Semi-Annual Jet Aircraft Value Listing

June 25, 2018

Larger Widebody Values Remain Under Pressure

Despite the still above trend rate of traffic growth, the market for most of the larger widebodies seems less assured than for narrowbodies and inevitably values are falling at a rate sometimes greater than the long-term average of eight percent per annum.

The most notable recent event is the expectation that some of the first A380s will be parted out. Finding a second user for the ex-SIA A380s has not been easy, particularly evident when Airbus is also failing to attract new orders. The intention is therefore to part out the A380s and there has been speculation that the components could eventually secure a return of $80 million – possibly more. The $80 million plus the lease rentals secured over the last 10 years would still have generated a handsome return for investors but the parting out of the leviathan after such a short time in service is a major concern for the values of younger A380s. The engines will probably be leased to Rolls-Royce which is perhaps a notable event as most of the time the flow of funds is in the opposite direction. The engines could lease for perhaps $100-150,000 per month each which would generate reasonable income. Lease rates for spare engines are comparatively high and many a time have engines been removed from parked aircraft, thereby generating more revenue than when the aircraft was flying. The shorter the lease the higher the lease rental. The time on the Rolls-Royce engines for the specific aircraft will probably approximate 5,000 cycle and with a target life limit of 15,000 cycles, there will be considerable time remaining to be used on other aircraft. The list price of a new set of LLPs for the Trent 970 currently approximates $7 million with an overhaul costing slightly more. The sale of other components, if managed, could generate At $80 million this figure is only slightly lower than the $90 million values being attributed to one of the first A380s. The question though is whether the $80 million will now be used for all vintages of A380s as it is the wont of some appraisers to take a single data point and apply it to all aircraft of the type.

Values of the B777-300ER are also a concern as the arrival of the B777-9 nudges ever nearer and the age profile of the existing fleet increases. The B777-300ER is used by a myriad of high profile flag carriers who have a penchant for operating the latest and newest aircraft and as such 10-12 year old -300ERs which have been subject to sale and leaseback deals or for which the B777-9 have been ordered will be the subject of replacement. The airlines using widebodies had also likely acquired a number of aircraft at the same time thereby securing a significant discount compared to the single used units that were being offered. The depreciation policies employed by some airlines also generated a very low book figure which had no relation to the perceived market value and this allowed their sale at a discounted price, thereby setting the level for future transactions. Investors who have financed the larger widebodies have sometimes sought a full payout within the first lease or finance term – 12 years. This means that the aircraft can be sold at a very low price and for a return on investment to still be recorded. During a downturn some investors have previously sought to exit aircraft financing accepting a low sale price on their investment. An ever increasing number of aircraft are the subject of EETCs. The unravelling of some EETCs post 2001 allowed some investors to sell aircraft at a seemingly substantial discount compared to the single unit market while still recording a significant actual profit even if this left junior investors in the transaction with a sizeable loss.

Medium to long term residual values of widebodies have nearly always failed to match forecasts and even those held in high regard today will likely suffer the same fate as widebodies face different challenges from narrowbodies. Widebody aircraft are generally used on long haul routes where the fuel component of direct operating costs is that much greater. Operating inefficient older widebodies immediately creates a problem when competing against other operators with new aircraft even if finance charges are that much less. The cost of maintaining the larger aircraft is that much greater with the logistics more problematical. When a widebody experiences an AOG situation an airline will incur considerable costs in remedying the situation and for the smaller operator exposed to onerous EU passenger compensation, operating less reliable older widebody aircraft will risk corporate collapse. Even finding pilots to crew the older used widebodies can be difficult when a shortage of pilots exists as more money can be made flying the newer aircraft.

Operating aircraft on longer haul services incurs much more regulation and even today there are bilateral agreements that limit the number of aircraft and routes that can be served between countries. This makes it difficult for new market entrants to emerge and seek to operate used widebodies contrasting sharply with the narrowbody domestic and regional markets.

