What’s next for aviation leasing? AeroTime talks to AviaAM CEO Tadas Goberis
As we mark Global Leasing Day, we invited Tadas Goberis, AviaAM Leasing chief executive officer, to the AeroTime studio where we discussed the current situation in the aircraft leasing market.
Just how has the COVID-19 pandemic impacted the leasing market? What fears did aircraft lessors have? Which came true, and which did not? Will pay-per-hour contracts survive beyond the pandemic? And is aviation cargo getting a little crowded?
AEROTIME STUDIO: We invited Tadas Goberis, AviaAM Leasing CEO, to the AeroTime studio to discuss the current situation in the aviation leasing market.
With so many disruptions, leading to several airline failures and disturbances to surrounding businesses in the aviation industry, how hard has it been for AviaAM leasing to close transactions and place aircraft this year?
We are part of the same industry that has suffered the most from the COVID-19 pandemic. As a lessor, as an aircraft owner, we faced similar problems to everybody in the market. We were approached by our lessees, asking to postpone payments or to restructure financing. And we were doing that, as it was the only choice to support an airline.
No one was eager to take the aircraft back. [While] you could do that formally because of the violation of the contract, you [then] ask yourself, ‘where do you place that aircraft after you take it?’ There was no choice of placing it anywhere. That's why I think we, like all lessors, were cooperating with the lessees and the airlines and trying to keep the contracts alive and the aircraft, if not flying, then at least standing in storage and just continuing with the contract and not taking the asset back.
There was some uncertainty regarding how long [the pandemic] would go [on for]. Initially, we were talking about six months deferrals of the payment. And obviously, it was clear that it would last longer, and a second round of negotiations came in.
We were smart enough to have strong lessees in our portfolio, and none of the contracts were canceled. I’m happy to say that. I know that it was much harder for certain airlines, especially [for] those who didn't have support from the government, but this is how we plan your portfolio.
Of course, when we were shaping our portfolio back in 2017, nobody was expecting COVID-19 or something like that. But for our brand new aircraft portfolio, we were aiming for strong names like Aeroflot and Emirates. Those airlines have much more muscle to survive any shake in the market.
AEROTIME STUDIO: AviaAM Leasing CEO Tadas Goberis
As an initial reaction to the impact of the pandemic, many airlines began to return aircraft. Why were none recovered by AviaAM Leasing?
Putting aircraft for money from one airline to another is not just the act of taking and giving; you need to find another lessee, you need to sign the contract, you need to prepare the aircraft, most probably you need to change something in the interior, you need to repaint it, all this stuff [involved in] aircraft transition, it's a costly thing to do. So, in our minds, it was not a plan B. It was plan G or F. We were really not thinking about it.
For us, the hard thing was to talk with the financiers, the loan providers [and] the banks who were financing this aircraft for us, as we were also struggling to pay the loan payments. So obviously, this discussion between the three of us, the lessor, the financing bank and the lessee, I am happy to say that it generally concluded well. Overall in the market, everybody at least strives to behave like that. I was a bit cautious that there would be quite a significant amount of aircraft returns and repossession in the very beginning. But frankly, the market showed that everybody involved in that business was cooperative because everybody understands that we are in the same boat.
Some airlines have talked about closing deals at ‘very favorable rates’, for them at least! What has been your experience with leasing rates this year?
I shouldn't be saying this as a lessor, but I think it was a perfect time and situation for the airlines to renegotiate the contracts. The previous, old type of classic lease contracts, which presumed that each and every month there is a fixed amount of the rental to be paid, was changed to the power-by-the-hour or pay-by-hour contracts because airlines were saying, “if we are not flying, how will we pay you now?”.
I think it brought certain efficiency in the contracts, at least from the airlines’ perspective. For lessors, it was diminishing the lease income. But then, you choose [to] either go to a certain compromise and get less of the lease payments, or you take the asset back if you don’t like it. We've seen both scenarios happening.
