The Age of Leasing

The operating leasing share of the global fleet is currently hovering around 55% but during the pandemic that share is reported to have easily topped 60%. The industry debate is just how far can operating leasing dominate the world fleet as the preferred form of aircraft ownership. 

Cowen’s Helane Becker has reiterated every year in this report that she doesn’t believe airlines should own their own aircraft at all. James Meyler, chief executive officer of ORIX Aviation, takes a similar view. “As I have said many times before, the largest hotel groups don’t own any hotels and arguably airlines shouldn’t own any aircraft,” he says. “It’s very possible, eventually that lessors will own all of the aircraft. Clearly some airlines will always either want to own their own aircraft but the 60% share is here to stay. Airlines are going to use the saleleaseback channel to fund deliveries or lease more aircraft because it makes more sense in a volatile environment to have a more flexible business model.” 

Meyler believes that airlines need to refresh their fleets much more regularly than before for aesthetic and environmental reasons to remain more competitive, but also because during a crisis period lessors have proven to be better risk partners for banks. 

Standard Chartered’s Kieran Corr also believes that the operating lease share of the fleet will continue to tick upwards due to the popularity of the product with airlines. “Airlines are using leases as a capacity management tool, as well as a way to hedge residual risk – using sale-leasebacks to shore up liquidity and also to growth quickly to respond to new market opportunities,” he says, adding that lead times for leased aircraft tend to be shorter than ordering aircraft directly from the manufacturers. 

Other lessors opine that the lease fleet may have hit a ceiling around 55-60% since there will always be airlines that can fund aircraft much more cheaply and benefit from the depreciation. 

BOC Aviation’s Robert Martin believes the share will not advance much further. “There are a number of airlines out there that will continue to invest in aircraft themselves to take advantage of the special tax depreciation benefits over the next two to three years as they become more profitable. And there are also carriers around the world that are investment grade ratings and will continue to tap into the unsecured markets.” 

Gary Fitzgerald, chief executive officer at Stratos agrees that although aircraft leasing has become more efficient and lessors are able to raise funding at attractive pricing, “we’re still seeing some of the largest airlines able to access cheaper funding than even the strongest lessor. We might start heading towards a 60% share, but I can’t really see it get a crazy amount higher, but I’m very happy to be proven wrong over time.” 

Fred Browne, chief executive officer of Aergo Capital, noted in his conversation with Joe O’Mara in January 2022 that for the leasing share of the global fleet to remain at 60% lessors will need to find almost $4 trillion in funding, which may be difficult should the operating environment remain challenging. 

Like many lessors, Austin Wiley, Chief Executive Officer of SKY Leasing, says that the company is very focused on country risk from a geopolitical perspective. “Unfortunately we can’t buy a derivative for geopolitical risk,” he says, “all we can do is manage that risk through diversification. The message to our investors is that diversification rules in this industry. When you don’t know exactly what macro forces will prompt a change in the cycle, you can be more insulated and better protected when those shocks hit if you have properly diversified your portfolio by asset type, by business model, and by region.” 

ALC’s John Plueger agrees that country risk has become more front of stage in the current geopolitical environment – Russia and Ukraine has increased global tensions but so too have the political tension between China and Taiwan. 

“After Russia, many people are now very concerned about China and Taiwan” says Plueger. “Our insurers are looking at this and have almost lumped the two issues into one basket from a risk perspective. China is such a large part of the global marketplace and going forward it represents a significant market uncertainty that we don’t quite know how to deal with. We’ve faced a strong dollar before, we’ve faced interest rate hikes before, and all other kinds of situations but never before have we faced what’s happened in Russia and Ukraine and now what could happen on a larger scale if something happens in China.” 

Although the country risk has increased, China is too large a market to ignore. “China will always be a big important marketplace but at the same time, if I had an opportunity to place a hundred more airplanes in China tomorrow, I would have to pause,” says Plueger. “They are great airline partners and are well-run airlines, but one cannot deny the political realities. The United States and China have a very difficult relationship at this point in time, and who knows when it may spill over. It’s a question of what degree of risk you want to accept. We’re happy with our leases there; we’ve got great airline customers there that continued to pay us during the pandemic, but each new deal would have to be assessed on a case-by-case basis.”

The biggest trend in the aircraft leasing sector over the past few years has been the rise in merger and acquisition (M&A) activity. In last year’s report, AerCap’s acquisition of GECAS was the foremost change in the leasing market as it created the world largest lessor by some margin. This year, although not quite on the same scale, there has been a healthy amount of M&A activity, principally the acquisition of Goshawk by SMBC Aviation Capital. 

