A320 and 737 Values at risk

Airbus and Boeing claim demand and record backlogs thousands of A320s and 737s requires them to boost production rates to record levels. There’s little doubt that this is true.

But while the two OEMs also claim that there is no effect on aircraft values and lease rates, there is sharp disagreement from lessors.
Values of late model airplanes — those as young as five to seven years — are being “crushed,” one lessor tells us.

Additionally, useful lives of modern single-aisle aircraft are being reduced to 20 years. At one time, useful lives were as much as 35 years.

Although Boeing likes to argue that the 737-800 holds its value better than the A320 because, in Boeing’s view, it’s simply a better airplane, the answer isn’t as simple as that. To a large degree, the values and lease rates evolve from different sales philosophies of the two firms dating back at least two decades.

Airbus engaged in an aggressive sales campaign to lessors early in the A320 program, while Boeing then focused more on airlines. The airlines were slow to accept operating leasing as a strategic fleet management tool. Legacy carriers preferred ownership or leveraged and finance leases with the attendant tax advantages. Operating leases were viewed as tools for weak airlines, third world carriers and temporary requirements. Operating leases were also the tool for start-up airlines, an industry that began with deregulation of the US airlines industry in 1979 and eventually became a global phenomenon.

Lessors put the A320s and other aircraft out on medium-term leases, typically 5-7 years. The new aircraft had maintenance holidays of, as it happens, 5-7 years. Although most start-up airlines failed, a few survived and some began arbitraging the maintenance holidays by churning the fleet when the operating leases expired, replacing them with the same aircraft coming with new maintenance holidays. This churning created a surplus of A320s and lease rates dropped to find homes for them the second time around.

Legacy airlines began seeing the advantages of operating leasing for fleet flexibility, spurred on by tightening capital markets and global instability due to disruptive economics, terrorist acts and a succession of Middle Eastern wars, conflicts and oil price shocks. It’s one thing to ground airplanes that are burdened by long-term debt or finance leases. It’s quite another to ground jets on operating leases that expire in the short-to-medium term.

As legacy airlines increase the number of airplanes on operating leasing, they now have the flexibility to churn the fleet for maintenance holidays or put these airplanes back into the market in a down-turn, depressing values.

American Airlines, with its order for nearly 500 Airbus and Boeing aircraft in July 2011 (still to be affirmed in bankruptcy, so none shows on the order books of the OEMs yet), will lease every single airplane. The order includes a mix of current generation A319s, A321s and 737-800s as well as the NEO and the MAX. American hasn’t said, but the scuttlebutt is that the current generation airplanes will be leased as long as it takes to get the re-engined airplanes into the fleet in quantity. So much for residual values on the current generation airplanes.

As lessors proliferated and gained market share, Boeing increased its sales to them but Airbus had been there first. Still, Boeing faced the same problem, albeit in smaller numbers, that Airbus did on the churn.

But that’s not all. Start-up airlines starting buying, rather than leasing, A320s directly from Airbus. It’s been conventional wisdom in the industry that Airbus’ backlog was defined by more risky sales than Boeing and that’s been true — precisely because Airbus took a flier in selling large numbers of airplanes to start-up airlines. The result, as with deregulation, has been mixed. Success stories include JetBlue, Frontier, Indigo and AirAsia. Notorious failures have been Skybus in the US (which had a goofy business plan) and, as it has proved, Kingfisher Airlines. Even some legacy carriers proved failures for Airbus: Pan Am and Mexicana come to mind.

The failures dumped scores of Airbus airplanes on the market, driving down prices.

Boeing was later in selling to start-up airlines, but plunged into the field in a big way. LionAir is a high profile example. One troubled airline that remade itself so dramatically that one could argue in extremis that it was a start-up became a huge Boeing customer: Ryanair. But Boeing was more conservative in its risks than Airbus and found fewer 737s dumped on the market due to large failures.

Today, Airbus and Boeing are engaged in a market-share war. Airbus wants to gain market share. Boeing wants to preserve its share. To be sure, backlogs of five or more years aren’t especially healthy or ideal so there is production demand. But as new airplanes are rolled out the factory doors (and especially if Airbus and Boeing boost production beyond the announced 42/mo), values of the predecessors will drop. Hence recasting useful lives to 20 years.

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