New rules may burden airline balance sheets by up to $500B
In 2016, the International Accounting Standards Board (IASB) adopted new financial reporting standards that require IFRS-compliant company to significantly reconsider their off balance equities, including operating leases. With almost 40% of the world aircraft being leased, new rules may burden airline balance sheets by $500 billion or more. However, the real impact on the industry might not be as dramatic as it seems, since it may bring more transparency to the airline cost structure.
Approximately half of the world’s 20,000+ commercial airplanes are in the air at any given time. Many passengers believe that airlines fully own the planes they are flying in. But few outsiders know that actually at least every third plane is owned by a leasing company or other lessor.
Air carriers take the planes, operate them on average for 7 to 12 years, and then return them to the lessors. This allows airlines to avoid the burden of actually buying the multi-million asset and, if demand changes either up or downward, to promptly adjust the fleet accordingly. All of this leads to operational savings, flexibility and, eventually, better fares for travelers.
“Some 10-12% of airline’s expenses go on aircraft ownership and full maintenance support. Those airlines which have aircraft under operating leasing can decrease theses costs since they are being shared with the aircraft’s owner. But most importantly, currently airlines don’t keep these assets on their balance sheets thus do not overburden the financial performance with extra debts,” comments Tadas Goberis, Chairman of the Board and CEO of AviaAM Leasing.
In the meantime, according to the International Air Transport Association (IATA), airlines around the world generated over $35 billion of net profit in 2016. This year, the organization expects the industry to generate just slightly above $29 billion due to higher fuel prices, the cool down of some emerging economies and other factors.
With seven years of profits in a row, the airline industry is further expanding its fleet. While in the narrow body, single aisle segment alone there are over 15,000 airplanes, airlines are expected to keep adding thousands of extra aircraft each year.
Such narrow body airplanes like Boeing 737 and Airbus A320 are the working horses of modern commercial aviation. Together with other similar types, these aircraft have a value of over $3 trillion, based on their catalog prices. Together with much more expensive wide bodies and smaller regional aircraft, a total world fleet worth of almost $6 trillion, according to Boeing.
“Now let’s cut the prices to have a bit more realistic market value, and we will see that about 50 publicly listed airlines alone will have to put an extra of $150 billion of liabilities on the balance, according to IASB. Industry-wide, if all airlines to follow IFRS 16 from January 1, 2019, this number can be as high as half a trillion dollars,” adds Tadas Goberis.
IFRS 16 is an International Financial Reporting Standard that provides guidance on accounting for leases. It was adopted by the International Accounting Standards Board (IASB) in 2016 and comes into force in 2019. Under the new standards, all companies that follow IFRS are obliged to bring their liabilities, including operating leases, onto their balance sheets.
Previously, only planes under finance lease were on the balance sheet, since the lessee gets the asset after the lease ends. Now, obligations under operating leases are to be included as well. For an airline which leases the majority of its fleet, this can lead to up to a 100% increase of its long-term liabilities. The biggest challenge will be for non-US airlines which predominantly lease aircraft in US dollars, but earn money in other currencies.
“Thus we have half a trillion-large liabilities from one side, and just $30 billion of annual profit – from another side. But liabilities are stretched for years ahead and, most importantly, are divided between multiple lessees, as one airplane usually has at least 2-3 operators over its lifecycle. In other words, one specific air carrier may have poorer results on the paper in the end of the year, but it shouldn’t bring any devastating damage in a long run. On the contrary, IFRS 16 will allow the carrier’s investors to see a clearer picture of its cost structure and long-term liabilities. Having a stronger investor’s confidence, the airline may find new borrowing options or even decrease the cost of borrowing with existing partners. Of course, an opposite outcome is also possible, but new requirements will affect the entire aircraft financing industry. This means that both airlines and their partners will eventually work out new game rules,” explains Tadas Goberis, Chairman of the Board and CEO of AviaAM Leasing.
And though new transparency rules will be mandatory only for publically-listed companies, private airlines should also assess possibilities for their implementation. According to Tadas Goberis: “This is particularly important for carriers which plan to have IPO in a five or ten years perspective. They should start drafting a strategy on how to present its balance to potential investors and other stakeholders already. In such cases, it’s vital to include the lessor into the process, regardless if it’s a leasing company, a bank or a private investor. After all, the lessor usually holds a deeper understanding of how to account aircraft and how to win the trust of financial partners.”
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