Fitch: Managing Fleet Age a Long-Term Issue for Aircraft Lessors

Aircraft lessors own some of the largest fleets in the world as a result of steady growth in global air travel demand and an increasing need for lease financing among airlines. As lessors’ fleets continue to expand, Fitch Ratings believes that managing exposure to older aircraft will become increasingly important. Although the secondary market for ageing aircraft has shown recent signs of life, the potential supply of these assets far exceeds current market capacity.

There are three distinct business strategies among the aircraft lessors related to fleet age. Several lessors, such as AerCap, Air Lease, BOC Aviation, Aviation Capital Group and Avolon have geared their operations to managing relatively new aircraft, which results in less residual value risk and doesn’t require large maintenance expenditures. Aircastle and AWAS comprise a niche group, which is relatively agnostic to age and focuses primarily on asset yields. Finally, both GECAS and ILFC have the capability to manage aircraft throughout their entire lifecycle, but see better opportunities, at present, in newer aircraft.

We have seen some nontraditional players express interest in filling the financing gaps for assets that lessors are looking to cycle out of their fleets. One example is the $1 billion sale of the equity tranche in the ALS securitization by AerCap to Guggenheim Partners last November. In another recent example, Merx Aviation, a portfolio company of Apollo Investment Corp., acquired 26 aircraft from GECAS late last year. In both of these cases, the seller will continue to service the assets. We believe this type of activity is positive for the leasing industry as it improves liquidity in the secondary market. We think more nontraditional players may be inclined to participate as the volume of secondary market activity grows.

Trading activity among the lessors has also picked up over the last several years, with the entry of several new players. While this trend is likely to continue, we do not believe adequate capacity exists in the leasing space to absorb all of the older aircraft that may hit the market before the end of the decade. Unless more alternative sources of financing become available, some lessors will need to revise their strategies to accommodate ageing fleets. In our view, this would likely create additional risks for some lessors related to residual values, maintenance costs and operational leverage.

Those firms that specialize in older aircraft must have the technical expertise and risk management capabilities to serve a segment of the market in which rising maintenance costs and exposure to weaker airlines pose unique risks. Older aircraft values are vulnerable to increased event risk, since outsized demand shocks during aviation downturns can put greater pressure on market values and lease rates for older fleet types with the highest unit operating costs and weakest fuel efficiency. Many of the oldest aircraft in U.S. airline fleets, for example, were the first to be grounded during the 2001-2002 and 2008-2009 industry downturns.

We view increasing exposure to older aircraft as a longer term risk facing the aircraft leasing industry, which will play out over a number of years. If we see market capacity expand further and become sufficient to absorb the growing number of older planes in lessors’ fleets, the ratings impact across the industry will be limited. However, if the secondary market remains narrow and lessors get saddled with aging fleets, ratings will likely be pressured. The issue would be more pronounced for those lessors with less conservative valuation policies, and underdeveloped technical and risk management functions.