Unprecedented Times – An Article by Tom Barrett for Airfinance Journal Engines Guide 2020

Last year, as it entered its 30th year in business Engine Lease Finance Corporation’s (“ELF”s) President & CEO, Tom Barrett, suggested that ELF, and independent engine lessors, would still be around in a further 30 years. Given what has come to pass in 2020, the more pertinent question now is what sort of engine leasing company might be around in a few years time.

Seen it all before

Everyone starting in aviation is told that it is a “cyclical” business. Last year at this time, and the unprecedented long run of profits and general good news for aviation, it was hard to see what event or series of events could bring the good cycle off its historic highs. Some speculated that it was past the peak but the level of new investment and terms that were available to airlines and aviation companies in general suggested otherwise. One year on, everything has changed.

Cycles come and go in this business and in 30 years ELF itself has been around for about 10 different regional and global events and a few cycles that have had a dramatic effect on the business. Although ELF did not recognise it the cyclical downturns started very early on for ELF, who acquired its first two engines with leases to Continental Airlines in March 1990, as a downturn followed the Persian Gulf War that started in August 1990. By December 1990 Continental Airlines had filed Chapter 11 and the ELF team were scrambling to source lawyers who could advise what were the implications for its engines with the airline. While ELF was tiny by comparison, some of the consequences of the events that followed would lead to the decline of the then aircraft lessor market leader, GPA, who were ultimately forced to pull their IPO in June 1992.

Other events were to follow, including the Asian Crisis of 1997 which prompted very different arrangements and issues for ELF with its most recent Asian customer who then accounted for 50% of ELF’s portfolio dramatically affected. This crisis was followed by 9/11, a second Gulf War, a SARS epidemic and in 2008 a Global Financial Crisis that led to a prolonged global recession and had a significant impact on the business of aviation.

The Covid 19 crisis of 2020 has, at least in ELF’s experience to date, touched the world of aviation in a far more profound and truly global way than anything that went before. The level of groundings, shutdowns, cancellations, manufacturing cessations, and cash shortfalls throughout the industry is new territory. Despite the current evidence of some green shoots as PRC domestic flights gradually resume (hopefully many more will have done so by the time of publication), there really is no certainty anywhere when flights will get back to level that might be considered normal. In addition, the debates, and by many much more learned than this author, are starting as to what will be the future shape of this business.

As a company in this “cyclical” business for 30 years, I have to say we have not seen anything like this before.

Immediate issues in the midst of a crisis

The implications of this crisis continue to play out and there will be many papers and books that will dissect all that has happened and what will come to pass but the truth today in 2020 is that nobody knows the final outcome.

However, what we can say right now is that many of the immediate impacts, although global in nature this time, have been seen in the various regional or other crises in the past.Presently it is clear that the public is not flying, aircraft are grounded, airlines cash reserves are dwindling fast, the herd mentality of the financial markets are making it more difficult to access liquidity and there is consequent pain for everyone involved in the industry.In terms of the key areas for any lessor, namely new acquisitions, utilisation of the portfolio, lease rentals and residual value retention, all have been directly and immediately impacted in common with every previous crisis.

The questions arise now about how each of these will play out over the near term and ultimately longer term as “normal” (if we are to see them again) conditions return. Or post Covid-19, are we to see a new normal.

New acquisitions

Clearly and long before this crisis, the debate has raged about the level of OEM aircraft production. There were many (usually those who had to market an order they themselves had placed) who suggested that the production rates were too high and unsustainable. There were others (the OEM and those that wanted to make an order) who suggested the production levels were appropriate. In the second quarter of 2020, the discussion is over as it is clear the production rates envisaged a couple of years ago would be, were they continuing, be far too high for the demand that will follow in the remainder of 2020, 2021 and maybe longer.

With the cashflows of all the airlines under pressure for the remainder of 2020 and into 2021, and the stark reality being that route plans will have to change it is inevitable that airlines and lessors will seek to postpone or cancel orders or defer plans for new aircraft. This will continue for a time and until airlines begin to see the demand return to pre-crisis levels. In the meantime, more will be asked of the current fleets, which at today’s fuel prices will provide competitive economics, to see the airlines through before refleeting resumes.

In terms of the SLB market, where ELF has traditionally sourced the majority of its product, that has been had pretty irrational low pricing with full values being paid, it is my view that there will, regardless of the funding increases imposed by the financiers in the short term, be a return to more rational pricing of SLB lease rentals that will more appropriately reflect the risks in this business. The pricing of the equipment too will see much more scrutiny in the period ahead and it will be interesting to see what trading and pricing of aircraft and engines will take place in the second half of 2020. Whatever it is, it will be less than before and business models that are totally dependent on trading, rather than asset management, will need to come up with new or innovative ways to operate.

