Last year was good for the aircraft leasing industry – very good indeed. “Outside the USA, this is the best market anyone has ever seen,” says Henry Hubschman, president of GECAS.
This is in sharp contrast with the downturn between 2001 and 2003, when leasing rates plummeted. By 2004 the bounce back was already in full swing. A year ago lessor chief executives were confident this would continue into 2005, but were less sure that the recovery would be strong enough to bring lease rates back to pre-2001 levels.
A year on, many are pleasantly surprised. “For widebodies and new-generation narrowbodies, recovery has reached pre-2001 levels,” says Klaus Heinemann, chief executive of AerCap (the former Debis AirFinance). Hubschman is even more bullish. “Lease rates are better than before 2001 – we are back to the levels of 1999 to early 2000,” he says. Harry Forsythe, vice-president marketing at AWAS, agrees: “On an interest-rate adjusted basis, we are probably in better shape than in 2001.”
The different interest rate climate is a crucial factor in assessing whether the industry is back to pre-2001 levels. Today, interest rates are 4.5-5% compared with around 7.5% in 2001. Dublin-based Orix Aviation Systems says the leasing industry is still 10-15% off 2001 levels before interest rate changes are taken into account. But when interest rate changes are taken into account, lease rates are in line with pre-9/11 levels. “This is all in the cost of funding – we are there or thereabouts,” says James Meyler, vice-president at Orix.
It is not easy to compare lease rates over different time periods. “The difficulty in comparing rates for five-year-old aircraft is that commentators are frequently not comparing like with like,” says Meyler. He notes that the Boeing 737NG, such as the -800, is more established than it was in 2000 and that as some early aircraft emerge onto the secondhand market meaningful comparisons are harder to make. To show how rates have fluctuated, the monthly lease rate for an Airbus A320 was around $300,000 in 2005, says Orix, compared with the low of $200,000 in 2002 and $350,000 in 1998.
While most regions are buoyant, the US market remains something of a conundrum. Lessor Babcock & Brown warns: “The liquidation of a major US legacy carrier under bankruptcy protection could temporarily depress lease rates and aircraft values as their fleets are absorbed by other airlines.”
Heavy orders
However, placing aircraft in today’s market, particularly the most popular modern narrowbodies, is clearly not the challenge it was a few years ago. On the back of two years of sustained recovery, the lessors are ordering heavily again. The order backlog from leasing companies is not far off the 1,000 mark – back to 2002 levels, according to figures from Airline Business sister company AvSoft (see table below).
Although still shy of the 1,200-plus levels seen in 2000 and 2001, this still represents a step change from 2003 and 2004, and will be further bolstered if a letter of intent from AerCap to acquire 70 A320s is converted into a firm order.
While GECAS and ILFC placed large orders in 2004, 2005 was the year when the second-tier lessors really returned to the market, taking the lessor market share of the two majors down from around 80% to 50%.
Our top 50 lessor ranking compiled by AvSoft, together with values by partner Avitas, shows that CIT Group remains the largest of the second-tier lessors (see table over page). SALE was edged out of the top 10 in 2005, while Aviation Capital Group was catapulted into fourth place from 15th by acquiring Boullioun Aviation.
Elsewhere, Babcock & Brown moved into the top 10, helped by strong demand in the Japanese syndication market ahead of tax changes that came into effect in April last year. Babcock & Brown has a strong presence in the Japanese private equity market through its relationship with Nomura Securities.
Further down the table, Kuwait-based ALAFCO, which specialises in Islamic operating leases, was a notable climber as it pushes for market share five years after its launch in 2000. The lessor is considering expanding into the freighter market too.
RBS has rapidly moved up the ranking through a mixture of sale and leaseback deals and finance leases over the past two to three years. In 2005 it placed its first speculative narrowbody orders.
GECAS and ILFC continued to be active, with the former ordering 40 A320s and 20 737NGs, as well as signing a letter of intent for 10 A350s. GECAS, which is looking to lessen its dependence on the US market, boosted its overseas marketing presence with new offices in Mexico City, New Delhi, São Paulo and Shanghai during 2005. ILFC, meanwhile, ordered 20 Boeing 787s in October, with options for four more. Then came an order for 12 A350s in November, which was hard on the heels of 20 737-700/800s, six 777-300ERs and two 777-200ERs ordered earlier. Like GECAS, ILFC has been trying to reduce its exposure to the US market.
Confidence has returned to the market. “The conditions are right – capital is returning, there is a low interest-rate environment, growth in demand for aircraft and improved credit quality of airlines,” says David Power, chief executive at Orix, adding: “orders are anticipatory.” There is another good reason for the increased order activity – scarcity of manufacturing slots. As Heinemann at AerCap puts it, for A320s and 737NGs, Airbus and Boeing are “sold out” in the near term.
However, some sound a note of caution. Pointing to the fact that some recently placed orders will not be delivered for another three years, Hubschman says: “The market is good now. When the aircraft are delivered, will the market still be good?” He says the market looks good for 2006 and 2007, but warns that the next stage of the economic cycle will then start to come into view. Others are confident that the good times will continue for some time yet. Ahmed Abdullah Al-Zabin, chairman of ALAFCO, says the lessor’s ambitious expansion plans are based on “the foreseen boom and growth in the air transport market until the end of the decade”.
