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Airfinance Journal Research Papers

Although the consequences of IFRS 16 for fleet planning and finance will take time to materialise, plenty of guidance already exists on how to apply the new standard to various key performance indicators (KPIs).

Only a small minority of respondents admit to insufficient understanding of IFRS 16, although almost one in five foresees a big challenge bringing staff up to speed.

Moreover, analysts have long incorporated operating leases into their reading of airline reporting.

“Analysts have been adjusting airlines’ balance sheets for years to capitalise in a proxy for the debt related to leased assets,” says Barry Flannery, Chief Financial Officer of SMBC Aviation Capital.

“Accordingly, it appears that leases offer limited balance sheet benefit for airlines who either borrow in the public markets or deal with specialist financiers,” he adds.

Natixis' Wui Jin Woon concurs: “We currently already take into account and adjust our debt metrics for operating leases in any case, so we expect the impact [of IFRS 16 on analysis] to be minimal.”

Nevertheless, airlines must ensure clear communication with investors about their accounting methodologies during the transition to IFRS 16. Almost three-quarters of airlines and two-thirds of investors identify this as a challenge.

“For airlines a lot will depend on how they can communicate to financial institutions what the standard is, how it is being implemented and adopted and how the fundamentals of the industry are affected by leasing,” says Breen.

Discount rate

How an airline calculates its discount rate is one of two variables (alongside adoption methodology – discussed in the Implementation section) that it must explain carefully to investors. Essentially, the discount rate applies a present value to future lease payments.

One way to calculate the discount rate is to ascertain the interest rate implicit in a lease, a job that 15% of airlines find the most challenging aspect of IFRS 16 reporting. This is because it requires commercially sensitive information from lessors, which is “not something we will disclose to airlines,” notes Breen.

More airlines aren’t concerned by this because they can use an alternative method: their incremental borrowing rate.

“Only in rare cases will we be able to find the interest rate implicit in the lease,” confirms Norwegian CFO Østby, adding: “In the case of aircraft leases, we will look at interest rates applicable to borrowings associated with our owned aircraft and make any necessary adjustments.”

Since the choice of discount rate affects costs such as depreciation and interest, it will affect numerous financial metrics, changes to which are important to understand for several reasons.

First, they may affect debt covenants. Second, different analysts use different adjustments, some of which may be further out of line with the new, harmonised standard than others.

“If implemented correctly, IFRS 16 will increase transparency and provide analysts with more accurate data instead of the output derived from home-made adjustments,” says Abramovici of Crédit Agricole.

Of all survey respondents, 61% pointed at increased transparency and comparability as the main benefit of IFRS 16 (chart 9). However, peer comparison of metrics is complicated by jurisdiction (IFRS and non-IFRS implementing – see Implementation chapter), while historical comparisons are affected by implementation methodology.

Balance sheet changes

Our survey highlighted seven key financial metrics that would be affected by IFRS 16 (chart 10).

Of these, 63% of respondents and 69% of airlines identify changes to gearing ratios as most problematic. Since IFRS 16 increases the liabilities of any airline with aircraft under operating lease, gearing ratios are set to increase.

“That will have an effect potentially on some financial covenants,” comments Stellwagen CEO Bourgade. He adds that while debt covenants often already account for leases, finance departments will need to ensure this is the case.

Lease data must also be reviewed, a task that 74% of airlines identify as either significantly or moderately challenging.

It could be worthwhile, though. For airlines with few years to run on their leases, their IFRS 16 debt might be lower than adjusted estimates. Air France-KLM, for instance, notified investors in late 2017 that its debt reported under IFRS 16 would be at least €1.5 billion ($1.7 billion) less than previous adjusted estimates.

Covenant breaches

Although operating leases rarely contain covenants pertaining to balance sheet metrics, loan contracts often do. Most lessors (61%) think IFRS 16 means airlines are more likely to breach such covenants, although airlines themselves are more confident they can avoid such violations (chart 11).

Still, while the risk of covenant breaches may be low, proving so will be a laborious job.

“Airlines will have to review all existing loan documentation to make sure that there is not one covenant that has an impact. Maybe they will discover nothing, but they will have to review to check so that will be time-consuming for airlines,” says Bourgade.

Air France-KLM says only its credit facility has covenants that relate to debt levels, and these are already adjusted to include 7x annual aircraft operating lease expense – a common multiplier used by analysts.

“We have agreed with the banks not to change the covenants despite the implementation of IFRS 16,” says de Peslouan at Air France-KLM.

Earnings

IFRS 16 will hit airline debt metrics, but it is also expected to boost parts of the income statements, as rental payments morph into finance costs and depreciation.

Without rental expenses, KPIs such as EBITDA and EBIT will rise, something that airlines and industry identify as the second-most problematic of IFRS 16’s changes to metrics.

De Peslouan, however, thinks that income statement changes will enhance Air France-KLM’s standing in relation to its peers.

“Lufthansa has nearly no operating leases so when we compare Air France-KLM with Lufthansa our operating income and margin are lowered by the operating leases we have.”

She adds that while analysts already include operating leases in their debt analysis, many fail to do the same when comparing KPIs such as EBITDA.

Also relevant is the ‘frontloading’ effect of IFRS 16 accounting, whereby lease expenses are recognised as higher in the early years of a lease. When IFRS 16 is implemented, therefore, airlines with many years to run on most of their leases will experience a greater initial impact on various metrics than those with varied tenors on their balance sheets.

Marc Bourgade, CEO, Stellwagen Finance

Marc Bourgade, CEO, Stellwagen Finance

Marc Bourgade, CEO, Stellwagen Finance

Marc Bourgade, CEO, Stellwagen Finance

Marc Bourgade, CEO, Stellwagen Finance

- Посмотрим, чем ты тут занимаешься. Окинув быстрым взглядом находящееся за стеклом помещение шифровалки, Сьюзан включила кнопку яркости. Вспыхнувший экран был совершенно пуст.

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