FLY steers steady course in tumultuous leasing market | Analysis | Airfinance Journal

FLY steers steady course in tumultuous leasing market

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A year of heavyweight consolidation in the leasing industry has not made “any difference” to market conditions yet, says the chief executive officer of New York-listed FLY Leasing.

Prior to its takeover of AWAS, DAE Capital had a similar-sized fleet to FLY, but Colm Barrington makes light of the Middle East-based lessor catapulting ahead: “At least AWAS and DAE aren’t both competing against us!” he says.

“On a longer-term basis, larger companies that do become investment grade can possibly finance themselves a little more cheaply and that is something we have to be concerned about, but that’s why we’re sticking so much of our financing into the secured market which is cheaper for us.”

Another problem for smaller lessors – at least according to DAE Capital – is that they lack the scale to offer comprehensive solutions to large airlines.

DAE’s CEO, Firoz Tarapore, told AFJ in September: “Increasingly, clients want to deal with bigger, strongly capitalised lessors who can sit across the table from them and offer a comprehensive range of solutions to help them grow their business and manage their fleet to adapt to changing market conditions.”

Barrington counters that FLY is backed by the BBAM group, which manages over 400 aircraft, and also has access to the extra financial clout of Japanese bank Nomura Babcock & Brown and Incline Aviation, an $881 million private equity aircraft fund that BBAM finalised in September.

“In several of our recent sale-and-leasebacks we have worked with these parties to offer larger deals to the airlines,” he says.

Examples include an Air India deal where FLY, Nomura BB and Incline shared a nine-aircraft sale and leaseback, and a recent deal with an Asian carrier where FLY and Incline split an eight-aircraft SLB down the middle.

New competition

A bigger worry for Barrington is the proliferation of new Chinese lessors; he suggests these risk distorting the sale-and-leaseback (SLB) market by offering unrealistic terms for new aircraft purchases.

“They are deploying capital at what appear to be very low rates, reflected in their offering sale-and-leaseback terms that don’t appear to make sense. The assumption is that they want to get into US dollar assets that are offshore,” says Barrington.

“Most don’t yet have platforms and may lack knowledge of the true costs involved in operating leasing. They may also have unrealistic expectations about residual values,” he adds.

The huge influx of Chinese money into leasing is a particular concern for FLY, which doesn’t have any outstanding orders with manufacturers and instead looks to the SLB market in which the new players are particularly active.

For its SLB additions, FLY has maintained a lease rate factor of above 0.8% per month, although Barrington recalls some “pretty horrific” stories of how low some factors have sunk.

“One has heard of airlines getting below 0.6% per month but we don’t think you can make money in this business at below 0.6% unless you don’t care about the cost of your capital and unless you’re making very bullish assumptions about residual value,” he warns.

Acquisitions and financing

FLY’s portfolio currently stands at 82 aircraft, which the lessor aims to raise to 85-90 units by the end of the year. Having deployed $459 million in the first half, Barrington is confident that the lessor will meet its target of $750 million worth of aircraft acquisitions this year.

Financing for additional aircraft will continue to be a mix of secured and unsecured debt, with FLY likely to maintain a rough ratio of 75% secured and 25% unsecured, Barrington predicts.

And while the lessor is slightly more leveraged than its peers, Barrington says this is compensated for by its preference for secured debt and the low cost of that debt.

“Instead of having these big one-off hits every few years when you have to refinance these big unsecured debts, we amortise our security over the life of the lease,” he comments.

Nonetheless, FLY will continue to tap the unsecured markets for “operational flexibility”. And although unsecured debt is more expensive for FLY, the lessor may soon refinance about $350 million of 2020 notes to lock in current low interest rates.

“We have some make-whole premiums which fall due towards the end of the year, whereby we could repay some of the unsecured debt. They ratchet down every year, so…we will consider refinancing those notes and raising new debt in the market over the next few weeks maybe, and then repaying that debt when the make-whole ratchets down in December.”

Its acquisition strategy will continue to focus on the used aircraft and SLB markets, as FLY doesn’t consider direct orders a good strategy for a public company, given the cyclical nature of the airline market.

“Every time we enter into a deal we know the price of an aircraft, the name of the lessee, the term of the lease, the rental amount, the security deposit, the documentation and what the financing is in terms of amount term and price,” comments Barrington.

“So the only imponderable we have when entering into a secondary market acquisition or an SLB is what the residual value will be and we normally make pretty conservative assumptions on that,” he adds.

Portfolio balance

With no aircraft sales imminent, FLY’s residual estimates are unlikely to be tested soon, although the lessor has been divesting older aircraft from its portfolio over the past two years. This has left it with a weighted average fleet age of just over six years, which Barrington says is the second-lowest of any listed lessor, and which may come down further following new acquisitions.

At the end of June FLY’s portfolio comprised 41 Boeing 737s, five 787s, two 777s, three 757s, 25 Airbus A320-family aircraft, three A330s and two A340s.

“We see ourselves as a narrowbody lessor,” says Barrington, adding: “We will only get into widebody transactions with the right type of aircraft – the 777, 787, A330-300 or A350 – with relatively good credits, on relatively long-term leases of 10-12 years, and if we can support them with attractive financing.”

On the narrowbody front, FLY has moved into new technology with the acquisition of two 737 Max aircraft. Barrington says that the lessor will keep its proportion of new-generation aircraft similar to those of its rivals

“There aren’t many delivered yet and as they are delivered we will be active in that market,” he says.

Unlike many larger lessors, though, FLY doesn’t have any order positions for A320neo or 737 Max aircraft. This leaves it reliant on the competitive sale-and-leaseback market, which might restrict its access to more efficient aircraft in the event of a fuel price rise.

Current costs dynamics, however, favour FLY’s approach, says Barrington.

“I think they are more exposed to lease rates for their future orders for Maxes and Neos because fuel prices are low and most people think they are likely to stay low.

“We moved out of the 737-300/400 and older Airbus aircraft more rapidly than most into the newer A320 models and the next-gen 737s, and we will move from the NG into the MAX over time,” he adds.

Air Berlin exposure

Fly’s current fleet includes an A321 and an A330-200 on lease to insolvent Air Berlin, which is on the verge of breaking up, according to comments this week by Carsten Spohr, chief executive of Lufthansa, which is bidding for the rump of Air Berlin’s aircraft.

Wells Fargo has warned that FLY’s third-quarter earnings may include a $1 million hit from its Air Berlin exposure, but Barrington says further information is needed about the German carrier’s restructuring.

“Until we know what the final solution with Air Berlin is, it is difficult for us to predict what the impact on Q3 earnings will be. It could be nothing if we recognise the security deposits, which is what they are for, but it’s too early to say.”

On 20 September Airfinance Journal reported that AerCap was seeking to repossess 10 A330-200s it had on lease to Air Berlin.

While dealing with airline failures is part of life for any lessor, FLY’s financial flexibility was questioned in September by Moody’s, which warned that the lessor had limited liquidity.

Barrington dismisses the agency’s note.

“We have absolutely no concerns about our liquidity and I don’t know where Moody’s got that from,” he says, pointing to FLY’s $335 million of cash and over $500 million of unencumbered aircraft.

In an industry of rapidly shifting sounds, those financials should provide a solid foundation for FLY’s measured approach to expansion.

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Regional Snapshot

Related Data

Transaction Snapshot
Air Company | Bond issue | 01-24 | $1.5bn
Financial Close:
11/02/2024
SPV:
Some Aviation Trust
Value:
$1,500.00m USD
Full Details