Aircraft financing is a big ticket activity which has seen an ascendency as aviation companies are buying additional aircraft
The present century has witnessed a colossal increase in the demand for aircraft that are fuel efficient, faster, technologically better, safer and provide greater luxury on board. As a result, old aircraft are being replaced even before the expiry of their total technical life. An aircraft is expensive. Consequently, there is a need to secure loans or leases to acquire expensive aircraft. The current economic slowdown in the Indian economy and the reluctance of banks to finance large expenditures have caused a liquidity crunch. Hence, airlines are diversifying their financier base. The challenges of securing aviation finance and the peculiarities of this sector can be overcome by a mix of funding sources.
The recent surge in global trade has induced mass movement of manpower and materials. This has led to the emergence of new markets for the aviation sector. The existing airlines saw this opportunity and started acquiring additional aircraft to satiate this emerging demand. With more people willing to spend on air travel, airlines procured new aircraft. When an airline acquires a new aircraft, it tries to sell off the old one. This has not been easy because new players prefer to buy smaller aircraft directly from the manufacturers instead of going for old stock. Consequently, the old unsold inventory blocks potential liquidity.
New aviation regulations have also forced airlines to acquire conforming aircraft. Consequently, airlines are introducing fuel efficient, ergonomic aircraft as the customers want the best flying experience. Accordingly, the airlines are forced to upgrade to better aircraft. Airline mergers and acquisitions lead to inventory expansion for standardisation, acquisition of incremental aircraft and to diversify the types of aircraft needed to cater to new demands. Inventory optimisation has become a norm as better mathematical and statistical tools are available to suggest cost minimisation and profit maximisation. The use of machine learning, artificial intelligence and big data analysis helps airlines to optimise aircraft holdings to remain profitable. All these facets indicate the requirement for procurement of additional aircraft. Hence, a colossal requirement of funds manifests itself. The aviation sector has some unique financial peculiarities which are articulated further.
PECULIARITIES OF AVIATION FINANCE
The typical cost of a Boeing 737-700 aircraft is 637 crore. Hence, we can easily see that aircraft acquisition is a large capital business where funding is secured before the purchase. An aircraft is a highly versatile vehicle. It can move over any geographical expanse of land or water and operate in any country having any political ideology. This is both an advantage and a challenge. The advantage accrues from the fact that an aircraft can be deployed in any country to earn money. The challenge lies in the fact that since its operations extend across different political ideologies and regulatory authorities, it becomes tricky in terms of ownership, taxation, depreciation, accounting practices and operating norms. The residual value of an aircraft can become quite volatile because of regulations, disposal norms and easy availability of new aircraft. Hence, considerable hedging, reserve creation and liquidity have to be ensured for survival.
An aircraft is globally reusable by any entity which buys it. Being an expensive proposition, a great deal of coordination and market survey is required to ensure that finance is raised from multiple sources with the least cost of borrowing. Usually, a single financial institution loathes to fund an airline because of high risk concentration. As a result, airlines have to source funding from different financiers at different interest rates. It can be seen that the aviation sector has got multiple financial peculiarities which create financial challenges.
CHALLENGES IN FINANCIAL ACQUISITION
The aviation financiers require hard assets as collateral securities against loans. Since the capital requirement is large, it has to be acquired through multiple agencies. This requires considerable coordination and cooperation between all the lenders and persons who raise the capital. A few years ago, the Basel III norms were promulgated to ensure financial stability in the banking sector. These norms indicated the quantum of liquidity that was required to be maintained by various financial institutions. As a result, it raised the cost of borrowing. The recent cases of loan default by industrialists followed by flight from India after frauds have forced the banks to loathe funding big ticket projects like aviation. Hence, a liquidity crunch is being faced by big ticket borrowers. Poor financial credibility of executives also makes funding difficult. More so, if the company taking the loan is unable to show credible cash flows. It heightens the risk of bad debts and makes funding scarce. New players prefer to buy smaller aircraft directly from the manufacturer rather than buying old aircraft. Consequently, money remains blocked in old unsold aircraft. Global economic uncertainty and black swan type disruptions have increased the risk of operating globally. Hence, financial institutions are now careful while funding aircraft acquisitions. In spite of all these issues, the aviation sector can still tap multiple sources of funding.
