Aircraft finance refers to
financing
Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Generally, this word is used when a firm use ...
for the purchase and operation of
aircraft
An aircraft is a vehicle that is able to fly by gaining support from the air. It 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 engine ...
. Complex aircraft finance (such as those schemes employed by
airline
An airline is a company that provides air transport services for traveling passengers and freight. Airlines use aircraft to supply these services and may form partnerships or alliances with other airlines for codeshare agreements, in wh ...
s) shares many characteristics with
maritime finance, and to a lesser extent with
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 its sponsors. Usually, a project financing structure involves a number of equi ...
.
Private aircraft
Financing for the purchase of private aircraft is similar to a
mortgage
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...
or
automobile
A car or automobile is a motor vehicle with wheels. Most definitions of ''cars'' say that they run primarily on roads, seat one to eight people, have four wheels, and mainly transport people instead of goods.
The year 1886 is regarde ...
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 appraisal of the aircraft's value.
#The lender performs a
title search
In real estate business and law, a title search or property title search is the process of examining public records and retrieving documents on the history of a piece of real property to determine and confirm property's legal ownership, and find o ...
based on the aircraft's registration number, in order to confirm that no
lien
A lien ( or ) 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. The owner of the property, who grants the lien, is referred to as the ''lienee'' and the per ...
s or title defects are present. In many cases, a
title insurance
Title insurance is a form of indemnity insurance predominantly found in the United States and Canada which insures against financial loss from defects in title to real property and from the invalidity or unenforceability of mortgage loans. Unlike ...
policy is procured to protect against any undetected defects in title.
#The lender then prepares documentation for the transaction:
#*A
security agreement, which establishes a
security interest
In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the ''collateral'') which enables the creditor to have recourse to the property if the debtor defaults in makin ...
in the aircraft, so that the lender may repossess it in the event of default on the loan
#*A
promissory note, 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
surety from a third party (or from multiple third parties)
#At
closing, the loan documentation is executed and then funds and title are transferred.
Commercial aircraft
Aircraft are expensive and owning one requires hefty
Capital Expenditure
Capital expenditure or capital expense (capex or CAPEX) is the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure ...
. A
Boeing 737-700, the type Southwest uses, is priced in the range of $58.5–69.5 million. 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
An airline is a company that provides air transport services for traveling passengers and freight. Airlines use aircraft to supply these services and may form partnerships or alliances with other airlines for codeshare agreements, in wh ...
s, use more sophisticated
lease
A lease is a contractual arrangement calling for the user (referred to as the ''lessee'') to pay the owner (referred to as the ''lessor'') for the use of an asset. Property, buildings and vehicles are common assets that are leased. Industrial ...
s and
debt
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
financing schemes. The three most common schemes for financing commercial aircraft are
#
Secured lending
#
Operating leasing
#
Finance leasing.
However, other ways to pay for the aircraft & flying equipment are:
# 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
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or n ...
and
accounting considerations, particularly tax-deductible
depreciation
In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...
,
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
, operating costs which can reduce tax liability for the operator, lessor and financier.
In May 2016, lessors had a 42% share of the market. It was increasing until 2008 but has since stagnated, and should continue so if not for a rise an
interest rates, a slowing of
airline
An airline is a company that provides air transport services for traveling passengers and freight. Airlines use aircraft to supply these services and may form partnerships or alliances with other airlines for codeshare agreements, in wh ...
s' profits, an increase in lessors' share of new
airliner deliveries, and
market liberalization
Free trade is a trade policy that does not restrict imports or exports. It can also be understood as the free market idea applied to international trade. In government, free trade is predominantly advocated by political parties that hold econo ...
. Lessors could also increase their market share by including more start-up
airline
An airline is a company that provides air transport services for traveling passengers and freight. Airlines use aircraft to supply these services and may form partnerships or alliances with other airlines for codeshare agreements, in wh ...
s, more older
aircraft recycling
Aircraft recycling is the process of scrapping and disassembling retired aircraft, and re-purposing their parts as spare parts or scrap. Airplanes are made of around 800 to 1000 parts that can be recycled, with the majority of them made from me ...
