The aviation industry often uses leasing arrangements for its high-value assets. The financial complexity of these contracts requires the expert input of treasury to unravel them, but when spreadsheets are the only tool available, the task takes on new and unwelcome challenges. Conor Ward, Managing Director of MoyleRoe Corporate Services and aviation consultant to Salmon Software, has a solution.
Leasing is a vital tool for airlines when acquiring aircraft. Many will typically have a mix of owned and leased assets. Ownership is a good investment, but a new aircraft is a huge capital expenditure. List price for the European industry workhorse Airbus A320 family, for example, starts around $101m.
By leasing rather than buying, airlines overcome the huge capital requirements of ownership, but more importantly they enable a faster response to market change, says Ward. That response time may be critical in meeting short-term capacity changes, or moving quickly into or out of certain routes. And it’s not just brand-new aircraft that are subject to leasing agreements: with planes having a typical ‘useful life’ of around 25 to 30 years, and a pre-owned example of the A320 going for an average of $25m, the used aircraft-leasing market is buoyant.
Aircraft leases typically range from three to 12 years, the tenor being steered by the airline’s strategy. In addition, leases tend to be acquired via aviation lessor or broker companies. New assets are often directly acquired from the manufacturer and then leased out to airlines. If an airline has bought an asset directly, a lessor may offer a sale-and-leaseback arrangement, in which it buys that asset from the airline and leases it back to it. Leases may be wet or dry, where dry means the aircraft and nothing else is provided, and wet includes the crew.
A lessor seeking to buy a new aircraft will usually need financing. This could be from a group of financial institutions, other investors, its own equity, or a combination of these. In leasing out an asset to an airline, commercial contracts will be negotiated, normally involving the setting of fees for rent and maintenance, the term of the contract, and the deposit of a security either in the form of cash or a bank LC. With the commercial terms established, counterparties progress to technical acceptance. This ascertains the aircraft’s fitness to fly, ensuring its unique technical log is fully up to date. Acceptance will see the lease executed.
The terms, cash flows and covenant obligations of aircraft financing can be complex, with derivatives or hedging instruments often embedded within the debt or equity instruments. In addition to the financing element, the associated operating cash flows, which include lease rentals, maintenance income or expenses, and other operating expenses, need to be managed over the ownership life of that asset.
Frequently, the cost and complexity of aircraft ownership and leasing will see a special purpose company (SPC) arrangement deployed. Where one asset is owned by one SPC, it ensures no cross-collateralisation with any other asset. This may be a lender requirement, with the SPC being owned by the holding or financing company which holds the debt/equity instruments, which in turn issues an intercompany loan to the SPC acquiring the asset, mirroring the terms of the external debt or equity. It’s a necessary structure that significantly adds to the volume of instruments held by an aviation group, consequently amplifying the volume of financial data it generates.
Of course, understanding the debt/equity position of the business is just one aspect. Another fundamental aspect of aircraft ownership and leasing is the day-to-day management of core treasury elements such as bank statements, payments, and accounting. “The volume of payments and the accounting-related tasks associated with banking transactions can be overwhelming at times, especially where there is a lack of visibility over the data,” says Ward.
An aviation-friendly platform
Of course, there needs to be a better process if all transactions are to be accounted for, and payments are to be made on time. However, Ward notes that treasurers in the aviation industry are all too often beholden to a mire of spreadsheets.
“If you had one leased asset financed by a bank it would be relatively practicable to use Excel. But aviation companies have multiple assets, and therefore multiple counterparties, to manage. Basic spreadsheet software would not give treasury teams the tools to collate, track, maintain and produce the output required to present to management and relevant stakeholders in good time, but this information is fundamental to the business.”
Frustration with the lack of visibility, timeliness, and clarity of spreadsheet data is compounded by the risk of error inherent within manual processing. The answer is the deployment of a TMS, which can begin to automate the treasury activities associated with leasing, and remove the risks. With the right connectivity, a TMS also facilitates faster processing speeds and easier access to essential data.
As with most modern TMSs, Salmon Software gives users the capability to track and update loan schedules, covenants, and cash flows for all instruments. It also presents this information in real-time. “This gives treasurers and other stakeholders the ability to make quick decisions and manage their business effectively,” Ward states. “It also improves the efficiency of the accounting process two-fold.”
But while Salmon Software has for many years worked with clients across a range of industries and sectors, it has a noteworthy number of implementations in the aviation space. As such, Ward says the Salmon TMS has developed into “a very aviation-friendly” platform.
The system can, for example, record all of a client’s aircraft-related lease transactions and present its data through dashboards tailored to the industry-specific needs of its user. With the requirements of the aviation sector well understood by Salmon allied to the platform’s design flexibility, Ward says the vendor has also been able to embed groundbreaking industry-focused contracts management functionality. While he says this is not intended to replace a specialist platform, it nonetheless provides the ability for treasury and other stakeholders to monitor essential contract components.
The covenants dashboard, for instance, checks and tracks compliance, flagging any potential issues in good time. The contract management function also records and tracks other significant elements such as current securities on leases, loan-to-value ratios, and even market values of aircraft.
A further example of Salmon’s aviation-friendliness cited by Ward is its capability to log and track the serial numbers and specific data points of each leased aircraft, including those of key components such as its engines. This data is static but nonetheless important, as it is often required by different stakeholders to help them easily monitor portfolio concentrations and other relevant information, with individual aircraft data linking to the various financial instruments, and associated providers, underpinning its lease.
Implementing for success
Salmon Software did not set out to attract the aviation sector per se, but the platform’s flexibility gave it the edge when meeting the nuanced needs of that sector, notes Ward. That it is used successfully in a diverse range of industries is certainly testament to that flexibility.
Of course, any treasurer taking the TMS path will need explore in depth every system that is being short-listed before signing on the line. “Functionality, flexibility, security, and the implementation process are all areas that must be explored in depth in every selection process,” urges Ward. Integration is another key topic, he adds, noting that any existing and planned internal systems, especially ERPs, and external systems including banking platforms, must be both compatible and connected.
The successful integration and connectivity of a TMS should ensure not only that automated data transfer is unhindered but also that cash is optimally visible across the enterprise, preferably in real-time. The addition of the aforementioned industry-customisable dashboard design, and the contract management functionality, should ensure every user is able to see what they need to see, when they need to see it, aviation sector or otherwise.
But there’s even more to Salmon’s offering than a host of useful and usable tools, states Ward. “A huge selling point for us is not only our aviation-friendly system but also our ability to work with clients on their implementations,” he explains. “We support that process with our detailed knowledge of the sector, helping them to get the best out of the system. It’s our level of communication in that process that reassures each client that there is an efficient and effective process in place. This is definitely a big advantage for them.”
Indeed, in terms of keeping treasury’s feet on the ground, when the rest of the business is intent on taking off, a TMS that comes with deep-rooted sector expertise has a lot to recommend it.
First published by TMI.