 431 strong 737-fleet only 31 are on lease, most other aircraft are financed through the airlines’ own resources or loans guaranteed from the US Export-Import (Ex-Im) Bank. Growing league Still, there is a growing league of airlines that prefer leasing. This might be a financial lease where airlines will eventually own the aircraft after paying monthly fees for a specific period of time. Most popular is the operating lease, where the leasing company always remains the owner. Depending on aircraft type an operating lease runs 8-10 years. Operating leases took off in the eighties and nineties thanks to Guinness Peat Aviation (GPA) and International Lease Finance Corporation (ILFC). They have merged since with different lessors, while dozens more have entered the market. Boeing counted 153 lessors in its Current Aircraft Finance Market Outlook released early December 2018. Despite ongoing reports that it will be sold, General Electric Capital Aviation Services (GECAS) ranks as #1 with a fleet of 1.685 fixed wing aircraft. At 1.060 aircraft AerCap cleared the 1,000-threshold in June, with 411 more on order. Air Lease Corporation (ALC) involves former ILFC-boss Steven Udvar-Hazy and owns 320+ aircraft, with more on order. “Boeing came to us and said: ‘At the pace you are leasing them you’re running out of MAX’. So we decided to order 75 more”, explained Udvar-Hazy at a Farnborough Air Show ceremony. There are less familiar names, but still all major lessors. Like BBAM Aircraft and Leasing Management, partly tied to Japanese investors as well as to the Onex private equity funds. It has a fleet of 476, not including 86 from its partner FLY Leasing Limited. Avolon is Dublin-based, but Chinese owned by HNA affiliate Bohai Capital Holding, and since a few months by Japan’s ORIX Aviation, itself owner of 230 aircraft. Despite recent cash issues at parent HNA Avolon aspires a top three ranking, growing its owned/managed fleet of 571 airliners by some 383 more. Singapore-based Bank of China’s BOC Aviation (295 owned aircraft, 163 on order), CDB Leasing (216 owned, 190+ on order) or China Aircraft Leasing Company (112 owned, 192 on order) are other strong parties from Asia. Don’t forget SMBC: Dublin-based, but Japanese owned by Sumitomo and a fleet of 665 airliners. After a few year’s absence more Japanese investors have returned, while there’s a growing presence from South Korea and the Gulf region. Dubai’s DAE secured new funds recently as it plans to double its fleet to 800 aircraft, having already doubled in size in just a few years. “Aircraft leasing has been a significant growth business over the last decade due to the significant amount of capital available to be deployed in the market, and the relative attractiveness of commercial passenger aircraft as an asset class”, says Bombardier’s vice president commercial operations Ross Mitchell. The downside is there are “quite a few tourists in this sector”, AerCap’s CEO Aengus Kelly remarked, referring to new entries from Asia. More competition is good for airlines as lease rates go down, but it hurts lessors’ profitability. “It is a very competitive market. The Chinese have been very aggressive, but you have large leasing companies in the West. We never have had any problem with aircraft financing”, says Bill Franke of Indigo Partners. Sale and leaseback Which comes in handy, as Franke (81) is looking to finance his order for 430 Airbus A320neo-family aircraft announced at the 2017 Dubai Air Show. Franke is clear about one thing: not a single Airbus will enter the balance sheet of the four airlines that will take delivery of them, Wizz Air, Frontier, JetSMART and Volaris. Instead of buying, Franke prefers a sale and leaseback (SLB), in which an airline orders the aircraft from the manufacturer, sells it to a lessor just before delivery and enters into an operating lease for a specific period. Indigo Partners' Bill Franke (left) and Airbus CCO John Leahy at the 2017 Dubai Air Show announcement of an order for 430 neo's. (Richard Schuurman) “What’s the most valuable thing you have as an airline? That’s your capital! You have to be very thoughtful about your capital and how you manage it. Airplanes have a value at the time you buy them. That value depreciates over time, particularly at the time when the manufacturer is changing the model. So you are going from a ceo to neo at Airbus and to a MAX at Boeing. That’s why we are buying aircraft that are having a sustained value over time and that’s why we do sale and leasebacks”, Franke explains. The SLB-market has been buoyant with both airlines and lessors. Of all Airbus aircraft delivered in 2016, 61 percent were on SLB. Boeing’s latest outlook says 25 percent of all its deliveries are as SLBs. Notably, low-cost carriers seem to prefer this arrangement. In 2017 Norwegian sold and leased back 45 Boeing 737-800s to improve its cash position. Jetblue has 40 Airbus jets financed like this. Air Asia has sold off its entire leasing company to BBAM, leasing back 79 aircraft in service plus 98 on order: “When we bought these planes, our gearing was high and some people could not see why we wanted to own these assets. This deal shows it was the right strategy as we have something of value to dispose of in return for cash and an equity relationship in two great companies, while removing residual risks”, CEO Tony Fernandes said of the $1,18bln deal. There has been some discussion about whether SLB will remain attractive. Lease margins have declined and from January 1, 2019, IFRS16 accounting rules come into effect, dictating the value of any leased object to be included as an asset on the balance sheet. Late in 2017 Deloitte, Air Finance Journal and Euromoney undertook a survey: 59 percent think IFRS16 will have a significant effect on leasing, with 90 percent of airlines and lessors responding contracts might have to be re-negotiated and SLBs and operating leases replaced by more flexible