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A New Lease on Life for Midlife Aircraft

The industry is currently unable to match the resurgence in traffic with capacity. Where traditionally customer demand had dictated manufacturers’ outputs, the supply chain has now become the key factor behind production levels. Supply chain constraints have curtailed original equipment manufacturers’ (OEMs’) ability to increase production level, a shortfall further exacerbated by ongoing reliability and quality issues, resulting in an imbalance between supply and demand. As a result, most airworthy assets have taken to the sky, extending to older assets and technology aircraft, with lease rates and market values rising.

Scarcity of Capacity

As reported in the press, in 2023, Airbus increased deliveries by 12% versus the prior year, whereas Boeing achieved a 10% increase. In terms of continued tightness of supply, there are a lot of moving parts, some of which are compounding the scarcity of capacity. We see production delays at the major manufacturers, with quality shortfalls adding to the current woes. In-service reliability issues are forcing operators to ground their fleets and source interim lift, for example with the Pratt & Whitney geared turbofan (GTF) engines and the powder metal contamination. There has been a backlog of engine shop visits since the pandemic, exacerbated by the unscheduled GTF inspections and slower wing-to-wing turnaround times at maintenance, repair and overhaul (MRO) facilities. Supply chain challenges can be traced back to both raw material and component shortages, further aggravated by a shortage of trained labor to operate the required machinery, as skilled manpower was let go as production collapsed during the pandemic.

For 2024, Airbus is targeting 770 commercial aircraft deliveries, which would represent a year-on-year increase of almost 9%. Airbus relies on some aircraft lines’ underperformance to be counterbalanced by stronger production output on other lines. So as to manage expectations, Airbus has warned customers that aircraft delivery delays may carry over into late 2024 and 2025. The earliest available delivery slots for new widebody orders are from 2028 onwards, and nothing
until the end of the decade as far as narrowbody aircraft are concerned.

Boeing, like its European rival, also suffers from supply chain issues, but manufacturing and quality issues are the core disrupters to the OEM’s scaling up ambition. In 2023, Boeing delivered 386 MAX aircraft, averaging a monthly output of 32 aircraft. It had planned to ramp up deliveries to a monthly output of 52, eyeing to repurpose its former 747/787 assembly line in Everett, Washington, into a fourth MAX production line by mid-2024, but production levels have been frozen by the Federal Aviation Authority (FAA). The FAA will not approve any production increase nor additional production lines until the shortcomings around quality control issues and safety culture are remedied. Quality over quantity is the modus operandi at Boeing for the foreseeable future, with deliveries being pushed further to the right. The added oversight and scrutiny from the FAA will further delay certifications for the 737-7/-10 and 777X, plus subsequent prospective deliveries of the models.

Midlife and Beyond

Once upon a time, utilization of midlife aircraft tended to decrease as the maintenance burden grew with age. After an aircraft’s first lease, different avenues are opened to realize further value from the aircraft, as maintenance condition becomes a more prominent value determinant. For one, owners may choose to pocket the maintenance reserves associated with the asset. The aircraft could remain in service as a flier and could go through freighter conversion or become a glider (i.e., engines are removed and placed as stand-alone assets, or be parted out). The current supply scarcity dictates what is the best economic outcome for an aircraft in terms of realizing value from the metal beyond its initial operations.

At present, most aircraft are being kept in service, and the International Air Transport Association (IATA) reports that the average age of the global fleet has increased by 18+ months over the past five years. The higher average fleet age is to perdure as deliveries are delayed, and IATA predicts the fleet renewal rate, the number of delivered aircraft over the total fleet, to reach 4.6% of the global fleet this year.

Looking at Airbus and Boeing aircraft fleets, using IBA Insight, the clear uptick for the average age of aircraft in service and at retirement are testament to older aircraft being kept in service for longer. As of June 2024, the average retirement age for narrowbody aircraft is 25.5 years and 24.2 years for widebody aircraft. Conversely, the average in-service age for narrowbody aircraft is 12.3 years and 12.6 years for widebody aircraft.

