Regional jet leasing yet to take off

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Traditionally, aircraft lessors have maintained a tight focus on the Airbus A320 and Boeing Next Generation 737 families, to the exclusion not just of the regional jets but also, to a large extent, widebody types.

The lure of narrowbodies is naturally boosted by strong demand in the sector, which makes it easy to place aircraft and easy to transition them from one lessee to another.

Regional jets, on the other hand, have presented particular problems to lessors.

One is the high levels of manufacturer-supported financing prevalent in the sector. Bombardier and Embraer have long had active financing departments, and support has been forthcoming from the relevant export credit agencies.

"Whether it was Canadian export credit- or Brazilian export credit-supported financing, it was really tough for a lessor, if not impossible for a lessor, to compete with those structures," says Franklin Pray, chief executive of AWAS, a Dublin, Ireland-based lessor with a portfolio of 220 aircraft and a further 128 on order from Airbus and Boeing.

Pray adds that 50-seat and even 70-seat regional jets have tended to be economically viable only where capital costs to the airline were kept low - and low capital costs imply low lease rates.

Credit quality has represented yet another stumbling block, since generally a large proportion of regional jets are operated on behalf of major airline codeshare partners.

 "In essence you're leasing into an operator who's not really in charge of his destiny, because that largely lies within the codeshare agreement," says Pray.

"These agreements are only three- to five-years old, whereas leases on some of these aircraft are 10 or 15 years old. There's a distinct mismatch."

Historically, the regional sector has been largely off limits to the leasing community, but a flood of new aircraft programmes has raised some optimism that this may change.

New Horizons?

One of the regional sector's two long-standing incumbents, Bombardier, aims to introduce its CSeries jets to service in 2013. The yet-to-be launched 110/130-seat aircraft will be powered by Pratt & Whitney's GTF geared turbofan.

bombardier cseries
 © Bombardier

After Lufthansa and Northwest Airlines apparently passed up the opportunity, China Southern has been mooted as a potential launch customer.

Yet orders from lessors seem distant. "We have also noticed a reluctance by large airline potential launch customers for the CSeries," says Steven Udvar-Hazy, chief executive of International Lease Finance, an AIG-owned lessor with a portfolio of 900-plus aircraft.

ILFC has evaluated not just the CSeries but also new programmes under development in China, Japan and Russia. Representing Russia, Sukhoi's 95-seat Superjet 100 is due to enter service in 2009, and will deploy engines developed by PowerJet, a joint venture between Snecma and NPO Saturn.

sukhoi superjet 100
 © Sukhoi

The Russian manufacturer has won firm orders from Russia's Financial Leasing Company (10 units) and Dubai-based leasing start-up Concord Aviation (10), but has struggled to win support from major international lessors or, indeed, major international airlines.

Similarly, new programmes in development in China and Japan are largely confined to domestic appeal.

Due to enter service in late 2009, China's 70/90-seat ARJ21 programme has won a five-unit order from General Electric Commercial Aviation Services, GE's leasing arm, but this is not unexpected given that GE CF34 engines will power the jets.

The similarly sized Mitsubishi Regional Jet, which will be powered by a variant of the GTF engine, is so far confined to one endorsement, from Japanese carrier All Nippon Airways, but is expected to announce a second at the Farnborough air show.

After-sales product support is the hurdle that the Chinese, Japanese and Russian programmes must vault if they are to gain truly international customer bases.

As Pray puts it: "It's a long-term project in terms of satisfying the operators, as well as the investor community like us, that these products will get supported in 30 or 40 years as it is with Boeing and Airbus today." Problematically for the manufacturers in question, a record of quality product support cannot be acquired overnight.

Attacking space

There may be a window of opportunity for the CSeries.

 "That is basically what we call a standalone application," says Pray. "This is not an aircraft you lease into a regional subsidiary because it only works at regional subsidiary pilot pay scales. For example, at American Airlines it was cheaper to operate 50-seat regional jets flown by American Eagle versus Fokker 100s operated by American mainline as the Fokker 100 pilots made so much more money."

