The financial and economic crisis affecting several of the East Asian 'tiger' economies has so far produced muted repercussions for commercial aircraft values. But at this early stage it would be dangerous to speculate that the current state of inertia should provide any comfort to the market. Most airlines are still assessing the short and longterm implications of the crisis and how it may affect the spate of impending new aircraft deliveries and future capacity requirements.
The question most widely posed is whether the regional crisis will be contained or whether it could precipitate a wider downturn in the industry. The Asia-Pacific region has provided above-average air travel growth patterns for many years. During the severe industry recession of the early 1990s, new aircraft demand from Asian carriers helped sustain production and offered the manufacturers an important respite at a time of reduced demand elsewhere.
However the predicament currently faced by Asian domiciled carriers, with reduced traffic levels and poor financial performance, has reversed the situation. The immediate reactions of the operators have included reducing capacity on the worst affected routes and reallocating this capacity to other destinations. Order positions have also been revised as early rumours of deferrals have been confirmed amid suggestions that the scale of postponements could intensify.
Outright order cancellations, which would have immediate implications for aircraft values, have not yet become a reality. Airlines contemplating this option are faced with the risk of losing the substantial downpayments held by the manufacturers as predelivery deposits. However, the ability of many operators to proceed with original delivery schedules may not be determined by their own financial positions or creditworthiness, but may depend on credit restrictions imposed by governments or the International Monetary Fund.
Asian carriers are collectively facing a double-edged sword. Not only has air travel demand been curtailed but local currencies have plunged in value. Although revenues may only be down 10-15 per cent, costs in local currencies have mushroomed due to the high relative costs of aircraft finance repayments and fuel which are denominated in dollars. Thailand, Malaysia, South Korea and Indonesia have seen their currencies devalue by between 40 to 100 per cent against the US dollar, placing an almost impossible burden on individual operators' finances. With significant demand derived domestically, carriers have been unable to pass the increased costs on fast enough.
The burden of repaying the high foreign debt levels accumulated during years of aggressive fleet expansion is therefore stretching resources to their limits. Further borrowings are, and will continue to be, restricted by more stringent credit analysis by foreign financial institutions while local banks will also be constrained on new lending as they are forced to improve solvency ratios to cover their accumulated bad debt. Cash constraints will therefore force many to look towards sale and leaseback transactions to free up capital.
Although aircraft values have so far been unaffected, the principal future threat is the failure of a major operator or a largescale hand-back of aircraft to a lessor or manufacturer. But it is more likely that, contrary to IMF wishes, most governments will afford financial protection to their flag carriers for reasons of prestige and national interest.
So what are the potential implications for aircraft values of order cancellations or postponements or older aircraft fleet withdrawals?
A picture of those aircraft more likely to be susceptible to the problems can be gained by looking at the current circumstances of some of the main casualties.
Both South Korea's main carriers, Korean Air and Asiana, have incurred massive foreign borrowings to support fleet growth. The fall in the value of the won has seen Korean Air announcing its largest ever loss of $246 million for 1997. Korean Air and Asiana hold combined outstanding orders for 76 aircraft, which they will find very difficult to absorb. In efforts to reduce debt levels, Korean Air recently reported that it will raise a total of $640 million through aircraft secured loans and the sale and leaseback of 10 aircraft. The carrier has not announced any changes to plans for taking 11 new aircraft during 1998.
As they look at sale and leaseback opportunities in the region, many operating lessors and financial institutions are comforted by the state of the general aircraft market. The low availability of modern equipment and a bullish resale market have seen used aircraft values reach their highest levels for several years. Their continued willingness to undertake sale and leaseback transactions will provide an important avenue of funding and a financial backstop to cash starved Asian carriers. Lessors will consider entering such arrangements with vulnerable Asian carriers, which they acknowledge to be longterm players, in the belief that ultimately government protection will be offered. In the worst case, if aircraft are handed back, lessors' market experience will help them redivert assets quickly to other customers.
The more tradeable, liquid aircraft assets, such as Stage 3 narrowbodies and widebody freighters, will be the first targets for such opportunistic traders. In addition to the precarious Korean carriers, most of the other large Asian airlines also hold significant order positions.
Table 1 illustrates the relative exposure to forward Asia-Pacific deliveries of each of the major manufacturers and aircraft types. Of the total world backlog at the beginning of March 1998, the region's carriers held order positions for 480 jet units - under 13 per cent of total world commitments. This level of exposure does not appear particularly worrying but if the orders held by operating lessors are excluded (many are likely to be leased to Asian carriers), the total share rises to over 20 per cent. And for widebody commitments alone, the region accounts for 35 per cent of the order book. The widebody sector may only represent 25 per cent of the total global aircraft fleet but unit costs are on average over three times that of narrowbodies so any fluctuation in widebody values will have a big impact on aircraft investors.
Widebodies have also historically accounted for a large share of manufacturer profits due to fatter margins from a less intense competitive environment. From this perspective, the manufacturers should also be genuinely anxious about the Asian situation. As of March 1998, widebody deliveries were scheduled to reach 97 by the end of the year, with Boeing responsible for 80 units (over 80 per cent). For the moment, Boeing is publicly putting on a brave face, but on paper it appears most at threat from the Asian problems. The Boeing 747-400 and 777 are exposed, with over 45 per cent and 48 per cent, respectively, of total orders for these types held by Asia-Pacific carriers. Many of these deliveries are due this year, so significant deferral activity will produce a shortterm market overhang and a potential buildup of undelivered aircraft. This would inevitably produce negative market sentiment and a softening of values. While latent demand from other regions could soak up excess aircraft, the ability of the market to absorb large numbers of high value widebody equipment quickly is limited as planning for the introduction of such aircraft types is a lengthy process.
