Aircraft finance
Encyclopedia
Aircraft finance refers to financing
for the purchase and operation of aircraft
. Complex aircraft finance (such as those schemes employed by airline
s) shares many characteristics with maritime finance, and to a lesser extent with project finance
.
or automobile
loan. A basic transaction for a small personal or corporate aircraft may proceed as follows:
, the type Southwest or Ryanair uses, is priced in 2008 USD in the range of $58.5 - $69.5 million (although very few airlines actually pay this much). Airlines also typically have low margins so very few airlines can afford to pay cash for all their fleet.
Commercial aircraft, such as those operated by airline
s, use more sophisticated lease
s and debt
financing schemes. The three most common schemes for financing commercial aircraft are secured lending, operating leasing and finance leasing. However, there are other ways to pay for the aircraft:
These schemes are primarily distinguished by tax
and accounting considerations, particularly tax-deductible depreciation
, interest
and operating costs which can reduce tax liability for the operator, lessor and financier.
Because the cost of a commercial aircraft may be hundreds of millions of dollars, most direct lending for aircraft purchases is accompanied by a security interest
in the aircraft, so that the aircraft may be repossessed in event of nonpayment. It is generally very difficult for borrowers to obtain affordable private unsecured financing of an aircraft purchase, unless the borrower is deemed particularly creditworthy (e.g. an established carrier with high equity
and a steady cash flow). However, certain governments finance the export of domestically-produced aircraft through the Large Aircraft Sector Understanding (LASU). This interstate agreement provides for financing of aircraft purchases at 120 to 175 points over prime rate for terms of 10 to 12 years, and the option to "lock in" an interest rate up to three months prior to taking out the loan. These terms are often less attractive for larger operators, which can obtain aircraft less expensively through other financing methods.
By directly owning their aircraft, airlines may deduct depreciation costs for tax purposes, or spread out depreciation costs to improve their bottom line. For instance, in 1992, Lufthansa
adjusted its accounting to depreciate aircraft over 12 years instead of 10 years; the resulting drop in depreciation "expenses" caused the company's reported profits to rise by DM392 million. JAL
made a similar adjustment in 1993, causing the company's profits to rise by ¥
29.6 million.
On the other hand, prior to the advent of commercial aircraft leasing in the 1980s, privately-owned airlines were highly vulnerable to market fluctuations due to their need to assume high levels of debt
in order to purchase new equipment; leases offer additional flexibility in this area, and have made airlines increasingly less sensitive to cost and revenue fluctuations, although some sensitivity still exists.
(CASL) company, the two largest of which are International Lease Finance Corporation
(ILFC) and GE Commercial Aviation Services
(GECAS).
Operating leases are generally short-term (less than 10 years in duration), making them attractive when aircraft are needed for a start-up venture, or for the tentative expansion of an established carrier. The short duration of an operating lease also protects against aircraft obsolescence, an important consideration in many countries due to changing noise and environmental laws. In some countries where airlines may be deemed less creditworthy (e.g. the former Soviet Union), operating leases may be the only way for an airline to acquire aircraft. Moreover, it provides the flexilibility to the airlines so that they can manage fleet size and composition as closely as possible, expanding and contracting to match demand.
Conversely, the aircraft's residual value at the end of the lease is an important consideration for the owner. The owner may require that the aircraft be returned in the same maintenance condition (e.g. post-C check) as it was delivered, so as to expedite turnaround to the next operator. Like leases in other fields, a security deposit
is often required.
One particular type of operating lease is the wet lease
, in which the aircraft is leased together with its crew. Such leases are generally on a short-term basis to cover bursts in demand, such as the Hajj
pilgrimage. Unlike a charter flight, a wet-leased aircraft operates as part of the leasing carrier's fleet and with that carrier's airline code, although it often retains the livery of its owner.
US and UK accounting rules differ regarding operating leases. In the UK, some operating lease expenses can be capitalized on the company's balance sheet; in the US, operating lease expenses are generally reported as operating expenses, similarly to fuel or wages.
