Ascend’s Global Head of Consultancy, Eddy Pieniazek, talks exclusively with CAPA about aviation prospects in the emerging BRIC markets and latest insights into aircraft leasing trends and aircraft values.
Emerging markets, in particularly the BRIC countries, are expected to account for the major of industry growth in the foreseeable future. Do you see any threats to growth in BRIC markets?
Each of the BRIC countries faces a different set of challenges as they work to capitalise on the anticipated growth. India’s infrastructure issues are well known and continue to be an obstacle to the efficient development of air services. China is far more adept at building the physical infrastructure, but faces the challenge of opening its airspace further, to enable more efficient airway utilisation. Russia’s network reflects the country’s geographic diversity – which means plenty of longer, thinner routes that make profitable operations all the more difficult. Brazil has probably the clearest path of them all – an economic giant that appears to have put the years of economic crises behind it. If there is a threat from outside of the BRIC countries themselves, it may come from the next wave of emerging economies who may begin to attract some investment away from the BRICs themselves – at Ascend we call these the ‘INVEST’ countries: Indonesia, Nigeria, Vietnam, Egypt, South Africa, and Turkey.
Do you believe there is an optimal level for airlines at which to lease aircraft? Do certain regions favour leasing more than others? If so, why is this the case?
36% of the airline fleet is now on operating lease. The lessors are adding 400 aircraft per year to their inventories, and they have become an established method of supply and financing for airlines of all shapes and sizes, from LCC start-ups to legacy carriers, from the US majors to the smallest of national African airlines. We expect Lessors to take another 2,600 aircraft worth USD168 billion from the OEMs over the next 10 years. Sale and Leasebacks over the same time period could add another 2,500.
Most Lessor business models are built around having the most liquid asset types in their portfolios, and then to spread the risk amongst multiple lessees and regions. As a result, all geographic regions have become immersed in the leasing model.
A metric regularly employed by Ascend to measure volatility is the market value to base value ratio. In previous downturns aircraft values took circa three to five years to rise above base value, has Ascend seen (or expecting) similar trends in aircraft values as we emerge from the 2008/2009 downturn?
If the aircraft value cycle behaves as anticipated, and performs in line with the traditional market cycle, then yes, we would expect market values to eventually exceed their respective base values for the majority of aircraft types. The mechanism to achieve this will be a combination of asset depreciation, which will bring the base values lower, and market forces in the shape of supply/demand, which can raise the market values higher. Different types and vintages will experience different rates of market value or base value movement, and our new Aircraft Ratings product encapsulates this trend, distilling the anticipated performance into a two digit rating which helps illuminate the investment issues at play.
One reason we developed our conference programme, which begins in Tokyo this coming September, was because the Japanese financing markets had begun to ask for more illustrative ways to measure and manage investment risk.
The ‘threat’ to values comes from supply/demand imbalances in the world's fleet inventory. The composition of this inventory is regulated by the amount of new production and deliveries at one end and the retirement or storage of the ‘unwanted’ at the other, ‘end of life’ sector of the market. Turning these taps on and off is part of the dynamic. Fuel price movements can additionally increase or decrease the desire to accelerate or decelerate these flows in and out of inventory. It’s a complex web. But you can see in the helicopter and corporate jet markets, where aircraft production has in the past been more controlled (with less speculative orders) that this helps to tighten supply, which in turn has supported residual values.
The recent downturn highlighted marked differences in values of newer model aircraft and older-model/out of production aircraft? Does Ascend believe a liquid market for these older model aircraft will return?
As I mentioned earlier, it’s a complex web. However, taking what we currently anticipate as a near term scenario, which is a continuing high fuel price environment, competition and costs driving demand for the most fuel efficient of types, reliability and performance issues driving demand for the newest and latest technologies, this doesn’t leave much space for older model aircraft. Looking at the aircraft types that JAL, Delta, United and others have recently released from inventory, a clear message continues to come through.
Aircraft market values sit below base values for longer periods than they do above base values. What sorts of depreciation methods do airlines and lessors most commonly employ? Given the often-wide imbalance between MVs and BVs, might it be prudent for aircraft owners to adopt an alternative depreciation method?
This is another area where Ascend’s Aircraft Rating comes into play. The shape (depreciation rate) of the curve, and the downside market volatility from that curve, are measures that will be invaluable to airlines, financiers and lessors. No one is questioning the technical life of an aircraft and its ability to fly for decades if well maintained, but the useful economic life? – that’s another question.
The euro has strengthened against the US dollar over 60% since its launch in 2002. EADS last week announced it’s in talks with several airlines to price and pay for Airbus aircraft in euros rather than US dollars, in a bid to reduce downside currency risk. What impact might this have on the aircraft finance market?
If we have a global market with globally migratable assets, but with assets priced or paid in multiple currencies and therefore subject to currency fluctuations, well this kind of complexity will create heightened opportunities as well as increased risks.
Has airlines’ and lessors’ access to capital changed? Will this continue to evolve? Have buyers of aircraft benefitted from historically low interest rates in major economies?
We expect our Tokyo conference will help to address some of these issues – Some traditional providers of capital have exited, yet capital markets are a more varied source of capital than ever, from EETCs and ABSs to lessor debt facilities, equity raising, IPOs and bond trading. Let's not forget the aviation banks that are still in play – with half a dozen top tier banks, a dozen second tier banks, and a growing number of third tier aviation banks, we hope to see many of them in Tokyo in September.
Does Ascend still see a liquid market for regional jets and/or turboprops? With several new manufacturers move into this segment, is there sufficient demand to justify the investment in it?
A big question in a fascinating sector. Yes, even in an environment of high fuel prices, there is a market for the larger, more efficient types of new Regional Jets, and for turboprops the market is equally interesting at an aircraft size level below. Is the market big enough for all the current and new players? It possibly is, if they all sell relatively well across the globe and get to build their markets. But if the sales are not achieved, you will see ‘winners and losers’ materialise, much as we saw in the 1990s when 8-10 OEMs became 3-4 in the turboprop and RJ sectors.
Ascend last year launched Aircraft Ratings. What were the motivations behind the product and how is it used?
Our clients saw, as we did, many sources of volatility in aircraft values, from the market cycle through to ease of financing through to speed of technological change, and a dozen other variables in between. Drilling down deeper into Ascend data, we also saw that volatility increases with age, and that ‘scorecards’ could be developed to communicate some of these measures and allow comparison between types. But it was hard to scientifically measure or quantify the risk this way.
Aircraft Ratings were therefore created by our Risk Advisory team to illustrate how assets retain value over time, under both depreciation and volatility measures. The market now has a sophisticated risk forecasting metric that accounts for qualitative and quantitative factors, which allows the easy comparison of aircraft types, and which has a potential application for economic capital calculation. Aircraft values and Residual value forecasts will tell some of the story in 2D black and white. Ratings on the other hand provide a 3D, full colour enhancement to the process. We see this as a game changer.
Ascend's Aviation 2020 Finance Forum will be held on 28/29 September 2011 at the Conrad Hotel, Tokyo. Click Here for more information