Wells Fargo (NYSE:WFC) is getting its feet wet in new ways to make money in a record-low interest rate environment. With more than $1.4 trillion in assets, it is not really a matter of if they have the money to invest, but rather where to make it work for them. One avenue that Wells Fargo is currently starting to pursue is the area of aircraft leasing.
What does Wells Fargo want with aircraft leasing?
Wells Fargo is no stranger to using commercial leasing to make money. They have been leasing out rail cars, trucks, and other transportation equipment for quite some time. This would not be their first rodeo in aircraft leasing, but it would be the first time that Wells Fargo has taken a major stake in the industry to turn a profit. Wells Fargo is looking to enter this market with a larger footprint simply because the current economic environment and sluggish recession recovery have pushed investment institutions to pursue more lucrative investments. A new study, 'The Commercial Aircraft Leasing Market 2011-2021', estimates that leased commercial aircraft will start to slowly make up a significant proportion of the aircraft that are flying over us every day. As it stands, nearly 7,000 of the aircraft being used commercially around the world are leased, and the market value of the business in 2011 was estimated at $233 billion. One of the key reasons why the industry is growing is that the cost of purchasing airplanes for airlines can sometimes become prohibitively expensive, and this is also a major barrier to entry in the industry. Airline ticket prices are a heavily price-driven market, and with rising fuel costs, it is getting harder to fly people affordably. If the airline wants to quickly expand their fleet, offer more flights, and do it for a cheaper price, then their market share and profits will grow. This is why many times leasing aircraft makes more sense for an airline than buying a large new fleet that will bury them in debt.
Risks and Rewards
With any type of investment or venture, valuable reward comes with some type of risk. One of the upsides to the aircraft leasing industry for the lender is that the debt is secured. That means that in the event of a default on the loan, there is an asset that can be sold to recoup the money that was borrowed. It may not cover the entire amount of the loan if the asset has depreciated, but at least it will not be total loss. Even if one of the engines blows up over the Atlantic and the aircraft is destroyed, there will be an insurance check coming their way to replace the asset. As previously stated, the growth in the market for leased aircraft is increasing as more airlines are looking to reduce their overhead and expand their fleets.
Smaller airlines that lack capital are better off to lease their aircraft initially to start their business. The argument is simply that over time, as airlines get bigger and acquire more capital, it can make sense to buy the airplanes and ride out the 30-year life, just like owning versus renting a house. The key to figuring out the equation is the life and maintenance of the equipment. According to Avinco, a leading company in commercial aircraft and helicopter leasing, the details and negotiation of the lease details greatly impact the IRR that an investor will receive. One of the most important details of the lease is how the maintenance of the aircraft will be paid for. Inexperienced managers may allow uncapped expenditures in the terms of the lease for maintenance. A sensitivity analysis done by Avinco shows that a 50% underestimation of maintenance costs could cause the investor to lose the entire investment in some cases. This may seem like an extreme example, but keep in mind, some of these companies are leasing out used airplanes. Even new airplanes can unpredictably break down more than anticipated.
Problems or Profits for Shareholders?
Wells Fargo is starting to look at different ways to make money for their shareholders. Aircraft leasing is a very promising way to accomplish that goal. The company has been involved in commercial leasing before and will most likely be quite savvy when it comes to negotiating the terms of the lease on the equipment to ensure that the IRR stays on the positive side. The growth that Wells Fargo has experienced, despite the recession that started in 2008, has been quite impressive. Revenue has increased an average of 14.92% over the past ten years with 16.58% growth in net income over the past ten years. The current price to earnings ratio for Wells Fargo is 11.0 compared to the industry average of 14.2 making them a decent buy compared to other banks. The price is still high relative to their earnings, but their investment decisions such as the new aircraft leasing venture could make them a smart buy. The debt-to-equity ratio has fallen over the past few years from a high of 3.94 in 2008 to 0.88 in the most recent year, showing a move towards a more financially solvent situation. Even though the company received $25 billion in TARP funds, they have since paid down their debt with over $2 billion in interest, unlike many other banks and insurance companies. It is clear that while Wells Fargo is just getting their feet wet in the aircraft leasing business, shareholders will most likely be pleased with the result. They have a proven track record and long history to show promise for future earnings, and the solvency to make it through more financially challenging market conditions.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was written by an analyst at Catalyst Investments.