The challenge of owning an aircraft lies in the fact that since its operations extend across different political ideologies and regulatory authorities, it becomes tricky in terms of ownership, taxation, depreciation, accounting practices and operating norms. The residual value of an aircraft can become quite volatile because of regulations, disposal norms and easy availability of new aircraft. Hence, considerable hedging, reserve creation and liquidity have to be ensured for survival.
SOURCES OF AVIATION FINANCE
Institutional wealth is the easiest way of getting money for aviation finance. Money from the sovereign wealth funds, insurance companies, pension funds, own cash and special purpose bonds will provide low cost, lump sum funds for financing aviation assets. In case, an institution has got its own cash, this is the best source of financing aircraft purchase. Bridge loans from banks would be available if the institutional investors have put in the margin money and are providing the aircraft as collateral security to the banks. This arrangement would enable the quick release of funds without too many strings being attached. Another important avenue is the manufacturer’s financial support to help the purchaser acquire the aircraft. Boeing has got a separate company for financing its own aircraft sales. Private Equity is one of best ways of getting low cost finance but it will bring in some control in the form of executive or non-executive members on the Board of Directors of the promoters. This funding hinges on the creditworthiness and the assured cash flow generation modeled by the operators. In the absence of any of these factors, it will be very difficult for the organisation to raise private equity.
Direct lending by multiple banks as secured or unsecured loans is also an option subject to the financial magnitude being raised. Banks prefer to have secured collaterals from creditworthy directorship of an airline. They would like to ascertain with guarantee, the cash flows and their ability to repossess and further resell these assets in the case of distress to recover their capital. This is known as secured lending. However, leasing is another option which can be used either as a stand-alone method of raising capital or as a combination with the options enumerated hithertofore.
Leasing is quite like renting. However, it is for a long term and has implications on depreciation, taxation and ownership rights. During the period of the lease or on its termination, the ownership of the assets can be an option for the operator. Operating lease is the most common form of financing. The leasing company uses its capital to buy an aircraft and provide it to the operator in exchange for being paid for its use on a monthly or yearly basis. The ownership lies with the leaser. Usually, it is a short-term recourse not exceeding ten years. It is preferred by a start-up company to reduce its capital out flow. It could be used to acquire better aircraft or to exploit a short-term opportunity. The operator chooses the aircraft and approaches the leasing company that buys the aircraft and provides or leases it to the operator for use. On expiry of the lease, the aircraft is returned to the leasing company in the same condition as it was received so that the aircraft can be leased to another operator. A lease could be a dry or a wet lease. In the case of a dry lease, only the aircraft is provided to the operator. No staff or maintenance services are provided with it. In the case of wet lease, the aircraft along with the crew and the necessary maintenance staff is provided to the operator, usually for a short duration. It is a more expensive option. Wet lease is usually preferred when a new type of aircraft is introduced in service by the operator for which it may not have trained staff. Once the operator has got its own staff, which may be less expensive, the operator may shift to dry lease. Thus, wet lease usually, is a short term bridge lease to capitalise on a fleeting opportunity.
Buy, sell and leaseback model entails the operator to purchase the aircraft which then is re-sold to the leasing company and is taken back on lease from the second buyer to be used by the first buyer or the operator. The latter then frees his own cash that he had spent on acquiring the original aircraft. This spare cash can now be used to tide over the liquidity issues and other operating expenses in terms of fuel hedging, advertising, administration and other operational expenditure. Finance leasing, also known as capital leasing, involves a capital-intensive company purchasing an aircraft and then leasing it to the operator. The latter can either acquire the asset at the end of the lease depending on the agreement or release it back to the owner, without having anything to do with the liabilities of the end life of the aircraft. Aircraft financing is a big ticket activity which has seen an ascendency as aviation companies are buying additional aircraft. This forces aircraft purchasers to raise money from different sources. Funding availability depends upon the buyer’s down payment, creditworthiness and production of credible cash flow statements. It is these factors that will be encourage the financiers to part with their money for the aviation sector.