Following on from last week’s session where IBA presented their approach to valuations and lease rates, our panel take a deeper dive looking specifically at commonly traded aircraft types. Topics covered included; IBA’s opinion on likely market performance in the near and long term, which assets types are more vulnerable and a 30 minute Q&A session with our panel.
Our senior ISTAT appraiser team also review the impact from Covid-19 on future asset performance for specific Narrowbody and Widebody aircraft.
The webinar was chaired by Phil Seymour, an ISTAT Senior Appraiser Fellow and former ISTAT International Appraisers’ Program Chairman. Phil was joined by Stuart Hatcher and Mike Yeomans – two of IBA’s Senior ISTAT Appraisers, and David Archer, IBA’s Senior Engine Analyst.
Webinar Synopsis – Narrowbody and Widebody Aircraft Values and Lease Rates: What are my Aviation Assets Worth?
After providing an update of the airline failures landscape and the support mechanisms being sought or in place, we go on to consider:
- Airline fleet decision factors, that is the various issues influencing fleet management evaluation including age, type, lease status and running cost
- Lease ends due in 2020 and 2021
- Narrowbody and widebody fleet age profile scenarios assuming an oversupply of around 2,500 aircraft
- How business modelling may adapt
- The expected impact of Covid-19 on narrowbody market values and lease rates
- The anticipated performance of widebody market values and lease rates
- How and to what extent engine market values and lease rates will be affected
Failure activity for widebody and narrowbody passenger fleets has been reduced short term due to their use for repatriation flights and temporarily for freight. Around 160 aircraft have been involved in failures, most relating to South African Airlines, Virgin Australia and Air Mauritius which are in administration. We expect these to restructure and escape collapse.
Larger carriers are more likely to receive state aid and lessor support and are better able to access the debt markets and to secure favourable loan terms. Problems are likely to arise once the recession bites and current liquidity measures are exhausted. It may not be until much later this year, after a dismal summer’s trading, when that materialises.
This is constantly evolving, but as of today the large US carriers have successfully arranged substantial government support alongside backing from the debt markets. A growing number of European carriers are receiving aid in the form of guaranteed loans and relaxation on taxation. Heading Eastwards, the situation is comparatively less clear, but we anticipate some level of support to emerge following the execution of big changes at each of the airlines.
Covid-19 and its ramifications have been described as a once-in-a-century event. Our understanding of the crisis and the best actions to pursue in its mitigation are therefore constantly evolving. Many under severe lockdown restrictions might at first have expected controls to be relaxed after six weeks, when life would slowly return to normal. As the pandemic progresses, it has become painfully clear that this will not be the case and the financial help granted may be inadequate for some. For other airlines the support offered appears more than reasonable which explains Michael O’Leary’s claims that there is not a ‘level playing field’. We envisage legal challenges on the horizon.
Five airlines: Singapore, Ryanair, BA, Wizz Air and IndiGo have been quieter than others although some like Singapore have or will receive state aid. BA have been discreet regarding lessor support but have announced consultation on a 28% reduction in staff, whilst Ryanair have been the most vocal about the nature of financial support coming from EU states and its illegality. They have announced a potential loss of 3,000 jobs.
Fleet Decision Factors for Airlines
Faced with a significant drop in demand, airlines will have to make many choices to establish sustainable liquidity, cut overhead costs and, crucially, to manage capacity. Some of these decisions will be straightforward: others difficult or almost impossible to make. Each airline’s situation will be unique but basic trends repeat in every downturn.
Clearly the oldest, least efficient aircraft are first in line for disposal, as are aircraft unencumbered by leases or with short unexpired lease terms having a low penalty for early return. Aircraft requiring heavy and expensive maintenance will be an obvious choice as will those which are expensive to operate in terms of cost per seat due to fuel burn, maintenance, reliability or very expensive financing mechanisms. Naturally, the largest aircraft will be vulnerable as they become difficult to fill and a decision to bring forward their conversion or retirement would seem logical. Airlines with a considerable number of assets still in long-term storage may decide to leave them where they are.
There will be aircraft an airline would ideally prefer to retain in service subject to adequate demand and it is these assets which will generate tough decisions. Previous economic crises have seen airlines holding onto their youngest and most efficient types. Despite them being more expensive to acquire and finance however and notwithstanding current low oil prices, fleet management is a continuous process: oil pricing will eventually increase, environmental measures will be introduced and consumer appeal will win out. Re-fleeting must go ahead.