In terms of aircraft types, as in recent years, it is the more modern types that have seen the broadest and strongest recovery – but some older varieties are benefiting from the scarcity of quality equipment. “For older-generation aircraft, such as the 737 Classic, there has been a significant degree of recovery, but not to pre-2001 levels,” says Heinemann at AerCap.
Ageing stalwarts
However, some are clearly beginning to see value – or at least availability – in older types. “Older 737-300s have seen lease rates double compared with three years ago,” says Power at Orix, noting that it is an efficient aircraft and still the stalwart of many airline fleets, including British Airways. “The difference between capital costs and lease rates for older A320s and 737 Classics is relatively significant,” he says, noting that lease rates for some less popular types are low enough to compensate for the higher operational costs.
Even the fuel-thirsty MD-80 family is finding favour in some quarters. “There is strong demand for the MD-82 due to [low] capital costs and availability – and engine overhaul costs can be cheaper,” says Power. One observer notes the lease rate for a MD-80 doubling overnight: “Even if that is double of virtually nothing, it still tells you something about the overall market.”
Whether this will see values for older types recover to pre-2001 levels is another matter. According to Jeff Knittel, chief executive of CIT: “As the supply and demand equation continues to tilt in favour of more demand, this will help the process for older aircraft.”
In the widebody sector, the Boeing 767 is hot property. “There have been some real dogfights over the 767,” says Hubschman. “The aircraft is extremely valuable, desirable and sought after.” His opposing number at ILFC, Steve Udvar-Hazy agrees: “Lease rates for the 767-300ERs have gone up more than any other widebody since the low point of 2002. For example, one carrier had a 767 coming off lease – it was paying $350,000 a month. It was so keen to keep it, knowing it was hard to get a similar type, that its first offer was $475,000 per month. It shows how much the market has changed.”
One reason the 767 and, to a lesser extent the Airbus A330, are finding so much favour is that airlines need mid-range capacity before the A350 and 787 come on stream around the end of the decade. Forsythe at AWAS says 767-300ER and Airbus A300-600R rates have risen as airlines soak up medium-term interim lift in advance of 787/A350 deliveries. Heinemann points out that the 787 will not be around in large numbers until 2009, and the A350 will not enter service until after the end of the decade.
Mid-range apathy
As they eye up the arrival of the 787 and A350, airlines are reluctant to purchase mid-range aircraft. “There are virtually no 767 orders. People are not interested in buying. Why invest in the residual value?” asks Hubschman.
The fact that leasing companies are again ordering aircraft partly reflects the restoration of shareholder faith in the airline business. These shareholders endured some rocky years earlier in the decade and many tried to exit the business. In 2003 and 2004 there were few leasing companies not in the shop window, either officially or unofficially.
The sale of Boullioun to Aviation Capital Group and Debis to US-based investor Cerberus Capital Management, which rebranded it as AerCap, were completed last year after months of speculation.
The only major name up for grabs today is Morgan Stanley-owned AWAS, with bidders including Australian bank Macquarie, AerCap parent Cerberus, Babcock & Brown, FortressCapital (which owns aviation finance company AirCastle), hedge fund Dune Capital and US investment house Terra Firma.
AWAS has a relatively old fleet, with an average age of 12.7 years, which has helped put off some leasing companies, including CIT. AWAS divested itself of 25 aircraft in the first quarter of 2005, and now has 156 aircraft in its fleet. Morgan Stanley took a write-down in the business to the tune of $1 billion in the third quarter of 2005 and says that “this estimate might have to be adjusted as additional information becomes available and discussions with potential purchasers begins” – hinting it may not get the $2.6 billion asking price for the concern. A sale is expected to be completed by the middle of 2006.
Even so, the prospective sale of AWAS is a sign that investors are warming to the leasing sector again. Lessors have long complained that banks have struggled to understand the long-term cyclical nature of the industry. “This is not a three-year business. The cycles last seven to 10 years,” says one leasing industry insider. CIT’s Knittel says: “People understand the aircraft leasing business more than they did.”
Many have now left the market. “Quite a few banks have decided that aircraft leasing is non-core business and have been exiting their positions,” says Forsythe. “There is, however, robust interest in leasing companies from hedge funds and this may lead to a more direct value-creation business model.”
However, ILFC’s Udvar-Hazy, while acknowledging that hedge funds and private equity investors are indeed on the trail for second- and third-tier lessors, believes that “they are on the prowl for a quick buck and should not be seen as long-term investors”.
Indeed, while these are clearly good times for the leasing industry, the next stage of the economic cycle may well again see investors shun the industry. For now, however, many in the leasing sector are confident that the upswing still has plenty of mileage and that ordering aircraft makes sense. Knittel at CIT sums ups this rationale: “The economics make sense. When these orders arrive in 2007, aircraft will be scarce.” ■
COLIN BAKER / LONDON
Source: Airline Business
