In a world characterized by speed, buying a plane is a particularly slow process. Unlike other transactions, three to five years can lapse between the initial purchase agreement and the point of delivery. How the market ebbs and flows is anybody’s guess. Cargo, in particular, has experienced significant market fluctuations in recent years. Decreased tonnages resulting from the recession of 2008 kept levels low throughout 2009, before recovering strongly in 2010.
2011 was another tumultuous year for air cargo, International Air Transport Association statistics revealed. Despite weak freight traffic throughout the year — propelled by the softening of the Asia-Pacific market — global freight volumes improved 0.2 percent, year-over-year, in December.
Such fluctuations have led some freight carriers to forgo the traditional means of acquiring an aircraft — purchasing it — in favor of a more flexible approach: leasing. It has also led some airlines to recant their decision to buy a plane and take a sale-and leaseback approach, Airbus’ senior vice president of leasing markets Andy Shankland says.
He says Airbus has recently seen an influx of carriers leasing a purchased aircraft before its delivery date — a trend Shankland expects to grow with time. His colleague Andreas Hermann, vice president of freighters at Airbus, agrees, especially as it relates to the airfreight sector.
“Leasing particularly comes in handy in industries with cyclical behaviors, and the cargo industry is predominated by that,” Hermann says. Freight carriers are increasingly attracted to the level of flexibility allowed by leasing, he says, “given that lease terms, as well as timing and direction of that term, are subject to negotiation.”
The leasing phenomenon
Forty years ago, less than 1 percent of the global air fleet was leased; today, that figure is 40 percent, according to Boeing statistics. Kostya Zolotusky, managing director of capital markets development for Boeing Capital Corp. expects this number to increase even more in the future, rising to 50 percent. Propelling this surge is the fact that the aggregate costs of buying versus leasing are about the same, he says.
“If airlines lease an aircraft, they don’t tie up their own equity,” Zolotusky says. “And
airlines, generally, have fairly expensive equity relative to the leasing companies. Leasing companies, because they’re financial institutions, tend to have better credits and, therefore, cheaper access to equity.”
Like Zolotusky, Shankland says the decision whether to buy or lease an aircraft is, above all, financial. In addition to demanding a significant investment up front in the form of down payments, purchasing a plane requires carriers to secure cash financing for the delivery, he explains. “The overall financing through cash requirements when you buy a plane are quite onerous,” he says, “particularly for a smaller airline.”
Mid-sized airlines are also feeling the sting, Shankland says. Because they, like smaller carriers, lack the capital of major global airlines, handing over the cash required to purchase an aircraft can be constraining. It’s a problem that has only worsened with the recent economic downturn, many aviation experts maintain. “I think that over the years, both passenger and freighter airlines have learned that if they have cash, there’s pressure to keep it in their bank accounts, rather than let everybody else have it,” Shankland says.
Not that all carriers let this philosophy dictate their spending behavior, he asserts. Shankland says some of the larger, richer airlines view lessors as middlemen and prefer to arrange financing directly with the manufacturer.
Although Zolotusky agrees that money plays the biggest role in the buy-versus-lease decision, he says its not the only factor. He explains that the decision also involves the airline’s specific business model and whether it wants to keep the aircraft for the duration of its lifecycle or return it to the lessor after a specific period. “But the predominant one is how well-capitalized the airline is,” Zolotusky says.
Hefty bank accounts or not, funding has been rather hard to come by for carriers lately, due to the conservative nature of aircraft financing, Zolotusky says. He likens it to the housing industry before the bubble, where buyers were forced to put 20 percent down and then borrow the rest. “When you look at the idea of buying an airplane, it means that the airline usually needs to have a stronger balance sheet because it needs to have enough capital or equity to put down for the plane,” he says. Carriers without these resources should lease, Zolotusky asserts.
Even so, GE Capital Aviation Services’ Daniel Whitney is quick to point out that aircraft financing hasn’t dried up. In fact, GECAS, which purchases aircraft from manufacturers and then leases them out to carriers, has seen more leniency among banks lately, Whitney says. “On the debt side, after months of tightening, debt spreads are beginning to widen,” he says. “Due to the EU debt crisis, EU banks are selling assets to raise liquidity, but are not willing to take significant book losses.” Aviation, Whitney maintains, is a sector banks are willing to invest in because of this development.
It’s a good thing, indeed, he says, as some cargo carriers are looking to upgrade their fleets. Whitney cites the emergence of dedicated freighters, such as Boeing’s 747-8F and 777F, as an example of fleet renovations. But these aircraft represent significant investments for carriers, “and, given the choice, an airline will likely choose to invest their capital in other areas of their business, such as sales, marketing, IT and personnel,” he says. Again, it’s a situation where leasing comes into play, Whitney maintains.
Atlas Air CEO Bill Flynn says he’s witnessed a similar trend in the ACMI sector. Atlas, which counts 24 747-400 freighters and nine 747-8Fs among its fleet, regularly wet leases these aircraft out to carriers on a three- to five-year basis, he says. Without the option to lease, Flynn asserts, many airlines wouldn’t be able to afford these aircraft or the extensive parts inventories they require.
Availability is another factor driving the demand for leased aircraft, Airbus’s Shankland says. If, for instance, the market hits an upswing and a carrier wants to deploy more aircraft to address the growth, leasing is ideal, he says. The same scenario rings true for start-up airlines. Rather than wait the requisite three to four years for a new aircraft to be built, carriers entering the market can lease a plane and have it delivered within 18 to 24 months, Shankland says.