Some aircraft will attract heavy penalties should they be removed from the fleet, those whose leases have a distant expiry date or punitive compensation clauses for example. Significantly refitted aircraft should be safe although it is not unheard of for newly refitted widebodies to go straight into storage as the plan for the aircraft changes. Aircraft fresh from maintenance, unless leased, are less likely to be stored although, again, it can happen to achieve fleet reduction.
Airlines may keep aircraft with favourable lessors and, finally, aircraft due to be delivered in the near term are probably safe. Though not yet in the fleet, as the delivery date approaches options open to the airline diminish such that they have little choice but to accept the aircraft.
Near-term Lease End Vulnerability
Whilst every lessor-lessee relationship is unique, the general principle is that the likelihood of a successful re-lease or lease extension will diminish as an aircraft’s age increases. Similarly, there is vulnerability for larger aircraft. What is most concerning is that over three quarters of the near-term lease end fleet during 2020-2021 fit into the 737NG and A320ceo categories below the age of 20. How this will fare in the evolving market is uncertain as is the fate of the leased A330s, 777s, 787s and A350s towards the younger end of the spectrum and close to their lease end dates.
Narrowbody Fleet Scenario
We envisage a situation that assumes an oversupply of 2,500 narrow and widebody aircraft in the market and a two-year horizon where Revenue Passenger Kilometres (RPKs) settle against the 2019 number, close to 20% down. This doesn’t specifically account for the 50% drop in RPKs expected for 2020, it is rather where we see the new norm settling by the close of 2020 and for 2021.
The picture we foresee includes narrowbody backlogs, almost entirely made up of new generation aircraft. It assumes normal manufacturing reopens now and follows the 2020-2021 production plan and it accounts for reentry of the MAX into service in September and its slow reactivation. We have then adjusted the situation for announced delivery rates from Boeing and Airbus.
Age, efficiency, lease ends, fewer new deliveries and a steady stream of MAX and other inter-lease aircraft: all these factors have a considerable impact on the current in-service fleet. If we remove aircraft over 16 years old and the least efficient assets, nearly 3,400 narrowbody aircraft from the in-service fleet can go into long-term storage which, in net terms, equates to a 7.5% reduction.
Of course many issues could influence this scenario to produce a different set of numbers. The timing and scale of recovery, fuel price levels, the ability of the OEMs to restart production all play a part. The oil price could soar as part of a world recovery, intensifying OEM delivery rates. A failure of RPK recovery to return to 2019 levels would mean a worse impact. Similarly, oil may remain benign, OEMs could take years to return to full production and demand could come back robustly from 2022 and force aircraft to return from storage.
Historically, part-out levels have been declining since 2014 whereas retirements have increased to an average of around 300 per year. When confronted with 3,400 narrowbodies in storage therefore, it is clear that the usual rate of part-outs, retirements and conversions will scarcely dent the numbers. Some aircraft can be parted-out to maintain older conversions and to feed into the conversion market. The part-out market is not necessarily an option for most of the rest however and if the storage yards are packed with decent NGs and ceos, the effect on values and rates could be more far reaching if demand fails to absorb the glut beyond 2021.
Widebody Fleet Scenario
Here, we include in our forecasts the backlog as it stands and the aircraft due to be delivered over the next 20 months starting from today (adjusted for OEM estimations released last month). Most deliveries relate to 787s, A330neos and A350s plus a small number of 777X and 300ERs that are currently in production. There are no large storage fleets to take into account such as those seen for the MAX.
If we identify the most vulnerable aircraft from an age, technology and lease end exposure perspective, add in new deliveries and reactivate some assets that were about to enter service, we envisage that in-service aircraft will reduce by 1,850 leading to a net change of 1,300, a drop of over 29%. This decrease is bigger than that for narrowbodies due to the pandemic’s greater impact on higher capacity, long-range sectors. The starkest difference with our narrowbody analysis is the age at which aircraft oversupply levels are reached. Unsurprisingly, here they fall close to average lease termination age. Lease extensions may be available for some and each aircraft will present its own challenges but we can identify likely trends. Our predictions reaffirm the direction the market’s followed for some time: efficient twin-engine aircraft are easier to manage and less risky than their larger and less efficient counterparts.
We are focusing on the period until the end of 2021 and the nature and speed of the market’s recovery, oil pricing and production rates will affect our forecasts. As with narrowbodies, beyond 2021 low production rates and high demand could ignite a resurgence in interest for the best kept in storage. Historically, the number of twin-engine conversions have been around 30 annually whilst the number of part-outs has not exceeded 150. The numbers of likely conversions, part-outs and retirements based on previous trends therefore produces nowhere near the 1,850 we anticipate here.
Whilst the market appears quite clear-cut when comparing quads and efficient twins, the fate of the mid-aging 777 and A330ceo market is particularly key. Slow entry for the 777X may prompt operators to retain their 777-300ERs for longer.
