Lessor impairments point to residual value risk

Source: Flightglobal.com
This story is sourced from Flightglobal.com

Recent fleet impairment charges in the lessor community highlight the asset quality risks impacting leasing companies due to the introduction of newer, more fuel-efficient aircraft, says Fitch Ratings.

"We believe changes in useful life and residual value assumptions for select older and less fuel-efficient aircraft may remain an issue for lessors as they adapt to changes in global airline fleet-plan priorities over the next few years," says Fitch. "We will continue to focus on asset quality risk in this context, while recognising the potential for technological obsolescence and short production runs to impair expected cash flows and residual values for certain older fleet types, particularly four-engine models."

Fitch views increasing exposure to older, uncompetitive aircraft as a "longer-term risk" facing the aircraft leasing industry, which will play out over a number of years.

Accoridng to the ratings agency, if global capacity grows fast enough to absorb the growing number of ageing aircraft in lessor fleets, the ratings impact across the industry will be limited. However, if the secondary market continues to narrow, then ratings of some lessors with greater exposure to older fleets may be pressured.

The supply and demand outlook for select widebody aircraft, including the Airbus A340 and Boeing 747-400 fleets, has shifted in recent years as "airline demand for these less fuel-efficient four-engine aircraft has slipped", says Fitch.

"Lessees now have greater opportunities to lower unit costs by adding more competitive twin-engine aircraft, such as the Boeing 787 and Airbus A350, to their fleets."

Also, says Fitch, lessors are finding "more value" in parting out the aircraft and selling parts, particularly engines, versus putting up significant maintenance expenses required to re-lease the assets at lower lease rates.

ILFC took a $1.2 billion non-cash impairment charge in the third quarter after determining that future cash flows for 36 four-engine widebody aircraft in its fleet did not support their previous net book values on the balance sheet. This decision reflected the lessor's view that the holding periods for Airbus A340s and certain Boeing 747-400s would be shorter than 25 years, which is the industry standard. The impairment charge, which comes two years after even larger impairments in 2010 and 2011, represents approximately 3.5% of ILFC's net book value, says Fitch.

The ratings agency notes ILFC's ratings continue to reflect "elevated residual value risk", which is driven by the relative size and age of its fleet.

ILFC currently owns 17 A340-300s and 13 of the larger model A340-600s.

Aircastle also reported a $98 million impairment charge, roughly 2% of net book value. This was driven primarily by a reduction in the useful lives and residual values of six 747-400 converted freighters. "Demand in the freighter market has remained stagnant and capacity has been added, resulting in an imbalance," adds Fitch, adding: "Aircastle's exposure to this segment is unique among the major aircraft lessors."