The sale and leaseback (“SLB”) model has been a key source of funding and portfolio management for lessors and airlines alike for some time now.
There are two principal SLB transaction structures employed for new aircraft, as illustrated below.
The first is the “back to back” sale, whereby an airline pays for and takes delivery of an aircraft as the purchaser under the purchase agreement with the manufacturer. The airline will then simultaneously sell the aircraft to the lessor and takes it back on lease. The second is the “purchase agreement assignment” variant, in which the purchase agreement with the manufacturer is assigned to the lessor before delivery, at which point the lessor pays for and takes delivery of the aircraft and it is leased to the airline. For “used” aircraft, the structure is more straightforward: the airline and lessor would typically enter into a sale and purchase agreement to govern the transfer of title from the airline to the lessor and a lease agreement by which the airline can then take the aircraft immediately back on lease.
Even with changes to accounting rules eroding some of the benefits of lease structures for airlines, these transactions continue to be advantageous for both lessors and airlines alike for a number of reasons.
Airlines may benefit from the continual renewal of their fleet through SLB transactions by avoiding those maintenance obligations that arise around the six year mark. Pricing is another key driver. Whilst lessors, who typically pay a premium for aircraft from manufacturers compared to airlines, will often be able to partially benefit from the airline’s more desirable pricing, the airlines themselves benefit from a sort of arbitrage. The discounts they typically obtain from manufacturers as well as ongoing price escalation usually means that an aircraft is worth more at delivery than at the time the order was placed. This is a pure cash “windfall” for an airline, which can be reinvested into its business, although some airlines do chose to amortise it over the duration of the lease term.
“when a lessor buys an aircraft from an airline in a SLB transaction, they know what they are getting and when they are getting it; there is no forward-looking gamble on market conditions and, in particular, there is no guess-work around the price of the aircraft”
Timing is also important: SLBs give lessors access to next-generation aircraft even where they have not placed orders for them. The alternative (at least for lessors looking for new aircraft) is to establish their own order book. But if they do this, they need to factor in price escalations and the uncertainty of the future aviation market (not to mention the uncertain future value and even utility or desirability of that particular aircraft or aircraft type). Further, order books come with the inevitable conundrum of pre-delivery payments – and the market to finance them is not the easiest to navigate.
With a significant number of new lessors entering the fray over recent years, SLBs have become a particularly attractive tool, enabling these new entrants to increase both their fleet size and their breadth of clientele in one move. Unfortunately for operating lessors, the desirability of the product for airlines means that the market is now super-charged.
Partly as a consequence of this, lease rates are at record lows and a lessor that wants to be competitive in this space will need a low cost and diversified funding base. They would also be well advised to mitigate their credit position by diversifying in relation to both airlines and jurisdictions. This does, of course, assume that all lessors will get the opportunity to participate, which is by no means a certainty. Market anecdotes suggest that whilst the pool of suitors for airlines offering SLB transactions is often vast, many airlines are now seeking to limit the number of participants in their RFPs to enable them to run a manageable process.
The inevitable consequence of a competitive process is that lease provisions are being more keenly fought over and lease rate factors are being pushed down. We understand that even lower calibre airlines are now requesting half-life return conditions and shorter lease terms. Lease provisions and pricing are an area where lessors need to exercise caution. It is all very well offering “rock bottom” lease provisions and pricing now, but experience suggests it can be difficult to improve them again even if the market picks up (or at least, there will be a time-lag before lessors can do so).