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Today, commercial aircraft leasing is a multi billion dollar industry employing thousands of people around the world; but it was not always like this. Changes and developments are constantly being made within the industry to facilitate its growth but it took a Quantum Leap in the concept of leasing, a generation ago, to actually initiate and fuel that growth. This post looks back at that Quantum Leap and predicts the next Quantum Leap set to add a new dimension to aircraft leasing.
The leasing of assets, itself, is a centuries old business activity. During my formative years in the asset finance industry (circa 1971) my mentors gave me examples of “asset leasing” from Roman times.
Despite the historical examples, the use of asset leasing by most companies, including airlines, in the early 1970s, barely featured on the asset finance industry radar. Asset financing was very much the realm of bank loans and hire purchase (eventually to be renamed “finance leases”). Leasing was viewed as the “poor relation” among asset financing options. It was the option used by those companies which could neither afford to buy their assets nor were deemed sufficiently creditworthy to qualify for bank loans or other credit facilities.
Fast forward 40+ years and how things have changed, particularly in the commercial aircraft sector with over 40% of the airline fleet worldwide now being leased.
Although there have been a lot of changes in the industry over the past 40+ years, these changes have been needed to facilitate growth rather than have been the key driver of that growth. Forty plus years ago, accepted wisdom was that airlines had to own their principal assets i.e. their aircraft fleets. It was a Quantum Leap for airlines to change their perception of that “wisdom” and to look at the concept of leasing.
Airlines began to recognize that the utilisation of an aircraft was more important than ownership. Simply owning an aircraft did not in itself create a profit for the airline; in fact, first and foremost, ownership created risk! As a result of this recognition, airlines started to transfer ownership risk to someone else (aircraft lessors) in return for paying a monthly lease rental in order to have the rights to use the aircraft (as if they did own it).
This shift of ownership risk may not seem such a big deal now but, make no mistake, it really was a conceptual Quantum Leap at the time.
Changes in the industry continue; there is ongoing consolidation of lessors, new aircraft lessors continue to spring up and new geographical sources of equity investment continue to be unearthed.
However, can any of these developments be viewed as another Quantum Leap which added an extra dimension to the growth of aircraft leasing? Probably not and, on reflection, probably not because a Quantum Leap event has to involve a fundamental transfer of risk from the airlines to the aircraft lessors and since the original transfer of ownership risk, no such risk transfer has occurred.
The aircraft leasing industry is still waiting for the next Quantum Leap but I believe that the wait will not be long. The constituent parts for the next transfer of risk are already available in the market, it’s just that no aircraft lessor has joined the dots and offered the resultant product. Why not is understandable however because when it does happen, the transfer of risk from airlines to aircraft lessors will be real and meaningful, both financially and logistically.
The next Quantum Leap will be the transfer of “Maintenance Risk” from airlines to aircraft lessors. The new product will be somewhere between a “Wet” (ACMI) lease and a “Dry” (Operating) lease with the lessor taking on the Aircraft Ownership (“A”) risk and the Maintenance (“M”) risk.
The introduction of such a leasing product, will undoubtedly be a Quantum Leap for both airlines and aircraft lessors with the airlines transferring and the lessors accepting the risk on billions of dollars’ worth of airframe and engine maintenance.
For the airlines, the basic elements of the lease product will include:
In return for the new lease product the airlines will pay a fixed monthly rental to cover all the above maintenance services although, as with traditional Contract Hire of smaller assets e.g. cars and photocopiers, there will be Terms and Conditions of usage (“T&Cs”), which will include payment of excess and supplementary charges for usage outside of those T&Cs. Notwithstanding any additional T&C payments, airlines are, once again, transferring risk to the aircraft lessors.
To complete the transfer of maintenance risk, aircraft lessors will need to cover that risk by effectively creating a bundle of power by the hour type constituent parts of the new lease product. This will ultimately lead to aircraft lessors aligning closer with OEMs and/or acquiring MROs.
The established aircraft lessors generally have strong technical teams and significant experience of the maintenance requirements of aircraft but their workload is going to grow significantly in the not too distant future.
Transferring maintenance risk from the airlines to the lessor may seem an unlikely development but so did the transfer of ownership risk a generation ago. Standby for the next Quantum Leap, it’s just around the corner!