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COVID Impact: Aircraft lessors find themselves re-evaluating India exposure

COVID Impact: Aircraft lessors find themselves re-evaluating India exposure

COVID Impact: Aircraft lessors find themselves re-evaluating India exposure
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By Satyendra Pandey  Jun 15, 2020 12:10:31 PM IST (Published)

Leasing remains the dominant method for Indian airlines to acquire aircraft. Of the current Indian commercial aviation fleet, more than 80 percent is leased compared to the global average of around 41 percent.

With aircraft being highly mobile assets that retain value, the concept of “aircraft as an asset class” has gained traction. Indeed, the last decade saw many new aircraft lessors emerge and as of today, multiple aircraft lessors have exposure to the Indian market.

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Leasing remains the dominant method for Indian airlines to acquire aircraft. Of the current Indian commercial aviation fleet, more than 80 percent is leased compared to the global average of around 41 percent. This because given the structural challenges in Indian aviation, options that minimise cash-burn are usually more attractive. Leasing is one such option. In addition to cash-flow considerations, leasing traditionally has also been driven by liquid credit markets, low-interest rates, high competition and high demand.
However, with the pandemic that has revealed the extremely fragile nature of some of India’s airlines, aircraft lessors are being forced to re-evaluate their India exposure.
The drying up of cash-flows has affected lease payments
Overall the leasing model is one wherein exchange for monthly payments airlines are granted use of the aircraft which in turn is deployed towards earning revenue for the airline. As such the cash-flow is secured via monthly payments not only for the use of the aircraft but also via monthly payments for provisions of maintenance of these aircraft. Add to this the deposits and final dues that are triggered at the end of the lease period.
With the pandemic, the Indian skies were shut for a period of 60 days. During this time, airlines had limited cash inflows (there was some inflow due to sporadic bookings and cargo flying). This against a backdrop of a banking crisis that was brewing even before the pandemic hit and also a recent airline failure that left several lenders taking significant writedowns. As the pandemic progressed and the lockdown was effected, the weaker airlines— without adequate balance sheet strength or a strong company backing—were unable to secure access to credit. Lease payments were suspended and several requests were made not only for deferrals but also lease holidays.
Aircraft value changes likely to impact lease terms and conditions
Aircraft values are critical to the leasing business and these are driven by a host of factors. This includes supply and demand dynamics as well. Just two years ago, airlines were clamoring for new aircraft but the OEMs (mostly Airbus and Boeing which constitute around 81 percent of the global commercial fleet) were booked solid. Thus airlines that required aircraft and did not have orders in place had no option but to approach the leasing market. Even airlines that had placed orders often saw their aircraft end up with lessors due to the sale-and-leaseback financing mechanism.
Because supply could not keep up with demand, the aircraft values held steady for the most part. But the pandemic has not only hit the current operations but also future demand. As such, there is a supply-demand mismatch and this is leading to pressure on aircraft values.
For India’s airlines, especially ones that are reliant on sale-and-leasebacks, this means a lower value realised on these transactions coupled with higher lease payments. Further lease conditions are likely to get more stringent as lessors reassess credit risk both for airlines and for the Indian market.
It doesn’t help that some of India’s airlines find themselves in a very precarious position and are pushing for lease terms that are highly relaxed. This demand will face squarely into the lessors' promise of a higher return to their shareholders. An impasse in many cases seems inevitable.
There is an ongoing debate between new technology versus fuel prices and capital costs
Aircraft technology usually changes once in 30 years. And the technology thus far has focused on fuel efficiency and capacity. That is, airplanes are flying longer, packing in more seats and burning less fuel. But there is always a tradeoff between the capital cost and efficiency of a new aircraft compared to that of an older aircraft. Only new engine technology has come up and not a clean-sheet design for aircraft. It is widely assumed that a clean sheet design is imminent and this too impacts aircraft values.
Interestingly, the latest round of changes has brought this to the forefront. Mostly because of the challenges with the 737Max8 and also the problems with the A320 NEOs traced back to the Geared TurboFan (GTF) engines. And perhaps for the first time, lessors started to cancel orders with OEMs.
At the same time, with depressed demand, fuel prices have declined significantly. Thus in many cases, the capital cost of a new aircraft simply did not deliver the benefit as compared to flying an older aircraft (albeit with a higher fuel burn).
Together the above factors are also factored on risk appetites and impact airlines. The airlines with their own order book are the ones that are most vulnerable. Mostly due to locked-in prices with OEMs, limited exit clauses, and a double whammy with low asset value and lack of financing options.
Lack of localised access means limited market insight
For aircraft lessors, travel is a large expense. This is because assets are placed all over the world and representatives continuously fly in and out to engage with airlines. With the lockdown and all international travel suspended, localised access has become a challenge. This comes at a time where bank lines have dried up and the overall outlook for the sector is extremely negative. Market information is at best incomplete and alarmingly media outlets report information that at times is downright inaccurate. For lessors, the lack of localised access in the current market conditions is akin to flying blind in a storm.
Outlook: More turbulence forecast before lessors find a comfortable cruising altitude
As Indian aviation struggles through what may be its greatest challenge to date, aircraft lessors will face challenges. Repossessions are not out of the question and in several cases these have begun. When it comes to airlines, it is only the ones that are able to shore up credit, cash and conviction that will be able to make it through. With this outlook, it will be extremely tough for weaker airlines to convince aircraft lessors to continue with India exposure.
For lessors, this will involve tough calls and a reassessment of risk. Overall, things are likely to get worse before they become better.
-Satyendra Pandey has held a variety of assignments in aviation. He is the former head of strategy at a fast-growing airline. Previously he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling, and turnarounds. 
Read his columns here.
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