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737-700 & -800 Freighters: The Argument for Leasing

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    737-700 & -800 Freighters: The Argument for Leasing

    AIRCRAFT VALUE RISK. The world’s aircraft appraisers agree that 737NG market values, particularly the revered 737-800, are likely to trade above base value depreciation curves for the next several years, and potentially even increase in value. The reason is the first few years of 737MAX and A320NEO production will mainly satisfy fleet growth demand, while new deliveries to replace older retiring 737NGs will only begin to happen from 2020 or even later, depending on global economics conditions.

    Boeing projects that 450 narrow body aircraft will retire annually beginning early next century. This means that 737NG freighter feedstock purchased over the next 3 to 5 years will potentially be much more expensive than their true market values, and that the airline or the lessor is at high risk of a major value correction as older 737NGs begin to retire in large numbers.

    And, should a global economic slow-down occur, airlines will shed their oldest aircraft as they reduce network capacity. This will substantially amplify such an overpayment.

    STC RISK. Major aircraft modifications, such as supplemental type certificate (STC)-based passenger-to-freighter conversions are inherently at risk of design change requirements discovered after early modified aircraft enter service and experience reliability or safety concerns.

    These changes can be significant and can have an effect on the utility and desirability of early production aircraft. One mitigation strategy is to lease early-year freighters in order to mitigate these risks to ownership investment and maintain the flexibility to trade out early freighters for younger and often better freighters.

    OLDEST AIRCRAFT QUALITY RISK. The oldest 737-700s (from 1997) and 737-800s (from 1998) will be the first to exit fleets. In fact, the oldest and ugliest are already exiting now. And for good reason. These are Boeing’s earliest and in some cases, least capable versions. But more importantly, airlines exit their most maintenance-intensive, least reliable aircraft first. And they exacerbate their poor condition by swapping the weakest engines and other major components onto these aircraft as they are retired and offered for sale.

    AIRCRAFT ACQUISITION RISK. Buying the wrong airplanes at the wrong price are among the most common problems airlines experience when looking to the secondary market for mid-life aircraft. Generally speaking, airlines are perceived as deep-pocket buyers with minimal experience in discerning true market value, often with the ability to over-pay for an asset, and frequently justified by some vague strategic objective.

    There is a better way to acquire airplanes than “Hello, I’m from Deep Pockets Airlines; I have a thick wallet (and minimal real-world experience) to buy your (likely overpriced) used airplane”.

    TECHNICAL INTEGRATION RISK. Once the freighter conversion feedstock has been acquired, now comes the risky process of investing substantial additional capital to bridge the previous operator’s maintenance program to your approved maintenance program, and restore the airframe, engines and major components to a condition that makes sense for your unique circumstances and market outlook for spare parts, utilization, etc.

    In addition to all the records research, heavy maintenance & spare parts provider selection, contracting, oversite and technical/financial oversite, there is the main event – the passenger-to-freighter (PTF) conversion selection and management.

    One US-based PTF STC-holder is reported by customers as averaging 60+ days late in delivering freighters. This could have a hidden project cost impact exceeding half a million dollars or more. Combine this with MRO cost-overruns, workmanship problems (that will haunt you for years), and the PTF provider selection and program management becomes a major area of concern.

    One of the best ways to mitigate this is to lease (or buy) a turnkey freighter from Spectre. Our principals have successfully executed more than 100 freighter conversions in the past ten years and are ready to help with your fleet development program, including the time consuming and financially risky technical integration elements, all for one upfront lease (or purchase) price.

    REMARKETING RISK. Eventually airlines must dispose of their aircraft. If you lease it, you meet the return conditions (or negotiate major deviations) and simply walk away. But if you own the aircraft, you’re responsible for its disposal. And just like owning versus leasing a car or residence, the process of selling can be stressful, time consuming and surprising costly when taken together with the overall cost of using the asset.

    When one buys an asset, we often assume we’ll get top dollar at the end of our use and that this top dollar will be easily and quickly obtained. Reality is generally something different. The same is true in the airline business.

    Finance will model scenarios of ownership vs. leasing a freighter that is 15 to 20 years old when it enters service. Assuming the airline has the cash or credit to buy (and no higher & better use for the cash), ownership can initially appear attractive. But important real-world consideration which these models often gloss over is that remarketing (disposing of) the asset years later will not be a simple or as lucrative as initial financial models suggest. Remember trying to sell that old car you once had….? The market value for an aircraft varies widely over its life, often due to uncontrollable exogenous global events. It you own the asset, these swings will impact the price for your aircraft.

    And without the substantial global sales network of an aircraft trading/leasing partner like Spectre, disposing of the aircraft will almost certainly be at scrap/part-out value, reducing the investment recovery potentially by millions of dollars.

    UNIVERSAL BENEFITS OF LEASING. Flexibility, cash flow, and retention of borrowing base are well known and certainly apply to 737NG freighters as well.

    Leasing is less capital intensive than cash purchase. The airline can use its cash for other purposes rather than keeping it tied up for years in an aircraft.

    Leasing shifts the residual value risk to the lessor. Aircraft values, unlike most property, depreciate over time. Companies that tried to sell their aircraft in 2001 – 2003 saw a significant loss in value over what they probably anticipated.

    Leasing is better than financing if a company does not need the tax write-off from depreciation. If an airline expects significant profit during the aircraft’s operation, the tax depreciation of an aircraft is one way to protect those profits. If the airline does not or cannot take the tax write-off, it still can write off the lease payments as an expense.

    Leases can be for relatively short periods compared to the useful life of a typical aircraft. And a lease allows you to walk away at lease end without being concerned with selling an owned aircraft. Those who completed their lease in 2001-2003 did not face the loss of residual value that the owner did.

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