The aviation leasing community has grown in size and stature over the past decade. Leading aircraft lessors share their views on the major issues impacting this burgeoning industry
Aircraft lessors are bullish about the global demand for aircraft and the relative health of airlines around the world. Despite some airline bankruptcies, mainly in Europe, and other areas of stress around the world created by terrorism and war, sanctions and regulatory pressures, the airline industry remains profitable and passenger demand continues to rise.
In December 2017, the International Air Transport Association (IATA) increased its estimates for 2018 industry net profit to $38.4 billion. Passenger numbers are expected to increase to 4.3 billion in 2018 with passenger traffic, measured in revenue passenger kilometres (RPKs), expected to rise 6.0% (slightly down on the 7.5% growth of 2017 but still ahead of the average of the past 10-20 years of 5.5%). The average load factor is pushing up to a record 81.4%. Passenger revenues are expected to grow by 9.2% to $581 billion in 2018, all aided by the support of expected robust GDP growth of 3.1%.
Colm Barrington, CEO of FLY Leasing and vice chairman of Finnair, points to the record load factors being reported by IATA carriers and by low-cost-carriers (LCC). “One of the incredible factors is how positive load factors have been,” he says. “For example, despite the significant crewing problems and the negative media exposure that Ryanair experienced in the fourth quarter, it reported a 96% load factor in November. That is just remarkable for that time of year. At Finnair we are also experiencing very, very high load factors. High load factors mean demand for more aircraft. Demand for more aircraft is good for lessors.”
Peter Barrett, CEO of SMBC Aviation Capital, sees the market as strong. “We have been in a pretty benign environment for a while…with a few bumps on the way ...but generally we view the market as strong.”
The positive environment has endured for considerably longer than previous cycles and the RPK growth rate of almost 8% in a sub-optimal global GDP growth is indicative of the robustness of the aviation sector. The RPK growth rate has surpassed what is required for the industry to achieve the sustainable replacement of older aircraft with new aircraft coming into the market. Production levels are being closely monitored by lessors to keep a keen eye on residual values and overcapacity risks. With airline profits increasing, airline credits are improving across the board, aided by the availability of liquidity, healthy demand and a low oil price.
Overall these factors have combined to create a benign environment for aircraft leasing to flourish – with many new entrants coming into the space in the past few years, notably from China and Asia, attracted by the robust market demand and stable and positive returns.
“Ten years ago, the operating lease aircraft fleet was approximately 4,000 aircraft, today it is closer to 10,000,” says Peter Chang, president and CEO of CDB Aviation Lease Finance (CDB Aviation). “So, it is not surprising that there are more operating lessors because there are more opportunities..”
The relatively muted impact of the recent airline bankruptcies in Europe – Alitalia, Air Berlin and Monarch – is demonstrative of the current robustness of the aviation sector. Despite all three airlines failing within a short space of time, the aircraft were quickly taken up by other carriers, mostly in Europe.
“We have seen significant uptick in demand for used aircraft,” says Aengus Kelly, chief executive of AerCap. “We have seen a lot of airplanes going into the wider European market, which for us includes Poland, Hungary, Turkey, North Africa, parts of the Middle East, the Ukraine and Eastern Russia. A few years ago, the US market was absorbing a lot of used capacity… the American carriers led the way somewhat on taking used airplanes for long leases. We are seeing more of that now in the European arena.”
The fact that European airlines are seeking used aircraft for additional lift also shows the need for additional capacity as demand continues to rise.
This benign environment has led many to consider the relationship between RPK and GDP growth to have uncoupled to an extent, driven by changes in the way people travel, according to David Power, CEO of ORIX Aviation: “We are seeing a structural change in the way people travel,” he says. “Ireland, for example, is a small country but it has one of the highest number of per capita passenger transits per person of 2.0. Compared to China at 0.4 per individual – which could treble over the next 20 years, based on current projections – it would still be below the US which is 1.8 and below other countries, developed countries which may be at 1.5 or 1.6. Indonesia is even lower even though it has a population of 260 million people. Based on these figures, there should be a decoupling between GDP growth and RPK growth.”
While there are new stimulants in the market place, the consensus is that should GDP materially fall, RPK would follow but at a different rate than before due to these additional drivers. The charts on the right shows RPK growth compared to world real GDP growth between 2011 to forecasts for 2018. Chart 8.1 shows a clear correlation between the two measurements until 2014 where the relationship trend appears to widen. This is being caused by the growth of emerging markets, which is shown in Fig 8.3. Established economies GDP growth also show a slight decoupling from the RPK growth trend.
