Fitch: Aircraft Lessor Impairments Point to Residual Value Risk

Recent decisions by large aircraft-leasing companies to write down the value of certain older, uncompetitive aircraft fleet types in response to shifting global supply-and-demand fundamentals highlight asset quality risks for some lessors, according to Fitch Ratings.

International Lease Finance Corp. (ILFC) took a $1.2 billion noncash impairment charge in the third quarter after determining that future cash flows for 36 four-engine wide-body aircraft in its fleet did not support their previous net book values on the balance sheet. This decision reflected the lessor’s view that the holding periods for Airbus A340s and certain Boeing B747-400s would be shorter than 25 years, which is the industry standard. The impairment charge, which comes two years after even larger impairments in 2010 and 2011, represents approximately 3.5% of ILFC’s net book value. ILFC’s ratings continue to reflect elevated residual value risk, which is driven by the relative size and age of its fleet.

The A340 has a very limited global operator base, which contributed to ILFC’s decision to reduce useful lives and residual values. The global fleet of A340s has grown to 350 since its initial debut in 1993. Amid increasing fuel prices, Airbus terminated production of A340s in 2011, citing increased competition from twin-engine aircraft. ILFC currently owns 17 A340-300s and 13 of the larger model A340-600s. Other Fitch-rated lessors do not have significant exposure to the A340 family. For many of the A340s it sold to airlines, Airbus provided guarantees that effectively limited the residual risk for owners.

Last month, Aircastle also reported a relatively large $98 million impairment charge (roughly 2.0% of net book value). This was driven primarily by a reduction in the useful lives and residual values of six B747-400 converted freighters. Demand in the freighter market has remained stagnant and capacity has been added, resulting in an imbalance. Aircastle’s exposure to this segment is unique among the major aircraft lessors, and Fitch does not expect others to be impacted.

The supply/demand outlook for select wide-body aircraft, including the A340 and B747-400 fleets, has shifted in recent years as airline demand for these less fuel-efficient four-engine aircraft has slipped. Lessees now have greater opportunities to lower unit costs by adding more competitive twin-engine aircraft, such as the Boeing 787 and Airbus A350, to their fleets. Meanwhile, lessors are finding more value in parting out the aircraft and selling parts, particularly engines, versus putting up significant maintenance expenses required to re-lease the assets at lower lease rates.

We believe changes in useful life and residual value assumptions for select older and less fuel-efficient aircraft may remain an issue for lessors as they adapt to changes in global airline fleet-plan priorities over the next few years. We will continue to focus on asset quality risk in this context, while recognizing the potential for technological obsolescence and short production runs to impair expected cash flows and residual values for certain older fleet types, particularly four-engine models.

We view increasing exposure to older, uncompetitive aircraft as a longer-term risk facing the aircraft leasing industry, which will play out over a number of years. If we see global capacity grow fast enough to absorb the growing number of aging aircraft in lessor fleets, the ratings impact across the industry will be limited. However, if the secondary market continues to narrow, then ratings of some lessors with greater exposure to older fleets may be pressured.