In terms of seat numbers, CSeries aircraft will be larger than types traditionally operated by regional airlines.

 In fact, they can be viewed as competitors to the smaller narrowbodies. The same applies to the Embraer 190 (98/114 seats) and 195 (108/122 seats), which perhaps explains why the former type has inspired two niche leasing operations.

 In April, Shannon, Ireland-based lessor Aldus Aviation launched operations with the acquisition from GECAS of 11 E-Jets, including four E-195s and two E-190s. Two months previously, Florida-based lessor Jetscape had placed a firm order for 10 E-190s.

Embraer and Bombardier have certainly enjoyed success by eating into the A320/737NG space. However, as Deutsche Bank aviation financier Chris Partridge points out, they have done so by going head to head with the 737-600 and the A318, which are "the least successful products" of their respective airframers.

"They're loss leaders, but they're selling those aircraft, generally speaking, into people who've already got either 737 or A320 families anyway," he adds. "I see the top-end Bombardier and Embraer products being stronger-selling products in the medium term."

Regional jets in the 100- to 140-seat segment appear to have rosier futures than smaller ones. However, the past struggles of Airbus and Boeing to succeed in this segment may reflect its limited potential.

"It's always going to be very, very tough for the smaller aircraft to have premium seat-mile economics," says Pray. "I think that's always been the issue that investors have faced with, for example, the MD-95/717, 737-500 and A318.

airbus a320

 © Airbus

"These aircraft, in as much as they have fairly low trip costs, have fairly high seat-mile costs, so there has been a tendency over the last 10, 15 years for operators to migrate into larger equipment.

 I think the primary challenge for these regional jet producers is to look at new technology that makes up for that effect."

Scheduled for service entry in 2013, P&W's GTF has been heralded a breakthrough in fuel efficiency and (by extension) environmental friendliness, but there is uncertainty in the market as to whether it provides the "step change" that operators and lessors require.

Udvar-Hazy, for example, labels it an "unknown quantity", while Partridge suggests the engine's impetus might be lost were fuel prices to drop, in which case operators would have less pressure to seek short-term gains than they do in today's "bubble environment".

While potential customers weigh up the impact of gearboxes on reliability and maintenance cost, P&W's rivals - CFM, GE and Rolls-Royce - are working on the next generation of turbofans, which could, depending on who you believe, reach the market anywhere between 2015 and 2020.

Open-rotor engines, which might bring a 10% improvement in fuel burn, also loom on the horizon. The prospect of the GTF being usurped, whether real or imagined, complicates the task of the CSeries and MRJ regional jets in finding a way into lessors' portfolios.

Residual Appeal

While an operator can adjust schedules, route networks and operating patterns to make optimal use of an asset, lessors might focus always on residual value retention, and the case for all the new regional jet programmes, even the CSeries, is unproven.

"There are many competitors in this segment and therefore projecting residual values 10, 15, 20 years from now is extremely difficult and challenging for ILFC," says Udvar-Hazy. "If for example we track the residual value graphing of Fokker 100s/70s or Avros or CRJ200/700s, they are generally depreciating in real value terms faster than their larger 120/180-seat counterparts."

Capital costs present a further sticking point. "We are struggling with the capital cost per seat for these new aircraft versus an A320/737-800 category aircraft, as well as the fact that their unit [per ASM] operating costs are still higher than the Airbus/Boeing latest models."

The regional jet manufacturers can perhaps take solace in Pray's observation that were AWAS to enter the regional jet space, it would do so in "a very big way".

For now, however, that is simply too risky a course of action, especially given the backdrop of economic slowdown, limited availability of credit, spiralling fuel prices and declining airline profitability.

"With Boeing and Airbus we get compensated [for risk]," says Pray. "As operating lessors we enjoy significant discounts, plus most of the aircraft that are committed for have quite wide operator bases, so there's some comfort in terms of predictability of where the market is on these aircraft. That has yet to be established for even the large regional jet aircraft."