IATA reported a 9.5 percent growth in passenger traffic in March although IATA does not represent all airlines. This compares with the average of approximately 5.5 percent recorded over the last ten year. At the same time capacity increased by 6.3 percent which means that load factors increased to 80 percent. Capacity can be increased by a number of ways – new aircraft are added; the new aircraft being added are larger and/or contain more seats; older aircraft are returned to service; the utilization of aircraft is increased; the number of aircraft retirements is reduced; the number of seats in existing aircraft is increased; or more passengers are carried in each aircraft. As load factors increased by nearly one percent this suggests that some of the traffic was accommodated by increasing the number of passengers on each flight which should allow airlines to improve their yields and profitability. Unfortunately, the higher price of fuel is eroding profits and indeed has contributed to the demise of some carriers. This higher price of fuel continues to place the focus on newer aircraft and is allowing the manufacturers to increase production of new A320neo (engines permitting) and B737MAX family members. The A320neo family deliveries in particular have become increasingly focused on the A321 with the majority of A320 deliveries featuring 180 or more seats rather than 150-160 seats. The shift in focus to larger narrowbodies has repercussions for the smaller aircraft – the A319 and B737-700s for example. New orders and deliveries are virtually zero although there continues to be placement of used aircraft at the right price. Any investors are conscious of the risks and will likely be willing to lend only 65-70 percent of the asset value compared to perhaps 75-80 percent for a new A320neo or B737MAX.

Today, interest and inflation rates are extremely low as is availability; traffic growth in high; availability of funding is strong; the backlog is long; the depth and breadth of the operator base is extensive. The market structure has also changed such that the depth and breadth of the operator base, at least for narrowbodies, is that much more extensive. This allows for the collapse of such airlines as Monarch and AirBerlin to be absorbed more easily. Conversely, oil prices are relatively high, yields can be variable, the product line is changing and political events can trigger changes in traffic patterns. Overall however, the market is in positive territory, and has been for some time. This has ensured that the transition of the product line virtually en-masse, has been less traumatic than might have otherwise been the case, especially for the narrowbodies. The values of the A320ceo and B737-800 have thus remained very stable over the last twelve months and lease rentals have suffered due to ever more competition. A decade ago there were less than ten financial institutions willing to invest in aircraft; today everyone is seeking to participate not least because of the proven track record of the sector over the last few years – usually the worst time to invest. The widebody sector is not faring so well as values for such aircraft as the B777, A380, B747 and A340 experience substantive falls, significantly greater than eight percent over the last year.

Prospectus for EETC transactions usually state that values fall by an average of three percent per annum. In reality, the trend is more likely to average eight percent per annum though the aircraft type and the state of the market can influence the downward trend to a greater or lesser extent. The current strength of the market suggests that the more popular aircraft are enjoying a decline of approximately four to six percent over the last twelve months while the less popular will be suffering from at least a double digit decay over the same timeframe.

While on average the value of the A320 has fallen by 10 percent per annum over the last 20 years, the fluctuation can be considerable ranging from no fall to a decline of more than 20 percent. For widebodies, the average annual fall in value has been higher over the last 20 years. The degree to which aircraft values change during a downturn varies considerably. Different aircraft types will react to a downturn – or Black Swan event – in different ways. An aircraft that is no longer in production will likely suffer more than an aircraft that is still in production. During a downturn, new aircraft act as replacement rather than growth capacity. Lessors will seek to place new aircraft at a discounted lease rate for a short term to generate at least some income and then when the market improves, re-lease at a higher rate. In the meantime, the older aircraft will likely be retired. The effect of 2001 was to see the values of a 1997 built A320 fall by 16 percent in a single year. Yet, in the year 2008, values of the same aircraft fell by 12 percent and in the following year by a further 18 percent. By 2008 the A320 had already been in production in for some 20 years and was no longer in the first flush of youth. Yet for the MD81 the effect of 2001 was to see a 26 percent year on year fall and in 2008 a 36 percent fall was recorded. Widebodies are also likely to fare worse during a downturn as the number of operators capable of absorbing the increase in supply of used units is limited. In 2009, the values of one of the first B777-200s to be produced fell by more than 30 percent in a single year when in 2001 the fall was only 15 percent. The prevailing interest and inflation rates at the downturn will also be an influence. In the aftermath of the financial crisis, both interest and inflation rates fell significantly thereby making newer aircraft that much cheaper and accelerating the decline in values of used types – as indeed the higher price of fuel.

The market remains buoyant and represents the best of conditions for a generation – or more. Yet, lease rentals for narrowbodies remain stagnant at best or have even fallen. With so many narrowbody aircraft being leased and given the double digit returns that leasing still mostly enjoys, there has of course been greater interest in becoming part of the aircraft leasing community. Asian financial institutions as well as private equity companies have entered the market in the last decade and more notably in the last five years acquiring existing lessors as well as rapidly expanding portfolios. The competition has therefore increased significantly.

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