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Lease Rates Increase for Less Financially Secure Lessees

October 29, 2018

Fragility of Some Lessees Seeing Premature Return of Aircraft

A raft of airline failures – both large and small – in recent years is leading to lessors placing a premium on rentals of aircraft to less financially secure operators.

Part of the success of the operating lease industry over the last decade, which has seen some 50 percent of the narrowbody fleet being acquired via a lease, has been due to the expansion of the number of operators, notably outside of the U.S. This very expansion has been due not only to traffic but also because of the ease with which aircraft can be leased. There are today many airlines that operate only a few A320s or B737NGs and are hardly known. These are the very airlines that have allowed the operating lease industry to expand at such a rapid rate. Cobaltair has become the latest airline to cease operations following Primera, AirBerlin and Monarch amongst many others. Cobaltair operated seven aircraft, five A320s and two A319s, leased from Jet Midwest, Avolon, Serapoh Aviation, GECAS and ICBC. The aircraft will no doubt be leased onto other airlines quickly assuming the condition is adequate. The lessors will be retaining the 2-3 months security deposits and the maintenance reserves which will provide coverage of expenses while the aircraft is transitioning along with loss of revenue. Over the past 15 years, an average of more than 50 airlines have collapsed each year. In 2008 there were nearly 100 failures although 2017 saw less than 20. The year 2018 has seen further notable collapses and lessors are having to take note the fragility of their lessees. Airline revenues are not rising as fast as expenses.

Receipts from the sale of tickets is instantaneous and are received ahead of most expenses associated with operating aircraft, including lease payments. Cash flow, as in most businesses, is of utmost importance. As an airline grows, expenses tend to increase and this drives the need to sell more tickets or the same number of tickets at a higher price. The unknown variable is the price of fuel, traffic patterns, exchange rates and competition. Consequently, there are a large number of operators who are particularly exposed to higher fuel costs and any other event that would affect either revenues or expenses. Wizz Air for example has become the second airline to place a clause in its conditions that disclaim any liability for flights being grounded due to Brexit on or after the 29th March 2019. Ryanair was the first. Should there not be a Brexit deal, the grounding of flights around Europe would have an immediate effect on revenues of airlines. Only the larger will likely have the resources to sustain a loss for any length of time, particularly during the off-peak period of travel.

For those operators without sufficient financial reserves, a rapid rise in expenses over even a few months can quickly lead to corporate collapse. This in turn leads to lessors receiving aircraft back prematurely and perhaps not in a condition that allows immediate re-leasing. Most lessors see utilization of their assets as a key indicator of success and any aircraft that is on the ground not generating revenue is therefore considered a failing. The last five to ten years has seen intense competition among lessors and sometimes aircraft have been leased to weak credits at rates that facilitate early placement rather than secure long term revenue. This has been particularly evident among the less mature lessors with different management imperatives where portfolio utilization statistics have a higher precedence when reporting to senior management.

Lease rentals for some airlines are rising. Lessors have more recently taken into account the relative financial strength of lessees and have accordingly increased lease rentals and security deposits to compensate. The high and low range of lease rentals being charged to lessees has therefore increased more recently as lessors seek to mitigate the risks. With the consolidation and expansion of lessors, comes increased emphasis on ensuring a more equitable assignment of risk. The less financially secure lessees are therefore having to pay although the stronger lessees may be able to secure a lower rental. With the major airlines struggling to acquire capacity amidst a shortage of aircraft and delivery slots, lessors are favoring the lease of aircraft to the more established operators albeit at lower rentals while the lease of aircraft to less financially secure operators will be at a higher rental. In assessing lease rentals it can be expected that a strong credit will pay perhaps 10-20 percent less than the average, a slightly weak credit ten percent more and a very weak credit 20 percent or more. A stronger credit may also be able to secure a fixed lease rental although most leases are linked to LIBOR rates with the weaker credits paying a higher rate. This will also be accompanied by different levels of security deposits. A secure lessee may also see an end of lease compensation arrangement rather the payment of maintenance reserves.

 

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