Ruth Kelly, CEO of Goshawk Aviation, agrees that there has been a slight change in the ratios between GDP growth and passenger growth but believes that the sector continues to be strongly correlated to the GDP cycle. “If you look back over history, the cyclical nature of our sector has always trended the general GDP pattern,” she says. “I don’t really think our sector is going to lead the downturn. If and when a downturn comes, we will follow the general economic cycle because fundamentally our sector is driven by demand for travel – demand is strong when GDP performance is strong, and it weakens when GDP performance weakens.”
Kelly agrees that there has been a change in the ratios between GDP growth and passenger growth, the ratios differ by region and there are other drivers to consider as well, but over the longer-term she sees strong correlation continuing between the two measures.
“Our industry has been through a level of change that maybe the ratios have changed a little bit in the medium and short-term,” says Kelly. “GDP growth has been benign in the western world, but it certainly hasn’t been in Asia… I see that pattern continuing. The big change in the western world is that airlines have become more cost efficient and are able to offer lower prices, which kicks on demand a little bit [despite benign GDP growth]. Perhaps a lot of that work is now done in the western world and the restructuring that has taken place over the past 15 years is done and we will see those kinds of patterns return to normal. I don’t particularly see a decoupling. When we break it down, there are reasons for everything. When looking for triggers, we should probably look to what economists are saying about the world economy.”
John Plueger, chief executive of Air Lease Corporation (ALC) is equally upbeat on passenger demand even during times of stress: “I don’t see any major crumbling of the stock market that can make people stop travelling suddenly,” he says. “There is a constant trend of traffic stimulation. Young people are spending their money on experiences rather than consumer products, which is an important aggregating factor globally. People in the US, Asia, and all over China, and Hong Kong want to travel, so it’s hard to see what would put any significant brakes on the global traffic growth in the near-term future.”
The extended period of continuing growth in passenger demand, the relative health of airlines, the availability of cheap funds and new investment into the sector have led some to question whether the cyclical nature of the aviation industry has been eradicated or at the very least redefined. Most of the leaders in the aircraft leasing community surveyed for this report agreed that the cycle remains but that the sector is experiencing an “extended peak”. Few leaders could be drawn on to call the top of the cycle – although most agree it has reached, or is approaching, its zenith.
One of the main roles of the chief executive is to prepare for all market eventualities – seeking signs of stress is one of those roles. For the aviation community, substantial increases in airline insolvencies are usually a key trigger point but there were five in 2017, which did not dent the global health of the industry. Low GDP growth is another but as already discussed the relationship with passenger demand is changing. Interest rates are creeping upward but have not yet had a major impact on the sector. Oil price remains relatively low, if increasing. When considering these macro-economic factors, it is easy to see why so many in our sector remain bullish.
“We’re in a continued expansion phase both in aviation as well as aviation finance sectors,” says Alec Burger, CEO of GECAS. “I think that’s going to continue. We are in a cyclical world. The trees do not grow to the sky, but the market is very liquid. There is a lot of capital that’s still looking to come into the space. Margins are being compressed as a result, but I think we can continue to grow for the foreseeable future.”
Others are more bearish. “We have been in a triple L period – lacklustre growth, lame in terms of interest rates, which is luring people into complacency,” says Khanh T. Tran, CEO of Aviation Capital Group (ACG). “We are starting to see some pockets of weakness – there was some surprise with respect to some of Western European operator [insolvencies] but as a lessor to two of those entities, we had seen the train coming and had been preparing and managing for it.”
“This upcycle has lasted longer than prior cycles in our space,” he adds. “The big question will be when interest rates will rise. It is tough to see oil price spiking except for event risks - North Korea for example. Airline consolidation and low oil prices have helped the industry a lot, so we may not be on the downside just yet, but it may be levelling off a bit – the question is how fast will things change over the next several years. I don’t see a lot of risk necessarily in 2018 but beyond this year is more questionable.”
Tran’s more bearish view is the current “triple-C threat” – capacity, cost and competition– will “morph into a triple-A opportunity – attractive asset acquisition for those who have equity, expertise and experience through a downcycle. New competitors in this industry is not a new thing. This has happened time and again over the past three-to-four decades. The question is which company has not only survived, but was able to capitalise through downturns.”
