India’s aviation market is huge and growing, but revelations that at least two carriers are feeling the strain from aircraft delays slowing sale-and-leaseback payments should raise some concern for lessors playing in that market.
In recent weeks, ratings agencies ICRA and Crisil have downgraded ratings on Jet Airways, IndiGo and SpiceJet. They cite poor market conditions and the impact on airline balance sheets.
Both are concerned that rising fuel prices are not being met with higher air fares, as competition forces airlines into a new round of discounting.
More worryingly, IndiGo indicated earlier in the year that discounts are being applied closer to flight dates in order to shore up loads. Passengers have cottoned onto that, becoming more price-sensitive closer to their travel dates.
This is the antithesis of good yield management. It is all but certainly leading to some carriers’ break-even load factors being pushed out – possibly beyond 100%.
Near-term discounting may ensure that seats are filled and generate revenue that may have gone begging, particularly at a time when oil prices have risen significantly, but this is a recipe for disaster.
IndiGo's strong cash balance and ability to raise capital means it is better placed to withstand the race to the bottom than peers. Still, ICRA cut its rating on the carrier from A+ to AA, reflecting the state of the market – while simultaneously lauding its "adequate liquidity position and superior cost structure".
"However, it remains imperative that pricing sanity returns in the industry and airlines pass on the increase in input costs to passengers in the form of increased yields, for operations to continue to remain sustainable," the agency adds.
In this context, Jet Airways and SpiceJet, especially, seem to be relying on sale-and-leaseback payments on new aircraft to keep operations rolling.
More worryingly for SpiceJet investors was Crisil's revelation that the carrier has faced liquidity pressure owing to delayed deliveries of Boeing 737 Max 8s, which has slowed sale-and-leaseback payments.
The situation is so acute that it has asked at least one lessor to delay payments on aircraft leases.
Sadly, this is nothing new for SpiceJet. In December 2014 it came close to bankruptcy when its fuel supplier briefly withdrew credit terms. It returned to the air within a few hours of that event, but spooked lessors repossessed several aircraft.
Under chairman and managing director Ajay Singh the airline has turned around. It is now India's second-best performing carrier after IndiGo.
But with fares falling fast when they should be rising, even load factors in the 90% range are insufficient to guarantee that the airline can pay its bills.
Meanwhile, ailing Jet Airways has also been surviving on advance payments from lessors. After releasing its delayed first quarter results, the carrier admitted that it had taken $300 million in advance payments from lessors in the three months to June 30, based on sale-and-leasebacks on its 737 Max 8s.
Jet also admitted on 31 October that it has received default and overdue payment notices from some of its aircraft lease payments, but adds that they are "mindful of the challenges currently faced by the Indian aviation industry and they have been supportive of the company's efforts."
It is with some irony that the king of using cash flow from sale-and-leasebacks – IndiGo – appears to be sitting pretty at the moment. Nonetheless, it too has signaled that it will bolster cash by using sale-and-leasebacks to finance its A320nes in the short term, after previously expressing a desire to bring more aircraft onto its balance sheet.
PICK YOUR RISK: ASSET OR CREDIT
At any other time, the situation that India’s carriers find themselves in would make them risky credits, suitable only for the bravest of creditors.
Despite growing alarm, several lessors are willing to deal in the Indian market. In recent weeks, CDB Leasing, SMBC Aviation Capital, GECAS and Jackson Square Aviation have all announced sale-and-leaseback or placement deals with Indian carriers.
Those lessors must be placing a larger bet on their assets than they are the potential credit risks. Given that those deals are for new-technology narrowbodies – A320neos and 737 Maxes – which are in-demand, none of them will lose much sleep. These aircraft are easily re-marketable and can be resettled in a new home rather quickly: Air Berlin's bankruptcy demonstrated how strong demand is for new narrowbodies.
Indeed, New Delhi’s announcement that it will finally ratify the Cape Town Convention will (in theory) make it easier to repossess aircraft should an airline fail or miss lease payments. Previously, India’s Directorate General of Civil Aviation dragged its feet when de-registering aircraft, but a 2014 court precedent has made it somewhat easier. Cape Town should make it as easy as anywhere else, but it is not law yet.
For large, India-savvy lessors such as GECAS and BOC Aviation, neither delayed lease payments nor re-possessions are an issue. They see these outcomes as part and parcel of the asset management business, and part of the risks inherent in a wide portfolio of different credits.
Nonetheless, the industry's new money could be on the verge of receiving a cautionary lesson. Banking asset risk and rolling the dice on the credit requires substantial buffer. This is essential to service debt on the asset if rentals are delayed or go unpaid.
Repossessing an aircraft can be complex and costly. Few new lessors and investors have had to deal with that in recent years. Hand in hand with that is the process of re-marketing. The choices an owner faces around selling an aircraft naked or attracting a new lessee quickly can make or break the asset's profitability.
Assuming India returns to fare price sanity over the next year, non-performing airlines and repossessions may become a non-issue. But with costs rising fast and yields continuing to compress, lessors should be on watch and readying contingency plans.