Good times definitely have returned to the mid-life aircraft trading market. There are, literally, hundreds of aircraft on the market in dozens of RFP processes, and many more that are not publicly offered. Furthermore, unlike maybe only 12 months ago, aircraft actually do trade in large numbers.
There is clearly a very healthy liquidity. But as we all know, this industry is cyclical, unpredictable and prone to external shocks, and so good times always come to an end. Is there a way we can, if only provisionally, predict what the future has in store for the Mid-life aircraft trading market? Obviously we cannot predict black swan events, but I do believe a closer look at the fundamentals of this market provides a useful insight
Fundamentals
Aircraft trading market activity is determined by 2 sets of parameters. Firstly, aircraft demand and supply (actual and expected), as that will drive (re)lease rates and projected future values, and therefor prices people are prepared to pay. And secondly financial market conditions, as they drive return requirements, availability of debt and its relative and absolute cost, risk appetite , relative value compared to other asset classes, and therefor prices people can afford to pay.
Demand
The airline industry
Passenger travel, and thus the airline industry’s revenue and profitability always had, and has today, a strong correlation with GDP. As such, the industry historically has always been a cyclical one, and there is no reason to assume that will not be the case in the future.
Logically the market for trading aircraft on lease (young and old) is cyclical too as perception of airline credit risk and future aircraft residual value performance, and therefor aircraft trading values, in principle move in tandem with airline profitability.
We all know that as much as this may be true in general, there are always lots of other, unfortunately often unpredictable, factors in play. But let’s start with this bigger picture first. Now that post-covid revenge travel is over, the airline industry is back on a more even growth path, very much the same trajectory that it was on pre-covid. Global GDP projections are relatively stable (~3% long term trend). There are concerns about China’s economy and the impact of escalating tariff / trade conflicts, for example, but that would only affect the rate of GDP growth, not growth itself, and these factors should also be transitory, not permanent, and so there is no reason why long term passenger demand should not continue to grow in line with GDP, and progressively faster even with the incremental growth in disposable income expected for example in India and other large population countries.
Now this translates into more demand for aircraft in general, but what about mid-life aircraft in particular? One could argue that ESG and decarbonization will progressively lead to more demand for new technology relative to current tech aircraft, but that only is relevant if there is sufficient supply of both mid-life and new aircraft so that airlines have a choice (which is not the case, as we will see below), and/or if additionally new aircraft offer sufficiently attractive relative direct operating cost advantages (which also is not the case currently).
So, without unpleasant GDP shock surprises to the downside (pandemics, war, other black swan events), global demand for aircraft will continue to be very healthy, irrespective of some temporary and local hiccups (like the current difficulties for the Ultra LCC market in theUS), both for new and mid-life aircraft.
Supply
This is the more interesting and less predictable part of the equation.Because of post-Covid supply chain issues, neither Airbus nor Boeing are able to ramp up production to the pre-covid levels that are required to deliver on their order book obligations. Boeing in particular has been the “gift that keeps on giving” in this respect. Industry experts (and indeed the OEM’s themselves) expect that it will take until towards the end of the decade before all supply chain issues are resolved. This is a significant additional driver for demand for mid-life aircraft (and thus lease rates and future values) for a prolonged period of time. There are more than 3000 aircraft that should have been built, but due to Covid have not, and that number is increasing still as result of these persistent supply chain issues . This means a significant extension of economic life for current tech aircraft (that make up the bulk of the mid-life aircraft market), and hence residual values.
And then there are the new tech engine reliability issues. Although on the narrow body side the PW GTF gets all the headlines, the Leap is not without issues either. This drives down the relative direct operating cost advantage for new tech aircraft to such an extent that the very reliable current tech, mid-life aircraft actually are a viable alternative to new tech aircraft. As we speak, it is still uncertain if PW will be able to adequately fix the GTF, although we have to assume that they will at some stage. In any case, this also supports mid-life aircraft lease rates and values.
There are some concerns being voiced about mid-life aircraft values‘ falling off the cliff’ towards the end of this decade once arguably OEM delivery rates have recovered and engine reliability issues resolved. Although there will naturally be an inflexion point when current tech aircraft are progressively being parted out and replaced by new tech aircraft, I think for three, related, reasons that that will be a gradual process and values will not all of a sudden drop dramatically.
