In this edition of mba Aviation’s Insight Series, Ryan Cross analyzes the effect of the COVID-19 Pandemic on Commercial Aviation.
The ongoing coronavirus (COVID-19) pandemic forced serious cuts to commercial aviation activity around the world. mba’s data team continually tracks airline schedule reductions and aircraft parking to quantify the impact of the virus.
In this edition of mba Aviation’s Insight Series, Ryan Cross analyzes the effect of the COVID-19 Pandemic on Commercial Aviation.
Following its emergence in December 2019, the coronavirus (COVID-19) has spread from China to the rest of the world. As a result, global aviation activity has plummeted. mba continually collects data about the commercial airline industry which helps quantify the impact of the virus. In particular, we can illustrate the ongoing pandemic’s damage by tracking the increases of cancelled flights and parked aircraft.
In this edition of mba Aviation’s Insight Series, the Forecasting & Modeling team analyzes the effect of monthly utilization on maintenance cash flow.
Maintenance Matters – Part II
Utilization is a major driver of aircraft maintenance. The majority of an aircraft’s value is in its engines, and the engines will deteriorate based on the number of flight hours and flight cycles they fly. Correspondingly, the majority of the maintenance compensation for an aircraft is driven by flight hours and flight cycles. However, if the utilization of an aircraft increases, the value of the cash flow associated with that aircraft may not increase in a linear fashion, or at all.
In order to demonstrate the effects of varying utilization on the maintenance cash flow of an aircraft, we will posit a generic scenario common to an aviation asset backed securitization (ABS).
The monthly cash flow was varied between 400 flight hours and 150 flight hours in increments of 10 and assigned a number of flight cycles that would correspond to that number of flight cycles using a linear formula based on industry information. A narrowbody operating 400 flight hours per month would be expected to be flying 2.54 hour flight lengths, which a narrowbody operating 150 hours per month would be expected to fly 1.73 hour flight lengths.
Maintenance inflow alone does not vary linearly with utilization. While in general, the present value of inflows over the period increases as utilization increases, the lack of reserve collection during maintenance downtime influences the totals.
The increase in maintenance outflows as utilization increases is significantly less constant. Some outflow-causing maintenance events, such as landing gear overhauls and airframe heavy checks, are primarily calendar-driven and do not shift as utilization is varied within this range. However, engine overhauls and engine LLP replacements, which are the cause of the vast majority of outflows over the life of the aircraft, are utilization driven. These events can occur due to engine condition (driven by hours and cycles), LLP life limits (driven by cycles), or minimum return conditions for engine condition or LLP cycles remaining until life limit (driven by lease negotiations).
The value of the aircraft’s maintenance condition at the end of the period is also relevant to the value of the aircraft over this period. Therefore, for as complete a picture as possible, and to be able to answer the question of if increased utilization increases value for the lessor, we will take these into consideration. The value of this aircraft’s maintenance over the Subject Period is the sum of the present value of the cash flow during the subject period and the present value of the maintenance adjustment at the end of the subject period.
In this edition of mba Aviation’s Insight Series, the Forecasting & Modeling team looks at the way Maintenance is considered in Aircraft Securitizations.
Maintenance value and the corresponding compensation, typically designated as “Supplemental Rent”, “Reserves”, or “End of Lease Compensation” within a lease agreement, contribute an essential element of value and liquidity within an Asset Backed Securitization (ABS) portfolio.
In an aircraft lease, lessors collect maintenance compensation for utilization on the individual components on each aircraft. These typically include the airframe, landing gear, auxiliary power unit (APU), engines, and engine life limited parts (LLPS). The chart below depicts a typical distribution of monthly maintenance reserves over each component, determined by cost and approximate interval of each relevant maintenance item on an A320-200.
Within an ABS deal, maintenance compensation collected from the lessees is funded into an aggregate Maintenance Support Account. Whereas typical leases will divide reserves into individual accounts to be drawn down at the time each component undergoes maintenance, the Maintenance Support Account is used to reimburse all future maintenance events for the assets in the portfolio, and is only required to have funding over a predetermined “look-ahead period”, typically 12 months.
