Leasing Jets Takes Off, but May Be Throttled Back : Tax Reform a Threat to Airline Suppliers Such as GE, Xerox

If Greyhound Corp. ever revamps its advertising slogan, the new wording might turn out to be “Go Greyhound--and Leave the Flying to Us.”

That’s because the nationwide bus operator, whose primary business has deteriorated in recent years as a result of strong competition from low-priced, post-deregulation upstart airlines, is also in the aviation business.

It owns big jets that it leases to the very airlines with which its buses are competing for passengers. Greyhound has three giant A300s being used by Pan American World Airways and has just bought--for more than $30 million--a dozen British Aerospace Jetstream 31 turboprop planes that it is leasing to small commuter airlines.

Indeed, it might come as a surprise to many passengers that a sizable number of non-aviation companies own planes that they lease to airlines. General Electric’s 160 large commercial airliners make its fleet almost as large as that operated by Trans World Airlines, the nation’s fifth-largest airline, and almost twice as large as Western Airlines’. (GE also owns 30 smaller commuter jets.)

Other major owners of commercial airliners include the financing subsidiaries of Chrysler, General Motors, Ford, Bank of America, Xerox, IBM, Westinghouse and Merrill Lynch. Dart & Kraft--better known for its Kraft salad dressings, Durocell batteries and Tupperware--owns three big jets. Philip Morris is the owner of six planes, two of which it got when it acquired General Foods last year.

These companies are helping to fill a need, because many of the airlines are strapped for cash, and some of the carriers lease a large portion of their fleets of airliners.

TWA, for example, leases 42 of its 165 planes. Western owns only half of its 82 aircraft. Financially ailing Eastern Airlines, which operates 290 planes, has 88 of them on lease--mostly large craft representing about half of the dollar value of its fleet. Northwest Airlines, which had never done it before, has just leased three from Westinghouse and two from the Bank of New York.

American Airlines, which has been making money, leases 120 of its 295 planes. Even prosperous United Airlines has a quarter of its carrying capacity on lease, mostly its larger planes. “It becomes more cost efficient,” John L. Cowan, UAL’s vice chairman and chief financial officer, said.

The first wave of aircraft leasing occurred between 1968 and 1972 when the new McDonnell Douglas DC-9s and Boeing 727s and the first wide-bodied planes were delivered. Aircraft leases usually run between 15 years and 18 years, so many are now ending. At the same time, new, more fuel-efficient aircraft are coming off the assembly lines.

Richard F. Walsh, director of the office of economics of the Transportation Department, calculates that the number of planes leased by the 21 largest airlines, the so-called “majors” and “nationals,” rose by 39% between the end of 1978, when these airlines were leasing 435 planes, and June 30, 1985, when the figure was 605. In 1978, 19.6% of all airplanes operated by these airlines were leased; by June of last year, the percentage had risen to 25.5%.

(An informal survey by The Times last week indicated that the number of planes leased by the 21 airlines has risen to 766 since last June, now making up 29% of their combined fleets.)

About 25% Is Leased

Of the roughly $34 billion worth of flight equipment being used by all airlines, between 20% and 25% is leased, according to William M. Hawkins, a vice president of the Air Transport Assn. of America, the trade group of U.S. airlines,

“Long-term leasing has become the predominant method of financing new and used aircraft,” said Morten S. Beyer, president of Avmark Inc., a worldwide aviation marketing and management service. “Cash-short airlines, sky-high aircraft prices, razor-thin profit margins and hungry manufacturers are all contributing to the development of leasing as the preferred way to finance new planes.”

Both the airlines and the companies that lease planes to them benefit from such arrangements.

For the leasing companies, it is a way of sheltering some or all of their income from taxes.

For the airlines, the benefit comes in not having to make massive investments in expensive jet aircraft while paying the usually lower cost of leasing. Furthermore, some airlines are either so new or in such poor financial condition that their poor credit makes it difficult for them to obtain any kind of financing for new equipment. They must lease their airplanes.

In a lease, the airline has no investment in the plane. And, through a lease arrangement, it cuts its monthly payments by more than half.

“The airlines are primarily concerned with the amount of monthly payments,” Thomas L. Smith, manager of air finance for General Electric Credit, said. “They incorporate it into their operating expenses. It comes from cash flow.” Smith said an airline would have to pay about 13% interest if it bought an airplane on credit, compared to a lease rate that might be as low as 5%.