Robert Martin, CEO of BOC Aviation, which is headquartered in Singapore and listed on the Hong Kong Stock Exchange, is very positive about the aviation leasing sector in general.
“I don’t have a good enough crystal ball [to call the cycle] but what I can tell you is it feels like 1998 all over again,” says Martin. “Why do we think it’s going to continue? It’s because of this wall of liquidity.” He explains that fund managers are investing more and more in the aviation sector, specifically aircraft leasing, because of the relatively low default rate and stable returns in an otherwise low yield environment.
Leasing companies today are so large that the diversification is significant and brings credit strength provided there is a very strong risk management focus within the company,” he says.
David Power agrees with his peers that the industry is in a “long peak of a cycle” but cautions that the macro economic environment is only one part of the puzzle. “We look at supply, demand, and liquidity, as well as the structure of the companies involved in aircraft leasing and financing, which often leads us to paint quite a different picture,” he says.
“You need to be able to transit aircraft for deliveries and redeliveries, which requires a liquid market for aircraft transfers but there are bottlenecks in the novation market currently, and there are wide discrepancies between financiers’ requirements. Then you need to consider the active capital markets and the increasing interest rate environment. You can’t just look at the macro and say all is rosy; you have to look at the various markets that influence aircraft leasing – the demand for aircraft, the credit worthiness of airlines, the health of the capital markets and the banking market, the amount of liquidity and return expectations – at certain points in the cycle, they all change. Sometimes they interact together and sometimes they interact quite differently.”
Despite the huge amount of liquidity that has entered the market, with strong demand for aircraft, airlines are facing areas of stress. Costs are rising slowly – there has been a small spike in the fuel price and competition among airlines is increasing. The GDP growth required to maintain the current production level of aircraft is a very narrow margin and lessors are always mindful that the aircraft market does not go into surplus. The strength of the dollar remains a concern for some airlines, namely those that have revenues in foreign currencies while regulation and changes to the tax regime in the US may change the industry dynamic further once the impact has been properly assessed.
The true impact of the impending departure of the United Kingdom from the European Union – Brexit – remains an unknown but one that could disrupt the European market, which otherwise has been showing strong growth with the capacity from the failing airlines in 2017 being absorbed quickly and efficiently by the market. In Asia, the status of the shadow banking system in China continues to cause concern especially considering the amount of Chinese liquidity being poured into the sector that could contract suddenly.
As head of aviation finance at Standard Chartered and CEO of Pembroke Group, Kieran Corr, sees many banking clients are becoming attracted to the aviation industry. “Private equity funds, hedge funds, sovereign wealth funds are evaluating the aviation sector to see whether they should be participating,” he says. “New investors will continue to move into the industry but you will see some of the new entrants realise that it’s difficult to build out your existing platform and they will recognise that you do need to have global reach... one way to get scale and build out your technical and marketing infrastructure is to acquire another entity. But with any M&A activity, there are challenges with integration, chemistry and synergies, etc.
There will be some further consolidation but a lot of new capital will keep coming into the sector.”
“All around us are issues and risks but that’s why you have well-established older leasing companies that can deal with that,” says ORIX Aviation’s Power, who believes an event is coming that will drive further consolidation in the leasing market. “As soon as there is some turmoil in the market – which there will be and possibly in two or three years’ time – there is certainly going to be consolidation because many firms won’t be well established to deal with that type of carnage.”
One veteran leasing chief executive who requested anonymity suggested that the coming downturn would result in “blood in the street” especially targeting those new entrant leasing companies with little experience of a pronounced stressed environment.
“We have had a bull run in this industry from 2004 to now, and things that should have turned the industry upside down didn’t – the credit crisis didn’t; high fuel prices didn’t; but that’s ending now,” he predicts. “There will be blood in the street and clearly, the strong guys will come through but there will be a few people who panic and exit. People forget that Morgan Stanley bought AWAS for $4 billion and sold it for $2.5 billion after 9/11, and it took them a couple of years to sell.”
According to data from FlightAscend’s Fleets Analyzer, the top 50 aircraft lessors have portfolios valued at more than $1bn. The top 15 lessors have portfolios worth more than $5bn, while the top 10 are all above $10bn portfolio size. Those below the top 10 really need to get enough scale to gain an investment grade credit rating and to be self-sustainable throughout a downturn when the defaults start,” says BOC Aviation’s Martin, who adds that the leasing market ecosystem, segmented into large, new aircraft lessors, and mid-life to end-of-life players, is vital for the health of the industry.