In addition to supplementing cash flows in a portfolio, maintenance adjustments, as calculated by the cost of a maintenance event and the position of the aircraft in its maintenance life cycle, are applied to each aircraft’s Base Value. The maintenance adjusted values are then used to assess the overall value of the collateral pool and determine the loan-to-value (LTV) on each tranche of issuance.
As an aircraft ages, the overall value of the asset depreciates. However, the cost to perform maintenance on each of its components increases over time with inflation. Therefore, as the asset ages, the inherent value of maintenance in the aircraft becomes a larger portion of its overall value.
Based on the full life market value and the full maintenance value of the components on an aircraft, an approximate run-out value on each vintage of the aircraft can be derived. The maintenance value to full-life value ratio illustrates how the value of maintenance in an aircraft encompasses a larger factor of the asset’s total value over time. The example below is an estimation of the reinvestment needed to bring an A320-200 back to full-life conditions.
As a result of the dynamic between aircraft depreciation and maintenance appreciation, we find two immediate impacts on ABS transactions over time: First, the inherent maintenance value become a larger component of each aircraft’s value and therefore the overall collateral pool. Second, as lease rates decrease with the decline in overall asset value, the maintenance-related cash flows become an increasing portion of the ABS’s liquidity.
In this edition of mba Aviation’s Insight Series, Ryan Cross, Analyst – Market Intelligence & Innovation, analyzes the appeal of the Airbus A321XLR to Operators.
Airbus scored a victory with the timing of its launch of the XLR program. Since it quickly locked down a healthy orderbook from an operationally-diverse range of airline customers, it proved the market’s appetite for a longer-ranger narrowbody aircraft with current engine technology. The wise decision to launch the XLR dealt a blow to Boeing’s product development strategy. Boeing was sidetracked for most of 2019 by the grounding of the 737 MAX program. As it labors over the safe return of the MAX to service, it will probably not make a counterpunch in the first half of 2020.
For several years, Boeing executives have pondered whether to commit to the full development of the New Midsize Aircraft (NMA). A number of loyal Boeing customers are clamoring for a modern replacement for midsize 757 and 767 aircraft. Nevertheless, the American airframer must now reevaluate the prospects of its NMA; several would-be customers have already defected to its European counterpart.
At the start of the Paris Air Show last June, Air Lease Corporation (ALC) placed the first public order for the XLR. John Plueger, the leasing company’s chief executive officer, described why the XLR might could squash interest in the NMA for prospective operators: “We think that [the XLR] addresses the smaller size of what Boeing envisions to be the NMA (a larger and smaller version). It remains to be seen as to market acceptance and economic viability of that program in terms of being able to develop it and deliver it to the airlines at a price point which is compelling… We will assess, and we are talking with Boeing as they continue to look at the NMA.” More recently, Plueger stated that the NMA’s development prospects had “diminished significantly” because of the broad range of difficulties weighing Boeing down.
Following ALC’s orderbook jump-start with 27 aircraft, GECAS placed an order for 20 aircraft in November. By winning orders from a duo of prominent lessors plus a pair of market-making American network carriers, Airbus demonstrated the XLR’s appeal among top-tier customer base.
The XLR offers 15% greater range than the prior-generation A321LR variant, which in turn surpassed the range of the A321neo by 15%. When configured with a low-density cabin with lie-flat seats for business class passengers, the aircraft’s range will stretch to 8,700 KM; its flight time will exceed nine hours. The aircraft offers a 1,500 KM increase over the 757-200 and 1,300 KM beyond the LR variant. From New York, as an example, this means that the XLR can operate deep into South America and far into Eastern Europe.
Reflecting on the first phase of the XLR program, Airbus should take particular pride in the XLR orders it received from American Airlines and United Airlines. Both operators fly large fleets of 757 and 767 aircraft which will reach the end of their economic life in the years ahead. By closing those deals early in the life of the XLR program, Airbus elbowed out Boeing from orders from these market-makers. Among the three American legacy carriers, only Delta Air Lines remains uncommitted to a midsize aircraft replacement order. The Atlanta-based carrier will eventually need to replace up to 200 midsize aircraft.
