Lease rates have rebounded, albeit from low levels, although this is a recovery from a severe downturn that has tested the nerves of some lessor shareholders
This time last year many in the leasing industry were predicting a pick-up in leasing rates on the back of a recovery in traffic volumes. They were proved right and lessors have even started to see the demand/supply balance work in their favour - a dramatic change from the buyers market of a year ago.
Back then, lessors were chasing rare airline customers, now most report that they have found themselves back in a situation where two airlines are once more chasing a single aircraft, at least for the most sought after types.
The low-cost sector and the Asia-Pacific market are picked out by most as the driving forces behind the recovery in rates, which have risen by between 20% and 40% for the more popular types, such as the Boeing 737 Next Generation and the newer Airbus A320s. "When you factor in [recent] low interest rates, 737NG rates have recovered to the levels of 2000," adds John Willingham, chief operating officer at lessor Boullioun.
Against this background, lessors have seen the value of their fleets stabilise and even rise, as highlighted by the latest leasing survey, compiled by Airline Business sister company AvSoft, together with values from partner Avitas (see survey from page 45). Analysis from the survey, which is this year expanded to cover a full top 50 companies, shows that average aircraft values have indeed edged up just ahead of inflation over the last year (see table page 42).
The two giants GECAS and ILFC again both steadily added to their fleets. Perhaps the most dramatic growth last year came from RBS Aviation Capital, the growing leasing arm of the UK's Royal Bank Scotland. RBS has been one of the most aggressive players in the market through the downturn and has shot up to fifth place in terms offleet value. At the same time, the Boeing Capital fleet shrunk by a quarter as the manufacturer scaled back ambitions to create a standalone lessor. Instead, Boeing Aircraft Holding has expanded in its more traditional role in manufacturer funding.
Further down the table, there are fresh entrants, including Guggenheim Aviation Partners, a new US leasing company set up to invest in what the founders believe is a market poised to recover. "The liquidity has been sucked out of the market and Guggenheim thinks that this type of fund can offer good upside with low-risk," says Steve Rimmer, executive officer, pointing to low aircraft values but rising demand.
An indication of the renewed confidence is demonstrated by Singapore Aircraft Leasing Enterprise (SALE), which is looking to place its first major order since 1999. Requests for proposals for narrowbodies in the 100-plus seat category have been sent out to Airbus, Boeing and Embraer.
The leasing sector had held over 1,200 jet aircraft orders going into the downturn, accounting for nearly 30% of the entire backlog. But by the end of last year that order volume had halved and the leasing company share had dwindled to 18% of the backlog (see table below right).
While the resurgence in lease rates looks impressive, this marks a recovery from a low base. Lessors seem pretty confident that the improvement will persist into 2005, however. Robert Martin, chief executive at SALE, says that May 2003 proved to be the bottom of the cycle with a visible recovery in 2004 which shows signs of continuing into 2005. "We are now at the beginning of the growth curve," he says. "If you look back 10 years, we are roughly at the same stage of the cycle as we were in 1994."
Klaus Heinemann, chief executive at Germany's debis AirFinance agrees. "There are similarities between the years 1991-4 and 2001-4," he says. "Passenger numbers start to increase while yields are still down, and load factors start to increase. Ultimately, the increased load factors will force up yields." Others are also confident that 2005 should see continued recovery in lease rates. "We're not anticipating more 20-40% hikes, but maybe somewhere in the 10-15% range," says Gordon Dixon, chief executive of UAE-based Oasis International Leasing. Airlines also seem to be accepting that the days of rock-bottom rates are over. "Rates are low and still very competitive," says Andreas Bierwirth, director of one of Europe's fast-growing low-cost carriers Germanwings. But he now expects to see lease rates increase.
There is a question mark over the leasing industry's ability to get lease rates back to their peak back in 2000. With no-frills carriers still driving down costs on the short-haul sector, Heinemann at debis warns that despite the current recovery "there will be no return to the good old days" of the late 1990s.
Others, however, believe that rates could indeed regain the peak if the economic GDPgrowth continues. "We have had one year of sustained traffic growth, with the highest growth in GDP in 30 years," argues Martin at SALE. "We need another two to three years of sustained GDP growth and we will be back up to 2000 levels."
As with previous industry cycles, the recovery in leasing rates has again been led by modern short-haul aircraft types, particularly the 737NGs and newer A320s. The upswing is also starting to feed through to older A320s and 737 Classics. Willingham at Boullioun says that the recovery has been led by the Boeing 737-800, which has benefited from the fact that Boeing took the axe to production rates, while Airbus kept output pretty constant.
He also points out that for Airbus the cycle for A320 deliveries was slightly later than that for Boeing 737NGs. While peak deliveries of the 737 to leasing companies came at the start of the downturn in 2001, the output of A320s peaked a year or so later at the lowest point in the cycle. "They peaked at the worst possible time," says Willingham. The fact that a number of airline failures or near failures involved operators with large A320s fleets did little to help.
Against this background, Willingham says that snap-back in 737-800 rates can be traced back to 2003, and adds encouragingly that 2004 saw the beginning of a recovery in the A320 market too.
