The View from the City: Summertime blues

This story is sourced from

It's been an interesting summer so far. Anyone expecting a nice, sunny and quiet period of rest must have been bitterly disappointed.

On the macro-economic level, the global economy is showing clear signs of another slowdown. There is an increasing belief that this may not be just a "speed-bump" but the second major phase of what started as the 2008 subprime-crisis. The private bank debt problems were "solved" with public bailout actions and now we face the sovereign debt crisis. Has the time come to really pay for our excesses of the past? The financial markets had to deal with the US Budget problems and the European sovereign debt crisis. Share prices jumped up and down in a nervous reaction to (rumours of) rating downgrades. Political unrest continued in the Middle East and some UK cities turned into warzones as groups of vandals created chaos. Even in the airfinance markets, the normal post-airshow quiet-period never materialized, thanks to Boeing and American Airlines.

To the surprise of many, on 20 July, Boeing confirmed that American Airlines had committed to order 100 units of a new variant of the 737, featuring new more fuel-efficient engines. In addition, the US Major had taken options for 60 more. The aircraft would exclusively be powered by CFM International's LEAP-X engines. In the same press release, Boeing acknowledged that the final configuration of this new 737 variant was still pending and that the launch still needed board of directors approval.

Interesting enough, a few months before, the head of Boeing's "737 Advanced Product-Development" unit told a group of experts explicitly that after carefully studying all options, a 737 re-engining would not give more than a few percent lower operating cost. As Mark Streeter (JP Morgan) already said, kudos to Avitas' Adam Pilarski who predicted that Boeing would launch a 737 re-engining, despite strong indications that an all new product would be preferred. Kudos to Airbus' John Leahy also, who predicted that Boeing would eventually have no other choice but to re-engine. To be fair, obviously Mr. Leahy must have had some inside knowledge from the American Airlines sales campaign that his own company was involved in. One could actually argue that Airbus' breakthrough order for 260 aircraft from the A320 Family (plus 365 options) actually left Boeing with no other choice but to re-engine, in order not to lose the entire narrowbody order to the European manufacturer. Apparently, the alternatives that Boeing could offer were not enough. American demanded better fuel burn economics than the current 737NG could offer but didn't want to wait for an all new Boeing narrowbody either.

Where does this leave us in the airfinance market? Well, to be honest, we really don't know until it becomes clear exactly what this new version of the 737 will be. Boeing will certainly be able to squeeze a pair of modified CFMI LEAP-X engines under the wings of a re-designed 737. It seems that Boeing has confidence that it will get a newly developed version of LEAP-X that will allow it to gain some space under the pylon. However, the fan diameter still seems an open issue. Reportedly, to fit a 70in fan, the nose gear needs to be extended to create the required extra space. Will this mean a nose-blister "A330F-style"? The A320neo reportedly can accommodate fan diameters up to 81in. A big difference. By offering just the LEAP-X, Boeing is also taking a gamble that this engine will be at least as competitive as the competing Pratt & Whitney PW1000G "GTF". With a fairly radical change in terms of engine position, what will be the consequences for the aerodynamics, loads and consequently airframe structure? According to Boeing's CEO Jim McNerney, the physical modifications required to re-engine the 737 will cause some systemic impact on parts of the airframe. Will the re-engining option cover all versions of the 737NG? It seems unlikely that a re-engined version of the poor selling 737-600 will be offered. More importantly, will a re-engined -700 be another threat to the CSeries, next to the A319neo? Will a re-engined 737-900ER be on offer and will the performance of this stretch be competitive with the A321neo as a potential 757 replacement? Could a re-engining undo Boeing's efforts to stimulate the market for the current -900ER?

From a financier's perspective, questions remain. For obvious reasons, the manufacturers as well as the aircraft lessors downplayed the impact of the A320neo on the residual values of the current A320 and 737NG, but won't the new 737 version have any additional impact ? Obviously, a scenario where Boeing would only be able to discount the current 737NG to stay competitive could have had very negative short term implications for -NG prices and eventually values and lease-rates. Assuming Boeing and CFMI will eventually be able to design a credible competitor to the A320neo, will this restore equilibrium in the narrowbody market? Will our industry's Godfathers give their blessing to this re-engined Boeing product? Some have clearly stated that Boeing has to show leadership, resist pressure to re-engine and proceed with the development of a next generation narrowbody. So, will we see a repeat of the response to the initial A350, which was condemned for not bringing "enough"? To what extent is the re-engined 737 just an interim solution? McNerney made the statement that the primary area of concern for an all-new aircraft centered on the "massive" production system that would be required to support such a program. This suggests that Boeing effectively was close to finalizing an acceptable all-new aircraft, but didn't launch it because of potential production problems. This would leave the door wide open for an all-new 737 successor as Boeing will surely try to regain the lead in the narrow body market.

Compared to the careful planned communication coming from Seattle when the 787 was launched, the "launch" (was it a launch?) of the re-engined 737 was remarkably low profile. For a company that "wasn't born to follow" this must have been a bitter pill. Was it a last minute reaction to salvage at least a part of the American Airlines order? On what basis did American "commit" to the new aircraft? Probably Boeing offered some performance guarantees for the new aircraft, in turn based on performance guarantees from CFMI. Many questions remain, but -for all involved- let's hope the new 737 will be good enough to help restore the equilibrium in the mainline single-aisle market segment. If Boeing's engineers can work such a miracle they deserve our eternal gratitude .. well at least till the end of the summer.

Article contributed by Bert Van Leeuwen, managing director Aviation Research of DVB Bank SE