Airbus will surely accumulate more orders for the XLR before 2023, when it intends to deliver the aircraft for commercial service. Whether or not the NMA comes to market, Airbus will continue to lure operators to the XLR with an enticing combination of narrowbody cabin capacity economics, intercontinental range, and superior fuel efficiency thanks to modern engine technology.
In this edition of mba Aviation’s Insight Series, Sloane Churchill, Analyst – Asset Valuations, uses analysis of the effect of the SARS outbreak of 2002-2003 on aircraft values and the aviation industry to provide insight on how today’s Coronavirus might take its toll.
Though the Coronavirus outbreak in China is reminiscent of the SARS outbreak in 2002 – 2003, the effects on the aviation industry have the potential to be quite different. So far, the Coronavirus has infected over 45,000 people, mostly in mainland China, leading to over 1,100 deaths. This Coronavirus is proving to be faster spreading, though less deadly than SARS, with a death rate of approximately 2.1%. Historically, while global health epidemics have hurt aviation by reducing revenue passenger kilometer (RPK) growth in the short term, there have been no long-term effects for any epidemic of the last twenty years, including SARS, Avian Flu, Swine Flu, Ebola, or Zika on aircraft values or the aviation market as a whole.
The SARS outbreak could provide some insight as to how aircraft values and the aviation industry might be affected by the current Coronavirus. mba values research shows SARS disproportionately affected aircraft values. Typically, older vintage and out of production aircraft were hit the hardest after the SARS outbreak, showing the most value volatility in the following two years. Newer vintage and current production aircraft were significantly less volatile.
Market values for aircraft and Brent Crude prices have historically had an inverse relationship; in low fuel price environments, aircraft values tend to increase as aircraft become less expensive to operate, while market values decrease in high fuel price environments. This is especially apparent in older vintage and out of production aircraft, as they are less fuel efficient, and thus more sensitive to fuel price. However, 9/11 and the SARS epidemic broke the correlation between Brent Crude prices and market values, and this relationship does not recover until after the worst point of the SARS epidemic in 3Q 2003 for most aircraft types and classes. After the SARS outbreak, looking at narrowbody aircraft, the market value of a 1988 737-400 and A320-200 fell 14.8% and 42.0% respectively in 1Q 2003 from the previous quarter, while market values for a 1998 737-400 and A320-200 fell 15.1% and 16.7% respectively in 1Q 2003. Market values for a 1998 737-800, which technologically replaced the 737-400, dropped 11.2%. At the same time, Brent Crude prices fell 3.5% from the previous quarter during 1Q 2003.
Generally, narrowbody aircraft values recovered by 3Q 2004 and show no long-term effects from the SARS outbreak. However, there were only limited travel restrictions in place during the SARS outbreak, while travel restrictions in China and internationally during this Coronavirus outbreak have been significantly more extensive, potentially having a larger effect on RPKs than SARS. The immediate reduction in passenger demand caused by these travel restrictions will likely hit narrowbody values slightly less than widebody values, as carriers will rely more on their narrowbody fleets in the reduced-demand environment, particularly in the domestic Asia market.
Widebody aircraft in particular took the brunt of the value hit during the SARS epidemic, as they potentially will in the quarters following this Coronavirus epidemic as well. Like narrowbodies, widebody values recovered by 3Q 2004. The small to mid-sized widebodies such as the 767-300ER and A330-300 showed less volatility than large widebodies. Market values of older vintage aircraft, such as a 1988 767-300ER and a 1994 A330-300, were affected the most, falling 13.3% and 18.8% respectively in 1Q 2003. The newer 1998 vintage 767-300ER and A330-300 market values fell slightly less at 10.4% and 13.6% respectively. With the A330 currently in a soft market, all vintages, but particularly older vintages, could be vulnerable to further market value volatility, as the A330 is a popular widebody in the Asia/Pacific region. The 787, also a popular type in the Asia/Pacific region, could be vulnerable to market value volatility as concerns of overproduction combined with reduced passenger demand might lead to delayed or cancelled deliveries of the type in the near to mid-term.