Lessors still hold fears that there will be a longer oversupply problem with the A320. "Airbus has been pushing the A320 and is looking at a production rate of 30 a month," says Willingham. "In our view this is very aggressive. Airbus says they won't produce at this level if nobody is buying, but they are pricing the product to clear."
Lessors also report a revival of interest in the 757, despite Boeing's decision to end new production for lack of orders. "Airlines have woken up to the fact that you get a lot of aircraft for your money," says Harry Forsythe, vice-president marketing at AWAS. He recalls that a few years ago, when the New Zealand government put out a tender for 757s it had over 70 offers from owners wanting to offload aircraft. "Today, they would get just a fraction of that," he says.
Investor caution
Although recovery may have set in, the downturn has strained the nerves of some financial backers. There are few owners that have not considered selling out of the aircraft leasing sector over the past three years of crisis, comments one old hand.
The sale of Boullioun by German bank West LB looks likely to go ahead this year, with four bidders left from the original 14. However, in general there have been few sales over the past year, with buyers proving hard to find. "There is no liquidity in the sector," says John Morrissey, formerly of lessor GPA, who advised one of the consortiums that pulled out of the Boullioun bidding.
Even so, he notes to his surprise that the Boullioun sale has attracted plenty of interest. He advised a consortium including Texas Pacific to pull out of the bidding due to the underlying yield situation in the airline industry and over-production by manufacturers.
Dixon at Oasis believes that some of those that have invested in leasing companies have not really fully understood the business. "If you take a long-term view of this industry, then you have to accept there are going to be cyclical downturns. If you look at ILFC or GECAS, these guys understand that. Some owners of other leasing companies do not understand this so well," he says.
Despite much talk in recent years of consolidation in the leasing industry, Dixon says this process "has not even started". He also questions perceived wisdom that you have to be big to survive in the leasing business. "It is not necessarily about scale. It is about profitability," he says.
While lessors may be optimistic, there are still a few potential minefields on the road to sustained recovery. As many have found, the rise of low-cost carriers has made operators more demanding. "Low-cost carriers expect low lease rates, and that is not always good for the industry," says Forsythe at AWAS. "Our job is to make sure that we get a balance of expectations."
Airline failures
However, the main concern is airline failures. Ronald Zech, chief executive of GATX, says that while lease rates are improving, particularly for the newer, narrowbody aircraft, "the airline industry remains under pressure". He warns of the potential for credit losses and asset impairments. Much depends on what happens at US Airways, which is back in Chapter 11 for the second time, while Independence Air, the USlow-cost regional, has also hit problems.
In Europe, the collapse of Italian low-cost operator Volare has been the most significant casualty in the increasingly crowded low-cost sector. The group has a short- and long-haul fleet of Airbus types sourced from a variety of lessors including GATX, ILFC, and SALE. "There is a very real danger," says Dixon. "As soon as the Volare aircraft came available there was an immediate effect on the market."
However, as Dixon notes, this proved to be short-lived. SALE, for instance, managed to sell three of its Volare A320s and place the other one with another carrier within three weeks, with other Volare aircraft also reported to have been placed quickly. "The aircraft were absorbed into the market much more easily than they would have been a few years ago," says Dixon.
This is in stark contrast to the situation in the wake of 2001, when leasing rates plummeting, especially for the A320, after the collapse of Swissair, Sabena and Ansett, which nearly brought down Air New Zealand with it, plus the subsequent bankruptcy filings at US Airways and United Airlines.
This time it will be different, says Heinemann at debis. "If airlines cease to operate it will cause only temporary disruption to leasing rates. The aircraft will be quickly absorbed," he says. He points out that Sabena and Swissair were effectively dumping aircraft that nobody wanted, as the industry itself was in deep crisis. This time round, he believes that Volare's aircraft will be swallowed up. "The passengers travelling with Volare haven't gone away. They will be picked up by the likes of easyJet and Ryanair," he says.
Dixon agrees, arguing that even if a US major were to fail today, the impact would be relatively limited. "We are past the point where airlines simply disappear into a vacuum. Someone is going to fill the gap," he says, adding that even if one of the majors were to ceases operations, some sort of phoenix will rise from its ashes.
The threat of unforeseen events is hardly new for aircraft lessors, but the sector appears to be much better equipped to deal with the collapse of major airlines than was the case just a few years ago. The predicted end of the benign interest-rate climate may temper some of joy by raising their cost of capital, but after a tough couple of years, the improvement in 2004 should offer hope to lessors and their shareholders.
| Leasing company year-end jet aircraft order backlog and share of total | |||||
| Type | 2000 | 2001 | 2002 | 2003 | 2004 |
|
| Units Share | Units Share | Units Share | Units Share | Units Share |
| Narrowbody | 901 36% | 874 39% | 731 39% | 612 30% | 480 24% |
| Widebody | 207 27% | 207 26% | 158 21% | 128 18% | 103 14% |
| Regional jets | 156 11% | 149 11% | 98 11% | 5 1% | 7 1% |
| TOTAL | 1,264 27% | 1,230 28% | 987 28% | 745 22% | 590 18% |
NOTES: Figures based on AvSoft's ACAS fleet database for years to end November. share=share of total order backlog by units
BY COLIN BAKER IN LONDON
Source: Airline Business
