ISTAT Asia day two: home for the elderly

Introduction

May 12, 2015, c. Leeham Co: As you would have guessed we are talking Asian civil airliners, where planning in the region for the fast growing older generations is inadequate. This was the subject of several sessions during day two of the ISTAT Asia (International Society of Transport Aircraft Trading) conference in Singapore.

The problem is new, as up to now a newly established airline fleet in Asia has not had any numbers of older aircraft. But the expansion over the last 20 years is now producing the first transition waves of aircraft and the planning around the problems this generates is inadequate.

The result will be surprising write-downs of airline assets as aircraft being replaced cannot be transitioned out at booked residual values. The scale of the problem was highlighted by a survey of the 500 gathered ISTAT industry experts. The question posed to them was “There are 4700 aircraft coming up for replacement until 2033, has Asian airlines planned adequately for this?”:

  • 49% of the delegates responded a few airlines have.
  • 45% answered there are only some that do it.
  • 5% of the delegates answered most airlines does it.
  • 2% thought all Asian airlines have done it.

A ticking bomb

The problem was highlighted in the concluding lessor CEO panel. Here the CEO of Bank Of China’s leasing company, BOC Aviation, Robert Martin, said: “when we sell for instance an A320neo or 737 MAX to an airline with a 7 year delivery schedule you would expect that the airline would start the replacement planning for the existing narrowbody that we replace. But they don’t! The aircraft sits on the airlines books, often with residual values in local currencies which are not in line with market values and nothing happens. This will put airlines into problems, they wake up to late and face considerable write-downs”.

The problem is relatively straight forward when the airline owns the aircraft. The airline has gradually written down the value of the aircraft and the remaining risk at transition of the aircraft to another operator is any mismatch of the book value to the actual market value.

A special case which was discussed is the mismatch which happens when a carrier uses a sell and lease-back operation to free the money invested in the aircraft. He then sells an aircraft in his possession to a leasing company and rent it back. In normal lease agreements the operator pays “used life” provisions to the leasing company called “maintenance provisions”. These funds are collected by the lessor to lower any used life risk at the event of an operator default. The funds are released back to the operator when he performs scheduled heavy checks or used at end of lease to recondition the aircraft to a usable life state for the next operator.

For carriers with good names and credit these monthly fees might not be part of the agreement.  This means there is a life used compensation to be paid by the airline at lease term end and the carrier might not have made adequate provisions for this. These sums can easily amount to $10m for larger aircraft and with say 10 aircraft in a sell and lease-back deal an end of term pay-out of $100m is ticking for the operator.

The attendees were subsequently asked how many affected airlines planned adequately for this:

  • 49% answered “a few”.
  • 38% answered “some airlines”.
  • 13% thought “most airlines plan for it”
  • 0% though this in the plans of all affected airlines.

The answer by the conference’s industry people clearly shows that the region has a number of problems with aircraft coming up for transition, be it for a second / third operator use, for freighter conversion or ultimate part-out.

Problem background

One of the reasons for the low awareness of these problems is that such transitions for the region’s airlines have been rare events. Asian civil aviation has come from a low number of state owned mainline carriers to an ultra-dynamic market with exponential growth of all operator variants over the last 20 years.

A study done for the conference on Ascend data shows:

  • 2010, a minor number of aircraft were transitioned / retired in the region
  • for 2015 a full 520 aircraft out of an Asian fleet size of 6300 aircraft will transition / retire during the year
  • this will almost double in the next five years to 1000 aircraft by 2020
  • it will be at 1700 aircraft in 2025.

While specialized lessors and part-out companies will service this market there are problems with how easy these aircraft are finding new homes at the residual values the airlines have them in their books.

A widebody problem

The single aisle market is very liquid and single aisle aircraft don’t represent such large residual values that any mismatch at their transitions will pose a considerable problem. There are a lot of airlines, start-up or those serving market niches, that will absorb older aircraft and they will be prepared to pay reasonable lease rates for such aircraft. In addition, any value problems are smaller per transaction for this market segment.

The situation is different for the widebody aircraft in the region. Here the value mismatch can be much higher and the placement of a 12 year old A330 aircraft is difficult according to the experts. A used 777-200ER is even harder to find a home for at or near its typical carrier residual value. These aircraft do not make for good feed-stock for freighter conversation as their payload – range capabilities are to low (cargo has higher density than passengers and therefore A330-200 or 777-200LR are the more suitable platforms for freighter conversions).

The result is problems with residual values of the regions widebody aircraft and few lessors are willing to engage in dealing with these fleets. The aircraft are also not attractive to freighter conversion specialist’s and are too young for part-out at the typical 12 years of age after first term use. A short term solution can be an extended lease for a sell-lease-back case but the used life cost problem is only deferred, it does not go away.

Summary

The Asian airliner market is maturing from youngster to middle age. Such life-state transitions carry its problems, the home for the elderly being one. Air traffic growth in the region has been phenomenal and as a result aircraft fleets have been young. Any elderly problem has not been important.

The first sign of this market transitioning into mid age maturity is there, the taking care of older aircraft is part of the deal. This year’s ISTAT Asia conference consequently analyzed the problem from a number of angles and the polls of the 500 industry people show that need for actions is at high noon. Rules and procedures for adequate life-time management for the regions fleets needs to be reemphasized and airlines need to plan accordingly.

Will this not be done, surprising airline losses will result and this can affect the confidence of the abundance of investors which are prepared to provide the capital for the continued expansion of the regions air traffic.

5 Comments on “ISTAT Asia day two: home for the elderly

  1. Although unrelated directly, the downfall of Malaysia Airlines is already putting a number of widebody aircraft on a soon to be saturated used aircraft market.

    • Did MH provide “seats” over capacity ? Probably not.
      I’d expect some open demand coming along with these frames on offer.

      Then with production lines fully booked for the near to middle term used frames available now should expect some interest.

  2. I think the retirement of young aircraft will be limited in Asia. The market keeps booming. In what colors and what places the aircraft will fly is another question, but demand is there. Demand will more then double of the said period. New aircraft will not replace young aircraft but be added. No doubt entrepreneurs will jump in if there’s any market mismatch. Maybe the lessors will take a hit.

    • There is no question the aircraft will find new homes, the question is at what residual value. The ones that the parting airline have in the books or lower. If lower, each transition will be accompanied by an unexpected asset write-down in the next quarterly report.

      • Qantas last year did a massive write down on its plane values of around A$2.5 billion. Some of that would have related to the 767 fleet which was retired completely not long after. Other causes were the local currency appreciation in relation to US$.

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