Insight: Wednesday 14 October 2020: The Leased Aircraft Bubble is Bursting |

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News

With the global pandemic, a lack of passenger demand, and airlines grounding aircraft, the fleet of leased aircraft and aircraft lessors will be under pressure. It is estimated that more than 1,000 aircraft will have their lease end in the coming year with no onward lessee to take the airplane. That represents a tremendous potential loss to lessors, who would, basically, need to eat the capital costs of an airplane generating no revenue.

Free markets tend to find a price point at which supply and demand come into balance. But in today’s case, the global pandemic has reduced demand to the point that supply greatly exceeds demand and some of the aircraft coming off lease will not be placed. In this situation, basically a market glut of product, prices tend to plummet until demand returns, upon which prices (values) rise again.

The question facing lessors is how low to price an aircraft to generate cash flow without losing money by underpricing the longer-term potential of the asset committing it to a low price over the longer term.

Analysis

The global economy and more specifically the airline industry are in for a long-haul to full recovery. Many industry experts are talking about a 2024-2025 time frame for a full return to 2019 traffic levels worldwide. We can expect the next few years to be more difficult overall. But market conditions, and the supply-demand balance, vary significantly by aircraft type. There is a difference between the market for an A380 and an A220, the former having been decimated the most and the latter the least. Older models, including 747s, 757s and 767s are being retired and many will never see flight again, opening opportunities for new aircraft over the next few years – but not today. The short-term squeeze requires some innovative thinking.

Lease extensions are one potential, on a year to year basis. That would leave an opportunity to reset to market pricing as demand increases but would also require the discipline of lessors to hold the line on long-term renewals. It would be logical to extend a lease based on what one could afford but is also logical to ink longer-term agreements when possible if they cover the costs of the airplane. It all depends on what your competitor is offering, and airlines know how to play potential sources of aircraft against each other.

Of course, credit risks for airlines have risen dramatically with massive losses this year. Their balance sheets have been decimated, and the criteria formerly used for pricing a deal to a questionable credit risk could easily be extended to many of the best names in the industry. When industry leaders turn into high credit risks, terms and conditions need to change.

Insight

Winning at the leasing game will require flexibility and innovation moving forward. Some assets have simply no demand, so cargo or firefighter conversions might make sense. Others will find homes, but require sharpening the pencil. The question is how far down lessors will need to go, and for what term.

There are parameters that can be adjusted, including return conditions. It is unlikely that a financially strapped airline will return an aircraft that is fully compliant with all the return conditions in a lease, but good luck collecting on the financial differences. You can’t get blood from a stone, as they say. Modifying return conditions and shortening term to provide airlines flexibility may be two weapons to win in the battle for whose aircraft remain flying, and whose remain grounded.

The aircraft bubble has burst, and “base values” from appraisers are meaningless in an environment when nobody wants to take on aircraft. With airlines flying about half their former schedules globally, somebody will win and somebody will lose. For those that lose, the value of the aircraft is an asset to hold at a short-term loss in the hope that it will be getting better. Depending on the aircraft type, some may fly again, but others will not. This isn’t an easy time to be a lessor, and the power appears to have shifted to the airlines, even those with massive losses that have seen their balance sheets eroded to high-risk levels.