Air Craft Funding: Turbulence Ahead

Eversince the government opened the skies to private carriers, the airline industry in India has metamorphosed from a two-carrier public sector operation into a multi-airline network with as many as five private domestic carriers and many small aircraft operators. To be able to survive in market with intense competition, it is clear that these airlines have to work out well-defined financial packages.

In India, itself, the initial boom in the industry saw a host of companies flocking to start an airline. By their own admission, these companies did not read the financial fineprint very closely and the results are for all to see. Many of the high-fliers have already bitten the dust. The have-beens include once-upon-a-time big names like Damania Airways, Continental Airways and Raj Air. Today, East West has the distinction of being the first private airline in the country, whose has its fleet totally grounded on account of financial disputes. The high casualty rate has also hit Modiluft which lost its German partner Lufthansa due to financial troubles over lease agreements with the Indian partner claiming that old aircraft were leased to it by the German firm which meant a higher outgo for Modiluft in terms of higher maintenance charges. And if Jet Airways is considered to be the only successful private airline in the ciuntry, it is because the comapny took more than two years to scrutinise the lease agreements and chart a proper future growth-plan before signing any leases.

 

As the private airlines mature, they are all planning to induct aircraft through outright purchases rather than carry on leasing aircraft. While the national carrier Air India will soon be finalising a 23-aircraft deal, Indian Airlines, too, would be heading for a fleet expansion by 1999. Amongst the private domestic carriers, Jet is planning to expand its fleet from 11 to 15 aircraft out of which atleast three may be inducted through an outright purchase. Undaunted by its breakup with Lufthansa, Modiluft is still planning to increase its fleet from six to 12 aircraft with an option to purchase two. Other airlines like East West and Sahara too have ambitious acquisition aircraft purchase plans lined up while the south-based NEPC group has already firmed up a lease cum purchase deal for three A 310s with Airbus Industrie.

In their quest to become large and profitable operators in the airline business, most airlines are moving towards acquiring their own aircraft. Till date, except for Air India and Indian Airlines, none of the airlines have any aircrafts they can call their own assets. But as the government has stopped issuing sovereign guarantees for the nationalised carriers, now all airlines have to work out their own aircraft financing patterns.

The financial fineprint

In such a scenario, investment decisions for buying aircrafts and fleet planning becomes synonymous for an airline. Depending on each airline's business plan, the investment may be undertaken to replace existing aircraft or to add new capacity. The costs associated with expansion would include not only the cost of the aircraft and the relevant ground support equipment but also the cost of the working capital like cash required for increased inventories of spares etc.

With Indian Airlines opting for gaining assets through aircraft acquisition, aircraft financing is coming of age in India. However, given the relative nascency of most airlines, the aircraft acquisition is of various kinds. One is a simple outright purchase of new aircraft, the other is outright purchase of a used aircraft while yet another way is to go in for a lease-cum-purchase deal (see table of possible hybrid financial structures).

Till now all aircraft used by the private domestic carriers have been obtained through an operating lease where the airline does not have the economic ownership of the aircraft and only operates the aircraft on basis of fixed rentals. These rates vary from $75,000 a month for older models like the Boeign 737-200s to $300,000 per month for Airbus A320-200s. These leases are dry leases which only provide the aircraft and not the crew, maintenance or insurance for the aircraft.

However, with most airlines opting for fleet expansion, the fundamental issue facing them appears to be simply to decide on the best mix of lease and purchase of aircraft. When airlines actually set out to practice this principle, the financing decision required involves a few logical steps starting with the airline defining its objectives. These include:

Asset value risk objectives: how much asset value risk does the airline wish to lay-off to financiers or conversely, how much potential equity upside does it wish to retain.

Balance sheet objectives: does the airline want the transaction to be on or off the balancesheet and what are its term, maturity profile and fixed or floating interest rate objectives.

Currency risk objectives: how important is it for the airline to chose financing structures which hedge its revenue currencies and what is its currency exposure from existing financings.

Tax objectives: is the airline projecting tax capacity during the term of the proposed transaction. This will have a further impact on the structuring of the deal.

Macro economic objectives: in case of say a country suffering under heavy foreign debt burden, particularly if it is subject to an IMF programme, the government might prefer to keep airfinance debt off `its balansheet' by having carriers enter into operating leases.

Once its objectives are identified, an airline would have to select the transaction characterisation which meets its objectives in all relevant jurisdictions. For example, Jet Airways has decided to keep its option open for outright purchase of aircrafts for the time being.

This is because, even with help from financiers like export credit agencies, it will have to bringin at least 15-20 per cent of the cost themselves. As raising this money could mean a change in its equity base, it has delayed its acquisitions for the time being.

The airline also needs to examine the internal rate of return (IRR) of each alternative financial structure together with the attached terms and conditions. Laxity in carefully scrutininsing the various terms and conditions between two parties can snowball into a major crisis. Both Modiluft and East West Airlines ran into troubles with its lessor PLM Transport (USA) because lease agreements were not understood or scrutinised thoroughly.

The financier's questions

From the aircraft financier's view point, too, there are certain key parameters for finalising loans and gauging the creditworthiness of the borrower. These are:

The airline's balance sheet which would give give ratios like debt-equity, total revenue accrual of the airline versus its debt, current assets and liabilities.

Profitability of the airline is also important and here financers would also scrutinise the airline's cashflows for atleast a few years. In case of a start-up, the financiers would still insist on projected cashflows by the airlines.

Macroeconomic condition of the airline's native country is also vouchsafed by finnacers with the help of embassies etc.

Several other parameters like tax considerations, aircraft registration, title retention etc are also considered by finnacers before finalising a loan.

In India, given the financial strength of most airlines, all financing transactions are expected to involve either secured debt or asset-based finance. This is because financing structures involving new equity and unsecured debt can prove highly problematic for all but the strongest airline. Though privatisation has been the source of some new equity for a number of formerly state-owned airlines, debt secured against aircraft is still a preferred mode of financing.

For example, Air India has recently concluded an asset-based financing deal with the US Exim-- #include virtual="/incs/bottom.inc"-->