There has been a demonstrable shift in the size of operating lessors, with a trend towards upscaling. This has fuelled M&A activity in the sector beginning with AerCap’s ground breaking acquisition of International Lease Finance Corporation in December 2013.
Avolon’s strong organic growth from its beginning in 2010 to 2016, followed by step change growth from the merger of Hong Kong Aviation Capital in 2016 and the acquisition of CIT Leasing in 2017, has propelled it to the third largest lessor in seven years. AWAS sold 40 aircraft to Macquarie in 2015 ahead of its full sale to DAE Capital in 2017. There have been numerous large portfolio sales between lessors as some of the larger lessors took advantage of the attractive pricing driven by the robust market.
The consensus among industry leaders is that lessor consolidation will likely continue as smaller entities are acquired. The large scale deals that we saw in previous years are less likely unless a change in market conditions presents such opportunities.
“Consolidation is part of the natural flow of the industry,” says Chang, “which contracts and expands depending on market forces. For the past six-plus years, operating lessors and airlines have consolidated – the formation of IAG for example and the rise of IndiGo – the trend is toward scaling up. We are becoming a larger, more capital-intensive business than we have ever been. Scale is one of the critical, comparative advantages, which is why the industry is growing so fast. Scale gives a company relevance with clients, banks, investors, suppliers, manufacturers; as well as a competitive advantage in terms of unit cost. So, those that can scale up, will. Consolidation is one of the most direct routes to achieve that aim.”
Despite the general acceptance that consolidation will continue, whether this is the right time to sell or to buy is debatable.
“Many owners … are not keen to sell because [lessors are] very stable, steady producers of cash flows and profits,” says AerCap’s Kelly, “so they are not in any great hurry to sell, particularly when there is a paucity of opportunity for reinvestment of the proceeds. There would have to be specific stress to the owner that would force a sale at the moment. I don’t think we’ll see any rush of consolidation in the near term, but there could be some. [An increase in market share is great], but you want to have market share in the right market. There’s no point in cornering 100% of a market that’s dead in the water. You have to be careful about that when it comes to building scale.”
Goshawk’s Kelly says that consolidation is likely to be a continuous feature for our sector: “There is a lot of capital out there waiting to be invested and in the current environment it is difficult to find good investment opportunities, generally. The current environment is conducive to buyers and sellers transacting. Even if there is a downturn, consolidation will continue but for different reasons and at different pricing levels.”
Firoz Tarapore, CEO of DAE Capital, which purchased AWAS in August 2017 and is currently in the final stages of a successful integration process, also believes there is an “impetus for further industry consolidation due to the need for scale to be truly relevant in today’s leasing industry”. For Tarapore, a successful acquisition begins with strong due diligence on the acquisition target to be able to understand the true value of the purchase. He also advises that integration efforts should begin as early as possible and focus on maintaining and developing the strengths of both companies. Adopting the processes and systems of the larger entity limits disruptions to customer interfacing segments, he adds.
Tarapore and DAE Capital is eager to expand further. Because AWAS had sold the large portfolio to Macquarie, the merged company has the platform with the ability to do so easily. In an interview with Airline Economics in October 2017, he said: “Now we have a platform, which is impressive, solid, and scalable, we will be looking to buy another portfolio. It is conceivable that in three years’ time, a second acquisition may be possible.”
In China, says Peter Huijbers, CEO of CALS Aviation Group, a new aircraft leasing company headquartered in Shanghai, China, “there are about 100 Chinese operating lessors but maybe only 15 that are really in business. That leaves another 85 companies that somehow needs to find their place, which is when it is a good opportunity to consolidate.”
The new entrant lessors have been criticised for driving down lease rate factors, particularly in the sale-leaseback market in recent years as they build market share seemingly at any cost. The race to the bottom in buying deals with lease rate factors (LRF) reported to be lower than 0.6 has many more seasoned observers predicting their demise once the cycle turns.
“New operating lessors need to follow the customs that we are used to, be it from the evaluation of portfolios, be it from the way we deal with airlines, be it from the types of deal we close – leasing companies cannot survive if they buy deals at a 0.6 lease rate factor,” says Huijbers. “There are a few issues that need to be resolved and they will either correct themselves, be swallowed by others, by beefing up themselves, or just leave the market altogether.”
