Operating lessors are achieving double-digit margins, proving that this type of lease is attractive. Indeed, the market for operating leases continues to expand not only in terms of the number of aircraft leased, but also regarding the proportion of the world’s fleet and arrival of new entrants.
But, although operating leases are attractive, lessors appreciate that rates change. At the end of 2010, lease rentals were starting to rise from their lows in 2008 and 2009, but such increases (apart from some widebodies) lost momentum.
In the five years since the last cyclic peak (3Q 2007), lease rentals have fallen by more than 25 per cent for in-production narrowbody aircraft – and to an even greater degree for older aircraft that have fallen out of favour with operators.
Yet during what was the industry’s worst recession for 30 years, lessors were still able to retain margins of 15 to 20 per cent. However, these margins have more recently been eroded by new deals at lower rates. Indeed, the fragile economy suggests that low interest rates will feature for some years, meaning lessors are fixing their rentals at low levels.
However, the cost of borrowing has also fallen, meaning larger lessors are able to secure finance at more reasonable prices. Meanwhile, operators have found it harder to secure financing and there are many for whom leasing is the only means of acquiring aircraft. This means lessors are no longer dependent on just a few large operators but have a wider market consisting of much smaller airlines.
Asia’s demand for the A320
The A320’s operator base has been expanding even further in recent years owing to the growth of Asian carriers. This market requires lessors to be more relationship-orientated, but as the Asian operator base matures, the risks associated with leasing to some countries in the Indian sub-continent have become more apparent. As a result, lessors are less enthusiastic to engage in significant discounts.
While repossession remains relatively rare, there are considerable costs involved when a lessee defaults. At the very least, the lessor will need to refurbish the cabin and repaint the aircraft. While the three-month security deposit will go some way towards covering these costs, lessors will need to reflect such a risk in the lease rental.
Lease renewals
This is good for lessors. However, unlike previous downturns, lessors have had fewer requests to extend leases. Indeed, as leases expire, lessors are less able to place those aircraft at the same rates. Yet, existing customers are also less able to re-negotiate existing agreements because lessors are able to lease their aircraft elsewhere, even if they have to reduce the rates for subsequent lessees.
The exception for this is the 767-300ER, for which a number of operators have sought lease extensions at levels that remain attractive to lessors – namely because of problems with the 787 and the fact it has been out of operation.
The lack of lease renewals (and cheaper rates for subsequent lessees) has undermined revenues. Indeed, if all aircraft currently owned by lessors were to be re-leased to other operators at current market rates, lessors would inevitably report much lower profits.
The majority of premium-grade leases will continue to erode during the course of the next year. But, lease rentals for older aircraft are likely to experience a sizeable recovery owing to the shorter lease terms held by less financially secure operators.
Lease rentals for most in-production aircraft have generally stopped falling, indeed some widebody lessors have been able to maintain or increase rates. For example, demand for the A330-300 continues, despite the development of the A350. New A330-300s can secure rates of more than $850,000, although there is much less appetite for those built in the 1990s.
Similarly, there is a shortage of 777-300ERs and, while sale and leasebacks dominate the market, lessors with 777-300ERs are able to secure significant rates.
Within the narrowbody market, demand for the 737-800 is still strong – in fact the strongest for any narrowbody at this time – but lease rates have already fallen, establishing a trend rather than a temporary departure. Lease rates of nearly $400,000 per month are now a feature of the past. The sustained reduction of interest rates, plus a competitive environment among lessors, lower lease rentals for the A320 and the availability of older 737-800s have made it necessary for lessors to lower rates.
Used A320s, particularly older builds, are more readily available at rentals that are significantly lower than those for the 737-800. This has had an adverse impact on the latter.
The 737-800 has been in production for nearly 15 years, meaning some have already been leased several times, and the specification of those early 737-800s differs significantly from those produced today. This has led to greater availability of used 737-800s and, combined with rising production rates for new aircraft, lease rates have dipped.
Yet, the 737-800 remains the most popular of narrowbodies for investors. However, demand, popularity, lease rentals and market values for the aircraft type all peaked before there was need for a replacement. Lease rentals for the 737-800 fell by some 15 per cent during the last 18 months, with the oldest being the most vulnerable to changes in market conditions. Lease rentals are now steady but the downward trend will re-occur with the rise of 737NG production rates.