A related concept to the operating lease is the leaseback
, in which the operator sells its own aircraft for cash, and then leases the same aircraft back from the purchaser for a periodic payment.The operating lease can affords the airlines flexible to change the fleet size, and created a burden to the leasing companies.
Under American
and British accounting rules, a finance lease is generally defined as one in which the lessor receives substantially all rights of ownership, or in which the present value
of the minimum lease payments for the duration of the lease exceeds 90% of the fair market value
of the aircraft. If a lease is defined as a finance lease, it must be counted as an asset
of the company, in contrast to an operating lease which only impacts the company's cash flow.
Finance leasing is attractive to the lessee because the lessee may claim depreciation
deductions over the aircraft's useful life, which offset the profits from the lease for tax purposes, and deduct interest
paid to those creditors who financed the purchase. This has made aircraft a popular form of tax shelter
for investors, and has also made finance leasing a cheaper alternative to operating leases or secured purchasing for many operators.
The various forms of finance leasing include:
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
for the purchase and operation of aircraft
Aircraft
An aircraft is a vehicle that is able to fly by gaining support from the air, or, in general, the atmosphere of a planet. An aircraft counters the force of gravity by using either static lift or by using the dynamic lift of an airfoil, or in a few cases the downward thrust from jet engines.Although...
. Complex aircraft finance (such as those schemes employed by airline
Airline
An airline provides air transport services for traveling passengers and freight. Airlines lease or own their aircraft with which to supply these services and may form partnerships or alliances with other airlines for mutual benefit...
s) shares many characteristics with maritime finance, and to a lesser extent with project finance
Project finance
Project finance is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors...
.
Private aircraft
Financing for the purchase of private aircraft is similar to a mortgageMortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
or automobile
Automobile
An automobile, autocar, motor car or car is a wheeled motor vehicle used for transporting passengers, which also carries its own engine or motor...
loan. A basic transaction for a small personal or corporate aircraft may proceed as follows:
- The borrower provides basic information about themselves and their prospective aircraft to the lender.
- The lender performs an appraisalAppraisalEconomic appraisal is a type of decision method applied to a project, programme or policy that takes into account a wide range of costs and benefits, denominated in monetary terms or for which a monetary equivalent can be estimated. Economic Appraisal is a key tool for achieving value for money and...
of the aircraft's value. - The lender performs a title searchTitle searchA title search is a process that is performed primarily to determine the answer to three questions:*Does the seller have a saleable interest in the property?...
based on the aircraft's registration number, in order to confirm that no lienLienIn law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
s or title defects are present. In many cases, a title insuranceTitle insuranceTitle insurance is a form of indemnity insurance predominantly found in the United States which insures against financial loss from defects in title to real property and from the invalidity or unenforceability of mortgage liens. Title insurance is principally a product developed and sold in the...
policy is procured to protect against any undetected defects in title. - The lender then prepares documentation for the transaction:
- A security agreementSecurity agreementA security agreement, in the law of the United States, is a contract that governs the relationship between the parties to a kind of financial transaction known as a secured transaction...
, which establishes a security interestSecurity interestA security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
in the aircraft, so that the lender may repossess it in the event of default on the loan - A promissory notePromissory noteA promissory note is a negotiable instrument, wherein one party makes an unconditional promise in writing to pay a determinate sum of money to the other , either at a fixed or determinable future time or on demand of the payee, under specific terms.Referred to as a note payable in accounting, or...
, which makes the borrower responsible for any outstanding loan balance not covered by repossession of the aircraft - If the borrower is deemed less credit-worthy, a suretySuretyA surety or guarantee, in finance, is a promise by one party to assume responsibility for the debt obligation of a borrower if that borrower defaults...
from a third party (or from multiple third parties)
- A security agreement
- At closingClosing (sales)Closing is a sales term which refers to the process of making a sale. The sales sense springs from real estate, where closing is the final step of a transaction. In sales, it is used more generally to mean achievement of the desired outcome, which may be an exchange of money or acquiring a...
, the loan documentation is executed and funds and title are transferred.