Lease rate factors at 0.6 are being debated in public as an indication of the fiercely competitive nature of the sale-leaseback market, with some deals rumoured to have been closed at 0.5, which is denied by most leasing companies.
For AerCap’s Kelly, paying too much for even a good asset is never a good idea: “Do I think that some people who have bought assets that they’re going to lose money? Sure, I do, but that’s the nature of business. What we’re going to see over time, is that anyone who bought an airplane at a lease rate factor below 0.6 is going to lose money. That’s going to happen. They can postpone the day of reckoning, but it’s going to happen. This isn’t anything new, we’ve seen this before when there were a lot of investors that came into the industry in the early 1990s from Japan who left because asset values were overheated for certain asset classes.”
However, as previously mentioned, Kelly isn’t predicting a continuation of the old industry cycle. He argues that the deep pools of capital that are now available to the industry – which has matured considerably – has created much more stability around asset values. “The level of cyclicality that we have experienced in the past was driven by a combination of small pools of debt capital (there were no unsecured capital markets until 2010) and investors buying the wrong assets and/or overpaying for good assets. Of course, you will always lose money if you buy poor assets or overpay for good ones but the lack of debt capital amplified the effect of downturns considerably.”
Nevertheless, there are some companies where low levels of return may make sense due to their low cost of funds.
“Rather than a high-risk market, more investors see our industry as a pretty mature market and one where lower returns are acceptable, but there are some variations to that theme,” says Power. “The low lease rate factors will need to match a particular type of credit profile, the length of the lease and the return conditions. Firms with good cost of funds and confidence with banks can achieve that level of return, but not everyone. The sale and leaseback market is acutely competitive but at the same time, I think it’s quite rational. We’re actually winning some deals in the sale and leaseback market where we may not have won them a year ago because we have good cost of funds, we can assess the risks but also we are probably offering longer lease terms and some changes in return conditions.”
The sale-leaseback market remains dominated by the more commoditized narrowbody assets, with new entrants particularly shunning widebody aircraft – Robert Martin believes that is a mistake. “In dollar terms, 55% of the market is widebodies, with 45% narrowbodies. About 40-45% of those narrowbodies will go directly to the source and will not be available for sale-leasebacks, which leaves about 25% of the market (in terms of dollar value) remaining. Of that 25%, about half are going to North American carriers, who are not interested in sale-leasebacks, which reduces the available pool to about 10% to 15%, and it is all that’s left for all these new lessors to fight over. That is what is causing purchase prices and sale-leasebacks to be bid up and yields to be bid down. We see this towards the end of every business cycle. It is no different.”
ALC’s Plueger predicts that within a one year from now, there will be fewer bidders in the sale-leaseback market for deals as the conversations surrounding low yield returns is having a “dampening effect”. You still hear widely inflated stories 40-50 responses for an RFP – that’s impossible. A dozen, fine. My sense is that these returns are not sustainable if, in fact, they’re all true for any business, even if you have a zero cost of capital,” he says.
Others believe this situation can continue for as long as the new money continues to flow into the industry: “Many of the residual assumptions are very aggressive and expect pain to be felt, but there is so much money flowing in, this may not stop the musical chairs, it may just hurt individual players who are then replaced in the mix by newer entrants,” warns Robert Korn, chairman and CEO of Apollo Aviation.
Fresh from a roadshow where a bond issuance was four times oversubscribed, Peter Chang described today as a “golden era” for the capital markets. Lessors are certainly taking advantage of the robust capital markets for funding aircraft as more companies seek to access unsecured funds to provide easier aircraft transitions in the future. Equally, more mid-life lessors have tapped the secured markets – notably the ABS market – both as a refinancing tool and to facilitate portfolio sales.
“Aircraft are the perfect assets for the capital markets,” says Peter Barrett, chief executive officer of SMBC Aviation Capital. “They are long-term, physical assets, they have immeasurable utility and they are mobile.”
Although the banking market remains open for lessors – indeed banks are clamouring for their business – the majority of deals are in the structured space, rather than traditional balance sheet financing, which with Basel IV will be curtailed even more in the next few years. Given the extended reliance on the capital markets for the leasing community, their relative health, along with interest rate rises, is being carefully monitored for any signs of weakness that could trigger a downturn that would lead to a repricing of risk in the mid-life and older aircraft space.
AE Capital’s Tarapore believes that capital markets investors “seem to be gaining a greater confidence in the robustness of the aircraft finance industry through cycles and in the time-tested returns offered by prudent investing in aircraft. Hopefully, this will result in the capital markets remaining open in future downcycles rather than closing up shop as they have often done during past downcycles in the aviation sector.”
