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Value proposition

Airlines and lessors have various ways of ensuring that the residual value of their aircraft is maintained at the highest level. Mario Pierobon reports

Commercial aircraft have traditionally been depreciated over 15-25 years to a residual of 5-20%. Increasingly however, the depreciation across various aircraft types is being applied differently by airlines and lessors. Aircraft economic lives have shifted over the last 35 years with the growth of leasing and increased competition, and the economic life of commercial jet aircraft is an issue of serious debate. We have reached out to some industry experts to consider best practices in aircraft asset depreciation and the options available for aircraft investors to maximise residual values at the end of the depreciation period.


Aircraft asset performance

To begin with, it should be noted that regional, narrowbody and widebody airliners over the last 10 years have had incredibly varied results, although volatility on resale pricing has reduced due to received wisdom that the market remains largely elastic. Dr Stuart Hatcher, Chief Intelligence Officer at Aviation Advisory & Asset Managers – IBA, says: “High oil pricing and poor liquidity had a significant impact on the expected useful lives and pricing for ageing equipment earlier this decade, although low interest rates and poor returns in other areas of investment have drawn in a large number of investors into the space. This has pushed up pricing and supressed lease rates for many deals performed. Direct orders generally go up during this time, as opposed to sale and leasebacks generated from requests for proposal, which get far too much competition to make them worthwhile for most lessors. New equipment is still generally preferred, whilst older widebody and regional jets have been volatile.”


“The market value of aircraft varies with demand and as such the A320 and the A321 – particularly the CFM56-powered aircraft – and 737-800 have held their value reasonably well,” says Mike Hawkins, Aviation Asset Management.


Depreciation practices

Aircraft depreciation standards have not changed in decades. “There is a good reason for this; the standards work very well. There is no link between the depreciated value and the fair market value. Companies cannot change their depreciation policies to align with fair market value. Accounting rules permit some changes to depreciation rates. This depends more on company strategy – especially in relation to tax advantages – and is not connected to fair market value,” says Paul Clark, Fleet Planning Consultant.


“My airline used to depreciate aircraft down to 15% of original value over 25 years. The values were corrected periodically to reflect true market values using the services of expert appraisers. The eventual sale price usually reflected the current market value at the time of sale,” says Hawkins.


“Airlines generally depreciate over a shorter time frame of less than 20 years, whereas lessors normally stick to the 25 year rule. We normally expect to see regional jets with shorter lives – due to more cyclic operations – than highly liquid narrowbody aircraft, which tend to even out around 23-27 years – although with the growth of leasing, a sizeable number are retired earlier as reserve collection makes financial sense to do so,” says Hatcher. “Useful lives on widebody aircraft have varied over time, and are dependent on whether they remain in passenger use, the cost of reconfiguration, and the operating economics. When large aircraft freight conversions were common, longer lives were expected. When the freight market collapsed following the global financial crisis, the demand for conversions disappeared overnight and long-term prospects for keeping older aircraft in operation declined. Freighters have traditionally had long lives due to lower cycle accumulation on the airframe. Converted freighters in particular have undergone two separate lives where the period after conversion needs to be long enough to provide a decent return on investment.”


Performance upgrades and new types can have a significant and opposing impact on useful lives. “Whilst an engine upgrade will keep an aircraft relevant during a high oil cost environment, new types can cause obsolescence for the older types – although when the oil price dropped, the older types remained in demand because economic disadvantages were outplayed by rising acquisition costs and technology risk,” Hatcher says.


Depreciation is usually conducted using the straight-line approach, although appraisers will recognise that value changes over time are not linear and tend to emulate this in value curves. “For leased assets, it is probable that the lessor will adjust book value based on the reserves collected and heavy maintenance performed. Resale pricing and book values can vary significantly due to market fluctuations and maintenance assumptions,” he says. >>


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