Even as India’s airlines have grounded operations, the bills continue to rise. The asset light model that the airlines adopted has come to haunt them. With 650 aircraft grounded across 22 airports, lease rental payments and parking (and other) charges continue to buildup. The lease rental payments alone which were averaging 1050 crores per month (~USD 152 million) have gone up by 7% due to the Indian Rupee depreciating against the USD $. Some airlines are facing the unfortunate eventuality of cessation of operations, while for those that survive, fleet plans will have to be revisited and drastically altered. The only options seem to be restructuring, re-pricing and renegotiation.

Restructuring Orders and Leases:

India’s airlines as of now, have 900 firm orders for aircraft ordered directly from Boeing and Airbus (excluding options). Another 40 aircraft have been ordered via aircraft lessors. However, with depressed demand, airlines will be unable to induct the same volume of aircraft. Yet contractual clauses may mandate minimum deliveries per year that an airline would be bound by and therefore, cannot walk away from.

If that wasn’t challenging enough, the financing method for most of the aircraft operating in India has been predominantly sale and leaseback (“SLB”), i.e. where the airline places a bulk order with the original equipment manufacturer (“OEM”) and sells the asset i.e. the aircraft to a lessor at more than capital cost, with the difference being a profit to the airline. The profit for stronger airlines has been used to strengthen the balance sheet while for weaker ones has been used towards operational expenses. In a SLB transaction, the lessor immediately leases the aircraft back to the airline back for an average of 8 years or more and the sale and lease agreements are usually executed simultaneously.

But concurrently, the SLB market is experiencing its own set of challenges – including liquidity drying up for lessors; declining lease premiums (more so for single aisle aircraft) e.g. the lease rental for a ten year old A320CEO and A321CEO has reduced by almost as much as 15% and 23% respectively since the beginning of 2020; supply demand imbalances and the inability to place aircraft after the end of the primary lease term. These factors (external to the airline) further impact airlines negatively.

Finally, for current leases, cash-flows are non-existent due to the grounding by the Government of India coupled with the fact that most airlines have stopped making lease payments while they look to liquidity options. And, even post the grounding, demand is anticipated to fall by 40% – 70% depending on a multitude of scenarios, most out of the hands of the airlines – and the cash-flow is likely to be severely depressed. Airlines also face significant challenges in restarting operations too which were detailed by us in the article titled “Lockdown Woes: Getting India Back in the Air”.

The only option for airlines in this scenario seems to be to re-negotiate leases and restructure future orders to align them with the new reality, i.e. the post coronavirus world.

Re-pricing of Orders and Re-negotiation of Lease Agreements

Aircraft values are dependent on a host of factors including technology, fuel-efficiency and liquidity of the asset type. In an irony of sorts, fuel prices have fallen to such a level where the capital costs of new technology such as the A320NEO outweigh the cost of using older depreciated assets with older technology such as the A320CEO. This too is a cause for concern for airlines and therefore to be competitive in this volatile atmosphere, airlines will have to push for re-pricing of the asset itself. Keep in mind that it is not uncommon to have purchase agreements which contain clauses that cater to escalation of costs and therefore higher asset purchase prices. As input costs rise over time, an aircraft being inducted in 2022 would be more expensive than one built in 2021. However, in the current environment those escalation clauses also require further discussion.

For countries like India, while the skies are shut, the other major challenge haunting airlines is the currency depreciation. Already the Indian Rupee has depreciated by 7% against the USD $. To put this number in context, every time the Indian currency falls against the USD$ by one Rupee – an airline with a fleet size of 20 aircraft all under standard lease agreements and current market rates, would be faced with an additional annual cash-burden to the tune of 7.2 crores (~USD 1 million). This foreign exchange exposure, for the most part, is not hedged. Thus, airlines have to recover this via revenue enhancements– however in a market where demand has evaporated and where price sensitivity is extremely high, this is easier said than done.