The 3,400 narrowbodies and 1,850 widebodies we expect to enter storage leave a number close to the 2,500 oversupply we envisage, although incorporating new deliveries and reactivations means the impact on today’s in-service fleet exceeds 5,000 units. Optimistically, the most the OEMs have ever delivered in a single year is a little over 1,600 aircraft combined. Therefore, if demand recovers in 2022, it is unlikely delivery rates will achieve sufficient capacity to wholly satisfy need without reactivating reasonable numbers of aircraft.
Airlines will focus on securing liquidity and reducing overheads: losing headcount, cutting salaries and upping early retirements. They will engage with the lessor community to both secure finance for new deliveries and to relieve the pressure on current leases. Airlines have a better chance than lessors of persuading OEMs to push out deliveries, whilst lessors tend to cancel if they have yet to place the slot with a customer.
Beyond that, airlines will slim down their fleet and attempt to stimulate demand: amending pricing, improving customer experience or operating routes others have shut down. Ongoing cashflows can be boosted by using green time from stored aircraft and selling parts or engines into the market. A wider group of leaner operators should result though some that ought to fail will remain in operation as the playing field remains uneven. But, will they survive the summer?
Lessors will have to adapt to airlines’ actions in long running partnerships. Airlines need lessors and vice versa so the relationship must be mutually beneficial. Whilst lessors will be under pressure to accept payment holidays and renegotiate lease rates where liquidity allows, opportunities will present themselves as new deliveries continue. With less liquidity in the market, lease rate factors will certainly benefit even if normal placement lease rates will fall. Maintaining confidence by focusing on the cyclical nature of the market and maintaining advantageous positioning and relationships must be prioritised. Those with the funds to move quickly will face fewer competing bids and be able to capitalise on emerging opportunities.
Depending on how the market behaves, lessor consolidation through acquisition is likely in time. Therefore, we expect fewer lessors but with a greater diversity of business models depending on available fleet and liquidity options.
Narrowbody Values and Lease Rates
Taking account of outgoing, current and new generation aircraft and adjusting half-life market values with a premium for those less than five years old, there is downward movement from pre Covid levels across the board. We need to see market recalibration between supply and demand for the older aircraft and the impact on their values is the most severe at 16% – 20%. Newer aircraft are least affected although we foresee pressure increasing as the pandemic fallout develops.
Turning to leases, our typical lease rate definition considers a term of around five years and a normal lease construction. Here again we see wholesale pressure and a tightening of rates. In previous downturns we have observed shorter lease terms and reduced rates to stimulate demand but here we’re looking at the long-term forecast.
The widebody market was oversupplied pre Covid and we’ve been downgrading our value opinions of some aircraft types such as the 777-200ER, 777-/300ER, A330 and A380 for several years. Despite previous reductions, further cuts are necessary and aircraft over 12 years old are especially vulnerable. New aircraft types were performing well before the crisis and attract a strong value opinion from us. Despite being more robust however, no aircraft is invulnerable to the current downgrades.
12-year-old aircraft suffer far steeper discounts than the newer models and for some pre Covid there was demand for little more than part-out, such as the 777-200ER. Evidently the situation will now be much worse. There has been significant operator divestment around the A380 for some time with many entering storage. We expect most if not all of these to remain stored for a long time, perhaps indefinitely.
In view of the pandemic’s global effect, we’re expecting the long-haul aviation market to be slower to recover and anticipate significant downgrades for even younger aircraft.
Engine Values and Lease Rates
We have evaluated pre and post Covid engine values and lease rates for narrowbodies and widebodies and, as we’ve already seen, it is with the mature engines that more storage, part-out and retirement activity is likely. Consequently, the already plentiful market for older widebody engines will soften by around 20% – 30% as supply increases. We had revised values for newer engine types downwards before the current crisis but expect further reductions in the region of 15%.
The few narrowbody transactions we have observed in the market have largely been driven by list price and the trends are similar to those for widebodies, new engine values softening by around 5%. We anticipate 30% drops for older model values. Alongside these patterns, there will be a pricing delta between engine variations depending on fuel burn efficiency or time on wing.
Lease rates present a comparable scenario: the older and larger the engine, the heavier the depreciation. The key word here is ‘deferral’. 80% of engines on lease are seeing deferral requests and though we expect rates to pick up, it won’t happen yet. Considering the issues we’ve seen in the engine supply chain over recent years, for example the entry into service problems suffered by the GTF, the downturn may provide OEMs with an opportunity to catch up and resolve the technical issues they’ve faced.