Aircraft finance

Airlines mostly do not own their aircraft. They lease them, from companies whose whole business is buying aircraft and renting them out. Those companies borrow to buy them, and that borrowing is aircraft finance.

What makes it work is that an aircraft is an unusually good thing to lend against. It has a serial number. It can be repossessed and flown somewhere else. It is standardised, so many airlines can use the same machine. And there is a real second-hand market with published values.

What makes it hard is the same thing seen from the other side. The loan runs for years and the aircraft will still be there at the end — but what is it worth then? A model that stays popular holds its value for decades. One the manufacturer replaces, or that becomes uneconomic to fly, does not.

So the lender is really taking two risks: whether the airline pays its rent, and what a used aircraft fetches in ten years. The second is a bet on a market, not on a borrower, and it is where the money is actually made or lost.

Why it can be repossessed, which is not obvious

An asset that moves between countries is normally a nightmare to take security over. International conventions were written specifically for this problem: they create an international registry of interests in aircraft and give creditors defined remedies that participating states agree to enforce.

Countries that have adopted them see cheaper financing for their airlines, precisely because lenders believe they can recover the asset. It is one of the clearest examples anywhere of a legal framework showing up directly in a price.

The structures

• An operating lease — the lessor owns the aircraft, the airline uses it for part of its life and returns it. The lessor keeps the residual risk.
• A finance lease — economically a purchase, and the airline generally ends up with the aircraft.
• A secured loan to the airline or lessor, with a mortgage over the aircraft.
• A tax-driven lease, structured through a jurisdiction whose rules reduce the overall cost, and shared between the parties.

Maintenance is part of the credit

Aircraft value depends on maintenance status: how long since the last major check, how much life remains on the engines. Leases therefore specify redelivery conditions in detail, and lessors collect maintenance reserves along the way. A machine returned in poor condition is worth substantially less, so these clauses are money rather than housekeeping.

Where the appraisers come in

Independent firms publish current and future value estimates by type and age. Loans are sized against those figures, and covenants are tested against them. The whole market rests on a small number of professional opinions about what things will be worth — which is a real concentration and everybody knows it.

Why residual value is the whole game

Consider a loan amortising to a balloon of forty per cent of the original cost after ten years. If the aircraft is then worth fifty per cent, the lender is repaid comfortably. At thirty per cent it is not. The difference between those outcomes has nothing to do with any airline's creditworthiness and everything to do with fuel prices, replacement models and how many of that type were built.

Which is why the sharpest analysis on this desk is about aircraft types rather than about borrowers, and why a lender's portfolio is described by what it is secured on rather than by who owes it.

What makes a type hold value

• A large operator base — many airlines flying it means many possible new homes.
• Fuel efficiency relative to what replaced it, which is what eventually retires a fleet.
• Continued manufacturer support for parts and service.
• A freighter conversion market, which gives an ageing passenger aircraft a second life.

The correlation problem

Airline defaults and aircraft values are correlated in the worst way: a downturn that stops airlines paying is the same downturn that fills the market with aircraft nobody wants. The security is weakest precisely when it is needed. That is not a defect of the analysis, it is a property of the asset, and it is why conservative advance rates matter more here than covenants do.

Where it sits relative to shipping

The structures are close cousins — see ship financing. Aircraft are more standardised, better documented and easier to repossess; ships are more varied and their earnings more volatile. Both are lending against a movable asset whose value moves with a global cycle, and both teach the same lesson about correlation.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.