Research from Scope Ratings GmbH shows that far from experiencing the three percent annual fall illustrated in EETC offerings, the more usual decline is approximately nine percent annum, rising to nearly 25 percent when a shock to the market occurs.
The market should be at its strongest in terms of values and lease rentals. Traffic is rising above trend not least because of the low cost of equipment and the willingness of lessors to lease aircraft to the less financially secure operators, the backlog remains at record levels and the number of aircraft in storage is at historic lows. Load factors have never been so high and overall airline profitability has recently made up for the years of losses. Yet a number of operators have already recently collapsed, and others are on the brink. Values of new aircraft have barely risen over the last ten years and monthly lease rentals for new A320s and B737s are sometimes below 0.6 percent when expressed as a percentage of the current market value compared to the expected 0.8 percent. The depth and breadth of the operator base has allowed lessors to mitigate the risk associated with leasing new and newer aircraft to less financially secure operators safe in the knowledge that there will be willing lessees should the current lessee fail. The very rapid redeployment of the AirBerlin and Monarch fleets point to the ability of the current market to not even register defaults that in the markets of the 1990s and 2000’s would have sent shockwaves through values.
In their analysis Scope Ratings has used data from The Aircraft Value Analysis Company (AVAC www.aircraftvalues.net). The UK based appraisal company has been publishing values for more than 26 years and therefore Scope Ratings was able to draw upon a wealth of historical data for all commercial jets and turboprops without being concerned over retrospective bias. Scope Ratings cites “The market is increasingly neglecting to discriminate between aircraft specifics (such as the model phase) despite having done so in the past. The model phase signifies where the model is in its life cycle, i.e., whether it is flying with new, mature, or out-of-production technology. During an expansionary part of the cycle, older-technology models have similar market values to newer-technology models of the same age, suggesting prices have inflated to unrealistic levels. We argue that bullish market sentiment is encouraging participants to neglect aircraft-specific characteristics. The expansionary part of the credit cycle sees aircraft prices inflate such that depreciation is ignored. Eventually such overvaluations lead to a sharp correction. We conclude that this is due to price inflation rather than market values recovering since the last crisis.”
Scope shows that the annual average depreciation is 9.7 percent, more than three times the fall declared in EETC offerings. In the aftermath of the 2001 crisis, values fell by some 16.9 percent per annum but this pales against the 23 percent that was experienced immediately after the financial crisis of a decade ago. The extent to which aircraft values fall following a crisis is not uniform amongst all aircraft types. Instead, the most vulnerable are those types no longer in production – effectively the A32ceo and the B737NG in todays market – while those that are in production experience a lesser fall over a shorter timeframe. Indeed, the values of aircraft no longer in production are fortunate to experience a recovery particularly when accompanied by low inflation. During a downturn the manufacturers fail to readjust production sufficiently and new aircraft deliveries act as replacement rather than growth capacity, effectively displacing older aircraft sooner than previously anticipated and more en-masse. At the same time, the lessors can only place newly delivered aircraft if they offer lease rentals at a comparable level to older equipment as a means of achieving placement. When aircraft orders are cancelled during a downturn, progress payments made by customers can be retained by the manufacturers which then allows the unwanted aircraft to be sold to other customers at a sizeable discount at no loss for the manufacturer.
In examining the AVAC historical value data, Scope highlights the period of stability before a market readjustment. In the years preceding a readjustment, market values may decline at a much lesser rate than the average of nine percent. This, according to Scope, can serve to overemphasize the asset value of the aircraft and lead to a more significant decline when the market experiences a shock event.
However, there is a fundamental difference between market values and seeking to address risk. As with any asset type, whether it be shipping, property, or automobiles, there has to be an appreciation of the potential risk should a downturn occur. At the same time, the very stability of market values in the near term is required to ensure that investors participate in aircraft financing. If investors purely focused on the potential decline of some 23 percent per annum, then there would be little point in participating. An undue emphasis on the potential fall of 23 percent per annum may have the unforeseen effect of actually contributing to declines greater than 23 percent in the future. If an investor has already allowed for such a low value, then a sale at such a price becomes that much more acceptable. A few such sales could easily lead to further discounting as investors seek to dispose of assets at what is seen as a modest loss compared to the book value. This practice of rapidly depreciating asset values itself can lead to the very distressed market conditions that such actions seek to mitigate against. Too much conservatism, in terms of addressing the effects of potential downturns, can lead to higher financing costs for airlines, thereby possibly contributing to the financial weakness of some airlines and propagating a domino effect.
The aircraft market is also slightly different from other asset classes in that there exists the opportunity to lease the aircraft through a downturn. While some German investors quickly exited aircraft financing in the aftermath of 2001, thereby contributing to the distressed selling of aircraft, others quickly realized that the more appropriate way of dealing with the crisis was to lease aircraft for a short time, albeit at a lower rental, and then dispose of the asset when the market improved – ie in the period 2006-2008 – when a recovery was very much in evidence. This is naturally dependent on selecting the right asset type, a type that has the potential to recovery. The very factors that contributed to the 16 and 23 percent annual falls post 2001 and post 2008 are also not necessarily present going forward. The last few years has not seen any real increase in values and while the fall may be less than the annual average of nine percent, a fall has still been in evidence for many if not all aircraft types, not least because the net price of new aircraft has not increased.