Airline Industry 105: Basics of Aircraft Leasing

Class is back in session 🙂

Today’s topic: Aircraft Leasing.

Leasing Aircraft has been a mainstay of the Airline industry for more than twenty years. Despite this, not many people – even in airlines themselves – know much about leasing. So, following a straw poll among some friends about what they’d like me to explain, I’ll outline the basics of Aircraft Leasing. One point on the scope: I’ll only be dealing with the leasing of commercial aircraft for airlines – I will not talk about corporate jet leasing or helicopter leasing (because frankly I know very little about them :-))

 

Aircraft leasing is broadly divided into two categories

1. Finance Leases
2. Operating Leases

Finance Leases

The key aspect of Finance Leases is that at the end of the lease term, the aircraft belongs to the airline. Finance leases are identical in concept to the mortgage on a house. The airline pays an agreed amount every period and once the term is over, ownership of the aircraft is transferred to the airline.

Finance Leases are sometimes done by leasing companies but for the most part they are used by lending institutions such as banks through Special Purpose Vehicles (SPVs).

A typical finance lease is 10-12 years long though they can sometimes be as long as 15-18 years.

When an airline takes out a finance lease, they take on the risk of what the future value of the aircraft will be (Residual Value risk). If the values hold or climb in the market, then the airline can sell the aircraft and make some profit on disposal. If the values drop, then it’s the airline that takes the hit and makes the loss. In reality, the only control the airline can exert on their residual values is to manage their depreciation of the aircraft on their books and in choosing when they will sell the aircraft. Beyond that, the market is what the market is.

Operating Leases

Operating Leases are what most people are referring to when they speak of Aircraft Leasing. Operating Lessors own roughly 40% of the aircraft being flown today. While there are several leasing companies in the world, the top 10 lessors by size and fleet value own easily 90% of the leased aircraft in service. Of these ten, the largest two are GECAS (GE Capital Aviation Services) and AerCap. Between them they own and manage (on behalf of other owners)  over 3000 aircraft – roughly 60% of the leasing market. This portfolio is in the region of $90-100 Bn in value.

There are two main types of Operating leases: Wet Leases and Dry leases. (Occasionally there is a sub category known as a Damp lease but it is usually just a modified Wet Lease)

In an Operating Lease, the Airline takes the Operating Risk (due to delays, cancellations and the inability to operate) while the lessor takes the Residual Value risk.

Wet Leases

These are also known by their more technical term – ACMI leases. They are short term leases (anywhere from a week to a few months) where the lessee pays a rate to the lessor covering the Aircraft, Crew, Maintenance and Insurance. Other costs such as fuel and handling fees are the responsibility of the lessee airline. In a wet lease, the airline lessee does not take control or registration of the aircraft, it remains under the control of the lessor.

Typically the lease rate is charged per hour of operation with a guaranteed minimum number of hours per week or per month. Wet leases tend to be quite expensive. Depending on the season, a wet lease of a wide body aircraft could be as high as $9,000-10,000 per hour of operation. Because of this, airlines only tend to go for wet leases in unusual or unexpected circumstances. Some of these (but not all) may include:

– Unexpected maintenance on an aircraft in the fleet that takes it out of service at a time when bookings are full

– A delay in delivery of an aircraft that has been planned for operations

– Trying out a new aircraft type before committing to a longer term lease or purchase

– Beginning operations before you (as the airline) have your own regulatory approvals to operate – such as an Air Operator’s Certificate (AOC)

Dry Leases

Dry Leases are by far the most common form of operating leases. Leases are medium to long term (typically 4 to 15 years). The aircraft is placed with the airline who register it under their name with their regulatory authority and take full operational control of it (Ownership still remains with the Lessor though).

The lease agreement with include commercial terms (such as rent and security  deposits) and technical terms (such as requirements for maintenance, insurance and conditions at return). Subject to the airline lessee meeting these terms, the lessor will grant Quiet Enjoyment whereby the let the lessee operate the aircraft without any interference.

Most of the payments made – especially Rent – are made on a monthly basis. While there are variances depending on the agreement between Lessor and Lessee, the rent is typically a fixed amount that will be paid every month for the duration of the lease.

A typical clause found in a lease is a “Hell or High Water” clause. Basically it places an obligation on the lessee to pay the amounts due to the lessor ‘come hell or high water’. So whether or not the lessee operates the plane – whether or not they are profitable – they have to meet their obligations under the lease or face mutually agreed penalties.

Operating Lessors acquire their aircraft in one of three main ways:

1. Speculative Orders – The Lessor places an order for aircraft with the manufacturer before they have found an airline to lease it from them. They then send their teams out to market the aircraft to airlines who can then sign up to lease them from the day they are delivered. The lease rental is determined partly by the market and partly by the price the Lessor has negotiated with the manufacturer (not to mention what return they are seeking)
2. Sale and Leaseback (SLB) – In this instance, the Lessor buys the aircraft from the airline (which either owns it or has a commitment to buy it) and then leases it back to them. The lease rent is directly linked to the purchase price agreed though some times competition can affect it.
3. Lease novation – This is a transaction between two lessors without the airline’s significant involvement. One lessor will sell the aircraft to the other with the lease attached.

This ends this lesson on the basics of Aircraft Leasing. Please feel free to ask any questions and I will do my best to expound or clarify.