Utilisation will drop

This is likely to be one of the least predictable areas for the lessors. Nobody knows when aircraft will operate, or knows what aircraft will return to service versus being parked longer term and for those that operate, will the emphasis be on newer technologies or will the B737NG/A320 core aircraft of the last 20 years, with fuel prices as low as they are now, be more desirable, as airlines try to avoid large capital outlays until they have a chance to rebuild their balance sheets and gain access to acceptable finance for such investments.

It would appear that the shorter haul, and larger domestic markets, will rebound first and this should augur well for the lessors who are more active in the existing narrowbody markets.

It will be more problematic for the return to normal service in the international, and in particular long haul, traffic as various countries, and their citizens, may be less open and accessible as has been the case prior to the current crisis. It is likely, as the virus revisits countries that were previously seeing reductions in infections, that it will lead to some form of restrictions on international and global travel.

Spare engines will be in oversupply

Before the Covid-19 Crisis, I had been wondering about the optimistic shop visit forecasts that were becoming the perceived wisdom for the industry. It was obvious that they built in little downside risk and assumed the growth profile seen in recent years continued. Whether they were optimistic or not, the fact today is that with so many aircraft parked, and no matter how long it continues, it is inevitable that the previous forecasts are in need of revision.

With the decrease in shop visits and any continuing storage of aircraft (and each having two “spare” engines on wing), the demand for spare engines can only decrease. The result being oversupply and average periods in inventory for engine lessors extend.

A graphic of how the months in inventory for one of its three core narrowbody engines behaved in ELF’s portfolio between 2012 and 2019 following the Global Financial Crisis is set out hereunder:

Average months in inventory

It can be seen from this that from an average of just over 5 months in inventory in February 2012 , the average months in inventory exceeded 12 months by February 2015. In fact it was only February 2017, that ELF’s period in inventory of the subject engine type got back to the 5 months average seen in 2012.

Engine lease rentals will drop

It remains simple economics that a period of oversupply of spare engines for the current fleets will lead to downward pressure on lease rentals. An immediate consequence of the Covid-19 crisis will be that airlines will seek to avoid long term cash commitments and instead rely on the spot lease market where there will be an abundance of engines available. Almost overnight in early 2020, the spare engine lease market has switched from a “sellers” (i.e. lessors) to a “buyers” (i.e. lessee) market. The consequences will hit lease rentals immediately.

It may be years before the lease rentals, assuming the market switches to a period of undersupply, starts to consistently be above the rates that will be seen for the rest of 2020. In the near future there will be a period of real volatility for engines rental rates.

The following chart sets out how the lease rental rates for the core narrowbody V2500-A5, CFM56-7B and CFM56-5B engines behaved in the ELF portfolio between a nominal base date in 2010 (two years after the Global Financial Crisis commenced) and 2019. The volatility for one the engine types was as wide as 60% between its lowest and highest rentals. Overall across the three engines, there was volatility of between 20-60%.

Although spare engines have not traditionally (with the exception of a few GE Engine Leasing vehicles and Willis Lease Finance’s “West” vehicle) been a big part of the securitised or ABS market, it will be interesting to see how these older vehicles and the two recent ABS structures done in early 2020 perform during the crisis. There may be things to learn for us all as we evaluate possible funding structures in the years to come.

Assets values will drop

Like all asset owners, the immediate result of a crisis, and the confidence it sucks out of economy, is that the buyers stop or slow all of their decision making. Within days of the closing of normal Transatlantic travel, buyers stopped enquiring and mandates which previously seemed certain, suddenly were not certain.

As with past cycles, the buyers who will be active in the immediate aftermath of such a massive event as we are seeing, will be the few “lucky” buyers with cash and all of them will be “bottom fishers”. The prices that are offered for the next few months will not represent the full value of the engines but at least these buyers will provide a service by proving liquidity of the asset, albeit at very opportunistic prices.

What will be very interesting to see over the next couple of years will be how current technology, the V2500-A5, CFM56-7B and CFM56-5B engines values behave compared to the newer technology Leap 1A and GTF. Obviously, the Leap-1B will only follow the return of the Max to service.

It would be my expectation that there will be tremendous volatility around the V2500-A5, CFM56-7B and CFM56-5B engine values and clear consistent pricing will only develop when the level of retirement for the host aircraft in storage becomes clear.