Commercial aircraft
Aircraft are expensive. A Boeing 737-700Boeing 737 Next Generation
The Boeing 737 Next Generation, commonly abbreviated as Boeing 737NG, is the name given to the -600/-700/-800/-900 series of the Boeing 737 after the introduction of the -300/-400/-500 Classic series. They are short- to medium-range, narrow-body jet airliners...
, the type Southwest or Ryanair uses, is priced in 2008 USD in the range of $58.5 - $69.5 million (although very few airlines actually pay this much). Airlines also typically have low margins so very few airlines can afford to pay cash for all their fleet.
Commercial aircraft, such as those operated by airline
Airline
An airline provides air transport services for traveling passengers and freight. Airlines lease or own their aircraft with which to supply these services and may form partnerships or alliances with other airlines for mutual benefit...
s, use more sophisticated lease
Lease
A lease is a contractual arrangement calling for the lessee to pay the lessor for use of an asset. A rental agreement is a lease in which the asset is tangible property...
s and debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
financing schemes. The three most common schemes for financing commercial aircraft are secured lending, operating leasing and finance leasing. However, there are other ways to pay for the aircraft:
- Cash
- Operating leasing and sale/leasebacks
- Bank loans/finance leases
- Export credit guaranteed loans
- Tax leases
- Manufacturer support
- EETCs
These schemes are primarily distinguished by tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
and accounting considerations, particularly tax-deductible depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
, interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
and operating costs which can reduce tax liability for the operator, lessor and financier.
Direct lending
As described above for private aircraft, an airline may simply take out a secured or unsecured loan to buy a commercial aircraft. In such large transactions, a syndicate of banks may collectively provide a loan to the borrower.Because the cost of a commercial aircraft may be hundreds of millions of dollars, most direct lending for aircraft purchases is accompanied by a security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
in the aircraft, so that the aircraft may be repossessed in event of nonpayment. It is generally very difficult for borrowers to obtain affordable private unsecured financing of an aircraft purchase, unless the borrower is deemed particularly creditworthy (e.g. an established carrier with high equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
and a steady cash flow). However, certain governments finance the export of domestically-produced aircraft through the Large Aircraft Sector Understanding (LASU). This interstate agreement provides for financing of aircraft purchases at 120 to 175 points over prime rate for terms of 10 to 12 years, and the option to "lock in" an interest rate up to three months prior to taking out the loan. These terms are often less attractive for larger operators, which can obtain aircraft less expensively through other financing methods.
By directly owning their aircraft, airlines may deduct depreciation costs for tax purposes, or spread out depreciation costs to improve their bottom line. For instance, in 1992, Lufthansa
Lufthansa
Deutsche Lufthansa AG is the flag carrier of Germany and the largest airline in Europe in terms of overall passengers carried. The name of the company is derived from Luft , and Hansa .The airline is the world's fourth-largest airline in terms of overall passengers carried, operating...
adjusted its accounting to depreciate aircraft over 12 years instead of 10 years; the resulting drop in depreciation "expenses" caused the company's reported profits to rise by DM392 million. JAL
Japan Airlines
is an airline headquartered in Shinagawa, Tokyo, Japan. It is the flag carrier of Japan and its main hubs are Tokyo's Narita International Airport and Tokyo International Airport , as well as Nagoya's Chūbu Centrair International Airport and Osaka's Kansai International Airport...
made a similar adjustment in 1993, causing the company's profits to rise by ¥
Japanese yen
The is the official currency of Japan. It is the third most traded currency in the foreign exchange market after the United States dollar and the euro. It is also widely used as a reserve currency after the U.S. dollar, the euro and the pound sterling...
29.6 million.
On the other hand, prior to the advent of commercial aircraft leasing in the 1980s, privately-owned airlines were highly vulnerable to market fluctuations due to their need to assume high levels of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
in order to purchase new equipment; leases offer additional flexibility in this area, and have made airlines increasingly less sensitive to cost and revenue fluctuations, although some sensitivity still exists.
