Sale and leaseback transactions are a common way for airlines to finance their aircraft purchases. In this article, you will learn what these transactions are, how they work, and what benefits they offer to airlines in terms of cash flow, tax, and risk management.
A sale and leaseback transaction is a type of aircraft leasing arrangement where an airline sells its newly acquired or existing aircraft to a lessor, and then leases it back for a fixed period and rent. The lessor is usually a financial institution, such as a bank or a leasing company, that specializes in aircraft financing. The airline retains the operational control and use of the aircraft, while the lessor owns the legal title and the residual value.
A sale and leaseback transaction involves an airline selling an owned asset, like an aircraft, and simultaneously leasing it back from the buyer. This financial strategy provides airlines with immediate capital infusion, enhancing liquidity. Advantages include cost-effective financing, avoiding depreciation risks, freeing up capital for operational needs, and improving balance sheet ratios. Airlines gain flexibility by outsourcing ownership-related risks, allowing them to focus on core operations. Sale and leaseback transactions are a valuable tool for optimizing financial resources in the dynamic aviation industry.
In short, The sale and lease back transaction takes place between the Airlines and the Leasing company where the original buyer of the aircraft is the airline and sells it to the leasing company with some profit and leases it back.
A sale and leaseback transaction involves two contracts: a sale contract and a lease contract. The sale contract transfers the ownership of the aircraft from the airline to the lessor, and the lease contract grants the airline the right to use the aircraft for a specified term and rent. The sale price is usually equal to or slightly higher than the purchase price of the aircraft, and the rent is determined by the market conditions and the creditworthiness of the airline. The lease term is usually shorter than the economic life of the aircraft, so that the lessor can recover its investment and earn a profit from the future sale or re-lease of the aircraft.
An airline places an order with an aircraft manufacturer such as Airbus or Boeing and invests a huge capital when they get the aircraft they approach the leasing company sells the aircraft to them at some profit and then make an agreement to use the same aircraft for the particular period in exchange of Rent to use the aircraft.
A sale and leaseback transaction can provide significant cash flow advantages to an airline, especially if it has limited access to other sources of financing. By selling its aircraft to a lessor, the airline can generate immediate cash inflow, which can be used to repay debt, fund expansion, or improve liquidity. The airline can also avoid the large upfront capital expenditure and depreciation costs associated with owning an aircraft, and instead pay a fixed and predictable rent over the lease term. This can help the airline to smooth its cash flow and reduce its financial leverage.
Sales and Leaseback help Airlines to gain an advantage as airlines get their investment amount back with some extra amount of profit that can be reinvested into the business which will help in gaining an advantage over competitors, also the amount airlines pay as rent can be recovered by the operations. or airlines can pay there debts.
A sale and leaseback transaction can also offer tax advantages to an airline, depending on the tax laws and regulations of the jurisdictions involved. In some cases, the airline can deduct the rent payments from its taxable income, while the lessor can claim the depreciation and interest expenses on the aircraft. This can result in a lower effective tax rate for both parties, and a higher after-tax cash flow for the airline. However, the tax benefits may vary depending on the type and structure of the lease, and the airline should consult with a tax advisor before entering into a sale and leaseback transaction.
A sale and leaseback transaction can also help an airline to manage its risks related to aircraft ownership and operation. By transferring the ownership of the aircraft to the lessor, the airline can avoid the risks of obsolescence, maintenance, and residual value fluctuations, which are borne by the lessor. The airline can also have more flexibility to adjust its fleet size and composition, as it can terminate, renew, or modify the lease terms at the end of the lease period, or negotiate with the lessor to swap or sublease the aircraft. This can enable the airline to respond to changing market conditions and customer demand more efficiently and effectively.
A sale and leaseback transaction is not without challenges and drawbacks for an airline. The main challenge is to find a suitable and reliable lessor that can offer competitive terms and conditions, and that can maintain a long-term relationship with the airline. The airline may also face higher transaction costs, such as legal fees, due diligence fees, and broker commissions, than if it purchased the aircraft outright. Moreover, the airline may lose some control and flexibility over the aircraft, as it has to comply with the lease provisions and the lessor's consent for certain actions, such as modifications, relocations, or disposals. Additionally, the airline may incur higher operating costs, such as rent, insurance, and maintenance fees, than if it owned the aircraft, and may have to recognize a gain or loss on the sale of the aircraft, depending on the accounting standards and policies applied.
It has a drawback that airlines need a huge amount of money to buy the aircraft from aircraft manufacturers at their initial level, also it requires lot of legal formalities with lot of terms and conditions between both parties, with loss of ownership and control over assets, airlines also lose there assets under there balance sheet that can be need during taking of debts.