forms of leasing. Almost half said leasing will become less attractive, but 48 percent expect airlines to buy more outright from OEMs again. Yet, a shift hasn’t been obvious from recent deals, with lessors still purchasing airliners at the same pace. Air Lease Corporation remarked at its Q3 presentation it continues to sign deals on long lead times for the 2020-2022 period. Value Short-term it’s been oil prices, currency fluctuations and, delivery issues that have impacted the buying/leasing market. A few years ago when oil prices and lease rates were low airlines extended contracts for older 737NGs and A320ceos. These aircraft were badly needed as Boeing and Airbus have been unable to deliver their MAXs and neos on time and engine issues hurt operational availability. But as deliveries started to pick up and oil prices have risen, the appetite for the newest airliners has grown. This could lead to a ‘bubble’ of airliner availability, UK consultant IBA has warned. Leasing contracts of some 10,000 airliners are set to expire in the next fifteen years, including some 2,000 737NGs and A320s by 2022. As new aircraft deliveries increase there could be way too many airliners available, slashing residual values of older types but also potentially leading to order cancellations or deferrals of new ones. Lessors have control over this bubble themselves. They can re-market aircraft once the original lease has expired, as GECAS and ALC do though dedicated ‘vehicles’ to serve the second-hand market. While it makes perfect sense for them to do so it creates an oversupply and affects the residual value and lease rates even more, giving investors a hard time to capitalize on their investment. There are a few ways out of this downward spiral. One is to reconfigure airliners into freighters. ALC sees 120-150 per year being converted to freighters, including 737NGs, A320s, and A330s. Alternatively, they are parked or parted out. Boeing's Kevin McCallister (left) and ALC's Steven Udvar-Hazy (centre) and John Plueger (right) announcing an order for MAX 8s and 787s in Farnborough 2018. (Richard Schuurman) Bubble or no bubble, order books have never been as filled as now, with Boeing, Airbus, Bombardier, Embraer, UAC, Mitsubishi and Comac having a combined backlog of over 16,000. Some orders will evaporate through cancellations, bankruptcies (Primera Air…), take-overs or lessors unable to fill ‘speculative orders’, where aircraft are ordered without a pre-defined customer. Some 20-25 percent of all MAX’ orders are ‘speculative’, Randy Tinseth confirms. IBA has seen more top lessors shifting to speculative orders in recent months. Kuwaiti lessor ALAFCO at last year’s Dubai Air Show ordered twenty ‘speculative’ MAX 8s, but deputy CEO Adel al Banwan isn’t worried: “Not at all. Year after year we see there is more flying, traffic has grown in this region. Airlines want to have the latest technology. Based on the interest of current and potential customers we place our orders”. ALC’s John Plueger confirms: “For our airline customers, the youngest, most fuel-efficient aircraft are the best hedge against rising fuel prices, and we see globally a renewed focus on the newest generation aircraft for this purpose.” Fifty percent or more? Buying versus leasing is on its way to reaching a 50/50 percent balance. Will there be a further shift? Likely so, most lessors think. As traffic doubles in the next two decades, aircraft will remain an attractive asset. In an October 2017 white paper, Avolon expects demand for 42,000 airliners and 800 freighters worth $4.200Bln, with 80 percent single-aisle aircraft, 14 percent double aisle (A330/A350/787) and 6 percent big widebodies (747/777/A380). Financing requirements will be some $170Bln each year. Airlines will finance only 9 percent outright while leasing companies have funds to finance 18 percent. With stricter rules for banks (especially within the EU), their share will drop from 51 to 36 percent. Hence more funds will come through capital investors and export credit facilities, increasing their combined share from 16 to 37 percent. Avolon sees a strong demand for new airliners and aspires a top 3 ranking amongst the world's biggest lessors. (Airbus) Avolon’s forecast is backed by Boeing’s latest outlook, which sees requirements grow from $126Bln in 2018 to $181Bln beyond 2023. In 2019 34 percent will be financed through banks, 30 percent by capital markets, 26 percent cash, 7 percent by export credits and 3 percent by manufacturer insurance. Avolon expects the share of leasing to reach 50 percent by 2026, something Airbus at 49 percent almost hit already in 2016. “Growth to fifty percent leasing is certainly feasible”, says Boeing’s Tinseth. “The focus will remain on single-aisle aircraft, but we see a growing demand for leasing of widebodies”. Bombardier’s Ross Mitchell expects more growth too: “Almost fifty percent of all in-service aircraft are now owned by lessors. We expect this to continue for the foreseeable future”. In particular, Bombardier sees more opportunity for smaller aircraft in the 60-150 seat market, which has been “under-served”. GECAS is more careful, says James Luton: “Since 2010 growth has leveled off with leasing penetration remaining at just under forty percent. Lessors have grown their fleets in absolute terms, however, the growth has been proportional to the total industry fleet growth. While a fundamental change in the current trend is unlikely, a significant market downturn could eliminate alternate financing sources, incentivizing an increase in leasing”. Steven Udvar-Hazy recently said he expects leasing to reach 60 percent market share. ALAFCO’s Al Banwan agrees: “It might go higher than fifty. If interest rates go up this will reduce the outright purchase from the airlines. The higher the interest rates, the more potential for lessors to penetrate into the market”.

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