In May 2022, NWS and CTFE agreed to sell Goshawk to SMBC Aviation Capital for an enterprise value of $6.7bn (equity value of $1.6bn). Citi acted as lead financial adviser to NWS and CTFE. Goldman Sachs advised SMBC Aviation Capital on the deal. The acquisition was complicated by the imposition of sanctions on Russia, which stranded several aircraft in the country, posing the question of whether those aircraft could legally be acquired. Ultimately it was decided to exclude the book value of the aircraft assets exposed to Russian leases from the equity consideration. SMBC Aviation Capital acquired Goshawk and all its fleet except for the six stranded aircraft. The transaction closed at the very end of December 2022 and created the world’s second largest aircraft leasing company with a fleet of 709 owned and management aircraft for a total value of $37bn, which includes the orderbook. 

Peter Barrett, CEO of SMBC Aviation Capital, commented that although this was a sizeable deal, which has brought additional scale to the business, it was manageable: “[The acquisition] is big enough,” he said. “It’s going to really move the needle for us, but not so big that it is going to overwhelm our business.” He added that the acquisition over the longer-term consolidates SMBC Aviation Capital’s position “as one of the leaders of the industry”. 

Goshawk was an attractive acquisition for SMBC Aviation Capital owing to its similar asset profile as well as its culture. “Goshawk is a very good match for us in terms of the portfolio,” says Barrett. “The team of people will add a lot to our business as well.” The timing of the acquisition was also highlighted as an advantage of the company to capitalise on the post-pandemic recovery, and Barrett also noted that it was acquired for “a good price”. 

The transaction was financed using a combination of debt and equity. SMBC Aviation Capital raised $2.54bn to partially fund the acquisition, which comprised a five year $1.83bn Term Loan and a five-year $710 million revolving credit facility. Both the initial term loan and RCF facility had been upsized by US$815 million after launch on the back of strong demand, which was successfully raised with 19 financial institutions, of which 14 were new banking relationships for the lessor. 

ANZ and Citi acted as joint global coordinators, mandated lead arrangers and active bookrunners; BNP Paribas, DBS Bank, OCBC and Cathay United Bank, were mandated lead arrangers and active bookrunners; KDB Bank, Caixa Bank and ICBC were mandated lead arrangers and bookrunners; HSBC acted as senior mandated lead arranger, with Apple Bank, KeyBank and China Everbright acting as mandated lead arrangers. Hogan Lovells was legal adviser. 

Carlyle Aviation Partners raised financing for the acquisition of AMCK, which was announced at the end of 2021. The team raised a $2.5bn bridge loan financing in April 2022 that supported the $4 billion acquisition of AMCK Aviation’s aircraft portfolio, which included over 120 aircraft by Maverick Aviation Partnership, an investment vehicle managed by Carlyle Aviation Partners. The financing provided Carlyle with significant flexibility to execute on its acquisition strategy in a very complex and dynamic market environment. The transaction was structured to allow Carlyle significant flexibility with respect to maximum tenor and refinancing alternatives. 

Goldman Sachs was the sole structuring agent with joint lead arrangers and lenders: Société Générale, BNP Paribas, Natixis, Royal Bank of Canada and Sumitomo Mitsui Banking Corporation. UMB was the security trustee and admin agent. Milbank acted as legal counsel to Maverick. Latham & Watkins acted as legal counsel to the lenders. 

Robert Korn, president of Carlyle Aviation Partners, commented that the acquisition of AMCK and FLY were both a good fit in terms of their portfolios and served the need to add aircraft to their funds, not in a conscious effort to add scale. “We were looking to acquire aircraft for our funds and [AMCK] was a very good fit,” he says. “It wasn’t a consequence of specifically adding scale, but certainly the result of that was a good economical transaction for both parties, benefiting us in that we have been able to enlarge the business and enter into the top 10 in terms of size and scale.” 

Also in 2022, Chorus Aviation completed its acquisition of Falko Regional Aircraft (Falko), which was first announced on February 27, 2022. The acquisition transformed Chorus into a premier fullservice provider in regional aviation, with a portfolio of 348 regional aircraft with an aggregate value of approximately US$4.5 billion that are owned, managed, and/or operated by Chorus subsidiaries. 