Sibylle Pähler, founding member and global head of structuring and financing at Doric Asset Finance, worries how those new entrant investors, which have been attracted to the market over the quantitative easing phase and have brought in capital from sources that have not been exposed to this industry before, will react to a standard industry event. “Will [a downturn] lead to them pulling out of this market leading to fire sale activities, or will they continue to be attracted to the asset class and be prepared to live through that cycle?” she questions. “It is a cyclical industry, but if you can manage the cycle and you’re not exposed to a fire sale, then it has always proven to provide a stable return, but for the new market entrants this is not yet obvious.”
Lessors are also at the forefront of financial innovation. Intrepid has taken advantage of the new insurance-guaranteed product offering by Marsh’s Aircraft Finance Insurance Consortium. CALS is raising funds using crowdfunding in China as a source of equity.
The demand for funding is rising steadily as the new technology aircraft are delivered, which drives the constant search for new capital sources.
“There needs to be new types of capital sources and funding structures than what we have today. Bank funding continues to be limited by regulatory restrictions and the capital markets as they exist today are inadequate to meet the OEM demand projections for aircraft growth and replacement, even if you haircut those projections materially,” says ACG’s Tran.
Lessors will continue to tap the capital markets in ever greater numbers so long as they remain open and an efficient source of debt financing. The bank market will also remain open despite regulatory pressures as new entrants, with balance sheet capacity, mainly from Asia, drive liquidity for commercial bank financing products. Sources of equity capital remains a challenge but within that market too there are deep pools of capital from Asian investors, although there are signs that this market is cooling a little and may present more challenges in the future.
When access to capital becomes easier, the onus is on the lessor to make the right assets choices to both service customer demands but also to protect the investment through the cycle. The entrance of new technology aircraft has changed the market but the number of variants being introduced by the manufacturers has complicated the environment. The 737Max family of aircraft, for example, has five variants, which is more than any product grouping in history.
“Ultimately, the choice comes down to what do we want to invest our money in,” says Plueger. “We placed our bets accordingly. At the same time, the 737-800 and now the MAX 8 are just blockbuster airplanes. They are just phenomenal. On the used aircraft today, you can’t find enough good 737-800s. Do I think that that’s going to be taken away by these new derivatives? Probably not because it’s a really sweet spot airplane. If anything, it just makes us more cautious on how many 9 MAXs or 10 MAXs we may want to buy against sticking to where the most breadth is.”
The Airbus A320/1 family are less stratified but the A321-200 is a considered to be a “niche-y” aircraft, while the issue may be further compounded if Airbus launches a re-engined A321, dubbed the A322.
“Most operating lessors are very active in the single aisle aircraft 737 family, A320 family,” says Kieran Corr. “When you look at the widebody market, the predominant focus is on the smaller twin-aisle aircraft where there is a wider operator base, more liquidity. When you start moving into more niche aircraft, there are opportunities to make higher returns but also they may have less liquidity. There are some very niche areas that do very well in that sector, but we are focused on the more liquid aircraft types, the 737, A320, A330, B787, B777 and A350 family aircraft types.”
“The key to purchasing assets is looking at the user base,” says AerCap’s Kelly. “That will determine the stability of the value of the asset over the long-term. If there is a significant user base for the asset, then you’ll do well. If there isn’t, then it’s more challenging, you’re subjecting yourself to more risk.”
AerCap collates information from its customers over the course of the relationship to use to inform its buying choices. “When you pick these airplanes, you’ve got to listen to the market, you’ve got to canvas the market,” says Kelly. “Every time, anyone in AerCap interacts with an airline, a manufacturer, a bank, or any financial institution, there’s a trip report written back to management overnight. That information is collated over years and years, which is used to see a) what the customer wants, and b) what they’re willing to pay for it.”
Widebodies are harder investments for leasing companies. The number of units of the new widebodies are relatively low, which makes it more difficult to assess the potential user base.
“There have been few sales of 777X and A350-1000,” says Plueger. “Although Singapore just reaffirmed an order on the 777X, those units are hard pressed. We have not ordered a 777X yet and only have a very small number of A350-1000s on order that have already been placed.”
“We have a belief that widebody aircraft are riskier assets,” says Accipiter’s Sheridan. “We’re not against them but we’ll price them more conservatively. Where we are focused is the well-priced narrowbodies with good airline credits.”
