High Return on Leasing Will Continue to See Lower Rentals

March 5, 2018

The net income reported by some of the major lessors for 2017 continues to see not only double digit returns but in some cases, 20 percent which will likely attract new investment to the detriment of some lease rentals.

Avolon has reported revenues of US$2.4 billion for 2017, bolstered by the acquisition of CIT last year. The net income was $550 million. This represented a pretax profit margin of more than 22 percent. The lessor has nearly a 1,000 aircraft which are owned or managed and 2017 saw the delivery of some 45 new aircraft, representing approximately five percent of all deliveries made by Airbus and Boeing. Aercap, with over 1,500 aircraft, also saw more than a 20 percent return recording a net profit of $1.08 billion on revenues of $5.04 billion. The average remaining lease term on the Aercap fleet is 6.9 years. Aircastle reported a $148 million net profit on revenues of just under $800 million. Aircastle sold eight aircraft during the year for $69 million registering a gain of $20 million. The lessor has 236 aircraft.

The approximate 20 percent net income has been consistent in the last few years even as lease rentals on narrowbodies have fallen. The lessors generally see ten percent of their fleet being re-leased each year. This has ensured that leases that were agreed at higher levels at still generating better returns than aircraft that have been placed more recently. The lessors have also been seeking to generate additional income to offset any fall in overall lease rentals. The larger lessors with an extensive fleet and order backlog and constantly turning over their aircraft to ensure a low average age. This involves the packaging and selling of some aircraft to other lessors including both established, niche and new market entrants. Such disposal of aircraft in a strong market such as today, can generate additional profits. The larger the lessor, the more opportunity exists for reducing the cost of funds. In a rising interest rate environment the cost of funds for the lessor will likely rise more slowly than the rate being charged on the lease. Lessors can actually benefit from a rise in interest rates, at least in the short term, until such time as it impacts demand.

The use of maintenance reserves is also another important revenue stream. An experienced lessor will have considerable technical resources that ensures that while maintenance reserves are collected, the use of such funds for maintenance by the operator is contained with warranty administration and oversight of overhauls being essential in ensuring that the maximum amount of monies are retained at the end of the lease. It is not unusual for a lessor to have $6-8 million in maintenance reserves at the end of the lease which then requires a decision on whether to sell the aircraft in its current condition or seek to limit the expenditure on any maintenance before leasing to a new lessee. The issue of maintenance reserves continues to be a problem for lessees as the price of engine spare parts – Life Limited Parts (LLPs) – continues to rise above any other measure of inflation. The annual rise in LLPs prices can be significantly higher than five percent each and every year. Some airlines asked the EU to investigate the seemingly excessive cost of aircraft maintenance in 2016. The cost of a set of LLPs for the CFM56 is approximately $3.5 million compared to approximately $2 million in 2009. The cost of a set of LLPs for the A350 is estimated to be in excess of $7.7 million. With respect to hourly maintenance reserves, the lessors will likely increase the hourly LLP cost to compensate for perhaps the unused 10 percent stub life and handling charges.

The high returns being recorded by the major lessors continues to attract new lessors who can access funds based on such result. The issue for any asset investment is that when there is clear evidence of good returns, that is not usually the best time to invest as this signals that the market is peaking. The recent reduction in lease rentals on new narrowbodies resulting from intense competition is a case in point. Some new market entrants eager to establish a foothold in the market are willing to pay more than the market value for aircraft while leasing at a lower than average level. As time progresses seeking to package such aircraft for onward sale to other lessors to fund new acquisitions and to lower the average age of the portfolio, will prove difficult.

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