Lose Tax Benefits

“There’s no question it saves you money on debt service,” C. J. David Davies, vice president and treasurer of Pan Am, said. “But it’s a little bit misleading, because you are giving up the value of the plane at the end of the contract and you have lost the tax benefits that go with ownership.”

Nevertheless, Cowan of United said the savings from leasing are great. In some cases, he said, the tax benefits that United passed on to lessors are worth between 25% and 30% of the cost of the plane. And, he said, the savings to United from leasing--rather than buying--a DC-10 could range from $20 million to $40 million over the life of the aircraft, and that the total savings to the airline from leasing planes has ranged between $150 million and $250 million a year.

Such business is profitable for the lessors, too. They do not like to talk about it, but observers say that their return on investment from aircraft leasing is more than 20%. “We have certain corporate hurdle rates,” Robert W. Bertrand, president and chief executive officer of Greyhound Leasing & Financial, said. “Greyhound is looking for a minimum after-tax return on its shareholders’ equity of 15% and we meet or exceed that.”

But such leasing arrangements are now threatened. The version of the tax reform bill passed by the House eliminates the investment tax credit and the availability of accelerated depreciation. (Leased equipment can now be fully depreciated in five years.)

Under current law, a business that buys new equipment can take a tax credit of up to 10% of the cost of the asset. For instance, if an airplane costs $23 million, its owner can take as much as $2.3 million credit against his tax bill in the year that the asset is put into service.

No Need for Credits

But, more often than not, airlines have made little or no money in recent years, so they have had no tax bills. Thus, the investment tax credit is of no value to the carriers and, if it is not used within five years, it is lost.

Airlines with low or non-existent profit margins usually are in no position to enjoy the tax benefits and are willing to transfer them to those who can exploit them. In return, the lessors give the airlines the lower lease rates made possible by the benefits.

The threat to eliminate the tax benefits comes at a time when the nation’s airline industry is getting set for one of its biggest shopping sprees. The Air Transport Assn. estimates that in the next five years the industry will have to invest nearly $50 billion in new equipment, more than double the investment of the past five years. This investment is needed to replace the aging planes purchased in the early 1970s and to respond to growth in airline traffic.

U.S. airlines already have 222 planes on order for delivery between 1986 and 1991 at an estimated cost of $7.5 billion. Additionally, the airlines have options to buy an additional 300 aircraft worth an estimated $12 billion.

The investment tax credit (ITC) was suspended twice before--from 1966 to 1967 and from 1969 to 1971. The Air Transport Assn. warned that doing away with the credit now would be a disaster for the airlines as well as for other segments of the economy and that business investment would be decreased significantly.

“The ITC has provided airlines with the additional financial ability to obtain the safest, most modern and fuel-efficient fleet of aircraft possible,” the association’s Hawkins said. “The repeal of the ITC will put into question future orders for new aircraft. Without new aircraft, the aircraft manufacturers and their many contractors and subcontractors will be faced with reduced work and layoffs.”

Would Increase Cost

Robert Burke, senior vice president of Met Capital Corp., the leasing subsidiary that Metropolitan Life Insurance Co. bought from Litton Industries recently, along with 11 jets, added:

“If the investment tax credit is abolished and depreciation lives are stretched out, it will severely reduce the attractiveness of leasing. Since we won’t have the tax benefits, the only way we can make the same rate of return is to increase the financing cost to the airline. . . . This would be an unmitigated disaster to capital formation.”

One recent study showed that 83% of airplane buyers would not have purchased the planes had it not been for the investment tax credit.

But for the time being, said Ramiro Collazo, senior vice president and general manager of Xerox Credit, which has interests worth slightly less than $500 million in 18 planes, there are about 50 lessors in the marketplace and the competition is hectic.

The vehicle by which the airlines lease planes from cash-rich companies is called the leveraged lease.

In such a transaction, the lessor generally makes a payment to the seller of 25% to 40% of the total cost of the plane. Lessors sometimes pay 100% of the cost but generally borrow the bulk of the money, usually from such lenders as insurance companies, pension funds and other large institutions. The airline has no direct investment in the plane.

But the process usually begins when the airline itself places an order for an aircraft with the manufacturer. The carrier puts down a deposit and makes periodic progress payments until the plane is delivered. If the airline decides to lease the plane, it will begin scouting around for a lessor, often as soon as it places the order.

Like a Home Purchase

So aircraft leasing works much like the purchase of a home, with the lessor in the role of the homeowner. The lessor, in effect, refunds the down payment to the airline, and the lender puts up the balance. The airline owns nothing and pays rent on a periodic basis.

