Investors chasing returns in a post-Covid world could find relief in the purchase of a leasing company.

The leasing industry is on a growth path as airlines alter their fleet activity due to excessive debt burdens resulting from the pandemic.

In November, Aercap chief executive officer, Aengus Kelly, said that lessors would likely own more than 50% of the world fleet within the next three years.

This view is backed by fellow lessor Air Lease and investment bank JP Morgan, which says lessors will grow their fleet share because of more activity in sale and leasebacks and operating leases.

“Operating lessors today manage 46% of the delivered passenger jet fleet, up 5% in the past five years. Leasing will be integral to airlines’ recovery plans as the pandemic has shown that asset-light business models are better positioned to experiment with new routes given flexibility in cost structures,” says JP Morgan in a research note.

The bank adds: “Lessors also drive technology adoption rates, managing nearly 60% of the delivered new technology fleet and holding a significant share of future production slots. There will be fewer operators than before with more liquidity chasing a smaller fleet, but lessors have increased their leverage this crisis as airlines need them for balance sheet repair.”

Fly Leasing has hired Goldman Sachs to undertake a strategic review of its business, including a potential sale of part or all of the publicly traded operating lessor, say sources.

The business review comes as the International Air Transport Association expects the airline industry to remain cash negative through 2021. Its analysis from November 2020 had predicted that airlines would turn cash positive in the fourth quarter of 2021, but now the trade body does not expect that to occur until 2022.

Estimates for cash burn in 2021 have ballooned to between $75 billion and $95 billion from a previously anticipated $48 billion.

The leasing vehicle’s potential sale has advanced to the next stage with the second group of bidders selected in February, sources close to the matter indicate.

Another round of offers is due next week.

Fly is right to consider all options, such as an outright sale or a go-private transaction, especially when trading at less than 50% to book value.

Is the public market the right place to be?

“We look at options all the time, but we are not going to comment on any sort of measures like this at this point in time,” Colm Barrington, Fly Leasing’s chief executive officer, said on a fourth-quarter earnings call in February.

It is a smart move to review the business strategy and to try and recognise the steep economic cost of the Covid-19 crisis now. Why not pursue the build-up in liquidity aided by a flood of central bank and fiscal stimulus?

No doubt Fly and others realise competing for growth acquisitions will be an increasingly tough exercise, especially when competitors such as Air Lease are accessing three-year money at 0.7%.

“It also will be increasingly difficult to extract more value from the portfolio as the pandemic carries on. Why not sell and be equipped with funds in a post-Covid world?” observes a leasing source.

The lessor, which has an 84-aircraft fleet and seven engines managed by BBAM, declines to comment on “rumours or market speculation”.

Despite the challenges of the coronavirus, though, Barrington remains optimistic.

“In the fourth quarter, global airline passenger traffic was 70% less than in the same quarter a year ago. Fortunately, as Covid vaccines reach the majority of populations and border testing becomes more efficient, we expect to see a lifting of government restrictions on travel and pent up demand returning passenger numbers towards pre-pandemic levels later in the year,” he says.

Fly Leasing swung to a $107 million net loss for the fourth quarter from a profit of $75.2 million in the year-earlier period because of the impairment of Airbus aircraft.

The lessor took a $115 million non-cash impairment during the quarter and indicates $106 million of that amount is related to two seven-year-old Airbus A330-300s, which the lessee will return in 2021.

The balance of the charge is related to two A320s and five A319s, which resulted in impairments of $5 million and $4 million, respectively.

The lessor expects the two 15-year-old A320s will be parted out, and the five A319s will be sold.

Fly has letters of intent on the seven aircraft and hopes to conclude the transactions in “the coming months”. Total cash amounted to $161.5 million, of which $132.1 million was unrestricted.

Its total assets were $3.2 billion at year-end, including investment in flight equipment totalling $2.8 billion. The average age of the portfolio, weighted by each aircraft and engine’s net book value, was 8.4 years.

The average remaining lease term was 4.7 years, also weighted by net book value.

Bullet repayment

Fly's fourth-quarter results revealed some good news. The lessor repaid its outstanding 2021 notes in the December quarter.

It has no significant debt maturities until mid-2023.

Fly closed a $180 million five-year secured term loan in October and used about $77 million to repay the $325 million unsecured notes due in October 2021. However, this proved an expensive exercise because the lessor’s borrowing rate was 7%.

Like any operating lessor, Fly has had to renegotiate terms with some of its customers since the beginning of the Covid-19 pandemic.

At the end of the fourth quarter, the lessor collected 47% of pre-deferral contracted rent, down from 53% in the third quarter.

Fly says the pace of deferrals granted “has slowed”, with only $4 million of incremental deferrals given in the quarter.

The lessor has “not granted deferrals past 2021”.

The lessor had about $54 million of rent deferrals, of which about $47 million were included in rent receivables at the end of last year. Deferrals granted at the end of February were $10 million for this year.

Its debt-to-equity ratio was 2.3 times at the end of 2020.

Operating lease rental revenue totalled $64.3 million compared with $88.6 million in the year-earlier quarter. Total revenue for the final quarter was $72.8 million versus $154.3 million in 2019.

Fly Leasing’s Barrington also notes that the lessor has pushed out its A321neo deliveries that are part of a sale and leaseback transaction with Air Asia, as well as the option aircraft.

“We don’t need to make any decision on those deliveries now, and we are working with the carrier on what might be the new delivery programme on those aircraft. We will have updates on that as the year progresses,” he says.

One source familiar with the Fly Leasing portfolio observes that the lessor may face a fair amount of remarketing activity over the next two years as a portion of the portfolio leases expires by 2023.

“Factoring this in conjunction with the likely rent restructuring, which will impact cash flows and scheduled lease expiries, could be a source of concern,” says the source.

At year-end, Air Asia, Air India and Ethiopian Airlines represented Fly’s largest exposures at 11.6%, 11% and 10.4%, respectively. Philippine Airlines and Malaysia Airlines represented 7% and 4.6%, respectively. The lessor also has exposure to Lion Air at 3.3%.

“Lion Air and Philippine Airlines are issues,” says one source, adding that Air India is government-supported, but “there are some big rent arrears there”.

Another driver in the potential sale could be BBAM. The management of the Fly Leasing portfolio is a lucrative contract for BBAM, say sources.

“But, on the other hand, the next few months, if not a couple of years, will be busy as the portfolio will need constant attention given the pandemic. Would BBAM, which has new funding to deploy, be willing to spend its time managing about 85 aircraft and remarket assets?” asks one source.

“The temptation would be to deploy new capital on deals that reflect the post-Covid-19 environment,” adds the source.

BBAM is a servicer and manager and the largest shareholder in the publicly traded lessor with more than 20% of the Fly stock.