Lease rate factors are continuing to fall to what some believe are unhealthy levels, partly driven by fierce market competition and a desire for lessors to expand their Asia-Pacific businesses, market sources tell Airfinance Journal.

Lessor sources report seeing lease rate factors lower than 0.60% on various financings.

“The reality is that, yes, from time to time we see some very low lease rate factors. Even where the lease rents are not far off-market, there may have been a relatively high price paid for the aircraft asset which squeezes the return,” says one Singapore-based market source.

“Due to the amount of liquidity still in the market and strong competition among lessors, many airlines have no problem acquiring aircraft for decent rates, and those doing sale and leasebacks often benefit from premium pricing."

The person adds that some leasing companies – many of them based in Asia – appear to be under pressure to rapidly grow their portfolios – which inevitably leads to a willingness to sacrifice return for scale.

A Hong Kong-based leasing company source agrees, saying that the ball has moved squarely into the airline’s court in terms of negotiating power on lease deals.

The risk is that airlines will become “spoilt” by these cheap deals, the person says.

The person has heard that certain Chinese lessors will tell their airline customers: “Take whatever offer our competitor has made you and then take 5-10% off it – that’s what we’ll give you.”

While he doubts that airlines will lose money on these deals, they may experience problems at the end of the lease in terms of managing the residual value.

A Hong Kong-based banker agrees, saying: “Many people just assume they will have traded those assets before the expiry of the lease term, but I’m not sure you can entirely rely on those assumptions. The lessors will have to bear the burden of refinancing, remarketing and reconfiguration costs.”

The Hong Kong-based leasing company executive adds that he has seen eight-year lease tenors for widebody aircraft – something that was previously rather rare. He has also seen five- to eight-year leases for narrowbody aircraft.

An executive at a Chinese airline tells Airfinance Journal that for 2017/18 deliveries, he is seeing “pretty good pricing from local lessors”, which is better than what he was seeing last year.

“Especially for some local lessors which are very aggressive in pricing,” he says.

The Hong Kong-based banker says this problem is the result of “a lot of money chasing a couple of deals and that translates into high purchase price and low rentals – the famous ‘high-low deals’”.

“You really need to have a high leverage to make it work. As long as you have high loan-to-values (LTV) and cheap financing costs it works, but if you don’t meet those two conditions then leasing is not profitable at all. You just accept a lower return, a lower lease rental. They may take the view that they will resell those leases to somebody else down the road.

“They are just in an easy bubble market now so it’s ok as long as the money keeps going…but it’s not going to end in a pretty manner I guess.”

 Moody’s China downgrade

On the capital markets side of the business, market sources in China and those who do business there are observing the potential impact of Moody’s recent downgrade of China’s sovereign credit rating to A1 from Aa3 and change of outlook to stable from negative.

A lawyer based in China who works on aircraft finance transactions told Airfinance Journal that the impact on domestic deals will be limited, but that international transactions could be hit.

“Of course, there are many Chinese leasing companies who have set up and then the borrower will be an Irish special purpose vehicle that intends to borrow from banks in Europe, Singapore or Hong Kong. I guess in that kind of scenario, the funding cost and maybe some of the documentation will be impacted, but how that’s going to be is yet to be tested.”

The lawyer adds that the market will also need to see how the other rating agencies react to Moody’s downgrade.

 A Singapore-based law firm partner says the downgrade may make it more expensive for some Chinese businesses, including airlines and lessors, to borrow US dollars from non-Chinese banks and investors, and to issue debt successfully into international markets.

“This could drive them to borrow more from domestic Chinese banks – which might lead to a further downgrade in due course given this one has largely been driven, as I understand it, by concerns about the amount of domestic Chinese debt,” he says.

A Hong Kong-based banker says that the “logical impact” of the downgrade would be that upcoming bonds from the downgraded entities will come at a “slight premium”.

“The markets are not always entirely rational – far from it, but I would expect the upcoming bond issues to be a bit more expensive for those leasing companies. Then that would put the aircraft secured bank financings a bit more on the radar screen of those leasing companies that have been financing themselves through the bond markets,” he says.