In June 2022, Elix Aviation merged with ADARE Aviation Capital, to create Abelo to integrate Elix Aviation’s turboprop portfolio with ACARE’s management expertise. 

Aergo Capital Partners, which is backed by CarVal and has been slowly building up a strong portfolio since the pandemic, acquired Seraph Aviation Management for an undisclosed fee towards the end of 2022. Aergo assumed the management and administration of 88 aviation assets and boosted its owned and managed portfolio to 304 aircraft (including aircraft under LOI), valued at approximately $6.8 billion. 

At the time the deal closed, Aergo CEO Fred Browne commented that Seraph was “an excellent strategic fit with our existing managed asset portfolio and which will bring Aergo to the top of the industry league table by quantity of aircraft assets under management”. 

Kuwaiti lessor Alafco shareholders have now approved the sale of 53 aircraft, plus the 20 Boeing 737 MAX 8s on order, to Macquarie Airfinance Group for $2.2bn. 

M&A activity is continuing into 2023 with the very recent announcement that Standard Chartered intends to explore alternatives for the future ownership of its aviation finance and leasing business. 

Although the large deals closed in the past two years seem to indicate a trend towards further consolidation of the leasing sector, industry leaders argue that little real consolidation has taken place. 

BOC Aviation’s Robert Martin sought to “destroy the myth” in an interview with KPMG’s Joe O’Mara in Singapore in November. “The industry didn’t consolidate; the industry has done the opposite,” he said. “If you measure the market by the top two, the top five, or the top 10 lessors, it has deconsolidated since 2010. The AerCap-GECAS deal was a minor blip in the middle of that, but even that has not stopped deconsolidation. Yes, there will be more M&A but it is always driven by a willing seller.

The key question is whether there are investors that want to get out of the industry or have financial problems of their own that means they have to divest. That sort of consolidation will stay at roughly the same level as we see today. I don’t see significant consolidation coming. If you look at lessor orderbooks and at the orderbook concentration for the top 10 lessors, those top 10 will continue to grow proportionate to the with the marketplace.”

Martin concedes, however, that the reopening of the ABS market may change this dynamic and, as new managers enter the market, it may start to fragment further. 

ACG’s Tom Baker says that he is also squeamish around the use of the consolidation word. “To me, it’s just a transfer of ownership of assets,” he says. “There were 95 leasing businesses 10 years ago. There were 105 five years ago, and there are 97 now. There are mergers and consolidation for platforms, but the overall number of players and the amount of capital in the space will remain relatively stable, at least over the shorter to medium term.” Baker also adds that this could change if the ABS market stays closed for longer. “If the ABS market stays closed, if those warehouses term out without the ability to refinance those assets, they will have to be disposed of in one way or another.” 

The larger lessors are chasing scale and M&A activity has been steady in recent years at the same time as the volume of new entrants into the leasing space has accelerated throughout the pandemic and now into the recovery period. Even as some companies exited the business after the crisis, new investors have stepped in seeking to capitalise on the volatility in the operating environment. Many investors are also aware of the somewhat suppressed distress in the sector from smaller companies that are struggling to cope with the sharp and rapid rise in interest rates and the lag in lease rate rises. 

“For a capital-intensive global industry, the barriers to entry into the leasing market have been surprisingly low, while the barriers to exit have been surprisingly high,” observes ACG’s Baker. “There are a lot of zombie portfolios limping around that I would have expected to disappear a while ago, but they still find a way to hang on for one reason or another.” 

Baker says that the future looks bleak for smaller lessors that rely on captive warehouses for funding or those that fund at the asset level or must term out existing facilities in this higher interest rate environment. “Capital will become less flexible or less visible”, says Baker who sees shorter term debt and lower LTVs as a major concern for lessors as they cannot know the price of debt for the term of a lease. “When interest rate spreads were low, money was cheap, it was easy for people to make business decisions based on fleeting costs of capital. Now it’s a lot harder, and I think you’ll see that play out this year.” 

Kelly adds that the “barriers to entry and barriers to success are very different”, stressing again that lessors without that global platform will struggle to compete in this more difficult operating environment. 

Despite the challenges, liquidity is still flooding into the sector, albeit perhaps on a more discerning basis that in the pandemic period and after the Russian situation. 

CALC’s Mike Poon views the new entrants into the leasing space as a positive development: “Continuous strong rebound in air travel has attracted smart money into the aviation market as we do see start-up airlines, lessors or asset managers across various regions looking to fill the void left by insolvencies in the past three years. It is expected the additional capital brought in by new entrants will further improve secondary market liquidity.” 

