Seldom have we seen such a clear winner of the "mine's bigger than yours"- game for new orders, at any airshow. Le Bourget 2011 was dominated by the flood of Airbus A320Neo announcements. An adequate reward for a brilliant and brave strategic move. Even after the airshow the ordering continued, when Tony Fernandes threw in another hundred commitments, and if market rumours are correct, very soon we will see some North American Majors defecting to the Airbus camp and signing up for dozens of Neo's as well.
Over a thousand Neo orders, letter of intent, memorandum of understanding etc... have been signed since the launch of the program early December 2010. During that period, Airbus booked twice as many orders for the A320 Family as its direct competitor. While Boeing seemed a bit shell-shocked by the success of the Neo and has not yet been able to come up with a clear answer (at least in public), for sure Seattle will soon get it's act together again. Assuming Boeing will announce a credible successor to their current narrowbody in the form of a re-engined 737NG or the "all new" new small aircraft, at least a similar order-flow could be expected for this Boeing aircraft as well. But remember, orders for these new aircraft are in addition to the existing backlog for the "old" models of around 4,500 units. Based on this backlog, both Airbus and Boeing already announced production rate increases to a combined 1,000+ narrowbodies per annum and reportedly Boeing is investigating technologies for low-cost mass production of the 737 successor. So, are the manufacturers right if they claim they need to increase production because of a shortage of narrowbodies?
Well, as always, it depends on one's perspective. Judging purely by the new order-volume coming from the airlines and lessors as well as by the current backlog, the manufacturers are right. Assuming all new orders are carefully screened by the OEM's and only customers are accepted that are able and willing to pay their PDP's (assuming those are more than just token money), nothing wrong here.
Why then are some respected industry experts still claiming the manufacturers are creating a bubble? The discussion looks very much like the one around the funding-gap a few years ago (remember?). If you are a manufacturer of new aircraft, supported by your friendly local ECA - which absorbed in the last few years about a third in value of all deliveries - there was no funding gap. However, if you were in the used aircraft market trying to buy a 12-year old 737 Classic, or an eight-year old A320 you could almost sink the entire aircraft in your funding gap. One could argue there is no oversupply of new commercial jets as all aircraft produced will be absorbed by the market. However could it be that - once more - the oversupply-situation is very real for airplanes seven years and older?
Already today, many airlines seem to have "the seven-year itch". It is a struggle for traders and lessors to place any aircraft older than say seven years with a decent combination of lessee and jurisdiction and for an acceptable lease rate. Lessees or buyers can be found, but (too) often only third tier names and/or for highly discounted lease-rates. With the upcoming technology/generation change, we fear this eventually will only get worse. The potential surplus of relatively young used aircraft will start to put enormous pressure on lease rates and residual values of these aircraft.
A bit of research using historic market values reveals that this process may actually already be going on for a while. While in the year 2000 a five-year old A320 would still have a value of about 78% of the price of a new A320 built in that year. By 2010 a then five-year old A320 would only be worth 68% of a new replacement aircraft. As such, no surprise, and the well understood result of technology aging of any aircraft type. What is more interesting to note is that the older the aircraft, the steeper the value loss! In the year 2000 a 10-year old A320 would still have a value of over 64% of a new replacement aircraft, in the year 2010 a then ten year old plane would only fetch 45% of the value of a new A320.
If this is real, why is this happening? The answer is complex and we may not even have identified all elements.
First of all, airlines have a strong preference to fly younger, more efficient and maintenance friendly aircraft. Given a choice, an airline will almost always select the younger aircraft. Even excluding any radical changes - like the Neo - aircraft and aero-engine designs are continuously improved, so newer is better.
The second reason, often cited, may be the easy availability of ECA and Ex-Im financing for new aircraft (under the old rules). Especially during the recent crisis it was often much easier to get an export credit facility for new aircraft than a commercial bank facility for used equipment. This reluctance of many banks to provide funding for older aircraft could also be a negative factor. Age restrictions in many of the 'growth' markets, Russia, India, Mexico, etc... do not really help to support a strong financiers' interest in that segment of the market.
Finally, the other, maybe under-estimated reason may be the significant increase in the share of leased aircraft in the world fleet. For the more popular narrowbody types, as well as the A330, the share of aircraft managed by lessors is moving to 40% or higher. It is precisely the widely advertised increased flexibility that a leased aircraft offers, that enables lessees to continuously look for the "latest and greatest" in aircraft technology. If - as an airline - you are stuck with an aircraft on your balance sheet, an early replacement by a more modern plane will often result in a significant book-loss. Not many airlines will be prepared to accept this. Replacing a leased aircraft at the end of the lease-term is much easier, especially in a very competitive market with attractive lease rates (from the lessee's perspective) for replacement aircraft. So, could it be that the more widespread use of operating leases speeds up the replacement cycle? In that case, the high lessor's share - by wide body standards - in the A330 fleet doesn't bode too well for values and lease rates, once 787's and A350's start delivering.
Now, if our analysis is correct, could it be that the massive ordering of the Neo (and in the future Boeing's new small aircraft) will cause the value loss of older aircraft to even accelerate? Are current depreciation standards still adequate and are current lease-rates sufficient to even allow adequate depreciation? This key question, was already raised a few months ago in this column. Rapid technology changes, age restriction, a large fleet of leased aircraft and manufacturers moving to low-cost mass producing of new aircraft: ingredients for what may be a toxic mix for used aircraft values. Some appraisers say financiers shouldn't panic, and they are right, but any investor today relying on an appraised value for a 2011-built A321 of $60 million (!) could be in for worse than a little itch, seven years down the road.
Article contributed by Bert Van Leeuwen, managing director Aviation Research of DVB Bank SE