Large widebodies, such as the 777-200ER and the 747-400 were also heavily affected by the SARS outbreak. Market values for the 1998 vintage 747-400 were hit the hardest by SARS in part because the type was nearing the end of its production run, falling 16.1% in 1Q 2003 while market values for a 1989 vintage only fell 7.7%. This time around, we could see softening of market values for older vintage 777-300ERs, or even the A350-900, as these types are popular on mid to long-haul routes in Asia.
Financial markets took an immediate hit with the shock of the epidemic after the Chinese New Year on January 27th, with the US’s S&P 500 and NASDAQ falling 1.6% and 1.9% respectively, and London’s FTSE 100 Index fell 2.3%. However, so far through the epidemic, the S&P 500 has only fallen 0.16% and the NASDAQ has actually risen 2.0%. Since the Coronavirus was announced, through the end of January, Hong Kong’s Hang Seng Index has fallen 6.7% and Shanghai’s SSE Composite Index has dropped nearly 10.0%.
International airline stocks were also affected, particularly airlines with large international presences and extensive Asian networks. China Eastern Airlines and China Southern Airlines’ stocks have been hit the hardest, both falling around 17.0% during the epidemic, as their networks rely heavily on international routes within Asia and around the globe. The following chart shows how several airlines were affected at various event dates throughout this epidemic, starting December 31, 2019 when China reported a new illness to the WHO, around the weekend of the Chinese New Year, and when the WHO deemed the Coronavirus to be an international public health emergency at the end of January.
Airlines are now more flexible than they were in the early 2000’s, becoming more savvy with capacity and revenue management, making changes to flight schedules just days after the start of the epidemic in response to anticipated drops in demand. Several airlines have cancelled their flights to China altogether, including British Airways, Lion Air, Lufthansa, Air France – KLM, Virgin Atlantic, Delta Air Lines, and American Airlines, with more expected to follow. While cutting flights to and from China might curb the spread of the illness, it could potentially have drastic effects for airlines’ financials. Research conducted by mba’s Forecasting and Modeling Group shows three of the top ten international routes from China to outside of the region by frequency are between China and the United States. United Airlines and American Airlines each serve two of those three routes, with Delta Air Lines serving one route, making them particularly exposed to the travel restrictions. United Airlines is also one of the top ten operators to China by frequency and has taken the largest hit to its stock price so far because of its exposure.
After the SARS outbreak, global financial markets fully recovered within one year, even while continuing to recover from the effects of the 9/11 terrorist attacks. This coronavirus hit during a long boom period for the financial and aviation markets, which may help to mitigate the financial effects of the epidemic on aviation, as most airlines are more flexible and financially fit, and thus more equipped to handle the reduction in passenger demand. The coronavirus has also affected the manufacturers, as Airbus announced it has closed its final assembly line in Tianjin, China in response to the coronavirus. China’s importance to the aviation industry has grown tremendously since the SARS outbreak 18 years ago, and is essential to many global airlines’ growth horizons, which may make this epidemic that much more painful for the industry. The aviation industry’s fears of an economic downturn ahead combined with the potential severity of this epidemic is likely to perpetuate the rash of airline bankruptcies we saw in 2019, as some financially suffering airlines might not cope with the reduced demand. It would also be reasonable to see a slowdown in aircraft transactions and financings in the near to mid-term, though the ABS and EETC markets might hold solid, as they are more long-term instruments.