James Meyler, ORIX Aviation, observes a reduction in certain types of investors: “Private equity investors tend to move around to where the opportunities are for higher returns over a shorter period of time,” he says. 

“They rightly assumed that the pandemic would provide huge opportunities for buying distressed assets but that actually hasn’t materialised. Lessors have proven the resilience of their business models through the pandemic and they have been able to remain sufficiently funded to survive even though they have seen further losses from bankruptcies or in Russia. As a result, private equity interest is reducing rapidly – either fully exiting or just stopping investment in the sector.” 

Meyler and others are seeing more insurance investors enter or re-enter the space attracted by the long-term nature of the business and its demonstrated resilience. “This suits the insurance company risk profile. Generally speaking, yields in reality are not at the typical private equity level, whereas they are at the level insurance companies seek and, for blue chip airlines and new aircraft types, they are actually also relatively low risk, with low volatility. We’re definitely seeing the insurance market money becoming a bigger and bigger player.” 

There has been an influx of new money into the leasing sector over the last decade that entered the leasing sector during a period of stability with low interest rates, steady macroeconomic growth and low fuel price volatility. As many have pointed out, the barriers to entry are low but managing a leased portfolio through a sharp downturn requires skill and experience as well as a global platform to succeed. “The more challenging the environment, the more the pendulum is swinging back to reality,” says Baker. “The challenges we have faced over the last three years requires expertise, scale, discipline, capacity, capability, capital. With these challenges flaring up, you will see a return to normal and start to greater differentiation in the platforms.” 

AviLease is currently building up the company infrastructure, choosing the right systems, hiring the relevant skillsets, while also investing in training young talent in Saudi Arabia, to lay strong foundations for the new global company that will focus on growth. “There was a 100 million passengers coming in and out of Saudi Arabia in 2019,” says O’Byrne.

“The expectation is that will reach over 300 million passengers by the end of the decade. The first opportunity is to support the local airlines to finance their backlog to accompany the growth of this country. We have a very robust and large investor behind us, which gives us available capital to deploy for large opportunities in our home country and globally.” 

For AviLease, the ambition is to add scale in step with the capabilities of the fledgling company. Although O’Byrne notes that the company is relatively agnostic in how it builds that scale, via sale-leasebacks or portfolio purchases, he is wary of buying in problems. “We are very cautious on the M&A side. M&A can be a fast accelerator but I don’t want to inherit other people’s problems. I want to build a top tier leasing company with the best-in-class systems,” he says.

“We have very disciplined investment approach; I don’t want to end up with a hodgepodge portfolio that frankly will get us into trouble in a few years’ time. We want to buy the best assets, as well as the best teams and best systems.” 

AviLease’s portfolio is now 32 aircraft after the company signed a deal with Saudi carrier flynas for the lease of 12 Airbus A320neos – two of which were delivered within four months of AviLease commencing operations – and more recently a sale-leaseback agreement was signed with Saudia Group, which owns Saudia and flyadeal, for 20 A320neos to be operated on longterm leases by low-cost carrier flyadeal.

Scale is important for AviLease, not least because it allows for a more diverse financing strategy. The team intends to reach a certain scale that would allow the lessor to access the debt capital markets and eventually to attain an investment grade credit rating, although that process takes at least three years. “2025 or 2026 is probably a good timeline for aiming for an IG rating,” says O’Byrne. “In the meantime, we want to make sure that we have access to many lenders as well as the capital markets but we are in no rush to lever up.” 

Targeting an investment grade rating will also enable AviLease to build in discipline to its processes and financing strategy from the ground up, providing certain thresholds such as liabilities. “We plan to maintain a secured side of our balance sheet,” says O’Byrne, noting that the business will not be aiming for a 99% unsecured structure like many other lessors. For a new lessor, building those financial relationships is key, which requires closing secured and unsecured transactions. “We want to make sure that we look at every pocket of capital,” says O’Byrne. 

O’Byrne views sale-leaseback transactions as the easiest way to deploy capital, he considers the next phase of growth as gaining access to OEM slots and trading in the secondary market. Both of which have their own challenges. With such deep pockets and a clear growth strategy, AviLease aims to become a major player in the leasing market, but O’Byrne is mindful of the market challenges.

“The speed of the interest rate rises has shocked the sector,” he says. “Many players have found it difficult to readjust their pricing mindset to add at least 10 basis points onto last year’s lease rate factors – which has clearly not happened. Part of this lag is being driven by a number of investors that have capital allocated that they need to deploy no matter what. We are not keen on that approach; we want to stay very disciplined in our approach.” 

