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Airfinance Journal covers all aspects of aviation finance including manufacturers, air traffic management, leasing companies and airports, but a lot of the magazine focuses on how airlines finance aircraft. The following is a guide for people new to the industry – or people who have managed to bluff for a very long time.
How airlines finance aircraft
Aircraft are expensive. A 737-700, the type Southwest or Ryanair uses, is priced at about $55 million (although very few airlines actually pay this much). Airlines also typically have low margins so very few airlines can afford to pay cash for all their fleet.
Airlines typically use one, or a combination, of the following techniques to pay for their fleet:
It is still the cheapest way to finance aircraft but only an option for profitable airlines (like Southwest) or state-owned ones with rich owners. Even then, the cash can usually be used for better purposes.
The other problem with financing all of the fleet with cash, is that during the downturn, when you need to release the cash, financing terms are much worse.
Similar to car hire. Operating lessors either order aircraft from manufacturers or buy them from airlines and lease them back (this is know as sale/leaseback). The operating lessor leases the aircraft to the airline, which is also called the lessee.
Leases can be as short as a couple of months to cope with seasonal demand like summer tourist peaks, ski seasons or the Haj. Airlines can also lease crew and pilots with aircraft, these are known as wet leases.
However, most leases are for three to five years with airlines paying monthly lease rentals.
Airlines like operating leases as they give them more flexibility.
They are however quite expensive.
Operating lessors expect to have to place an aircraft several times during its life. The aircraft often starts with a strong carrier and ends up in a developing country or as a cargo aircraft.
Like airlines, lessors also need a lot of capital so are regular borrowers.
Just like mortgages. Banks lend money to airlines with the loan guaranteed by the aircraft. The bank can repossess the aircraft if the airline stops paying its loan.
Banks need to manage their risk so they often sell part of loans on to other banks. This is known as syndicating a loan. Loans are usually 12 years long.
Finance leases are similar to loans, except the bank then buys the aircraft from the airline (another sale/leaseback). The airline then makes monthly lease payments and at the end of the lease it owns the aircraft. Finance leasing is just like hire purchase.
Banks typically lend 85% of the aircraft’s value with airlines paying 15% in cash. This 15% is known as equity.
It takes a lot of people to build an aircraft so aircraft manufacturers are very important to the countries there are based in. Governments realise this so to help aircraft exports they often guarantee loans.
Kazakhstan Airlines, for example, may want to buy Boeing aircraft. Few banks, however, would be prepared to lend money to the airline as it does not make large profits and the country is viewed as risky. So the Export-Import Bank of the United States (Ex-Im Bank) will guarantee the loan.
A bank will lend the money to Kazakhstan Airlines but it the airline stops paying Ex-Im Bank will cover the bank’s losses.
Airbus aircraft are made in France, Germany and the UK so each government covers the proportion made in their country. The French export credit agency is as Coface, the German agency is called Hermes and the UK has the Export Credits Guarantee Department or ECGD.
Export Development Canada handles bombardier loans and BNDES guaranteed Embraer exports.
Export credit loans cover 85% of the aircraft’s value.
This type of finance is extremely important during a downturn when many banks stop lending.
Governments always want their businesses to be as efficient as possible so their industries can compete with other countries. One way to improve efficiency is to have modern equipment, so government encourage companies with tax breaks. Companies that buy equipment get to avoid paying tax on them (this is usually done through depreciation allowances).
The problem is airlines rarely make enough profits to benefit from these allowances. So airlines pass these benefits off to companies or individuals that have large tax bills by selling the aircraft and leasing them back.
In France and Spain only banks are eligible to buy aircraft. In Japan and US companies often take stakes.
Most investors only take 15% of the aircraft, with a bank (or group of banks) lending the rest as a loan. This is why they are often called leverage leases.
The main types of tax leases are: Japanese operating leases (JOLs) which most airlines can close; French Leverage Leases (FLLs), which are only allowed for French airlines; Spanish operating leases (SOLs) only for Spanish airlines; and US leverage leases.
Most manufacturers do not like financing aircraft, but they accept that some times finance help it is needed to get a sale. Typical support could include the manufacturer leasing the aircraft on a finance or operating lease, or guaranteeing the aircraft’s value at the end of a lease or loan (this is known as a residual value guarantee). The easiest way to provide a residual value guarantee is to agree a price that the manufacturer will pay for the aircraft at the end of the loan.
EETCs – or enhanced equipment trust certificates – are bonds that airlines issue to pay for aircraft. The airline sets up a special purpose company or SPV (it’s only purpose or business is to own the aircraft) that issues bonds to investors. The SPV then uses the cash from these bonds to buy aircraft through a sale/leaseback.
The airline then makes lease payments to the SPV and the SPV passes these on to the investors as bond interest.
Shariah, or Islamic law, prevents lenders for charging interest. The main Islamic aircraft finance technique is Ijara or leasing (see Glossary for more details).