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Perfect Storm Drives Part-Out Trend

In many ways, the aviation industry's business environment during the past few years has created a perfect storm for early aircraft retirements, reduced valuations and engine part-outs.
Fuel prices are high, and new aircraft are on the way that promise savings of 15% or more on fuel costs. The financing to acquire those aircraft has been cheap and easy to get, thanks to a long period of historically low interest rates and readily available export credit agency assistance. Simultaneously, it has become more difficult to obtain financing for used aircraft.
In addition to those factors, airlines' historically high usage of leased aircraft gives them more flexibility to get rid of aging jets, which they can simply return when the leases expire. The global recession dampened an increase in airline traffic and the need for fleet growth to carry those passengers. Passenger travel has come back, but the slow recovery of the cargo market has lessened the demand for the freighter conversions that can give old aircraft new life.
What will happen next, especially whether or when some of those contributing factors will change, is a hotly debated topic. For example, Boeing and aircraft lessor Avolon are pushing back hard against assumptions that the trend toward younger retirement ages will continue, because any assumptions that reduced the expected economic life of aircraft below 25 years would raise financing costs, lower aircraft valuations and increase depreciation. Currently, aircraft typically are depreciated to a 15% residual value over a 25-year period.
But, at the moment, the effect on the retirement ages and valuations of certain aircraft types is difficult to deny: An analysis using the Aviation Week Intelligence Network (AWIN) fleet database shows an average retirement age of about 23 years in 2012, down from about 27 in the three prior years and 29-30 each year in 2008, 2007 and 2006. Those retirements are inextricably linked to engines, because the tipping point on the retirement decision often rests on how much value the aircraft's owner or acquirer believes it can get from parting out the powerplants.
The impact of the perfect storm has not been universal, however, with some aircraft types affected more than others.
Airbus A320s and Boeing 737NGs: The most hotly contested debate right now is what the future holds for the current A320s and Next Generation 737s, given the pending arrival of the reengined, significantly more fuel-efficient A320NEO and 737 MAX. The fate of the current A320 is a big deal for lessors, because that has been an extremely popular model for them to acquire: More than half of the world's A320 fleet is leased, Frankfurt-based DVB Bank has determined based on data received from Ascend .
Four-engine aircraft, such as this 23-year-old 747-400 still flown by Lufthansa, are more vulnerable to early retirement because of high fuel prices that make them less appealing than two-engine alternatives. (Credit: aircraft, such as this 23-year-old 747-400 still flown by Lufthansa, are more vulnerable to early retirement because of high fuel prices that make them less appealing than two-engine alternatives. (Credit: and Boeing argue that concern about the fate of A320s and 737NGs is overblown. A recent Avolon study, for example, concludes that it will take eight years from entry into service for the MAX and NEO to build 35% shares of their respective family fleets, which the lessor describes as the "tipping point" for the valuations of the aircraft they will be replacing.
But this view is far from universal. "It is by no means guaranteed that the only value impact is after a significant part of the old fleet is replaced," says Bert van Leeuwen, managing director of aviation research for DVB, which cites the valuation history of the late-built 737 Classics as an example.
DVB's recent research, using historical value data from Ascend, found the value of 10-year-old A320 aircraft dropped from 79% of their new value in 2000 to just 43% in 2012. Lease rates for 10-year-old A320s are following a similar line, van Leeuwen says, falling from 85% of the lease rate for a new A320 to just 54%.
The same trend is starting to emerge for 737-800s, van Leeuwen says, with the value of 10-year-old aircraft in that model dropping to 54% from 67% over the past five or six years.
Aviation Week's Fleet & MRO Forecast projects about 250 A320 retirements over the next five years. Aviation Week's forecast for all aircraft models is based on historical trends and other factors, including but not limited to projected maintenance requirements, aircraft operating economics, airframe versatility and flexibility, and ownership type.
But Owen Geach, IBA Group's commercial director, notes a potential restraint on A320 retirements: too many would flood the market with spare engines, lowering the part-out value to the point where an early teardown does not make financial sense.
Boeing 737 Classics: The number of 737-300s, -400s and -500s being retired jumped by about 40% in 2012, primarily for the -300s and -500s. Moreover, they are being retired relatively young: under 24 years for the -300s and under 21 for the -500s, both of which use CFM56-3B1 engines.
The demand for -500s is less than for the other Classics because they are smaller-a particular disadvantage with the escalation in fuel costs-and none are being converted to freighters.
Boeing 747-400: Geach says 747 values ​​have fallen so dramatically over the past six years that the aircraft have reached the point where there only real value is in their engines, although some airlines still will operate the aircraft until the end of their useful lives because they are expensive to replace. The 747-400s use Pratt & Whitney PW4062, Rolls-Royce RB211-524H2-T or General Electric CF6-80C2B5Fs.
As a four-engine aircraft, the 747-400's fate is especially tied to fuel costs; many airlines prefer the twin-engine Airbus A330-300 as an alternative, and Boeing's 787 also could push some of them out early. In van Leeuwen's figures for valuation of 10-year-old aircraft, some of the steepest declines in the past year show up for -400s, with a drop that exceeds 20%.
Airbus A340-300: This four-engine aircraft, powered by CFM56-5C4 / Ps, shows up with the biggest market value decline in the past year at 10 years of age in van Leeuwen's numbers-more than 30%.
A few years ago, Geach says, the A340-300 could be sold in the high $ 20 million or low $ 30 million range. But in addition to the four-engine handicap, values ​​began to tumble after late 2011 when Airbus announced the end of its production. With carriers such as Lufthansa and Swiss International Air Lines expected to retire them in considerable quantities in coming years, the selling price is expected to drop below $ 10 million, he says.
Bombardier CRJ100 / 200s and ERJ 135/145: It is no secret that the smaller regional jets, and the 50-seaters in particular, have fallen far out of favor in the US because fuel costs have made them uneconomical on many routes. That is already showing up in higher retirement rates at young ages for the CRJs, and in valuations for the ERJs.
The ERJ retirements are just beginning, but could be exacerbated because Rolls-Royce exercises more control over the secondhand market for its engines than General Electric, which powers the CRJs with CF34-3As and -3Bs. Rolls selectively licenses its engine overhaul work and restricts an overhaul company's choice of parts suppliers, which can make engine maintenance more expensive for potential ERJ leasers or acquirers. Rolls, in response, says its TotalCare agreements provide predictability in costs and on-wing performance for the AE 3007 turbofans.
What does the future hold for retirements? AWIN's forecast sees a handful of aircraft models retiring in significant numbers at average ages under 25 over the next five years, including the small regional jets, the A340-200 / -300, A320 and 747-400.

ANDREW COMPART | Aviation Week & Space Technology

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