The stratospheric rise in leasing rates over the past two years has been well documented. Healthy traffic growth, economic growth and network expansion have seen a scramble for aircraft, and lease rates have in some cases more than doubled.

Values have also gone up, but not by nearly as much. As Doug Kelly, vice-president of asset valuation at Avitas points out, this is not completely atypical: "Lease rates are far more volatile." There are certainly signs the market is being driven by operators, often in urgent need of lift and willing to pay lease rates that reflect that. However, Ed Greenslet, consultant at Airline Capital Associates, thinks the disconnect between the two is now so large that something will have to give. "Either lease rates will start to come down or values will go up," he says.

Appraisers, often a cautious crowd by nature, are keen to point out that the apparent lag in values is in part a reflection of the severity of the downturn. Just how far they have come back depends as ever on the type, with newer models generally faring better. Gueric Dechavanne, manager of valuation services at BACK Aviation Services, notes: "If you look at in-production types, they are certainly back up to, and in some cases beyond, base value. Some out-of-production types haven't come back to base level just because of the hit they've taken in the past."

Some of the older types took hits of up to 50% in the downturn, so have a lot of ground to make up. With the peak of the cycle approaching, Dechavanne says it is highly debateable whether many out-of-production aircraft will come back to base value level.

Much depends on when the next downturn begins. Kelly at Avitas argues that the huge spike in lease rates for the most popular types is not a short-term phenomenon. "We see it continuing for the next two to three years. [There are] the Airbus A380 delays. Boeing is sold out of 787s until 2010. The A350 won't arrive until 2013. [We are seeing] huge shortfalls in capacity just as the North American market is becoming healthier." Kelly predicts a peak in 2009-10 ahead of a downturn in 2012-13.

Dechavanne has seen indications of investor caution over the past three to six months. "If this is not the peak then we are pretty close to it. We've reached that point where, to get an aircraft, you do have to pay a premium, so some of the financiers and lessors that have been through a downturn are being cautious." Even with lease rates still being driven up by operators who need the lift, Dechavanne sees limited scope for this being translated into higher values.

Popular widebodies

In the meantime, there is no doubt that demand exceeds supply for the most popular types. The intermediate widebody market is particularly active as airlines chase higher-yielding international traffic.

The Boeing 767-300ER is tipped by appraisers as red-hot, with lease rates in the region of $500,000 a month - more than double the rates seen during the downturn. But even then investors are cautious, notes Bryson Monteleone, managing director at appraiser Morten Beyer & Agnew. "There is a desire to have the aircraft, but not the long-term residual exposure."

Even so, the popularity of the 767-300ER is putting pressure on the market for other 767 variants, with the 767-200ER also becoming a limited option. Monteleone reports that one of his clients recently picked up an early 1980s vintage 767-200. "Two years ago, the market for this aircraft was not there. However, the aircraft is in good condition. They can't find other aircraft and it is suitable for their needs."

While lease rates for the 767-300ER may not have much higher to go, the flip-side of this is that values could get pulled up. "You are starting to see more purchasing, with Hawaiian Airlines being an example. This is a sign that lease rates may be topping out and bringing values up," says Kelly.

Strategic pricing

The A330-200 has also benefited from the desire for intermediate widebodies, although appraisers suggest Airbus is discounting to keep the line going until it has the A350 to offer. "They don't want to lose orders to the 787, so are pricing to keep customers," says Kelly. "In addition, for customers who are being compensated for the A380 problems, it's better to give them a good deal on the A330 rather than cash. We don't have perfect information, but we know there's aggressive pricing going on." Despite this, Kelly says Avitas has recently raised its value estimate for used A330s due to the shortage of aircraft in the 300-seat range.

Also faring well is the 747-400, which struggled in the downturn. The A380's problems have helped, and Monteleone says airlines are now holding onto 747-400s to build capacity for A380 routes. "You still have 747 transpacific routes that would not really get A380 loads," he says. There is also a need for feedstock for freighter conversions.

"As a result, while there has been a shift by some operators towards the 777-300ER, availability hasn't increased," notes Dechavanne. BACK's Monteleone says that in March there were just two 747-400s on the market, compared with 14 in March 2006.

What is a fair price?

While Airbus and Boeing keep the actual prices paid for aircraft a closely guarded secret, snippets of information do reach the market. Some feel this data suggests appraisers are being too conservative in their valuations. Consultant Ed Greenslet says: "Perceived value hasn't grown that much in three years when we have had a boom in most asset types."

BACK's Gueric Dechavanne says that some financiers think appraisers should increase new-build values, but believes the industry understands that cabin add-ons, such as in-flight entertainment, combined with price escalation to reflect inflation, can affect delivery price.

"Escalation factors are actually greater than the market often perceives. They are often thought to be around 2.5-3%, but we've been told initial escalations are being quoted at 4-5% - although this is something that can be negotiated depending on the client and order size."

It is a similar story with the 757, which saw values slump in the downturn. "It fits the need for a lot of carriers that need to increase capacity but have small aircraft, and need that quasi long-haul aircraft," says Monteleone. "You also need feedstock for the 757-200 freighter conversion programme."

Appraisers point to FedEx's stated requirement for 90-plus 757s for conversion in the medium term as a sign that residual values should hold up. However, they add that FedEx has no urgent need to replace its 727s, and will only buy at the right price, or as Dechavanne puts it, "at the FedEx price, which is always the right price". The general feeling is that 757 values have stabilised, but are not overperforming.

Even so, the freighter programme is likely to provide a cushion in a downturn. This is not an option for the MD-80, which has barely managed to lift itself from the bottom of the market as high fuel prices deter bargain hunters. Lease rates are at around $75,000 a month, against a low of $50,000.

The 737 Classic has seen values climb. Dechavanne says that 737 Classics that were selling for $4-5 million in the first quarter of 2004, were fetching prices of $9-10 million in the first quarter of 2007. Even so, he adds the aircraft is still not quite up to base value. "In the last downturn these guys really took a beating."

Late to market

Appraisers have doubts about Boeing's stretched 737-900ER, arguing that it may have come too late. "Why didn't Boeing launch that four years ago?" asks Monteleone. Kelly predicts that airlines will hold on to their 757s and wait for the next aircraft generation rather than opt for the 737-900ER.

For the time being at least, it looks like the 737 Classic is benefiting from the shortage of 737NGs and A320s. Greenslet points to Southwest's failure to get new 737-700s from Boeing as a sign of the times: "This tells you they are not willing to build extra aircraft for anybody. It should drive up the price of secondhand 737-700s."

Greenslet adds that it also demonstrates that manufacturers are being more conservative with their output than they have been previously. This is something which most observers see as a hopeful sign for residual values.

In the widebody sector, the 777 market has been strong over the past couple of years, although there may be hints of weakness in a type that will compete against the 787 to some extent.

"There is something of a shift from the 777-200ER to the 777-300ER," says Dechavanne. "There is a larger cabin and a bit more range. The -200ER is probably an aircraft to keep an eye on." Interestingly, the first 777s are also being broken up for spares, says Monteleone, with an ex-Varig 1994 vintage 777-200 being retired.

Meanwhile, the A340 continues to struggle to convince, with appraisers pointing to its four engines as a handicap to overcome. "The -500/-600 variants are just not commanding the market," says Monteleone.

However, there are plenty of aircraft that are commanding the market, and Greenslet argues that the appraisal community may be too cautious when it comes to pricing pressure on new builds. Clearly, for the time being it is a seller's market.




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Source: Airline Business

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