Airlines will also want to shrink their current fleet size to adjust to new demand dynamics. However, since most aircraft lessors charge hefty penalties for early exits from such agreements, this too is a daunting task. “Force majeure” seems to be a consideration many are looking at but the question as to whether force majeure would apply to exonerate airlines from their obligations also is on very shaky ground. Our article on the application of force majeure and other clauses in aircraft lease agreements titled “Lockdown Woes: Does Force Majeure apply to Aircraft Lease Agreements” is self-explanatory.

Airlines do have the option to invoke an early termination option or “ETO”. It is up the parties to an aircraft lease to agree on ETO terms, however in most agreements, in order to avail of an early termination, airlines need to be current on lease rentals and agree to pay a significant termination fee which is essentially an amount paid in consideration of the waiver by the Lessor of the various return conditions under the Lease.

In the context of leases and early termination options it is important to note that India became a party to the Cape Town Convention on International Interests in Mobile Equipment (“CTC”) and the Aircraft Protocol on the 1^st of July 2008. The CTC and Aircraft Protocol are inter-alia, designed to facilitate asset-based financing and leasing of aircraft assets. The Aviation Working Group in its inaugural Cape Town Convention Compliance Index (created to monitor and assess the implementation of the Cape Town Convention and its Aircraft Protocol in contracting states) ranked India along with Kenya and Indonesia with a score of 69 out of 100. This score falls under the “medium” category and implies that there is a medium probability level that the terms of the CTC (with applicable declarations) will be “substantially” complied with.

Despite India having made serious attempts to properly implement the CTC and Aircraft Protocol yet several loop holes and shortcomings remain in their implementation in India, resulting in Indian airlines having to pay lease rentals of up to 3 months in advance as security deposit (this is completely up to the parties, therefore, may vary significantly from airline to airline and even from lessor to lessor) to allay any concerns the lessor might have about the aircraft being placed in India. The monthly lease rental for a narrow body aircraft varies between $ 2,50,000 – $ 3,00,000 therefore 3 months security deposit may amount to almost 1 million USD$ – a significant amount. Airlines might be able to recover some of this blocked capital upon termination of a lease agreement.

In some case, an aircraft lessor might choose to terminate lease agreements before the airline does. This due to default on lease rentals and to mitigate risk (after all if the airline goes into bankruptcy the only option lessors are left with is an actionable claim against an airline which is anyway challenged to make payments. Subsequently, lessors may choose to terminate lease agreements, repossess aircraft and fly aircraft out of the country if they feel an airline does not have the financial backing and may end up in bankruptcy.

So, the complexities for the airlines continue.

Renegotiation with all other stakeholders

To successfully navigate their way out of this situation, airlines especially those with long-term plans, will engage with stakeholders to renegotiate all other contracts apart from aircraft lease agreements too. A renegotiation at this time is not a “win-win” proposition. Rather it is a “lose-less, lose-less” proposition for both sides. Because majority of airlines in India have negative equity and given the balance sheet strength and risk profiles more than one airline is staring squarely at business failure.

Some airlines may use the threat of bankruptcy or business failure as a negotiation ploy. This has to be carefully evaluated as business failure carries with it other complexities with the repossession of assets, legal hurdles and regulatory compliances (a point to note is that Jet Airways’ assets continue to be under moratorium issued under the Insolvency and Bankruptcy Code 2016).

Outlook

To say the situation faced by airlines in India is grim would be an understatement. As it stands the airline business in India is looking extremely challenging and significant capital infusion is required for the survival of Indian airlines.

Cash-flow, credit and credibility of business models are all significantly constrained. Without bailout support, the only two airlines that can tide over the crisis are India largest low-cost airline, IndiGo with its substantial cash reserves and Vistara, backed by the Tata Group and Singapore Airlines.

In all cases to ensure continuity and survival the airlines essentially have to restructure, reprice and renegotiate with stakeholders. There are not many other options.