Operating leasing
Commercial aircraft are often leased through a Commercial Aircraft Sales and LeasingCommercial Aircraft Sales and Leasing
Commercial Aircraft Sales and Leasing is a common phrase used to describe organizations which typically market used commercial airliners and related equipment to governments and other various customers from manufacturers such as Airbus and Boeing as a primary function...
(CASL) company, the two largest of which are International Lease Finance Corporation
International Lease Finance Corporation
The International Lease Finance Corporation is an aircraft lessor headquartered in Century City, Los Angeles, California.It is the world's largest aircraft lessor by value, though ILFC's rival, General Electric's GECAS unit, has more aircraft...
(ILFC) and GE Commercial Aviation Services
GE Commercial Aviation Services
GECAS is a unit of GE Capital, itself part of the large conglomerate General Electric. The president of GECAS is Norman Liu. GECAS is responsible for the leasing of aircraft and associated equipment to airlines...
(GECAS).
Operating leases are generally short-term (less than 10 years in duration), making them attractive when aircraft are needed for a start-up venture, or for the tentative expansion of an established carrier. The short duration of an operating lease also protects against aircraft obsolescence, an important consideration in many countries due to changing noise and environmental laws. In some countries where airlines may be deemed less creditworthy (e.g. the former Soviet Union), operating leases may be the only way for an airline to acquire aircraft. Moreover, it provides the flexilibility to the airlines so that they can manage fleet size and composition as closely as possible, expanding and contracting to match demand.
Conversely, the aircraft's residual value at the end of the lease is an important consideration for the owner. The owner may require that the aircraft be returned in the same maintenance condition (e.g. post-C check) as it was delivered, so as to expedite turnaround to the next operator. Like leases in other fields, a security deposit
Security deposit
In the field of taxation, a deposit is not included as gross income to the receiving party until the depositing party chooses to apply the funds to purchase services. A 1990 ruling provides that a deposit differs from an advance payment because the depositing party has dominion over the funds and...
is often required.
One particular type of operating lease is the wet lease
Wet lease
Aircraft leases are a number of types of leases used by airlines and other aircraft operators. Airlines lease aircraft from other airlines or leasing companies for two main reasons; to operate aircraft without the financial burden of buying them, and to provide temporary increase in capacity...
, in which the aircraft is leased together with its crew. Such leases are generally on a short-term basis to cover bursts in demand, such as the Hajj
Hajj
The Hajj is the pilgrimage to Mecca, Saudi Arabia. It is one of the largest pilgrimages in the world, and is the fifth pillar of Islam, a religious duty that must be carried out at least once in their lifetime by every able-bodied Muslim who can afford to do so...
pilgrimage. Unlike a charter flight, a wet-leased aircraft operates as part of the leasing carrier's fleet and with that carrier's airline code, although it often retains the livery of its owner.
US and UK accounting rules differ regarding operating leases. In the UK, some operating lease expenses can be capitalized on the company's balance sheet; in the US, operating lease expenses are generally reported as operating expenses, similarly to fuel or wages.
A related concept to the operating lease is the leaseback
Leaseback
Leaseback, short for sale-and-leaseback, is a financial transaction, where one sells an asset and leases it back for the long-term; therefore, one continues to be able to use the asset but no longer owns it...
, in which the operator sells its own aircraft for cash, and then leases the same aircraft back from the purchaser for a periodic payment.The operating lease can affords the airlines flexible to change the fleet size, and created a burden to the leasing companies.
Finance leasing
Finance leasing, also known as "capital leasing," is a longer-term arrangement in which the operator comes closer to effectively "owning" the aircraft. It involves a more complicated transaction in which a lessor, often a special purpose company (SPC) or partnership, purchases the aircraft through a combination of debt and equity financing, and then leases it to the operator. The operator may have the option to purchase the aircraft at the expiration of the lease, or may automatically receive the aircraft at the expiration of the lease.Under American
Accounting for leases in the United States
Accounting for leases in the United States regulated by the Financial Accounting Standards Board by the Financial Accounting Standards Number 13. These standards were effective as of January 1, 1977...
and British accounting rules, a finance lease is generally defined as one in which the lessor receives substantially all rights of ownership, or in which the present value
Present value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...
of the minimum lease payments for the duration of the lease exceeds 90% of the fair market value
Fair market value
Fair market value is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. An estimate of fair market value may be founded either on precedent or...
of the aircraft. If a lease is defined as a finance lease, it must be counted as an asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
of the company, in contrast to an operating lease which only impacts the company's cash flow.
