Discipline Leads to Greater Stability in Narrowbody Lease Rentals

January 20, 2020

Recent Decline In Rentals Abates as Competition Eases

The decline in narrowbody rentals has been mostly halted as the market has become disciplined and because of the problems with the MAX.

The lease rentals of the mainstream narrowbodies – the A320 and B737 families – have experienced a notable fall over the course of the last five years. Rates essentially fell by some 20 percent between 2015 and early 2019. The decline has been most notable for newer A320ceo/neo and B737NG/MAX examples. Rates for new A320ceos were in excess of $330,000 per month just as the A320neo entered service but these have notably dropped to under $300,000 per month, with $250,000 per month being possible. At $250,000 per month this represents a LRF (Lease Rental Factor expresses the monthly lease rental as a percentage of the market value) of only 0.6 whereas lessors may previously enjoyed LRF’s of above 0.7. The rates for the A32neo are also not as high as originally expected with less than $320,000 per month becoming more the norm. Longer term leases to good credits have seen rates of less than $290,000 for a new A320neo.

The lessors have also been able to reduce the rates perhaps because of the rise in emphasis of return conditions and maintenance reserves. End of lease compensation adjustments as well as maintenance reserves based on OEM (Original Equipment Manufacturers) list prices can easily add $8 million (half to full life) or more to the financial engineering equation. This equates to at least another $50,000 per month to the lease rentals if correctly managed.

There has been notable pressure from new market entrants primarily from Asia. Leasing aircraft has for perhaps 15 years generated double digit returns for investors, representing one of the most attractive of asset classes. Aircraft leasing has experienced some volatility, notably post 2008, but generally has exhibited lesser fluctuation than shipping and property and this has sustained the interest in the sector. However, there is a need for considerable expertise in terms of placing aircraft, in selecting the right asset, and in overseeing the credit and maintenance which is why most market entrants seek to acquire an existing lessor or form a company using experienced personnel. There have been some corporate failures that have seen a number of aircraft entering the market not least Thomas Cook. Most of Thomas Cook aircraft have been placed with other lessees but there are some A321s and A330-200s still in storage. The need for lessors to place aircraft quickly to generate revenues can sometimes see lower than market rentals being accepted but this has become less evident given the ability of lessors to firstly recover aircraft because of Cape Town and secondly due to the existence of security deposits. The demand from the rest of the world for such aircraft as the A320/A321 has to some extent prevented a rapid fall in rentals.

The competition among lessors therefore intensified and forced rentals downwards. The strategy of some lessors also saw a focus on securing market share. This may have meant that aircraft were acquired and placed at lower than usual rates, thereby dragging down the market. The actual number of lessors may not have changed dramatically but the number and proportion of aircraft being leased has increased significantly thereby increasing the competition still further. Most importantly, the nature of leasing has perhaps undergone a fundamental change. The depth and spread of the operator base has multiplied such that there are many more operators leasing aircraft. The operating lease model has both stimulated this expansion as well as meeting the demand. Moreover, there is lesser emphasis on the credit rating of the lessee. Historically, a new lessee with a limited track record, would have warranted a sizeable premium compared to a stable lessee. Such a distinction has become less apparent and, as new leases have been arranged with the rates for less financially secure lessees, the rates have converged on the lower rates for the more established operators. The arrival of the A320neo and the B737MAX also resulted in lesser rates for the outgoing models despite the record backlogs and strong traffic growth.

The last year has seen a change in fortunes for the A320ceo and B737NGfamilies. The influx of new market entrants has waned to some extent although it is noted that Avation is now for sale. With an increased focus on yields rather than market size, there has been greater rigor when lessors are placing new or used aircraft. Interest rates have little opportunity to go even lower. While traffic growth has fallen back from previous highs, the rate of growth is still high enough to see lessees competing for available aircraft. The problems associated with the MAX, both in terms of stored aircraft and the lack of new deliveries, has inevitably added to the difficulty of lessees and this has allowed lessors to at least stabilize, if not increase their rentals. The specification of the aircraft being leased has also been raised and this justifies an increase in the rates. SpaceFlex and the fitment of sharklets to the A320neo can see another $10,000+ per month being added to the rental. Consequently, the lease rentals for the A320 and B737s have experienced a measure of stability over the last nine months. The rates for both aircraft types have at the very least stabilized and may have increased as operators seek to mitigate the effects of sustained growth, the need to replace aging aircraft and to take account of the problems of the MAX. The issue for the MAX will be the length of time that will be required to bring the aircraft back into service now that simulator training is likely to be stipulated. There will also be the issue of various jurisdictions requiring different recertification all of which will delay the return to service and therefore increase pressure on lease rentals. As the MAX re-enters service in numbers there will be the risk that existing A320ceos and B737NGs will be replaced particularly if the focus continues to be on operating aircraft with more passengers in each aircraft. But for the moment leasing of aircraft continues to offer good and possibly, rising levels of return.

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