This review and restructuring of the contracts favored the lessees because the market dictated that certain things should be changed in the contracts and reflect the reality. If you are not flying, you are not paying. If you are flying, you are paying as much as you are flying, which is reasonable. Of course, it was decreasing the lessors’ revenue stream, but, once again, we were sharing the pains.
You have talked about power-by-the-hour leasing. We saw this trend in the industry as a short-term solution for airlines to reduce the costs of leasing an aircraft and stop the negative impact on balance sheets. But what benefits do such leases offer lessors?
As part of the lease payments, many other things are on the shoulders of the airlines. It’s not only paying the lease, it’s also keeping up the maintenance of the aircraft, the continuous airworthiness of the aircraft, they are paying for parking or storage, whichever is the case. For the lessors, leaving the aircraft with the lessee and not getting the lease payment, nothing at all, is still valuable because all these things are covered by the lessee, at least. The aircraft is airworthy, maybe not flying, but stored in a proper way and ready for operations at any time.
For lessors, of course, it is better to have a certain stream of revenue. The power-by-the-hour contract indicates that the aircraft will not be heavily utilized. That means that you might be losing some money, but it’s not on the utilization. I see this as a compromise for everybody.
Can power-by-the-hour leases be applied long-term?
It depends on the negotiation skills and power. I do see certain contracts as a combination of both. Everybody knows about the seasonality, especially on the northern side of our planet. Everybody's busy and happy flying during summer, and then there's nothing to do during wintertime. So, I have seen the contracts evolving into the ones with standard fixed lease rentals during the summer period, and they have the PBH part during the low season. These can be seen in the market, depending on how the lessee and the lessor find a compromise that satisfies both parties. Nobody was, or is, willing to take the asset back as soon as possible because everybody understands the market for the placement of the aircraft is really limited.
Let’s turn to a bright spot in aviation ‒ the cargo market. In April 2021, you said that you wanted to convert 10 Boeing 737s into freighters within a year. What progress has been made?
We are progressing. Maybe not up to the speed we wanted, but, currently, we already have four aircraft converted, and the fifth is on the way. We have booked 10 slots for the cargo conversion. So, this is in line with the plan, but then we had a Plan B.
It's never good when you buy an asset and then put it in storage until it waits for certain things to be done. To avoid this kind of situation, we changed the plan a bit. We decided that some of the aircraft, five of them, would be given to our sister ACMI operator for the summer operations. And then, after they finish their high season, we will send them for cargo conversion. So, that was a bit of a shift in strategy. That's why it's [taking] a bit longer than one year, but we are on the way.
Overall, we are planning for 25 conversions in the upcoming four years for different types of aircraft. It's not because it's fashionable to be in the cargo market. It's more because Avia Solutions Group is stepping into cargo as a significant player by a couple of acquisitions, Chapman Freeborn and Bluebird Nordic. These companies are now a really important part of the Avia Solutions Group business. My role in the group is to support them as much as I can for their operations, meaning providing them with cargo aircraft.
There is much speculation that it is just a temporary thing, and the cargo market will collapse once again when long-haul passenger flights restart. I have a different view. In my eyes, the situation, despite COVID-19, is like this: because of many reasons like e-commerce, more expensive sea containers and many other things, the cargo market is growing. And [it is] growing much faster than cargo or aviation can cope with. Even if we bring back all the passenger wide-body aircraft into operation within two or three years, we [can] still see [that] there will be a gap [created by] the demands from the cargo market.
Secondly, we did a thorough analysis of the world’s cargo fleet. No surprise, there are many aging aircraft that are still flying because of the market conditions. Anything which can go up in the air and carry something is now valuable. A significant number of aircraft are close to the end of life. There will be points in time when they will be phased out, and the production of brand new freighters really doesn’t replace them.