Faster deliveries are particularly advantageous to cargo carriers, an Airbus spokesman explains. Since the freight market is prone to greater fluctuation than the passenger sector, fleet planning is especially difficult for cargo airlines, he says. “That’s why you see a lot of airlines that are going to have a fully ACMI cargo fleet, which gives them the flexibility to address the shorter span of time than would be possible if they had their own freighters,” the spokesman says. It’s a trend he and other airfreight experts anticipate is here to stay.
With IATA forecasting another difficult year for passenger and freight markets, the option to lease has never looked so attractive, some advocates say. Although Flynn points out that leasing companies, such as Atlas Air, don’t necessarily market their services as a safeguard against market volatility, he says it’s a natural byproduct of leasing. Flynn maintains that his customers have been slightly less vulnerable to cargo fluctuations and predicts that this merit will continue to serve the leasing market well in the future.
“We think cargo is going to grow as we come into 2012 and beyond, and I think the reasons that created the ACMI market in the past are the same reasons going forward — and maybe even more so,” Flynn says.
GECAS’ Daniel Whitney believes the same rings true for dry leases. He projects that carriers will be increasingly attracted to operating leases because of the flexibility they provide over purchasing. “This is especially important in today’s environment, when demand trends change, aircraft size requirements change, and there are changes in route networks,” Whitney says.
Still, the leasing sector hasn’t been immune to market fluctuations. World Airways’ parent company Global Aviation Holdings filed for Chapter 11 bankruptcy on February 5 after its board of directors deemed insolvency the most effective way to restructure. Global’s vice president of planning and development, Sean Frick, who detailed the company’s leasing outlook prior to the bankruptcy filing, says World Airways’ cargo charter business is integral to operations. Despite the bankruptcy filing, a company spokesman says World’s ACMI freighter operations and Global’s U.S. military charter business will run as scheduled.
Although Frick admits that his company’s aircraft business tends to be lower-utilization, he says the charter business has been lucrative for World. “We’ve found that the operating lease tends to work well for us because it reduces the amount of capital expenditure a company has to put in place,” Frick says. For instance, he reveals that World has worked with leasing companies to perform freighter conversions, which is a very capital-intensive process. “But in the end, we’re able to have an even flow of cash outflows in the form of rents for converted freighters,” Frick says.
Currently, three-quarters of all cargo planes fit into this category, Boeing’s Kostya Zolotusky says. And as more carriers go the converted-freighter route, Zolotusky sees leasing only growing in popularity. The distinction lies in leasing companies’ expertise, he says. Since converted freighters are typically older than other aircraft, they require a skill level not mandated by all other planes.
“Being able to deal with and understand assets that are older is usually harder than dealing with new airplanes,” Zolotusky says. “It’s another factor facilitating the expansion of lessors in that space; lessors tend to be very specialized and have a significant amount of expertise around aircraft assets and how their residual values will perform. So they’re better able to deal with this older-asset class.”
Many carriers don’t want to fool with conversions, Zolotusky explains. Along with requiring a great deal of expertise, performing a conversion means that the aircraft isn’t generating revenue during the renovation process. And revenue is what keeps carriers going. Zolotusky says these and other elements, such as the availability of shorter-term financing commitments, will continue to drive demand in the leasing sector.
The ability to quickly redeploy aircraft is another advantage of leasing. “If a certain type of plane or cargo capability disappears in a particular region, a carrier can much more easily deploy it to where the demand continues is [if it goes through the leasing channel],” he says.
Airbus’ Shankland, concurs. “The magnitude of the swings up and down is much greater on the freight side, and having flexibility with your fleet — which is something leasing companies provide — is typically beneficial,” he says.
As cargo carriers enter the third month of what could be another tumultuous year, such flexibility may very well lead to another surge in leasing.
Wet leasing versus dry leasing
Once carriers choose to lease, they must decide whether to go the wet or dry route. Although both options have their pros and cons, Atlas Air’s Bill Flynn says ACMI leases have one clear advantage over their counterpart: maintenance efficiency. “If you’re a carrier, and you’re only operating a few types of any given aircraft, you would potentially risk investing in long inventories of aircraft parts simply to maintain high reliability of the aircraft, but that may not be very efficient if you’re buying those inventories for only a few aircraft,” he says of wet leasing.
Ultimately, however, the decision whether to dry or wet lease an aircraft is risk-related, Flynn explains. He says Atlas, for instance, takes a 30-year-live-asset approach and leases aircraft out to customers for three to five years. “So the airline, freight forwarder or integrator is getting access to modern technology with a shorter time commitment to the asset than if they dry leased the aircraft or outright bought it,” Flynn says.
That’s not to say dry leasing is without merits, GE Capital Aviation Services’ Daniel Whitney argues. Since GECAS is more of a financial enterprise than an aircraft operator, Whitney says dry leasing has worked well from his company.
“With wet leasing, you’re essentially operating an airline,” he says. “And we don’t have the infrastructure in place to manage that.” Still, Whitney says GECAS occasionally finances dry leases to ACMI operators.
Flynn projects that the number of wet-leased aircraft will soon increase, as more carriers look to replace their Boeing 747-400 passenger planes — which he dubs “the former workhorse of the long-haul, intercontinental fleet”— with newer-model aircraft, such as Airbus’ A380, and Boeing’s 777 and 787. Such renovations may lead to the wet leasing of more 747-8Fs and 747-400 freighters, Flynn maintains, as carriers seek to increase fleet efficiency. “So the ACMI may be a more attractive option to them as they have lower fleet requirements for the aircraft type on a relative basis,” he says.
Whether this projection comes to fruition or not, one thing is for certain: Both wet and dry leasing are likely here to stay.