The speed of technological advancements to engine and airframe design has led some to question again whether the economic useful life of an aircraft should remain at the standard 25 years. While most lessors agree that a 25-year depreciation curve makes the most accounting sense, there is some division on whether the economic life of a new aircraft is shortening or lengthening.
“The maintenance programmes, the composite structure, from a materials and technology point of view, supports the argument that the new technology aircraft are actually longer life airplanes,” says Plueger. He points to the development of new engine technology – CFMi’s LEAP and Pratt& Whitney’s geared turbofan (GTF) – each has had some introductory issues, but the OEMs will be hard pressed to develop yet another set of engines that promise another step change of 10-15% fuel burn reduction. Moreover, he stresses, since most of the engine companies today make little money selling their engines, with the bulk of the profit in the aftermarket and engine care agreements, expending further R&D dollars to develop new technology engines is unlikely.
For other operating lessors, the useful life of an aircraft is closer to 20 years, where the economics of overhauling an 18-year old aircraft and revitalising the interiors often doesn’t make sense. From a purely economic perspective, the returns may be higher overhauling and selling the engines alone.
The cost of designing and producing a clean-sheet aircraft are significant, which AerCap’s Kelly says is helping to maintain a long technology cycle. “The investments are just extraordinary. A clean-sheet aircraft is a “moonshot”, which is what Boeing called the 787. The A380 was another moonshot. These are huge risks for these businesses to take, so for large commercial airplanes, evolution is better than revolution.
It’s just not worth the risk. Airbus and Boeing have close to 90% of the market, they have the ability to be able to evolve their products at a lower risk and still get a decent return, rather than take that revolutionary approach, which is all or nothing risk.
Advances in technology are not confined to the equipment in the aviation industry. Like other industries, aviation is being impacted by the move to digitalisation, from the advent of advanced technologies such as distributed ledgers, or blockchains, to big data and artificial intelligence.
For lessors, the onus to date has been on digitalising aircraft maintenance records – a major underlying factor in the appraised value of an aircraft asset – as well as how to manage and commoditise big data. More firms are leveraging software tools to streamline processes and improve visibility of the detail in the information they have already.
“The ability to manage and use our data changes an entire complexion about our business,” says Chang. “It allows us to trade with more accuracy and to protect our asset values.
David Power agrees that technology is laying a terribly important role and is becoming a competitive advantage, but it can only be as useful as the inputted data. “If you think that technology is going to make your job easier and that it’s going to make your information tell you the answer, you’re doomed to failure at the outset,” he warns. “Aircraft leasing is very subjective; it’s all about debate. When it comes down to serious decisions about what you do with aircraft or how you invest, it’s about a real debate about what are the merits of various points on the lease, on the aircraft and its technical condition. Great systems are about what you have put into them to be able to produce those outputs.”
He adds: “Ultimately, the whole objective is to be a much more coherent and communicative organization rather than about control-driven systems. Our fundamental controls and systems will be providing a lot of information that will drive our decision-making process.”
ORIX Aviation and many other lessors, including SMBC Aviation Capital and BOC Aviation, are putting a lot of time and energy into making big data work for their companies.
SMBC Aviation Capital invested heavily in its information technology platform. “”We have invested significantly in the last number of years on our information technology platforms,” says Barrett.
“A huge amount of data comes with every transaction from the physical aircraft, the transaction, the lease - we have invested in building a successful platform that can help us manage that information in a very effective, efficient way. Both in a defensive way because it provides accuracy of our accounts, accuracy of our data and information to provide to different stakeholders, and also in an offensive way because it enables us to manage our business better – for example for aircraft trading. Being able to produce a complete and accurate t of documents for foreign investors immediately is really, really important. It saves time, reduces costs, and there are fewer grey areas to negotiate. Going forward, I can see a lot of potential with technology like AI and blockchains.”
“The use of maintenance data to predict when future maintenance requirements – currently being led by GE – has the potential to save the industry a fortune,” says Robert Martin. “But one of the major unsolved issues is who owns the data? The manufacturer? The airline? The aircraft owner? The answer is that all of them have to.”
This problem was highlighted by most industry respondents, and needs an industry wide solution. “The last thing we want is for manufacturers to claim the data and seek to charge the operator or owner to get it back,” adds Martin. “That’s the big unknown that’s going to have to be sorted out in the next three to five years.”