It will be some time before full values return and for anyone who paid above the odds in the cycle just ended, or was under depreciating, or maybe taking all of their considerable maintenance reserve revenue to profit, there will be pressure. The issue for these lessors will be that poor discipline around these core areas will result in significant impairments and inevitably there will be eloquent explanations for any losses that follow. The excuses will flow, the use of words like once in a 100 years, one-off, never to be repeated etc. will flow off the lips of countless lessors’ senior managers but the reality will be that if they adopted poor pricing strategies, or were reluctant to properly write down the assets, then the result is that in the inevitable cyclical downturn, they will be left suffering the consequences for their earlier poor decision making.

The pressure on asset values will be most obvious as the companies approach their audits where appraisal questions and impairment considerations will be inevitable. The good news is that for most, the 2020 audits/results are still almost 9 months away.

The overwhelming lesson for all lessors in this period is that it is sound pricing strategies that will separate the winners from those who played “musical chairs” and are left without a seat when the music stopped, i.e. with the overpriced asset that nobody (airline or another investor) wants.

What will it take to be around in 2025?

While the emphasis of my article for this publication last year was on whether the industry needed an independent engine lessor in 2049, I realise in these times of crisis that nobody is (even if they ever did) thinking about 2049. Instead everyone is thinking about 2020 and at a stretch a few (the lucky few) are thinking about their strategies to see them succeed over, say, a 5 year horizon, into 2025.

The good news is that if a lessor maintained discipline around pricing strategies and depreciation/maintenance reserves write-offs, then the lessor can be assured, once it has desirable assets, that it can have a future.

At this point, I would like outline how ELF as a 30 year veteran will react to its customers in this market and thus ensure it succeeds until 2025, and who knows maybe 2049.

Firstly, ELF will continue to follow very simple principles which include our focus to:

  1. Understand our customers needs and motivations for a deal,
  2. Know what ELF can and cannot do to meet the customers wishes,
  3. Keep open communication with the customer so that they are very clear on what ELF can offer and
  4. Honour our commitments (I am very proud that ELF was in a position during this crisis to honour mandates won prior to the onset of the crisis).

Secondly ELF will be as flexible as is possible with all its customers. This is not a time to grandstand or punish customers with overly punitive opportunistic demands in return for some concession that might help that customer survive this crisis.

Thirdly as a portfolio manager, who has prudently depreciated and written down its portfolio in the good times, ELF will adapt our portfolio, our protocols, and our plans to ensure that we are well positioned to match the new industry reality, whenever that emerges.

With the above customer focused emphasis and by continuously using the experience for the past downturns, ELF is confident that it can, as a strong independent lessor, meet its customers’ needs as they navigate this crisis.

Independents will remain crucial

Before closing, and not to lose sight of the industry trend that has dominated engine leasing for years, I want to comment on the OEM dominance in the engine leasing market. As is well known, and documented previously, all three/four major engine manufacturers have in-house engine lessors, i.e. Rolls Royce Partners Finance, Shannon Engine Support, GE Engine Leasing and Pratt & Whitney Engine Leasing.

As the orders rolled in on the Leap and GTF engines in particular, there was considerable debate about aftermarket control. At times the Rolls Royce model of control through programmes, repairs and MRO, and dominance in the leasing of its own products must have seemed attractive to CFMI, GE and PW.

As we all continue through these uncertain times, and entry into service issues remain for many of the engine programmes, I am firmly of the view that the OEM’s will continue to “allow” the independents operate in their market. The independent participants will be crucial to the OEM’s as they will want to evidence liquidity of their product as they grow their markets once the entry into service issues are resolved.

As a fiercely independent lessor, who values the OEM’s as lessees and partners from time to time, it will remain crucial for the airlines that they have strong independents to provide:

  1. Competitive pricing on lease rentals,
  2. Flexibility to allow the airline use whatever maintenance (MRO) provider they choose,
  3. Through their parts subsidiaries, INAV in the case of ELF, quality used serviceable material and
  4. A strong alternative to the OEM “only” service outcome, i.e. OEM make it, lease it, repair it and charge for it all.

In this independent path that ELF pursues, it has the considerable support of its parent Mitsubishi UFJ Lease & Finance, who have been its owner since 2014.

It remains ELF’s firm view that OEM’s are better served focusing on manufacturing the engines, delivering the engines to airlines and ultimately, in a level playing field, delivering the new spare parts.


In conclusion, can I apologise to anyone who sees little new in this article and say to the readers that while the extent of this crisis might be unprecedented, it remains a simple business. Those who will succeed are the ones who adopt the right asset pricing strategies, excel at customer focus, develop and retain the best staff and deliver stable returns consistently for their shareholder.

As every novice to the industry knows, there will be cycles and casualties in this business but companies can survive if they keep it simple, remain focused on their customer and the asset.

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