[When thinking about] carriers capable of ordering brand new cargo aircraft, especially wide-body aircraft, it's quite a limited number of players, because it is a huge sum to buy a new aircraft for 160, 150 million dollars. So, everybody rushed into cargo conversion, taking older passenger aircraft and converting them into cargo. But then, once again, the capacity to convert an aircraft is not unlimited. If we speak about the Boeing 737-800, fully occupied converters can do 50-60 aircraft per year. Is it a big number or a low number? Only China can take 50 aircraft each and every year.
So, we just see that COVID-19 kick-started this rush into cargo aviation. It was a bit earlier for us as a group because of the acquisitions we made as we stepped into the cargo business. But we do not see it as a temporary thing. We see it as the backbone for all our group, results, and an important part of the business.
That's why we are here to support them. We are converting the aircraft, and we are not aiming to step into brand new aircraft ordering. That's what we will do for the next five years, and we’re going to be quite heavily occupied with cargo things.
You mentioned an extremely optimistic view of acquiring 25 aircraft in the next few years and you're also talking about a rush into the market. So much attention is being placed on the cargo sector right now. But are there any concerns that it might become overcrowded?
If this market were to become crowded, it would first affect the lease rentals. Usually, for the cargo conversion, you take a 20-year-old aircraft, or close to 20 years old. COVID-19 pushed this situation a bit. The cargo conversion of the Boeing 737-800 happened a bit too early because there is still a big number of the previous generation, 737-400, flying for much cheaper.
If you think about the lease rental, the 800 is almost twice as expensive as the 400. The difference is one pallet in the capacity. And with flights of one hour, there's no room for the 800 to show its efficiency in fuel consumption. But as more and more of the 737-800s were put on the ground for storage or returned from the lessee, the lessors obviously wanted to do something with them to keep up with the values they have. So, that happened a bit earlier than it should have.
Being too crowded, I think the market will regulate that. For the time being, if you think about the mainstream narrowbody cargo conversion, we have two models, the 737-800 from Boeing and Airbus A321. And all the slots are fully booked two years ahead. So, if you want to convert your aircraft as soon as possible, the earliest time you can [secure the] slots is in two years from now.
So, that rush was a bit chaotic, because you need to plan for it, and we were quite deep into that. That's why we were booking the slots in advance, which was a really good thing to do. Because otherwise, we would be waiting for two years for the next slot to come.
The important thing is also on the widebody side, because, obviously, everybody understands that 747-400 will also be gradually phased out. And then, the very logical replacement is the 777-300ER conversion, which is currently on the verge because the first prototype has just flown and the first aircraft has just been converted.
AEROTIME STUDIO: Global Leasing Day Interview
As we celebrate 2021 Global Leasing Day, a day that AviaAM Leasing has had a hand in establishing, what is your forecast for the leasing market for the end of this year? Additionally, what is your prediction for 2022 and the years that follow?
Probably nothing major will happen by the end of this year. The high season has ended or is close to being in our part of the world. So, all of the things will stay as they are. The question is for next year, to know if the market is really recovering like everybody was happy to see with numbers or statistics backing this up. But there's still quite a bit of uncertainty.
This relates to travel restrictions, policies that can apply overnight, and you don't know what will happen in a month or two. So, if we are thinking about the next summer, everybody's hungry to travel, no doubt about it, but then nobody can clearly state what countries will close or will be open. These conditions and uncertainties are, of course, bringing down this optimism.
But, in my eyes, the thing that is gradually recovering in many countries, and many big countries, is domestic traffic. In some countries, it's even higher than before COVID-19. Of course, it's just the domestic market. But once again, it's a good sign that aviation can keep on running.
The biggest question in regards to long-haul flights, which will probably remain the most significant issue. It will also gradually recover, but my prediction is that long-haul flights will not recover earlier than three to four or five years.
On the narrowbody side, the regional aviation side, even in domestic markets in the EU zone, the situation is getting better. Frankly, I'm happy to say that we were expecting more bankruptcies. We wish the best for the lessees, and we will support them as much as we can.
This article was first published on November 9, 2021.
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