Transactional Activity

Lease extensions have been the preferred method for operators to source interim capacity, whereby airlines keep hold of the assets they are operating and negotiate an extension from lessors. It is a pragmatic solution for both lessees and lessors, as it saves on transitioning downtime and costs. From the COVID-19 time of holiday payment, lessors now can recoup their losses by locking in lessees at higher lease rates, and we are firmly in a lessors’ market.

Aircraft are also being sold to current operators, and 15 airlines have acquired capacity that way so far this year. For instance, United bought 13 aircraft (two 787-9s from BOC Aviation, nine 737-800s and two 737-900s from AerCap), Hawaiian Airlines got one A330-200 from Macquarie AirFinance, while SpiceJet secured one 737-700 from Cross Ocean Aviation and two 737-700s from Echelon Transportation LLC.

Several lessors have been selling some of their assets to repay debts and release liquidity, but those are getting snapped up quickly by more lessors seizing the opportunity to grow their portfolios.

Aviation Research at MUFG has taken a closer look at operators with MAX and neo aircraft on backlog, and the likes of United Airlines, China Southern, Turkish Airlines, Jet2.com, Xiamen Airlines, Southwest, SunExpress and Qantas have turned to the secondary market since 2023 to acquire (lease or purchase) additional capacity as interim lift as they await delayed deliveries.

Looking at ordering activity, it is becoming apparent that airlines are cautiously planning their fleet requirements and ordering from different OEMs. The recent order from American Airlines in March shows an airline’s fleet strategy being hedged among many OEMs (85 A321neos, 85 737-10s and 90 E175s) but also a relative proactivity to plan ahead to factor in the protracted lead time.

Valuation

The ongoing supply and demand imbalance leads to upward pressure on market values and lease rates, with the compounded effect of inflation and a high interest rate environment. Operators would rather opt for higher costs than not meeting demand and losing market share through lack of capacity, but there is little headroom remaining on airlines’ balance sheets for profitability.

Since mid-2023, values for midlife assets have been rising, whereby market values are rising above base values. The differential between market and base is more prominent for narrowbody aircraft, which are more affected by the lack of capacity: A320ceo and 737-800 more particularly, and the premium/discount associated with vintages is reducing.

As of August 2024, Cirium Ascend Consultancy had a half-life market value for a 14-year-old A320ceo at US$18.4 million, compared to $12.4 million in May 2023, with market lease rate at US$217,000. Cirium showed that while market and base values are in close proximity for newer aircraft, the market to base value ratio for narrowbody aircraft neared 160% by retirement age. At the time of writing, Cirium was in the process of revising its value opinions to capture the latest upward market trends.

IBA reports that lease rates for midlife A320 family aircraft have exhibited a 35% annual growth and have risen beyond US$230,000 for 12-year-olds. In parallel, market values for mature widebody assets have more than doubled in a year. Lease rates as they pertain to A330 and 777-300ER aircraft have now surpassed their pre-COVID-19 levels.

Conclusion

Fewer deliveries translate into fewer new aircraft to finance. As such, MUFG has seen a rise in financing needs for midlife assets used as interim capacity. While midlife aircraft are currently at a sweet spot, the technology, country and execution risks associated with these assets cannot be ignored, and caution ought to be exerted. As older aircraft are kept flying, the benefits of fuel efficiency and lower emissions offered by newer technologies to meet the net- zero agenda are deferred.

The industry is not immune to exogenous factors and other Black Swan events that could severely rebalance the supply and demand. Some industry observers have opined that when deliveries of new technology aircraft ramp up to a sizeable volume, there is an element of crossover and technological obsolescence risk, dubbed as the “midlife” crisis. When large operators take deliveries of their orders, they may exit older aircraft in high volume, with an associated risk of oversupply, which will shift the market to base ratio. As new technology capacity constraints are expected to last beyond the end of the decade, it may be that aircraft will retire when they reach the end of their economic life without undue pressure on value.

For the time being, high demand for parts and materials is driving market appetite for end-of-life assets, even extending to younger assets for which the value of the stripped-down parts may be greater than that of the aircraft as a whole. Maybe the current market dynamics will give midlife assets a second wind.

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