China Aviation News Network: Thomas Kaplan, senior valuation analyst at Ascend by Cirium, analyzes how the operating leasing industry is dealing with the current crisis and provides an outlook on the market.

The original purpose of the aircraft leasing business was to cope with the downturn in the market. Staggered lease expiration times will ensure that the impact of a weak market on the fleet is manageable. The global distribution of the air fleet ensures that the impact of unbalanced regional development is minimized.

However, the downturn in the market caused by the current pandemic and its global impact are increasingly putting pressure on the aircraft leasing industry. Since the outbreak of the epidemic, what measures have leasing companies taken to deal with this crisis?

Beginning in March, the air passenger transport business shrank sharply, but compared with airlines, the impact of large fluctuations in demand on leasing companies was slightly minor. Theoretically speaking, since leasing fees within a certain lease period are fixed, as long as the airline does not default, even if the airline does not make a profit, the leasing company's revenue will not be affected. Although airlines have not gone bankrupt on a large scale until now, leasing companies' revenue was impacted during this period due to delays in rent payments by a large number of customers and the renegotiation of some lease contracts. The degree of flexibility of leasing companies in terms of contracts will not be discussed here. We will mainly discuss the impact of the current market downturn on aircraft leasing activities.

Business activities of leasing companies

The business activities of leasing companies include: aircraft transactions with leases, new aircraft leasing in reserve orders, aircraft leasing in the second-hand market, aircraft transactions without leases, and the sale and leaseback of new and existing aircraft. Out of these six business activities, four indicators are at historic lows over the past 20 years. The severe impact of the pandemic on the market can be seen. Since the outbreak of the pandemic, only one business has seen an increase in metrics.

Figure 1

Figure 2

Figure 1 and Figure 2 show in detail the share of various business activities of leasing companies in the total leased fleet during the year. In order to make a better comparison, Cirium carried out “annualized processing” based on transactions in the first 8 months of this year and the assumption that the remaining months would continue the previous development trend to obtain full-year data for 2020, focusing on commercial wide-body and narrow-body jets that are less than 20 years old.

The trading volume of aircraft with leases has always fluctuated greatly, but it is clearly cyclical, and trading volume will decline during periods of market downturn. In 2020, the volume of transactions with leases decreased by 40% compared to the same period last year, which is also lower than the same period in previous years. When market performance is sluggish, potential buyers will depress prices on the grounds that risk is higher, and sellers want to avoid selling at a discount, so leasing companies usually wait and see when aircraft deals with leases are involved.

New aircraft deliveries in reserve orders from leasing companies have also been reduced by more than 40% compared to 2019. Due to reduced demand and financial pressure, airlines delayed aircraft deliveries, resulting in the delivery of new aircraft being cut in half. In the early days of the epidemic, epidemic prevention measures such as medical isolation and social distancing also caused delays in aircraft production and delivery. Similarly, as deliveries declined, there was a corresponding reduction in the sale and leaseback of newly delivered aircraft.

An aircraft is re-leased or sold after the lease expires (whether as scheduled or terminated early), and the leasing company uses this to seize the residual value of the aircraft. The number of aircraft that were re-leased or sold after being withdrawn in 2020 decreased by 65% and 40%, respectively, compared to 2019. Although the decline in sales of aircraft without leases appears to be relatively low, about 40%, it is worth noting that the trading volume for January-February this year was 17 aircraft, while the trading volume for the next 6 months was only 23. Since March, the average age of aircraft sold has also increased from 13.5 years before the pandemic to about 16 years, indicating that it is more difficult to complete high book value asset transactions. Furthermore, most aircraft transactions without a lease are purchased by leasing companies, so they are mostly investment acts rather than locking in the residual value of the aircraft.

The only business with increased indicators came from the non-new aircraft sale-and-leaseback market. Selling aircraft without leases has become a way for more reputable airlines to increase their liquidity. Due to confidence in airlines and market recovery, some leasing companies are happy to increase their exposure to “blue chip” airlines, and these “blue chip” airlines have previously mostly used other financing methods. From the perspective of leasing companies, this is a “low-level purchase” while ensuring that they don't have to spend years remarketing the aircraft (provided the airline doesn't go bankrupt); from this point of view, they expect an improvement in the market environment. Airlines participating in this type of operation include: United Airlines (United),Delta Air Lines (Delta),Southwest Airlines(Southwest), easyJet (easyJet), Wizz (Wizz), Etihad (Etihad), andCathay Pacific(Cathay Pacific) Ascend by Cirium's Market Values estimates show that since March, airlines have raised more than 6 billion US dollars in capital through this method. As a result, during the pandemic, the leased fleet increased by 200 narrow-body and wide-body aircraft by a net increase of about 1.7%.

Lease expiration is about to peak

Although leasing companies can slow the impact of market weakness on them by reducing transactions, the cumulative volume of rent-outs will eventually force them to act accordingly. So far in 2020, more than 380 jet leases have expired, of which 30 have been extended. A further 500 aircraft leases will expire during the year (including about 90 wide-body aircraft), not including unexpected chargebacks due to airline defaults. This means that leasing companies will have to process at least 900 aircraft whose leases have expired or been withdrawn in 2020, up from 750 aircraft in 2019.

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Figure 3 shows the historical leaseback volume of wide-body and narrowbody commercial aircraft that are less than 20 years old, including both unexpected charge-back situations and lease extensions, because extension is also a method of dealing with lease expiration. Based on known lease expiration plans in the Fleets Analyzer database, and the lease expiration situation assessed based on factors such as an initial lease period of 12 years and a renewal period of 5 years, Cirium estimates future rent-outs, but does not include unexpected rent-outs due to airline bankruptcy, etc., so the actual number of rent-refunds may be higher.

Although the second half of the year will usher in a wave of lease expiration, the next peak in lease expiration will occur in 2024. At that time, the market is expected to improve, enabling airlines to continue leasing aircraft at reasonable prices. However, as current demand continues to be sluggish, it is extremely challenging to sell aircraft whose leases have recently expired to customers. As the volume of lease returns accumulates, the cost of aircraft storage will exceed the cost of selling at a loss or leasing at preferential rent. As a result, although the current business volume of leasing companies is at a low point, it will not remain low for long.

Most leasing companies hope to get through this crisis naturally, but under the ongoing impact of the pandemic and the economic downturn, it is necessary to take proactive measures to deal with it.