As jet lessors face the worst recession in aviation history, Julia Kollewe from Asset Finance International takes the pulse of the industry.

While the first greenshoots are emerging in Europe’s corporate jet leasing market, a recovery is still some way off as many banks remain reluctant to lend and swollen inventories drive aircraft prices lower.

In what is being described as the “worst recession in aviation history”, some lessors have exited the market, notably Royal Bank of Scotland, although its Lombard subsidiary is still active. Icelandic bank Kaupthing collapsed, while Fortis Lease has downsized its business and pulled out of the UK.

Air finance dries up

The downturn led to the demise of Jet Republic in August. The private jet club, which offered fractional ownership of Learjets and lasted barely 12 months, confirmed that aircraft finance had dried up. Air Partner, the listed British air charter broker, recently forecast more collapses in the industry after its annual profits plummeted by 90%. In the US, several bankrupt parent companies have put their aircraft leasing arms up for sale, such as AIG’s International Lease Finance Corp. and CIT’s Aerospace leasing subsidiary.

Neil Poland, global head of aviation at Norton Rose, summed up the situation: “There’s been quite a lot of poor press for the corporate jet market. Prices are down, values are down, orders are down and manufacturers are cutting workforces. Inventory of used aircraft has increased enormously over the last year.”

Experts estimate that aircraft prices have dropped by 20% to 40% from their peak some 18 months ago, depending on the model and the age of the plane. Manufacturers have been discounting heavily, especially if they have a lot of “whitetails” – jets without a customer and hence no tail number or design. Residual values – crucial to a profitable leasing agreement – are down by a similar amount.

The price falls are particularly pronounced because the market overheated in 2007 and into the spring of 2008. One banker recalls: “There were some mad people who wanted to buy aircraft and didn’t want to wait for the delivery – sometimes it can take four years. Premiums for jets that were immediately available went up massively, by nearly 50%. Aircraft that should have cost $45m were sold for $65m.” The order book was half full of speculators at the time.

Then, in the summer of last year the market suddenly turned as the global financial crisis worsened and companies could no longer afford their expensive jets. Bankers say it went from a seller’s market to a buyer’s market in just four weeks.

“Flipping” on the wane

Alan Cunningham, a partner at DWF who specializes in structured asset finance, including aviation, said the practice of ‘flipping’ build slots to make a profit was very common two years ago and played a big part in the market’s overheating. It involved people ordering aircraft early from manufacturers and selling it on before delivery. In a “hot” market, the right to buy an aircraft and take delivery now, has a premium value.

“Manufacturers didn’t like it because they had no influence over secondary prices. People did make significant profits,” Cunningham remembers. “The practice of ‘flipping’ build slots to make a profit has stopped completely and is unlikely to return in the foreseeable future. It is unlikely that we will see a hot market for some time.”

“I do believe that prices will recover to a sensible level and that level will be in line with manufacturers’ prices,” he added.

Just how long this will take is anyone’s guess. Dassault Falcon Jet has said it could take two years for the stock of used business jets, which has reached record levels, to be absorbed. Honeywell, a supplier of jet engines and parts to business jet builders, including Bombardier, does not expect a recovery to get under way until 2011, and Bombardier is planning further production cuts. “The industry must buckle down for a slow and steady recovery ahead,” Honeywell said last month.

Donal Boylan, the former head of RBS Aviation Capital who now runs Odyssey Aviation, said the consensus is that the recovery will be U-shaped. Between January and September, he said, you could pick up a brand new jet, within a month or two, for 85% of the original contracted purchase price – and that had fallen from 120% two years ago.

Turning the corner?

But things have changed in the last two months. “If you want to buy a Gulfstream G550 today, the market has now turned the corner and you now cannot get delivery of that jet before 2011, and the pricing has gone back up to the purchase price again,” he said. “That indicates the market is stable. There are fewer jets being ordered, the order books have started to build back up. There is a genuine turn in the market. There is no premium, no increase, but in other words we have now hit a nice flat bottom of the U.” Boylan said the market is held together by (ultra) high net-worth individuals. “No bank will lend to an air operator.”

Erhard Waldinger, who heads up aircraft leasing at Austria’s Raiffeisen Leasing, was also cautiously optimistic: “We have seen some tentative signs of recovery in the last few weeks. The first buyers are beginning to come back to the market. We hope that in the New Year activity will increase again.”

Poland concurred. “You’re seeing some activity, it’s not all doom and gloom, but it’s a pretty mixed picture,” he said. He pointed to the charter and light jet market in particular, such as Phenom 100s which remain popular.

Toennies von Limburg, director of international sales at Bank of America’s Corporate Aircraft Finance, says now is a good time to invest in corporate aircraft. “We are still in a buyer’s market with low aircraft prices which allow for good financing structures,” he told a conference on the future of business jets in London a week ago. “At the same time, refinancing of existing aircraft or financing orders placed two or three years ago in the peak market is difficult.”

Faced with falling residuals

When faced with falling residual values, corporate aircraft financiers keep the assets and re-market them for short-term leases of one to three years. “If someone offers a good price you can sell the aircraft but if not, you return to the market with a lower lease rate rather than making losses. Everyone knows the market is cyclical and will come back,” one lessor said.

When deals turn bad, lessors will first seek to work with the customer to find a joint solution, but obviously “if the lessor has taken an aggressive residual value and it coincides with a downturn in the market, the client won’t extend the lease,” he explained.

This only applies to operating lessors. With finance lessors – who are more common in Europe – the client bears the residual value risk.

Turning to defaults, several big lessors operating in Germany and Austria say they are not really an issue for them as they have always adopted a conservative approach.

A patchy recovery

Demand for aircraft financing has actually risen during the economic slump, because companies have less cash to buy long-life assets and there are fewer institutions providing finance.

Cunningham sees the ongoing lack of availability of credit as the main problem. A big issue is refinancing debt as it comes due. And where banks are willing to lend, they have tightened the terms – many have adopted more conservative loan-to-value ratios.

“The market is somewhere between distressed and poor – but it’s stable,” Cunningham said. “The fall in prices stopped six months ago, but I don’t think [the recovery] will happen in the current year. We need the banks to start lending again and that has in many cases already happened. But lots of banks are in very different positions. Some are dealing with a lot of bad debt on the aircraft book.”

“The recovery of banking appetite for corporate jets will continue to be patchy right through the next year,” he concluded.

‘The Ups and Downs of Jet Leasing’ is reproduced by kind permission of Asset Finance International ( www.assetfinanceinternational.com ). Copyright Asset Finance International Ltd, 2009. All rights reserved.

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