The airline industry across Asia and the Middle East appears to be in rude health.

Barely a day goes by without a significant aircraft order being reported. In addition to record sales of smaller narrow-bodied aircraft, delivery positions for new wide-bodies such as the Airbus A350 and Boeing’s 777X (with list prices of over $250m) are positively flying off the shelves.

This increase in capacity is largely driven by a predicted exponential rise in passenger numbers across and through these regions. Further, free from most of the regulatory and tax constraints affecting their US and European counterparts, many airlines in Asia and the Middle East are delivering substantial profits, no mean feat in an industry notorious for its wafer-thin margins.

The very strongest airline credits may look to finance these fleet renewals from their own cash reserves. However most will choose to access external funding or acquire aircraft off balance sheet. While interest rates remain low, aircraft financiers and lessors are competing hard for airlines’ business and offering attractive terms to win deals. Indeed, after a period of limited liquidity during the global financial crisis, successful airlines have a wide variety of different acquisition support options open to them including export credit and commercial debt finance, structured and tax lease products (particularly through Japanese, German and French arrangers) and increasingly through accessing debt capital markets. However the acquisition tool most commonly used and that which is likely to grow to 40% of the global commercial aircraft fleet by 2020 is Operating Leasing.

In the aircraft context, an operating lease allows an airline to lease an aircraft for a fixed period of time in return for lease rentals. Throughout the lease term the airline will be responsible for the operation, maintenance and insurance of the aircraft on terms agreed with the lessor.

The lessor’s primary concerns throughout any negotiation will be to ensure that the aircraft retains its value throughout the lease term and that, in the event of a default by the lessee, it is able to quickly recover the aircraft (and its records) and move them on to a new lessee. Lessors will aim to limit their exposure, insisting that the airline pays a cash security deposit and builds up a cache of reserves to secure upcoming costly maintenance events. This objective will run counter to that of the airline’s treasurer who is likely to want minimal capital tied up in the lease arrangement and therefore might push for a position whereby, instead of reserves, the airline simply pays for maintenance as it falls due with a reconciliation payment at the end of the lease to reflect the condition of the aircraft at that time. When agreeing lease terms, the airline should also be focussed on ensuring that it is free to operate the aircraft with as much flexibility as possible without undue interference or oversight by the lessor. Airlines’ commercial and technical teams will welcome commonality of use and maintenance covenants across their fleet, regardless of which lessor has leased a particular aircraft into it. The engineering team may also be keen to have the flexibility to swap engines around the fleet, regardless of the ultimate owner of those engines or the airframe on which it is installed.

Historically, lessors (and their financiers) have tended to call the shots in relation to many of these key issues however with airlines flying high and an influx of ambitious new Asian leasing companies into the market, letter of intent and lease negotiations are likely to become more robust than ever.

For further information, please contact:

Leo Fattorini, Partner, ATMD Bird & Bird
[email protected]