, a change in views on
residual value
''Residual value'' is one of the constituents of a leasing calculus or operation. It describes the future value of a good in terms of absolute value in monetary terms and it is sometimes abbreviated into a percentage of the initial price when the i ...
s, and lower returns acceptance.
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
In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the ''collateral'') which enables the creditor to have recourse to the property if the debtor defaults in makin ...
in the aircraft, so that the aircraft may be repossessed in event of non-payment. 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
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
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 Leasing
Aircraft leases are 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 tempora ...
(CASL) company, the two largest of which are
International Lease Finance Corporation
The International Lease Finance Corporation (ILFC) was an aircraft lessor headquartered in the Constellation Place in Century City, Los Angeles, California, US.
It was the world's largest aircraft lessor by value, though ILFC's rival, General El ...
(ILFC) and
GE Commercial Aviation Services
GECAS (GE Capital Aviation Services) was an Irish–American commercial aviation financing and leasing company. AerCap acquired the company from GE Capital on November 1, 2021.
GECAS was the largest commercial airline leasing/financing company in ...
(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 flexibility 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
Aircraft leases are 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 tempora ...
, 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
Air charter is the business of renting an entire aircraft (i.e., chartering) as opposed to individual aircraft seats (i.e., purchasing a ticket through a traditional airline).
Regulation
Charter – also called air taxi or ad hoc – flights ...
, 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, short for "sale-and-leaseback", is a financial transaction in which 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. The transaction is generally done ...
, 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 afford the airlines flexibility to change their fleet size, and create 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 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
In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of the minimum lease payments for the duration of the lease exceeds 90% of the
fair market value
The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by sever ...
of the aircraft. If a lease is defined as a finance lease, it must be counted as an
asset
In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...
of the company, in contrast to an operating lease which only affects the company's cash flow.
Finance leasing is attractive to the lessee because the lessee may claim
depreciation
In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...
deductions over the aircraft's useful life, which offset the profits from the lease for tax purposes, and deduct
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
paid to those creditors who financed the purchase. This has made aircraft a popular form of
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. The methodology can vary depending on local and international tax laws.
Types of ...
for investors, and has also made finance leasing a cheaper alternative to operating leases or
secured purchasing.
The various forms of finance leasing include:
*
Equipment trust certificate An equipment trust certificate (ETC) is a financial security used in aircraft finance, most commonly to take advantage of tax benefits in North America.Peter S. Morrell, ''Airline Finance'' (Ashgate, 1997), p. 153.
Details
In a typical ETC transa ...
(ETC): Most commonly used in North America. A
trust
Trust often refers to:
* Trust (social science), confidence in or dependence on a person or quality
It may also refer to:
Business and law
* Trust law, a body of law under which one person holds property for the benefit of another
* Trust (bus ...
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
securitization 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 States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...
. In a US lease, a
Foreign Sales Corporation
Foreign Sales Corporation (FSC) was a type of tax device allowed under the United States Internal Revenue Code that allowed companies to receive a reduction in U.S. federal income tax for profits derived from exports.
The FSC was created in 198 ...
(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 747s 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
Japanese 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 Kong
Hong Kong ( (US) or (UK); , ), officially the Hong Kong Special Administrative Region of the People's Republic of China (abbr. Hong Kong SAR or HKSAR), is a city and special administrative region of China on the eastern Pearl River Delta i ...
, 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 partnerships, in which the investors' liability is mainly limited by
insurance
Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to hedge ...
and by contract with the operator.
Corporate trust lease
Some U.S. banks hold an aircraft "in trust" to protect the privacy of the true "owners" of the aircraft or to "secure U.S. registration of aircraft for non-U.S. citizen corporations and individuals".
See also
*
Option (aircraft purchasing)
An ''option'', when purchasing aircraft, allows an airline
An airline is a company that provides air transport services for traveling passengers and freight. Airlines use aircraft to supply these services and may form partnerships or ...
References
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