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Minimal Inflation Fails to Obscure Real Cost of Escalation for Customers

December 9, 2019

The effect of inflation, in terms of the value of new aircraft, represents a key component in any calculation of the value of used aircraft with a low rate of inflation having a detrimental impact but at the same time customers are still subject to escalation.

The lessors of aircraft view inflation as to be particularly beneficial to the leasing model as it allows the values of used aircraft to remain stable or at least fall by a lesser amount. The average annual fall in values amounts to eight to ten percent per annum with aircraft in production experiencing a lesser decline while those that are no longer in production suffer a greater than average deterioration. But with high inflation, this fall is less pronounced. During the high inflation periods of the 1970s and 1980s, the value of used aircraft rose as the price of new aircraft significantly increased. Higher rates of inflation can also see a higher interest rate with the differential between the borrowing interest rate for the lessors and the LIBOR rate charged on lease rentals being that much greater thus benefitting the lessor. Over the last 20 years the market has seen U.S. consumer inflation amount to some 55 percent. However, for a B737-800, the value of a new aircraft in 1999 was $43 million and in 2019, a new aircraft was still only worth $43 million. A ten year old aircraft in 2009 was worth some $24 million and today a ten year old aircraft is worth $23 million. Thus, there has been very little change in the values of new aircraft.

But this is not the case aircraft customers. All aircraft orders are subject to escalation. This is not an issue if there is a short timeframe between the order and delivery. Where there is a lengthy time between order and delivery – more than one year – then the final price can be much higher than the original base price. With new values and lease rentals not increasing over the same time, then the lessor may find that the lease rental achieved generates a lesser return when compared to the delivery price of the aircraft. In the current market, values of the A320neo family are perhaps rising by around 1.5 percent per annum such is the demand, but this may below the 2-3 percent escalation being applied. For those aircraft approaching the end of their product life and with values actually falling for newly delivered aircraft, this will raise issues for the customer. The ideal is to secure a low base price to allow the escalation to be offset. But with such a backlog both Airbus and Boeing are likely to be reluctant to offer deep discounts although there is speculation that Boeing may be even less willing than Airbus to discount despite their recent issues. This makes it ever more likely that lessors will need critical mass to allow for more aircraft to be ordered and for their internal interest rates to be as low as possible – hence the increasing size of the average lessor and the ability to draw upon low cost funds.

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