Even with the forecasted decline in lease rentals, the 737-800NG will remain the most desirable of assets for the next few years. The aircraft type has made money for its investors, lessors and operators. However, as the 737 MAX nears entry into service, allegiances will switch and both praise and prices for the 737-800 will fall at a faster rate.
Falling A320 rates
Conversely, lease rentals for the newer A320 are staging something of a recovery. As a result of the A320 Neo and the availability of used units, lease rentals for the A320 have been under severe pressure, but the trend is now being reversed as lessors gain the upper hand.
The notable decline in rentals for newer A320s – which during 2011 had sometimes been above $350,000 per month before falling to below $300,000 per month – was a consequence of factors regarding both specific aircraft and wider industry influences.
The fall in A320 rentals between 2011 and late 2012 was partly due to the delivery of approximately 3,250 A320s over a 25-year period. Such a long production cycle has had an effect on lease rentals for both new and used A320s.
The A320 has been in production for such a long time and it has been such a good vehicle of the operating lease that those delivered in the first years of the programme have been leased a number of times since.
As appetite for operating leases increased, lessors sold A320s – with leases attached – to new lessors or those seeking to expand their existing portfolios. This further increased competition for the aircraft. Less experienced lessors with older A320s in poorer condition, may also have placed aircraft at lower rates, which became the starting point for operators leasing newer aircraft from established lessors.
A320s delivered today are sometimes mistakenly believed to be similar to those produced 20 (or more) years ago. Consequently, lessees had been unwilling to pay a premium to lease a younger aircraft, believing it was similar to one built a decade before.
It is now widely recognised that A320s produced in the last 10 years are very different from those built in the 1980s and 1990s. The specifications of younger A320s (the systems, engines, structure and avionics) have been improved, giving greater reliability and less maintenance. Also, older aircraft can be five per cent less fuel-efficient just because of wear and tear and additional drag caused by minor repairs.
The old versus the new
While lessees still pay less for older A320s, (perhaps less than $70,000 per month) the premium for newer aircraft has been re-established such that rates for new A320s are likely to once again approximate $300,000 per month, excluding maintenance reserves.
Yet, demand for the aircraft will remain. A strong market for air travel will see new A320s create more capacity while in weaker market conditions, the new aircraft will be used to replace existing aircraft. Indeed, in a weak market, lessors are forced to make new aircraft attractive, offering discounted rates to encourage lessees to switch. While this was partially in evidence in late 2011 and during 2012, (hence lower rentals for the A320) the market has since improved. Lessors are now placing aircraft on the basis of growth rather than replacement. And while the market for leased A320s used to favour the lessee, it now increasingly favours the lessor.
A number of A320s have already been scrapped at relatively low prices; this has highlighted the need to be realistic about the values of ageing aircraft. Additionally, the A320’s asset life has been under considerable scrutiny during the last year. If, as many believe, the asset life is now shorter, lease rentals for the first and second leases should compensate for it.
A320 values have suffered as a result of restricted finance and a need for greater equity. Lessors have perhaps needed to realise that the lease therefore needs to generate a greater portion of the profit. Indeed, because of the Neo and Max, there is greater need for lessors to generate the majority of their profit from leases, not residual values.
Meanwhile, operators have had to recognise that the benefits of the newer A320s will be reflected in the lease rentals. Similarly, disadvantages to operating the older aircraft should be reflected in lower rentals. Lower rentals for older A320s are also a reflection of the greater level of availability.
Lessors have built cost contingencies into their A320 lease rentals to cover the uncertainty of residual values, but in seeking higher lease rentals for newer A320s, lessors also build in higher acquisition costs. Also, with an extensive backlog and lack of delivery slots for both the existing A320 Ceo and future A320 Neo, it is likely lessors will have to pay more to buy these aircraft. High pricing is more pronounced for orders that were placed some years ago – before the recession – but are only now being delivered. The rate of escalation continues to increase delivery prices, even if the original base price was relatively low.
Yet, lessors are also able to secure higher rates for the A320 because of a lack of delivery slots. Airlines need to respond to relatively short-term demand patterns, so waiting years for a delivery slot is not an option. With airlines so dependent on cash flow, capacity needs to be acquired quickly, meaning they are willing to pay more to lease A320s.
When comparing lease rentals for different aircraft types, interest rates are of particular relevance and recent low interest rates have made accurate comparisons for like-for-like rates more difficult. However, it seems clear that rates for older A320s will continue to face problems. The extent and duration of those problems will rest in the delivery of, and demand for, the A320 Neo.
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