Aircraft lessors are the victims of their own success, it seems. Attracted by the steady returns on offer, a wave of new lessors – particularly Chinese-backed vehicles – have entered the space over the last few years. But, in their efforts to grow, these new entrants have created unfavourable market conditions.
Smaller, more aggressive lessors, including Chinese entrants, have posed problems for the leasing industry as a whole by buying aircraft at higher-than-market rates and then offering low lease rates, FlightGlobal understands.
"Many of the newer lessors, particularly those who have an aggressive growth mandate, have been undisciplined. Not only have they overpaid for many of their aircraft in the sale-leaseback market, they have then undercharged on lease rates in order to win the campaigns," says Provident Aviation's Jennifer Villa Tennity, formerly chief risk officer for CIT's commercial air unit.
"Plus, the trend of relinquishing the requirement for airlines to pay proper maintenance reserves and the softening of return conditions leave millions of dollars per asset essentially exposed. This will become brutally clear in a default, but also even in a scheduled return where you are taking back an aircraft that will need a lot of money invested in order to bridge to the next operator."
Undisciplined lessors may have begun this trend, but their more disciplined counterparts have found themselves dragged into what has become a race to the bottom. Why? Because it is now what many airlines have come to expect.
"Ultimately this has created an extremely lessee-friendly environment, which has impacted disciplined lessors by driving down expected lease-rate factors well below acceptable, oftentimes to 0.6 or thereabouts, where anyone is hard-pressed to make good returns," says Villa Tennity. "Also, the airlines expect the softened lease terms from everyone. Once they get it from one lessor, it becomes 'market' to them."
She adds: "That has made many sale-and-leaseback transactions exceedingly unpalatable for lessors. I can remember at CIT coming in last or close to last in certain campaigns, but with the winning terms as difficult as they were, as chief risk officer, I was often happy to avoid what I would consider a Pyrrhic victory."
Chinese lessors, particularly the smaller players, are already feeling the impact from this strategy now that they need to sell older jets in their portfolios in order to show trading activity.
Often having paid too much for the aircraft initially, the lessors essentially have to accept impairments on sales, a remarketing source tells FlightGlobal.
Additionally, potential buyers have been asking the lessors to underwrite future lease rates on the jets when the lessee is judged as high risk, the source adds. Such is the lessors' need to show trading activity, these underwriting lease-rate terms are actively being negotiated.
THE LONG DECLINE
Declining lease rates have become the new normal for aircraft lessors. In October last year, market rumours suggested that the lease-rate factor had dipped as low as 0.55 for one recent Airbus narrowbody transaction.
Many in leasing do not expect a reversal of the low-lease-rate trend anytime soon.
Air Lease indicated during a May earnings call that it expected continuing downward pressure on lease rates.
"We are still seeing downward pressure... In some regions of the world and campaigns, we're getting higher lease-rate factors, and in others lower lease-rate factors," the lessor's chief executive John Plueger remarked at the time.
There has been a wave of consolidation in the aircraft leasing industry recently, with AWAS, Avolon, CIT and ILFC all being acquired in recent years.
Indeed, what the market may need for a favourable environment is fewer lessors. Whether that will come about through more consolidation or the natural selection of the free market remains to be seen.
"Having so many lessors in the market is simply not sustainable. There are only a finite number of airlines in the world," Villa Tennity notes.
"Frankly, with equilibrium essentially reached in a lot of these countries finally and airlines actually profitable, it is not desirable for new entrants to enter the space and disrupt that."