The global aviation industry has seen significant improvements in health in the past two years. However, it still faces the lingering effects of the pandemic, supply chain disruptions, profitability concerns, labor issues, and regional variations in demand and recovery. These factors contribute to the ongoing resurgence of the aircraft leasing and trading market as airlines look to insulate themselves from the financial burden of directly owning aircraft, engines, and parts.
Market research firm Polaris forecasts aircraft leasing to grow at a compound annual growth rate (CAGR) of 7.8% through 2029 to $295 billion, slowly approaching previous highs just before the pandemic.1 Some industry experts expect annual trading to increase as much as six-fold to $30 billion annually in the recovery from pandemic lows.2
These outlooks largely echo the context of our recent client conversations. Structural and financial flexibility reflect the changed economic conditions of the aviation industry. They also underscore the role of trust structures in scenarios such as operating leases, financing leases, and leasebacks, each of which mitigates risks by streamlining market conditions for manufacturers, lessors, and lessees.
A Primer on Leasing Structures
There are three core leasing structures within the aircraft space.
- Operating lease: An owner or lessor acquires and leases equipment to an airline or lessee. The lessor retains most ownership risks and rewards. After the lease term, they regain possession and often re-lease or sell the equipment.
- Finance lease: The owner or lessor purchases equipment from a manufacturer on behalf of an airline or lessee. They fund the purchase price and structure the lease to recover most, if not all, of the cost through lease payments. In many cases, the lessee must purchase the equipment at the lease term’s end.
- Leaseback: An airline sells used equipment or its right to purchase a new one to a leasing company or lessor, then leases it back. Unlike aircraft ownership, this arrangement offers fleet flexibility with shorter-term leases and helps raise capital for the airline’s needs.
Two types of entities can fulfill the lessor’s role. An owner trust holds legal title to the equipment on behalf of beneficial owners. This structure facilitates ownership and registration while helping comply with regulations. A Special Purpose Vehicle (SPV) is a separate entity established to isolate risk and protect the parent company from liabilities tied to the SPV’s equipment assets or activities. Forming an SVP entails the additional overhead of establishing a board and undergoing audits.
Trading Dynamics
Several factors have driven increased trading of leases. In addition to the recovery of freight and travel in the wake of the pandemic and the financial challenges in aviation, inflation and interest rates create additional arbitrage opportunities. In the long term, growing demand and fleet renewal may also fuel secondary trading.
More tangibly, the launch of the Global Aircraft Trading System (GATS), developed by the Aviation Working Group (AWG), increased the transparency and efficiency of aircraft trading beginning in June 2020. It standardizes transfer document formats and provides a digital platform for trading activity. Wilmington Trust was an early adopter of the platform, cleared as a trustee on June 16, 2020.3
Keeping the Model Running
Trustees are crucial to the smooth closure, ongoing administration, and trading of leasing transactions. Appointed trustees act as an independent and neutral party that holds legal title to the aircraft or assets, such as engines or parts, on behalf of the beneficial owners or investors. Their primary responsibilities are as follows:
- Legal Ownership and Registration: The trustee holds legal title to the leased equipment. Beneficial owners have economic interest, while lessees have the right to use the equipment. This function helps fulfill regulatory requirements for aircraft ownership, such as those of the U.S. Federal Aviation Administration.
- Compliance, Documentation, and Enforcement: The trustee ensures legal and regulatory compliance, overseeing transaction documents, leases, and financing agreements. In case of defaults or breaches, the trustee enforces the rights of beneficial owners, including repossessing the aircraft or recovering outstanding debts.
- Transparency and Reporting: The trustee maintains accurate records and provides periodic reports to inform beneficial owners, lenders, or investors about the aircraft’s status and transaction details.
- Safeguarding Assets: The trustee ensures equipment is used per lease or financing terms, acting as a custodian to prevent unauthorized transfers or other activity.
- Collection and Distribution of Payments: In lease transactions, the trustee collects and distributes lease payments to beneficial owners. In financing deals, they handle loan repayments to lenders or investors.
Transfer of Beneficial Ownership: When equipment is traded, the trustee follows lease documentation and required processes to handle the transfer, including certificate issuance and regulatory filings.
Experience Matters
When considering aviation equipment leasing and the route ahead for equipment asset-backed securities more broadly,4 the role of a trustee goes beyond plain “vanilla” administrative support. In forming owner trusts and SPVs, having providers with extensive experience with the jurisdictional requirements of both the lessor and the lessee helps avoid potential compliance issues that can stall payments or the use of the equipment.
Given the many nuances of various structures, an experienced provider will be familiar with the transaction agreements and assist with innovation to the advantage of all parties. Moreover, experience with financing paradigms such as bonds, loan facilities, and securitizations gives owners/lessors the broadest range of additional solutions. Finally, in a traded market, both counterparties to a trade expect the focus on detail and speed of execution that a practiced provider can offer.
For further insights on aviation equipment leasing and other financing mechanisms, contact an Equipment and Transportation Finance specialist.
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