PBH - Building a win-win relationship

At the beginning of this crisis, many lessors agreed on rent deferrals from few months up to even 12 months and/or contract term extensions as the aim was to “hedge” themselves against extensive insolvency in the industry especially if a large quantity of second-hand aircraft hit the marketplace at once and the negative impact it would have on aircraft rental rates.

As lackluster demand and depressed revenue environment continue impacting the business (at least 36 months for domestic flights), airlines have started to play a new card: Power-By-the-Hour (PBH) negotiations as oversupplied market conditions exist.

PBH leasing is an operating lease wherein the Lessor retains ownership of the engine and provides the engine to the Lessee on a fixed cost basis either a cost per flight hour or cost per month.

Recently and to preserve liquidity and contain cost while trying to match revenues and costs, a number of airlines have asked lessors for PBH agreements. For an airline perspective, it makes sense as it allows to establish known engine operating cost (CFO will love it), provides a reduction in capital assets (more money in the pocket) and help deleveraged the balance sheet (meet financial covenants & ratios). From a lessor perspective, it will eat up profits but allows it to remain in the game.

For any successful business negotiation, commercial agreement and relationship to prosper, both parties need to feel they got something out of the negotiation. Therefore, a number factors need to be considered in a PBH negotiation and many negotiations venues can be observed:

1.     An established minimum monthly payment (or minimum number of engine flown or not hrs.) followed by payment by the hour 

2.     Reduced “or bare” minimum number of engine flown hrs. (flown or not) + payment by the hour inclusive of a built-in rate premiums clauses (two to three premiums can be conceive based on pre-determined milestone reached). Caveat: If minimum flight hours are reached on a specific timeline (daily, weekly or monthly basis), premiums cancel out or are deducted from next invoicing period.

3.  A maximum charge up to X engine hrs. agreed, plus multi flown hour incentives (per block) if said target and subsequent levels are surpassed

4.     Shorter term leases (12 up to 24 months) to assess progress and relationship as well as revise terms and conditions if need to especially as lessors don’t know if airlines will keep aircraft long term or what their fleet divestments strategy might be as 2nd (and perhaps 3rd) waves of infection are occurring / will occur

5.     Special clauses and business considerations. Chapter 11 restructuring proceeding and business closure protections need to be built in contract. For example Senior debt payment guarantees, macro level indicator protection and adjustments (inflation rate, currency depreciation, interest rates, etc.) as well as asset repossession without delay guarantees, deposits for late payments, and special arbitrations and remedies, among others.

6.     Others.

For airlines, this move is one in the right direction as they try to cut cost and “control” budget visibility. For lessors, a PBH deal will translate into reduced profitability but in these uncertain times they will have to share the pain or be negatively impacted in a crowded secondhand aircraft market.

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