The timing of the outbreak is also unfortunate for the industry as the Chinese New Year January 25th, China’s largest travel holiday, was effectively cancelled by the outbreak. According to CNN, in 2019 the Chinese New Year accounted for around 73 million trips by air travel. According to IATA, at the worst of the SARS outbreak in May 2003, RPK’s dropped by about 35% with no travel restrictions by countries. Currently, with the travel ban within China and many other countries limiting travel to and from China, RPK’s are expected to take a sizeable hit. With economic growth slowed to 6.1% in 2019, and resulting reduced passenger demand growth in China over the past two years, if the Coronavirus lasts through the quarter, it could have long-term economic effects, unlike prior health epidemics, as Asia grows to be one of the largest aviation markets in the world.
Hong Kong Airlines undertook aggressive fleet expansion to launch long-haul low-cost routes. Diminished air travel in Hong Kong, caused by ongoing civil unrest, exacerbated the airline’s problems. To comply with new requirements set by Hong Kong’s civil aviation authority last week, the company obtained a $568 million USD capital injection from the HNA Group. This will allow it to continue operations.
In this edition of Morten Beyer & Agnew’s Insight Series, Anna Kopinski, mba’s Senior Associate of Asset Valuations, analyzes how the cargo market has fared in 2019, what aircraft are being used the most—and least—and how different metrics reveal divergent views on the state of the market. Later in this continuing series, she will assess the external factors which may influence the air cargo industry, such as US-China trade tensions.
A cursory read of the press would have us believe that the air cargo market has been in flux with a deep downward trend this year. Headlines have been shouting that the market is “faltering”, “sliding”, “declining”, and “flat-lining.” And indeed, the numbers look scary: compared to a peak in mid-2017, the growth rates have been trending downward:
Source: CargoFacts, 2017-2019
However, the reality is that 2017 and 2018 had unprecedented levels of growth in the market. When we take a closer look at those numbers, we begin to see that while growth has slowed and begun lagging, it has not really begun to decline in any appreciable fashion. In fact, according to OAG, while 1Q19 saw a rather noteworthy dip in total freight tons, the second and third quarters have seen more total freight tons than ever measured before, with nearly 8 million tons more freight flown year to date this year compared to the same time period in 2018. While it is impossible to encapsulate all trends by all carriers, we wanted to examine how the largers air freight operators were faring quarter over quarter, 2018 vs. 2019. As a cyclical industry, this provides a snapshot of market health. While the largest carrier, Emirates, saw declines in the second quarter of 2019, many carriers saw significant growth in 2Q19, both year over year and compared to the previous quarter. Looking at the dedicated air freight carriers, while there may not be growth, there is no great decline, either. 
Source: OAG Analyser, August 2019
Finally, it is instructive to look at total freight tons carried by all air carriers over the quarters. Though the numbers fluctuate, the trend remains clearly growing. 
Source: OAG Analyser, August 2019
In short, as tempting as it is to see this as the beginning of a deep decline in air freight traffic, the data does not substantiate such a negative outlook. Time will tell whether this is the market reaching critical mass, a market correction, or simply a plateau. Over the last few years, operators have taken aging passenger 737s, 767s, and 757s and converted them to freighters. In Part II of this series, we will investigate the equipment being utilized in the air cargo sector and how changes to fleet optimization methods impacts market capacity and growth. In Part III, we will revisit mba’s earlier position that a major hurdle for the freighter market would be the after-effect of trade tensions experienced between the U.S. and China in 2H 2018 and 1H 2019, which could severely derail the upward growth track that the market has enjoyed since 2014. Finally in Part IV, we will take a look back at all of the 2019 air cargo market, and try to ascertain whether delaying tariffs until after the holiday season had any meaningful effect on air freight traffic.
Frequent Flyer Programs (FFPs) are an increasingly common tool airlines use to generate revenue and valuable customer data. As they were originally crafted as marketing tools, the industry is now witnessing the evolution of FFPs into valuable assets for airlines. In this edition of Morten Beyer & Agnew’s Insight Series, Anne Correa, mba’s Director of Airline & Airport Services, delves into the formation of FFPs for airlines and the noted importance of outside investors in helping airlines stay afloat, especially as FFPs enter a time of transparency and re-privatization.