Firstly, many aircraft that would under normal circumstances be parted out at or around age 24 (Airbus second 12y check) will be going into another maintenance cycle instead (“30 is the new 24”). Same is already happening with engines: you cannot find engines with any green time at a reasonable price and people are already deciding that also for older engines it is cheaper (or indeed unavoidable) to put engines through another full EPR instead of exchanging them for green time engines. This means a lot of airframe and engine maintenance value is and will be invested in mid-life and older aircraft during the remainder of this decade, and lessors and airlines will want to continue operating these aircraft and monetize that maintenance value, well into the next decade.
Secondly, most of the value for older aircraft is in the engines, and as long as current tech aircraft are being operated, their green time will have value. And thirdly: these 3000+ aircraft that have never been built do not all of a sudden magically appear, it will take years before that shortage is absorbed, and even longer before deliveries have caught up with actual longterm demand for new aircraft. (Right now Airbus is only just getting back to pre-covid delivery rate, and Boeing is even nowhere near that, so this deficit still only increases).
In summary, also looking at aircraft replacement projections from, for example, Cirium, I expect mid-life and older aircraft to retain their value well into the next decade.
Financial Market conditions
Aircraft have book values. For a long time (best part of 10 years),interest rates were very low and there was an oversupply of capital vying for new aircraft deals which meant LRF’s were low and acquisition prices (and book values) high especially for new SLB aircraft, but also for mid-life aircraft bought with a lease in place.
Obviously, the rising interest rates over the past 2 years made it challenging for lessors to sell aircraft to buyers with a now higher cost of capital without making a loss, and so many decided to simply not trade at all.
But for a number of reasons that has changed now: two years of additional book value depreciation have done its work, aircraft need to be monetized when Fund lives are maturing, warehouses are maturing, other debt facilities or capital market deals are maturing, large lessors need to maintain their IG rating and need to sell to keep their average fleet age down, and the shortage of aircraft is slowly but surely translating into higher lease rates and therefor higher aircraft values.
On the buy side, folks are more aggressive in their release rate assumptions and have more conviction on their residual value assumptions, which allows them to bid more competitively. Furthermore, the relative value attractiveness of other asset classes (junk bonds for example) in a rising interest rate environment, seems to have largely disappeared now that interest rates are stabilizing and the window of opportunity to pick up alpha in those other asset classes seems to have passed.
This increased willingness to sell and more appetite to buy is facilitated by healthy other financial market conditions: commercial banks and alternative debt providers offer competitive and efficient debt financing, capital market debt is available at good terms, and the ABS market has re-opened as well.
And the outlook is positive. The Fed seems to have curtailed inflation.Notwithstanding the recent rise in long term interest rates, More Fed rate cutsare expected and interest rates in general should slowly go down further (“the soft landing”). Which is good for aircraft trading.
Even if not, aircraft have shown to be good a good inflation hedge. Fordecades that was only theory, but it is now demonstrated in practice. Inflation is typically partly the result of supplychain issues which will arguably also feature in the aviation industry for thenext few years, but in any case will lead to increased labour cost, which areboth factors that will increase Maintenance value in aircraft which in turn isthe most important component of mid-life and older aircraft values.
If it is true that the new US administration’s budget and tariffs policy will lead to a resurgence of inflation (as most economists expect), that is only good news for aircraft values, whereas the risk of another fast and strong rise in interest rates as seen over the last few years, would seem limited. And none of the other supply related factors described above that have benefited the mid-life aircraft market, are affected by such a development.
In conclusion, my view is that fundamentally the mid-life aircraft trading market will be a healthy and liquid one for a good many years still, even well into the next decade. That is not to say that there will be no cyclicality in this market – of course there will be – but the scope of this article is not to predict values but to analyse future liquidity, and from that point of view all supply and demand parameters as well as the financial market outlook, all point in the right direction.
Patick den Elzen
CEO – Arena Aviation Capital
You can also find the full article published on Aviation Finance.