Finance leasing is attractive to the lessee because the lessee may claim depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
deductions over the aircraft's useful life, which offset the profits from the lease for tax purposes, and deduct interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
paid to those creditors who financed the purchase. This has made aircraft a popular form of tax shelter
Tax shelter
Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments...
for investors, and has also made finance leasing a cheaper alternative to operating leases or secured purchasing for many operators.
The various forms of finance leasing include:
- Equipment trust certificateEquipment Trust CertificateAn equipment trust certificate is a financial security used in aircraft finance, most commonly to take advantage of tax benefits in North America....
(ETC): Most commonly used in North America. A trustTrust lawIn common law legal systems, a trust is a relationship whereby property is held by one party for the benefit of another...
of investors purchases the aircraft and then "leases" it to the operator, on condition that the airline will receive title upon full performance of the lease. ETCs blur the line between finance leasing and secured lending, and in their most recent forms have begun to resemble securitizationSecuritizationSecuritization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation , to...
arrangements. - Extendible operating lease: Although an EOL resembles a finance lease, the lessee generally has the option to terminate the lease at specified points (e.g. every three years); thus, the lease can also be conceptualized as an operating lease. Whether EOLs qualify as operating leases depends on the timing of the termination right and the accounting rules applicable to the companies.
- US leveraged lease: Used by foreign airlines importing aircraft from the United StatesUnited StatesThe United States of America is a federal constitutional republic comprising fifty states and a federal district...
. In a US lease, a Foreign Sales CorporationForeign Sales CorporationForeign Sales Corporations was a means formerly provided by United States taxation law for US companies to receive a reduction in US federal income taxes for profits derived from exports, through the use of an offshore subsidiary .The European Union launched proceedings against these provisions...
(FSC) purchases and leases the aircraft, and is tax-exempt so long as at least 50% of the aircraft is made in the US, and at least 50% of its flight miles are flown outside the US. Because of the extensive documentation required for these leases, they have only been used for very expensive aircraft being operated entirely outside the US, such as Boeing 747Boeing 747The Boeing 747 is a wide-body commercial airliner and cargo transport, often referred to by its original nickname, Jumbo Jet, or Queen of the Skies. It is among the world's most recognizable aircraft, and was the first wide-body ever produced...
s purchased for domestic routes within Japan. - Japanese leveraged lease: A JLL requires the establishment of a special purpose company to acquire the aircraft, and at least 20% of the equity in the company must be held by JapanJapanJapan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...
ese nationals. Widebody aircraft are leased for 12 years, while narrowbody aircraft are leased for 10 years. Under a JLL, the airline receives tax deductions in its home country, and the Japanese investors are exempt from taxation on their investment. JLLs were encouraged in the early 1990s as a form of re-exporting currency generated by Japan's trade surplus. - Hong Kong leveraged lease: In Hong KongHong KongHong Kong is one of two Special Administrative Regions of the People's Republic of China , the other being Macau. A city-state situated on China's south coast and enclosed by the Pearl River Delta and South China Sea, it is renowned for its expansive skyline and deep natural harbour...
, where income taxes are low in comparison to other countries, leveraged leasing to local operators is common. In such transactions, a locally-incorporated lessor acquires an aircraft through a combination of non-recourse debt, recourse debt and equity (generally in a 49-16-35 proportion), and thus be able to claim depreciation allowances despite only being liable for half of the purchase price. Its high tax losses can then be set off against profits from leasing the aircraft to a local carrier. Due to local tax laws, these investments are set up as general partnershipGeneral partnershipIn the commercial and legal parlance of most countries, a general partnership or simply a partnership, refers to an association of persons or an unincorporated company with the following major features:...
s, in which the investors' liability is mainly limited by insuranceInsuranceIn law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
and by contract with the operator.