Originally designed in the 1980s as marketing tools for rewarding customers, FFPs have evolved into very profitable businesses and valuable assets for the airlines. There are 216 frequent flyer programs (“FFP”) in the world, as of November 2018. Over the past couple of decades, airlines have experimented with different ownership scenarios in an effort to extract various levels of value. A small number of these programs have been spun-off from the airline or had a part carved out and sold to investors. As FFPs have matured alongside a strong-performing aviation industry, airlines are again evaluating the best strategy for one of its most valuable assets. Air Canada is the only airline, to date, that has ever opted to spin-off its entire FFP. In 2005, Air Canada gradually began selling stakes in its program, Aeroplan, until its ownership was completely under a separate company; AIMIA, Inc. Private interest in investing in FFPs has expanded globally as airlines have sought additional capital. AIMIA has since expanded its FFP portfolio to include a 49% share of Aeromexico’s Club Premier and a 20% share of Air Asia’s Big Loyalty. Virgin Australia sold a 35% share of its FFP to Affinity Equity Partners in 2014 and Avianca sold a 30% share of LifeMiles, its FFP, in 2015. Etihad also boasts a FFP portfolio, holding a 24% share in Jet Airway’s JetPrivilege and a 75% share in Alitalia’s MilleMiglia[1]. Before AirBerlin declared bankruptcy, Etihad also owned a 70% share in its FFP, topbonus. In addition to private divestitures, airlines have also looked to public issuances to monetize their FFPs. In 2010, LATAM became the first airline to offer shares of its FFP, Multiplus, to the public. LATAM sold 27% of its share in Multiplus. In 2013, GOL also offered shares of its Smiles program to the public, retaining only a 57% stake. Offering shares to the public allowed LATAM and GOL to raise additional capital via the markets while still garnering revenue from their programs.
“Private interest in investing in FFPs has expanded globally as airlines have sought additional capital”
While the sale of interests in FFPs allowed airlines to access much-needed capital to stay afloat, they could no longer fully recognize the benefits of FFPs as a source of ancillary revenue. Realizing that this arrangement placed them at a significant competitive disadvantage, Air Canada signed a definitive agreement in November 2018 to buy back the Aeroplan loyalty program from AIMIA Inc. for $450 million in cash. Under the deal, Air Canada will also assume $1.9 billion of Aeroplan miles liability.[1] LATAM has also announced its intentions to buy back the 27% shares from the market and make Multiplus private.[2] In October 2018, GOL announced it plans to buy out minority shareholders of Smiles and delist the subsidiary.[3] The recent buybacks from the different airlines show a combination of the strength of revenue generation in FFPs and the cash flexibility desired by the airlines. Some aviation industry analysts are vocal in their wish for more airlines to spin-off their FFPs. This would create more transparency for the programs and investors could finally understand their true value. Although airlines are disclosing more information in relation to their FFPs, as required by new revenue recognition standards, it is unlikely these analysts will get their wish for financial detail in the near-term, as the only publicly traded FFPs with transparency into their financials are expected to re-privatize in 2019. Thanks to an increased number of partnerships with long-term agreements that provide large and consistent cash flow coupled with strong traffic growth, FFPs are experiencing unprecedented revenues. In addition to creating strong profits, FFPs generate large amounts of valuable customer data. Airlines that were previously willing to forego the flexible use of cash from its FFP are now rethinking their strategies in light of the current economy and the rise in importance loyalty programs have seen in the airline industry.
[1] https://www.cbc.ca/news/business/air-canada-aeroplan-aimia-1.4920551
[2] https://www.reuters.com/article/us-latam-airlines-multiplus-delisting/chiles-latam-airlines-to-take-multiplus-loyalty-program-private-idUSKCN1LL35E
[3] https://www.reuters.com/article/smiles-ma-gol-linhas-ae/brazil-airline-gols-talks-on-smiles-takeover-seen-taking-3-months-exec-idUSL2N1Y318L
[1] It has been recently announced that Etihad plans to return its 75% share in Alitalia’s millemiglia