(Image source: NYCAviation)
Airline Behavioral Economics features and is often sponsored by recommended partners. However, sponsors do not pay for or control specific content, which is exclusively by me. This week’s features:
“Aviation records don’t fall until someone is willing to mortgage the present for the future”
- Amelia Earhart -
When you know your history, you can better help shape the future. This also applies to aviation and aircraft leasing. Many take it for granted. But it’s had its ups and downs related to the underlying swings in air transport demand and regulation. But that’s how it started.
There were three elements behind the creation of aircraft leasing:
Deregulation and the sprint for market share (late ‘70s);
The need to put idle 747s to use (Aer Lingus in 1975), which created GPA-Guinness Peat Aviation with Tony Ryan (see what else came from that?);
Personalities, especially Steven Udvar-Hazy.
But, given the regulatory changes the airlines had to cope with in accounting for leased aircraft, there have not been any more recent seismic shifts. I believe how we could monetize aircraft and what it will do to EBITDA, P&Ls, and B.S., will.
If we can monetize aircraft as assets with assets themselves inflight, lessors, airlines, and manufacturers could all share the gain (see article). It will impact on lease rates, but we could also lease services to lessors, flipping the financial models on their heads.
What are some of the renewed methods that lessors, airlines, and aircraft manufacturers can use as industry partners to improve both P&Ls and Balance Sheets?
Read on to find out more about renewed methods that lessors, airlines, and aircraft manufacturers can use as industry partners to improve both P&Ls and Balance Sheets:
The total number of aircraft listed on remarketing sites had decreased moderately by Nov. ‘22, with 471 aircraft being actively remarketed , down from 493 in October and 497 at the end of August (Source: Ishka). A few months ago, this (below) was the picture of aircraft being remarketed as most aircraft values dropped (e.g. A330). Few went up a lot, given the market structure today that favored narrowbodies during the post-pandemic recovery (A320neo, A321neo LR, 737MAX). [For details, contact ISHKA or IBA.aero Group.]
But in this market, personalities also rule and influence overall trends, even some airline CEOs’ that demand customized aircraft performance to fit their network strategy (like the 777X-8 and -9).
No need to mention the airline CEO.
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Personalities
Key personalities in aviation in the late 1970s-80s kickstarted aviation to another level since the leaders that did so post WWII. Juan Trippe (CEO Pan Am), Alfred Kahn (who started deregulation under President Carter), and, yes, Steven Udvar-Hazy.
Mr. Udvar-Hazy was an Hungarian immigrant in the USA, worked with his bear hands packing pallets in NYC, and came with the idea of aircraft leasing in his 20s.
Known to be excentric, determined, demanding, but also funny and personable, Udvar-Hazy was the driving force behind the world’s first global leasing company ILFC.
But all tailwinds cannot prevent headwinds as you change course or simply pass through different waypoints in aviation. But they also bring new opportunities, later.
Leasing as a target
In the late 1990s, (operating) leasing became so popular not in the least because it was a way to dress up Balance Sheets (“off-balance sheet financing”). Aircraft lease payments were expenses in the P&L, and did not create liabilities on the Balance Sheet.
This was not considered a fair representation, and with 46.9% of all aircraft now leased, the leasing market became a target for reform. Finance markets and regulators were driving this.
* * * * *
Ending off-balance sheet financing: IFRS16
The implementation of IFRS 16 added almost $3 trillion of leasing commitments to airline balance sheets globally.
This is because the International Financial Reporting Standards (IFRS) 16 - published by the International Accounting Standards Board - in January 2016 brought an end to off-balance sheet treatment of operating leases by 31 December 2018.
The existing accounting treatment distinction that existed under IAS 17 between on-balance sheet finance leases and off-balance sheet operating leases for lessees was eliminated. This also had tax implications, that I won’t get into here.
So what happened or really changed?
* * * * *
From 1 January 2019, a lessee under an aircraft operating lease with a lease term of more than 12 months was required to report on-balance sheet a right-of-use asset and its lease liability based on net present value rent and (if applicable) maintenance reserves payments taking into account the lease term as determined under IFRS 16.
Depreciation of lease assets was also to be recognized separately from interest on profit and loss statements as “amortization” (until they are fully ‘depreciated’ at the end of the right-of-use life cycle.
These changes required airlines to communicate the impacts to shareholders.
Why?
Well, because of the implications for airlines:
Airlines having adopted IFRS financial reporting will appear to be more asset rich but also more indebted as a result of increased liabilities recorded on-balance sheet.
Airlines were aware that IFRS 16 could affect nearly all commonly used financial covenants including, in particular, those in unsecured loan agreements.
Financial covenants in any airline contract need to be reviewed and may also need to be revised to more appropriately reflect an airline's post-implementation financial performance. This may also affect an airline's borrowing costs(!)
Airlines with aircraft on operating lease, their debt and equity providers, and also their lessors needed to be prepared for the impact that IRFS 16 would have, in particular, on an airline's financial reporting and (if applicable) any financial covenants with respect to that airline.
* * * * *
Monetizing aircraft - inflight
When we start offering marketplace-type platforms underpinned by Edge-AI based applications (refer article), we can potentially also lease out new monetizable physical and digital assets to lessors. This can increase the negotiating power of OEMs (a/c manufacturers, too).
Because we will be:
Increasing the value of the asset (aircraft) quantified by the NPV of additional revenue streams, including all those on the marketplace platform (refer article)
Enhancing the lessor’s bargaining power to increase lease rates
Increasing the airline top revenues but also higher expenses (P&L)
Increasing asset values and liabilities to amortize (B.S.)
Increasing the aircraft manufacturers potential revenue share in the connectivity platform.
The balance needs to be worked out on what bottom line impact of the improved EBITDA is, which depends on the spread between incremental operating revenues and operating expenses, minus the after-tax impact of increased lease liabilities, which will depend on the cost of capital.
These calculations are not easy, as they are all inter-related. For instance, capital costs might go up if the financial rating of the airlines is mediocre and increased lease payments increase the liabilities beyond a comfortable threshold.
But it is given, that this will represent a new seismic shift in what we can do with aircraft as assets and as modernized financial instruments or covenants.
The bottom line = positive, guaranteed.
Wishing you all a wonderful day, and greetings from thawing Montréal.
Ricardo
Montreal, Tuesday, 7 February 2023
Feel free to contact me for questions, comments, or a chat:
ricardo(at)pomonaadvisors(dot)com
my general email has changed to: info(at)ricardopilon(dot)com