Aircraft financing is a less straightforward investment proposition than it is sometimes made to appear, says Scope Ratings. Realistic loan-to-value calculations are a moving target that need to reflect uneven rates of aircraft depreciation over time.
Scope urges investors to use a sufficiently conservative approach, ideally using an aircraft’s so-called constant half-life base value, and to further stress test this value, when assessing the LTV.
“Generally, it is important that the amortisation of the investment is faster than the depreciating aircraft value,” says Helene Spro, analyst at Scope. Investors need to monitor the LTV over time, and its rate of change, to control risk exposure, rather than focus solely on the initial and final LTV when entering into a transaction. “While the L in the LTV calculation is easy to determine, the V is up for debate,” says Spro.
One issue is whether the LTV should be based on the value of the aircraft traded in a balanced supply-demand market in an arm’s length transaction, its base value, or its current market value, which is harder to forecast for the future. Scope recommends the former.
Another critical issue is where an aircraft is in its maintenance cycle. Investors are often presented with an LTV calculation based on a full-life aircraft value—in other words, a valuation assuming an aircraft has just had a maintenance overhaul—rather than half-life, when an aircraft is between overhauls.
“Investors are unlikely to receive an aircraft back in a full-life condition in a default scenario,” says Spro. The older the aircraft, the larger the difference between its half-life and full-life value, she says.
Stressing an aircraft’s base value is another essential element in deriving a realistic LTV, whether it is for extreme financial-market conditions, or how an aircraft fits into a manufacturer’s product cycle. Scope’s analysis of three different Boeing 737s delivered in 2000 show that newer -700 and -800 models recovered some of their value after a drop following the 2001 crisis unlike the older -600 aircraft, but none retained much if any value after the 2008 financial crisis.
In most transactions, stressed constant half-life base values will produce periods of losses in the event of a default.
“This doesn’t mean the investment shouldn’t be undertaken, just that investors need to look at worse-case scenarios and unlikely events to properly understand the true potential downside of a transaction and ensure the risk is priced appropriately,” says Spro.