Prof. Ian Giddy, New York University
Founded in 1931 by a New Zealand pilot of the Royal Canadian Air Force named Lowell Yerex, "Transportes Aéreos Centroamericanos" (TACA) started operations in Tegucigalpa, Honduras with one airplane and a contract from the Honduran government to transport goods. Thirty years later a well known Salvadoran businessman invested in TACA, becoming the majority shareholder and making TACA a multi-national carrier with a base in San Salvador, El Salvador. Between 1989 and 1992, Taca also acquired shares in AVIATECA (Guatemala), LACSA (Costa Rica) , and NICA (Nicaragua), linking these carriers in a strong multi-national alliance, that would later include TACA PERU. GRUPO TACA provides services under one operational brand with a fleet of five Airbus A319s and 23 A320s.
To meet cargo traffic demand, the company had decided to acquire 5 Airbus A300s, as long as the financing could obtained. The five Airbus Industrie jets - once used by Alitalia to ferry passengers to and from Italy - would be based at Miami International Airport, following their conversion by British Aerospace PLC in Bristol, England. Taca chose the Airbus A300 because the aircraft could be unloaded in 30 minutes and loaded in 60 minutes, requiring a total of one and a half hours - a factor that would help keep operating costs down. The estimated cost amounted to $100 million. The question was how to finance this amount.
Unlike many other airlines, Taca was financially sound and expected cash flows would be sufficient to pay the debt service on a conventional bank loan. "Our freight rates are higher, but we try to give the best service in the industry. People prefer to fly with Taca, even though it costs 2 cents per pound more," said Julio Flores, Grupo Taca's cargo manager. 1999 revenues of the privately company reached a reported $600 million, up approximately 10 percent from 1998. With this strength in mind, a friend of the CEO, Federico Bloch, suggested he approach Bank of America's asset financing group for a loan, secured by the equipment. Bloch argued for a fixed long-term rate, so that the airline would not have to worry about refinancing for many years. A banker had told him that 15-year fixed-rate financing would add only 1/4% to 1/2% to the cost.
His CFO countered with the following reasoning: "We should go with a 15-year amortizing loan with a 7-year balloon for two reasons. First, long-term money costs more than short-term money. Secondly, the average aircraft buyer keeps an aircraft only 32 to 36 months. I don't think we are any different. We can keep the payments low with a long-term amortization of principal, and take advantage of a lower rate."
After initial discussions, Bank of America had indicated their willingness to provide a secured loan on the following terms: 90% financing at 11% fixed with a 15-year balloon, prepayable after 5 years. The 15 years was the expected useful life of the aircraft. The interest was payable monthly, and the aircraft would be used as security for the loan.
On the other hand, several aircraft executives had pointed out that leasing, not borrowing, was the normal way to finance aircraft. Lease payments can be tailored to suit the lessee's cash flows and provide up to 100% financing. A further advantage of leasing was that the lease payments were fully tax deductible, while on a loan only the interest, and not the principal, was deductible. On the other hand, if Taca was not the owner of the planes, the company could not take advantage of depreciation (for this kind of equipment, depreciation over over 10 years or more was normal). Hence it seemed that the technique worked best where the lessor could take greater advantage of accelerated depreciation than the user of the aircraft. One prominent provider of such lease finance was GE Capital Aviation Services, whose web page provided an overview of several different ways of leasing a fleet (Appendix 1).
After some negotiation, GECAS offered Taca a 10-year capital lease with 120 monthly payments of $1.4 million. At the end of that period, Taca would have the option of purchasing the aircraft at the appraised market value. Based on past experience, Taca management estimated the residual value of the 5 planes at $3.5 million each at the end of 10 years, and $2 million each at the end of 15 years. The lease payments would be fully deductable for tax purposes. Taca's profits were taxed at a rate of approximately 25%. Another advantage of leasing was that the full amount would be financed; this was good because Taca's estimated cost of capital was about 15%.
Alternatively, Taca could use so-called wet leasing or dry leasing. Both involved leasing aircraft for a relatively short period, ranging from a few months to several years. This could allow the airline to test the demand without committing a huge amount of capital, and would protect against obsolescence. See Appendix 2, a copy of a memo Taca had received from one firm providing such services (Appendix 2).
Appendix 1. GECAS Aircraft Financing
Appendix 2. Realistic Air Leasing
Memo to: Grupo Taca
From: Realistic Air Leasing
Subject: Explanation of our leasing services
Wet Leasing (ACMI, Aircraft Crew Maintenance and Insurance)
Through our ACMI Leasing Services, Realistic Air Leasing will provide in essence a turn key aircraft ready to be used for our client's needs. We will be responsible for providing to our clients the Aircraft, Required Crew, and we will cover any related Maintenance costs required to maintain the aircraft in top condition in addition to paying for the Aircraft Insurance (Hull).
All other costs such as fuel, passenger and/or cargo loading and off loading costs, costs for over-flight permits, catering costs, airport permit costs, required accommodation costs for the crew...etc. will fall under the responsibility of our client, the Lessee.
Unlike other Lessors our ACMI services come with full operational support and assistance in order help create an efficient, cohesive and successful operation. Due to our asset based company position, our ACMI lease rates are the most competitive rates throughout the global market. We will work with our customers in order to competitively meet their financial needs thus insuring the success of both parties.
For those customers who do not require any support or crew services and are simply in need of an aircraft only for lease, Realistic Air offers Dry Lease Services. Our Dry Lease Terms usually range from 1-3 years minimum.
With our Dry Lease Services, our clients will bear responsibility for all costs other than costs related to any major checks and required servicing that the aircraft needs, such as an engine overhaul, a landing gear overhaul and/or a D-Check. All other costs such as routine maintenance that the aircraft requires (this maintenance includes all minor checks) and operating costs in addition to required personnel costs, insurance and any other measures to keep the aircraft in top condition will be the responsibility of our client.
All aircraft in our fleet are kept in excellent condition in order to provide our clients with the most reliable and well maintained aircraft available in the market.
If you choose to apply for a dry lease, RA will require the following information:
1. Does it make sense for Taca to use a wet lease, an operating lease or a finance lease?
2. If Taca decides to acquire its own aircraft, should it lease or buy? Explain your answer with calculations.
3. What other financing alternatives could Taca explore?