A grounded American Airlines Boeing 737 Max 8 is towed to another location at Miami International... [+]
Boeing reported earnings last week that showed it had managed to return to profitability in the third quarter in spite of its recent troubles. The Chicago-based company revealed in July that it was taking a $4.9 billion after-tax charge to compensate airlines and customers affected by the grounding of the 737 Max. Fatal crashes in Indonesia and Ethiopia that were blamed on a faulty software system prompted the grounding of the plane in March, which is why it may come as a surprise to many that Boeing and Airbus had actually raised their long-term forecasts for the aircraft financing market in the months that followed.
Both Boeing and Airbus’s 20-year projections that were released in June and September, respectively, are still bullish with increases shown for the next 20 years in their respective yearly projections of the market. Boeing's Commercial Market Outlook shows a 20-year global aircraft requirements projection from 2019 to 2038 of 44,040 new aircraft including growth and replacements (an increase of 3.06%, or 1,310 aircraft, from the prior year’s projections). This was while the overall compounded growth rate of the market fell slightly to 3.42% from 3.50%. The 20-year projection for the Asia-Pacific region showed demand of 17,390 new aircraft including growth and replacements (an increase of 2.71%, or 460 aircraft, from the prior year’s projections). While the compounded growth rate of the Asia market stayed flat at 4.6%.
Airbus’s Global Market Forecast shows a 20-year global aircraft projection of 39,210 new aircraft including growth and replacements (an increase of 4.86%, or 1,820 aircraft, from the prior year’s projections). While the overall compounded growth rate of the market fell slightly to 3.8% from 4.1%. The 20-year projection for the Asia-Pacific region shows demand for 16,325 new aircraft including growth and replacements (an increase of 4.36%, or 682 aircraft, from the prior year’s projections). While the overall compounded growth rate of the market fell slightly to 5.1% from 5.5%.
Aircraft manufacturers are still bullish for overall long-term demand, although there is some uncertainty in the market since the grounding of the 737 Max aircraft. Boeing has not shared enough information with airlines and even less to lessors other than the public announcements. Normally, when there is a delay in aircraft delivery with any manufacturer, a couple of things need to be addressed based on the rescheduled date of delivery of the aircraft through direct dialogue. First, the escalation on the price of the aircraft due to the delayed delivery. Second, if this is a lessor order, while a lease is normally drafted so that it accommodates delays, is there a cut-off date when the lease is no longer valid and accepted. Is the lease agreed in the form of an absolute fixed rate, does the lease reflect some sort of formula such as interest-rate benchmarks before it becomes a fixed lease rate or it's purely floating based on a formula? These are on top of the normal fleet planning requirements that determine the routes that the aircraft will fly. These might be some of the problem areas that might occur.
In most cases, where a delivery slot is delayed, then some sort of negotiation will take place to discuss whether credit can be given perhaps on a new order. The main question faced by customers who placed orders and the airlines using the product, is at what point should they cancel the order and does that lead to any compensation to the parties involved? This is a Pandora’s box for Boeing which has not fully revealed itself yet.
The legal language in most sales agreements is heavily in the favor of the manufacturer unless there are specific amendments to the contrary. Paul Jebely, Partner of Pillsbury Winthrop Shaw Pittman LLP notes that “…any contractual right of cancellation in advance of delivery based on contractual termination rights or product assurance obligations may be difficult to invoke to the extent the applicable purchase agreement limits termination rights to insolvency events…” But others do have different views, such as Avia Capital Services, a Russian aircraft lessor who ordered 35 737MAX aircraft. Avia is the first and only party to sue Boeing over this issue in Illinois court for breach of contract and is asking for cancelation and compensation. Most sale agreements have excusable and inexcusable delay provisions, and the question is where will these circumstances fall? The silver lining for lessors who had 737NG aircraft for lease saw their positions strengthened in negotiations.
Some parties are talking about moving orders to competitors which is easier said than done as the most likely replacement option is the A320neo family from Airbus. Even assuming the buyer can extricate itself from its obligations with Boeing, the backlogs for the 3 Airbus neo variants amount to a total of 5,721 aircraft. These are mostly the A320neo and A321neo types ordered which roughly is equivalent to 10-year backlog.
An Airbus A320neo pictured on the plant premises of Airbus in Hamburg, Germany in February 2016.
Lukas Schulze/picture alliance via Getty ImagesAdditionally, there has also been some recent issues with the A320neo family as well. The European Aviation Safety Agency (EASA) has recently issued an airworthiness directive (AD) to operators of the Airbus A321neo for a pitch instability issue that requires a software update. The A320neo with P&W 1100G engine option has experienced its share of issues that has resulted in downtime of the aircraft and some flight cancelations. The issues result from excess vibration and low pressure turbine and gearbox failures in the engine.
Recent events are spurring demand for older generations of narrowbody aircraft such as the 737NG and A320ceo family to take up the slack. There are more extensions on almost expiring leases and more demand on the acquisition side. It is not all bad news if the aircraft were not already placed on lease with an airline then this uncertainty might be helpful as there is more time to find a lessee at perhaps a higher rental rate or better terms than could have been achieved before. While the breakdown of each manufacturer’s market share has not changed significantly in this duopoly, this might have consequences for the market in the future, especially with more new entrants, such as China's state-backed Comac, which reflects the continued strength of the market over the long term.
https://www.forbes.com/sites/davidyu/2019/10/28/aviation-finance-market-still-buoyant-despite-some-headwinds/
2019-10-28 09:00:02Z
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