The coverage of the current aviation crisis has mainly focused on airlines and manufacturers. Without a doubt, these are the most severely impacted players in the industry. However, very soon, another vital component of the aviation industry might come under pressure. Aircraft lessors could face mounting financial pressures and significant disruption to their pre-pandemic activity; in fact, first signs of that are already evident.
About the industry
Last week, we wrote an introductory piece about aircraft leasing, where we explained the business concept and the various types of leases. Before we dive slightly more in-depth into the likely impact on aircraft lessors, it is worth taking a closer look at the key players within the industry.
There are around 150 leasing companies globally, while the market is worth close to $300 bn. In 2019 the world’s five largest firms owned a total of over 3,860 planes. GECAS and AerCap are the most prominent players, both holding over a thousand airplanes. Other big names in the industry are Avolon, BBAM, Nordic Aviation Capital, and Air Lease Corporation.
A few industry operational features are worth highlighting before we continue.
Airplane lessors tend to have a diversified customer base; that is, they prefer to lease a smaller amount of planes to more airlines to mitigate the financial risk of their clients’ bankruptcies. They also tend to lease the same airplane to various airlines throughout their lifetime. That also reduces risk and increases flexibility to the prevailing market conditions.
Furthermore, lessors finance airplane purchases with a mix of cash and loans. They are usually very indebted (80% debt to equity for Aercap, 75% for Air Lease, for example) and need the contractual payments from the airlines to fulfill their debt obligations.
As airlines are contractually obliged to fulfill their leasing payments, even in past industry downturns, the leasing companies have performed well. This time, however, the scale of the problem is so much greater that no diversification nor financial engineering would have left them prepared. There are plenty of ways in which the revenue of aircraft lessors will be affected, for example:
- 1. Airline bankruptcies
The biggest threat is the bankruptcy of a lessee. In such a case, the plane returns to the lessor for which it won’t receive the amount of money expected. That can create serious issues for these highly leveraged companies, as they stop receiving cash needed to cover the loans they obtained to buy the aircraft in the first place. Government aid and bailouts will limit the extent of bankruptcies; however, without any doubt, some airlines will not survive.
- 2. Falling rates
Another aspect is the industry-wide willingness to renegotiate leasing rates. As airlines strive to retain cash, they are likely to try and defer their leasing payments or at least to reduce them. Such deferrals and reductions are likely to happen, yet they will be limited because the leasing companies have financial obligations themselves.
- 3. Future rates
The leasing rates will fall not only in the short term but also in the future. Reduced demand for air travel will likely depress future leasing rates, reducing revenues and profitability for the lessors. Most leasing contracts have a duration of fewer than five years. Contract renewals or finding new clients won’t be easy.
Airplanes are likely to stay idle for longer than usual, all contributing to a reduction in leasing rates. The newly signed contract in the depressed-rate environment will hurt the revenues in the longer term too; it could even eradicate profitability.
- 4. New aircraft orders
This point is fundamentally connected to the third one. Reduced air travel demand will result in order delays and cancellations by airlines. Most orders made by the lessors are firm ones, meaning that their cancellations would result in severe fines. It could happen that lessors will be forced to pay these penalties or lease planes at rates resulting in losses. Any orders in the form of options will probably be canceled quite rapidly, as this action does not result in fines.
- 5. Oversupply and falling aircraft values
The airline industry is currently vastly oversupplied with planes. It is likely to translate into falling aircraft prices and values quickly. Boeing and Airbus will soon become desperate to land new orders, which will see prices drop significantly. The value of used planes, whose leasing-contracts will come to an end, is likely to fall dramatically as finding new lessors for them will be close to impossible. We could even witness scrapings of young planes taking place, as lessors fail to find new clients for their aircraft.
First warning signs
Points 1, 4, and 5 have already started to take place.
SAA’s bankruptcy will hurt Avolon, which leased two brand new A350s to the airline, as well as Aircastle, which leased two A330s. Lessors exposed to financially vulnerable airlines could soon come under real pressure.
GECAS and Avolon have just canceled their option orders for 69 and 75 planes, respectively. More lessors are expected to follow. Last week we reported Alaska Airlines scrapping a young 12-year-old A320, which was leased from Smbc.
What do you think will happen in the leasing market? Let us know your thoughts in the comments.