Aviation Finance Outlook 2019: Pre-crisis aircraft valuation trends reassert themselves

The aviation finance sector’s outlook for 2019 is delicately balanced: Market conditions remain relatively benign, but a price correction could be close at hand, says Scope Ratings.

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In particular, market players have become less discriminating in valuing different versions of aircraft models, fitting a pattern of previous late-cycle behaviour, says Helene Spro, analyst at Scope.

“Our analysis of 26 years of data shows a trend of the market neglecting to take aircraft-specific factors into consideration around two years before a crisis, and narrowing valuations have proved a feature in 2018,” Spro says.

“Along with abundant liquidity and high loan-to-value ratios, this creates a market vulnerable to external shocks,” she says. “Certain riskier investments might suffer losses if a disruptive event occurs.”

In 2018, market players are again neglecting to take aircraft specifics into consideration despite having discriminated between different aircraft in the years before. Take the market values for a 2018 vintage Airbus A320-200ceo and the newer technology A320-200neo, estimated at USD 45.42m and USD 46.36m respectively, according to Oriel. The valuation gap is small even though the new-engine model has 15% better fuel efficiency, according to Airbus. The present value of the A320-200neo and A320ceo should be fundamentally different due to the cost saving potential from fuel savings. If both aircraft are financed with the same LTV, the credit risk is higher for the A320-200ceo. It is more likely the A320-200neo will recover some lost market value after a crisis compared with the older-technology model.

Annual depreciation rates of around 9% are historically correct when looking over an aircraft’s lifetime, but the rate includes both benign markets and downturns. Most investors invest in only a short part of the aircraft’s full life-cycle. So if an investor assumes a 9% depreciation, but a crisis happens a few years into the deal, the market value can be more than 14% lower than expected, judging by the 2009 crisis. If the airline defaults and the aircraft has to be sold in a market downturn, the value can be dramatically lower than what the initial risk assessment accounted for. In 2009, aircraft values fell on average 23%, exposing investors to substantial losses if they were hit by defaults. Scope stresses the average depreciation with extra rating-conditional stresses to account for market downturns to calculate the total expected loss.

Volatile oil prices and rising interest rates represent the main short-term external risks for commercial aviation sector in 2019. High fuel prices in particular partially explains the default of a number of small European carriers, including Primera Air, VLM, Small Planet, Azur and SkyWork. Scope has seen little effect from these defaults on aircraft values due to the benign overall market environment, marked by continued economic growth, falling unemployment and growing demand for air travel. The effect would be more severe if larger carriers were to default in a downturn.

“We believe benign market conditions will continue into 2019, but investors should perform conservative risk assessments to build value buffers to prepare for a market downturn,” says Spro.