Pre-crisis headwinds

victoria@aviationnews-online.com
By victoria@aviationnews-online.com December 3, 2018 22:51

Pre-crisis headwinds

Scope has an interesting report out today that states, ahead of a crisis situation, aircraft valuations begin to narrow as market players become less discriminating in valuing different versions of aircraft models.

“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,” Helene 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.”

The report picks out market values for a 2018-vintage A320-200ceo and the newer technology A320-200neo, estimated at US$45.42m and US$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, says Scope, adding that it is more likely the A320-200neo will recover some lost market value after a crisis compared with the older-technology model.

The report says that 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.

Everyone in the industry is attempting to predict when the next downturn will hit but the extended upcycle is making forecasts tricky to make with any certainty. This report attempts to see patterns in valuation trends – this is all very methodical, but the report doesn’t mention, entry into service issues with the new technology nor the ultra competitive market for aircraft at the moment, which is awash with capital. If you have a different take on the valuation trend set out by Scope, please let us know.

victoria@aviationnews-online.com
By victoria@aviationnews-online.com December 3, 2018 22:51