As soon as new aircraft deliveries return to a more normal delivery schedule, O’Byrne expects that sort of capital to flow away and not return any time soon. “The increase in deliveries will also see yield spreads increase – that has to happen otherwise the risk-reward ratio cannot be justified.” 

Lease rate factors are a constant cause of concern for lessors especially since they have been at historically low levels for more than a decade before COVID. Post pandemic there was the expectation or hope that levels would start to include but the abundance of liquidity raised kept competition high.

Today lease rates are reported to be rising but not quick enough to keep pace with the hike in interest rates and to cover the increase cost of funds. The natural lag between lease rates and interest rates has been discussed throughout this report but the accepted length of that gap is debated by lessors. 

“Some people will tell me it’s nine months; some people will tell me it’s 12 months,” says ACG’s Baker. “Some even say 18 months. The needle is already starting to move up. When rate volatility really started to kick up and rates really started to exceed in Spring 2021, that nine to 12-to-18-month rule would suggest that upward trajectory in lease rate factors has already begun and will continue to rise into summer to a place where people can make money. You can only put so much dumb capital to work and you can only lose so much money, before discipline forces you to rerate your business.” 

The challenging environment may serve to flush out some weaker competitors. In a rising rate and inflationary environment, many lessors build in protection in lease contracts, which should offer some protection going forward, but there are still many leases out there that are on fixed rate terms that could cause pain if rates continue to rise.

ALC’s John Plueger believes that this could reduce trading volume if buyers struggle to find financing at a cost of funding that makes sense. “Most leases around the world, especially coming from a low interest rate environment, are at fixed rates,” he says. “It remains to be seen if the appetite for buying aircraft is tempered by the buyer’s own ability to finance at a rate that makes that transaction feasible.

All I can tell you is there’s no shortage at all of demand requests.” Speaking in October 2022, Plueger commented on the rise in demand for aircraft in the secondary trading market despite rising inflation and increased cost of funds. “My gut feeling is that we will see a much more robust aircraft trading environment as we go through into 2023.” 

Even though high interest rates may be dampening asset values as the cost of capital rises, rising inflation, although it increases costs for everyone, should have a positive impact on asset values for aircraft lessors. Avolon’s Andy Cronin says that correlation between inflation and asset prices remains in place and that he “expects appraisers to put a higher level of inflation on aircraft values over year end than we have seen in past decade.” 

For Robert Martin, those value hikes cannot come quick enough: “Appraisers are living in their own little bubble at the moment,” he says. “When the rest of the world is seeing inflation, the aircraft appraiser community is not. They need to change that and catch up with the market.” 

Martin further notes that higher asset values will breathe life back into the ABS market, which should increase trading activity further. Castlelake’s McConnell agrees: “When the trading market finally opens up, which we believe it will and that we could get back to $30bn of trading a year (up from $5bn during the last 2-3 years), sellers will be looking for credible buyers that have committed debt and equity funding. We’ve seen many failed transactions in the market over the last few years where LOIs were signed but the transaction doesn’t end up closing for a host of reasons.” 

Since the pandemic, the shortage of new aircraft deliveries from the manufacturers and the trend for lessors to keep hold of their assets due to the demand for lift from their customers and because they need to keep on top of their growth targets that stalled during the pandemic, kept a lid on trading. Leasing companies are slowly easing back into trading more aircraft. Kelly has already stated that AerCap has sold a significant number of assets in the past year and for “healthy gains”. 

Other market observers see a continued mismatch between aircraft bidding and asking prices. “Lessors who are looking to trade are trading off calculations they made several years ago when interest rates were very low whereas the acquirers who are basing their calculations off interest rates of today creating a mismatch,” says Greg Byrnes, CFO, White Oak Aviation Management Services, an affiliate of White Oak Global Advisors. “That needs to be bridged at some point, and with new funding expected to come downstream, we hope to be ready to secure the best economics we can from an aircraft acquisition perspective.” 

There is likely to be a very crowded marketplace once asset values right size. Gary Rothschild, Partner, Head of Aviation Finance, Credit at Apollo, warns that the new entrants in the sector will be eager to boost their portfolios: “A lot of these new platforms are going to try and pry assets away,” he says. “As deliveries ramp up, as exposures start to become an issue, there will be increased frequency and volume of trading.”