Airbus Industrie also counts on the region for a large share of its widebody sales, although it does not appear as exposed as Boeing. Airbus is monitoring the situation closely and working with customers who may face difficulties in accepting new aircraft. Asiana has already announced that its Airbus 330-200 positions are to be pushed back beyond 1999. However, Airbus is bullishly sticking with its longer term 20-year forecasts, predicting 6.5 per cent year-on-year traffic growth. Iata, conversely, has revised its five year forecasts down from 7.7 per cent annual Asia-Pacific traffic growth to 4.4 per cent.
Cathay Pacific is among those in the region which are scrutinising costs and examining future fleet requirements. Usually in the most profitable league of global airlines, Cathay's earnings plunged 55 per cent in 1997, as traffic fell away, especially on the usually high performing Japanese routes. The carrier says it can see no signs of an emergence from the downturn and, although remaining committed to the 12 aircraft held on firm order, will sell five older 747-200s. The market for these older aircraft may not, however, be quite as receptive as last year. Qantas has withdrawn its interest but Virgin Atlantic was still considering taking two of the B747-200s at presstime.
Thai International has also announced a massive loss - $578.3 million in the quarter ending December 1997 - almost entirely due to foreign currency provisions. Thai has reduced frequencies on badly affected routes such as those to Korea, but has not yet suggested that any of its 15 outstanding orders will be deferred or cancelled.
Philippine Airlines was pursuing one of the more radical reequipment programmes in the region, with orders for 20 aircraft. However PAL was one of the first local carriers to admit publicly an inability to absorb all new orders and has, unofficially, indefinitely deferred six 747-400 deliveries of which three were due this year. Three orders for Airbus A320s were also stated to have been affected by the delays. PAL will dispose of 20 aircraft from its present fleet, including nine A300B4s and 11 737-300s.
Malaysian Airline System had also pursued aggressive fleet plans. In early 1998 MAS held firm orders for 11 777-200s and -300s and nine 747-400s. The collapse of the ringgit and government deferral of large ticket item imports have forced MAS to seek revisions, including delivery swaps with other carriers. Delta Air Lines decided against taking up some of the early 777 deliveries, leaving MAS to examine refinancing aircraft delivered in 1997 to raise cash.
The situation in Indonesia remains very uncertain as the government has so far failed to implement IMF reforms and get to grips with the underlying political and economic weaknesses. All the Indonesian airlines are in dire financial condition with the second tier carriers Merpati, Sempati, Bouraq and Mandala all forced to return aircraft to lessors. Sempati has returned four leased A300s and seven leased Fokker 100s and Bouraq has returned two B737-200s to lessors. Garuda is reportedly planning to sell 16 aircraft, including five DC-10-30s, four B747-200s, five A300B4s and five F28s.
Pacific-based carriers are not immune from the troubles. Qantas, Ansett and Air New Zealand have instigated moves, or stated their intention, to divert capacity from poorly performing markets to more lucrative routes such as those to Europe. Singapore Airlines has reduced services to Seoul, Bangkok, Jakarta and Kuala Lumpur but increased capacity to the US, Europe and Australia. SIA says it will defer three 777s and one 747-400 delivery.
For the moment, mainland China appears to be immune. This market will continue to demonstrate a large appetite for capacity, but PRC carriers will probably consolidate current and committed fleet requirements. The Bank of China has provided huge guarantees on aircraft financings and, longer term, will probably want to reduce its exposure to the sector.
Taiwan, with high dollar reserves, has also been protected. Japanese carriers are suffering from reduced demand but, unlike other regional carriers whose orders are largely for capacity expansion, the Japanese need to replace older aircraft such as the DC-10 and 747-200 fleets.
Although the general global aircraft market has appeared robust, in real terms, values of new aircraft have remained fairly static over the last 12-18 months, as a result of heavy manufacturer discounting and list price capping. The Asia effect is likely to reinforce these dampening effects and new values should remain vulnerable. The fall-out of the crisis is expected to continue until the end of the decade, forcing most Asian carriers to forget new order activity at best, and cancel existing orders at worst. The manufacturers will work closely with their customers to alleviate the short-term pain in the hope of retaining their loyalty for the longer term.
Narrowbody values will be better protected as Asia is not a big demand centre. If single aisle aircraft from Asia enter the market they will be fairly easy to reallocate to other regions, particularly as global demand still exceeds supply. A slight weakening of lease rates may be evidenced, but this is generally already anticipated due to peaking delivery rates and the introduction into service of the third generation 737 series. Narrowbody values are therefore predicted to hold firm through 1998, before weakening during 1999 as new aircraft deliveries continue to increase.
The short-term prognosis for widebody values is an across-the-board softening for both new and used models towards the end of 1998. Newer aircraft values are expected to fall in real terms by between 2-5 per cent, while older aircraft may fall by 10 per cent or more. Value declines for new aircraft may be tempered by manufacturer efforts to mitigate the effects of aircraft deferrals through a clever reallocation of orders and production controls.
But if the Asian problems preface a global industry recession, any large scale overcapacity will affect the less efficient older models first. As in previous downturns, older aircraft will be quickly removed from service and parked. The at-risk models here include all 727, DC-9, 747-100 and 200, DC-10, L.1011 and A300 variants.
Aircraft investors should brace themselves for the impact of a softening in widebody values and the shock of any exposure to potential largescale aircraft returns by Asian carriers.
Source: Airline Business