A few lessors have begun to buy airplanes directly from manufacturers and then look for airlines that want to lease them. GATX Air of San Francisco, a division of Chicago-based GATX Leasing, purchased two McDonnell Douglas MD-80s in 1981 and now leases them to AirCal and Jet America. In doing so, GATX was able to offer to supply the planes more quickly than the airlines, which had not yet placed orders, could otherwise have obtained them.

GATX recently agreed to purchase 10 new generation A320s from Airbus Industrie, the European consortium, for more than $300 million. Only one airline, Pan Am, stands ahead of GATX for delivery of A320s. So far, according to James M. Robertson, president of GATX Air, interest in leasing the planes has been expressed only by an airline in a country that is “politically unstable. I have not been inclined to chase it.”

The lender, not the lessor, can foreclose on the planes. In case of a default, the lender gets the collateral--the airplane--and the lessor loses his equity investment. But, according to lessors, this hardly ever happens. Even when Air Florida went bankrupt a few years ago, General Electric, which owned three of the airline’s jets, was able to lease them to somebody else.

Sometimes, airlines sell airplanes, then lease them back and continue operating them. This can occur if the carrier is strapped for cash or if it thinks it can make a profit on the sale. Delta, for example, recently sold five DC-9s and 15 727s but kept them on lease.

Take a Gamble

“If you think the value is quite attractive,” Delta Treasurer Frank Chew said, “sell now and keep (operating) the plane as long as you originally planned. (But) certainly you take a bit of a crap shoot.”

Delta did not lease planes until 1983 when its tax situation changed. Before that it was making money and, thus, was able to take advantage of its own tax credits. “We were a taxpayer,” Chew said.

But then the airline entered a period in which it had poor operating results, yet went ahead with an ambitious airplane acquisition program. “We wanted to buy new planes and we did not want to put a whole lot of debt on the books,” Chew recalled. In late 1983, Delta leased 33 new 737s; now, about a fourth of its total fleet of 200 planes is leased.

For the airlines, the decision whether to lease or purchase airplanes is a difficult one. The lessor, not the airline, owns the aircraft at the end of the lease. The lessor then can sell the plane to the airline that has leased it, or can sell it to someone else, or can lease it again.

To try to reduce the risks, airlines conduct “lease-versus-buy” analyses. But, “you never know what you are saving until you know what your actual tax rate was at the end of the period,” John C. Pope, senior vice president of American Airlines, said, “and you never know until the end of the lease what the residual value of the plane will be” in 15 to 18 years.

Both airlines and lessors have begun to consider residual value as a much more important ingredient in the lease equation. Some leases have been expiring recently and, according to Avmark Inc., the value of some aging airplanes is rising. As a result, many lessors made windfall profits.

Values Increased

For example, US Air recently paid $5.3 million each for two DC-9s that it had leased for 12 years from First Chicago Leasing. And Eastern has purchased seven DC-9s and 11 727s in the last three years from lessors for an average of $4.6 million and $5.5 million respectively. The sums were generally more than the planes cost new. On the other hand, the value of older 707s and DC-8s has decreased sharply, with residual worth often no more than scrap prices.

If a passenger wants to know whether he is on a leased aircraft, he often must look hard to find the required notice inside the plane that gives the name of the actual owner.

“It’s a bit of a fight we always have with the airlines,” said Evans Whilby, senior investment officer of transportation for John Hancock Mutual Life’s bond and corporate finance department, which has interests in 20 airplanes. “They don’t really want to make it as visible as it should be. . . . But we like to see it.”

Total Planes Planes “Major” airlines* fleet owned leased American 295 175 120 Continental 131 98 33 Delta 248 195 53 Eastern 290 202 88 Northwest 129 124 5 Pan American 125 63 62 People Express 78 54 24 Piedmont 129 83 46 Republic 168 138 30 TWA 165 123 42 United 348 (a) 307 41 USAIR 143 118 25 Western 82 41 41 “National” airlines* Air Cal 32 5 27 Braniff 20 0 20 Frontier 43 8 35 (b) Midway 27 11 16 New York Air 29 1 28 Ozark 50 41 9 PSA 53 32 21 Southwest 56 56 0

*The Department of Transportation classes airlines with more than $1 billion in revenues annually as “majors” and those between $100 million and $1 billion as “nationals.”

(a) United leases 23 of its planes to other companies.

(b) Frontier leases 3 more planes but has subleased them to others.