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ANALYSIS: LCCs profit from sale and leaseback strategy

Low-cost carriers have been active users players in sale-and-leaseback transactions. The deals, under which an investment firm such as a bank or lessor will purchase an aircraft from an airline and then lease it back, removes the aircraft, and its associated debt, from the carrier's balance sheet. This allows the airline to reinvest the equity elsewhere.

Airlines typically acquire aircraft at a steeper discount from manufacturers than third parties, so when carriers sell these units, it is likely to be at a premium. Aircraft prices would have increased since the time of the orders, further contributing to the gain realised on each sale. Also influencing the profit is the size of the aircraft order and the credit of the airline.

"In some cases, these deals can be extremely profitable for the airline," says a lessor, adding: "This extra money can be very useful, particularly if the airline is just starting operations."

Carriers can either accept the gain as a cash benefit or amortise the profit for the term of the lease.

India's IndiGo has been the most active user of sale-and-leaseback financing among low-cost carriers, and Flightglobal's Ascend Online database reveals it has completed 37 transactions in the past two years to 1 May.

A year before starting operations in 2006, IndiGo placed a firm order for 100 Airbus A320s, which were likely acquired at a discount given the size of the deal.

With an average lease term of five-and-a-half years, according to Ascend, the carrier is also benefitting from the continual renewal of its fleet by avoiding costly maintenance repairs that creep in after the six-year mark.

According to a lessor source, it is not uncommon for IndiGo to make as much as $4-5 million per aircraft under each Sale-and-leaseback transaction. "IndiGo, more so than any other carrier, has been extremely transparent in its efforts to focus primarily on sale-and-leaseback financing and, as a result, has created a profitable business for itself just in the buying and selling of aircraft," he says.

Virgin Australia is the next largest user, with 35 transactions completed in the past 24 months, followed by Lion Air, SpiceJet and Norwegian, which have closed 28 sale-and-leaseback transactions each.

Air Berlin and Brazil's Azul both completed 25 during this time, while Spirit Airlines had 22 sale-and-leasebacks under its belt.

Although Southwest Airlines is considered to be the "original" low-cost carrier, it has not been a big user of the sale-and-leaseback model. Part of the reason for this is because Southwest is able to tap a wide variety of financing. Most importantly, though, it can access the capital markets easily, unlike carriers in Europe and Asia, providing the budget carrier with a reliable and cheap funding source.

A lack of liquidity for older aircraft because of struggling financial markets is also pushing those low-cost carriers which maintain six-year fleet rollover plans into the sale-and-leaseback market.

A financier highlights a recent deal for a European low-cost carrier which failed to sell its six-year-old aircraft at the required price in the sales market, so it went with "plan B, a sale-and-leaseback deal", and will return aircraft at the end of the leases in 2017 or 2018.

"This will happen more and more because smaller pools of liquidity are forcing these airlines to change their exit plans, by avoiding outright sales and reverting to where there is liquidity, such as in sale and leasebacks," says the source.

Pushing the risk of a potential dip in aircraft values on to third parties is a perk of sale-and-leaseback financing, but one that has investors worried in the wake of new-technology aircraft.

The move is being referred to as the next "bow wave" in operating leasing by the financial community, to signify the potential value risk to lessors because of current-engine aircraft being returned when Airbus A320neo and Boeing 737 Max aircraft enter the global fleet. The first A320neo is due to be delivered in October 2015, while the first 737 Max will enter service in 2017.

Ascend data shows approximately 209 leases with low-cost carriers will expire in the 2016-2021 timeframe.

"What will happen to current-engine values during these initial years is a mystery. Some lessors, no doubt, did deals back in 2010 and 2011 that will come back to haunt them as they needed to keep aircraft moving," says a banker. "This event could impact the number of players in the sale-and-leaseback space in the future if residual values become a real concern."

However, a source at a low-cost carrier remains optimistic. "Sale-and-leaseback financing is a two-way street: a number of lessors have not ordered new-technology aircraft, so these lessors will be at the mercy of budget carriers, which have big orderbooks, even if there are some hiccups over residual values," he says. "Airlines need lessors and vice versa."

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