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AFG Yearbook 2011.indd 2 17/09/2010 15:09 AIRCRAFT FINANCE GUIDE Financing the A320 Family Since the recent credit crunch, the term ‘no-brainer’ is often associated with bankers rather than anything else. Traditionally though, the term is used to describe transactions involving credits or aircraft that are considered a safe investment, promising the bank a trouble-free transaction. For most asset based lenders, the A320 Family comes close to being a no-brainer aircraft type. Bert van Leeuwen, head of aviation research at DVB bank discusses the pros and cons of fi nancing the A320 Family aircraft.

HE A320 WAS LAUNCHED OVER 20 years ago in 1984 HISTORY Tand made its fi rst fl ight in 1987. Today, there are over 4000 For the European Airbus consortium, the A320 was the aircraft in the global fl eet and over 2300 more on order. Flying first product in the short- to- medium haul single aisle jet for over 300 operators, the A320 family possesses most of the market. While Europe had already entered the market with characteristics believed to make an aircraft ideal for asset based Mercure, Caravelle, Trident, and BAC One-Eleven, the US had financing purposes; versatility, great market liquidity and a dominated with the JT8D powered Douglas DC-9 and 727 and stable, long value history. Although the majority of A320 family 737 Families. In the early 1980s McDonnell Douglas was the aircraft have proven well suited to asset based transactions as fi rst to adapt the DC-9 to the higher fuel cost environment and with any family, there are a few black sheep among the group. the upcoming Stage III noise-regulations by stretching the DC-9

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and re-engining this DC-9 Super 80 (later renamed revolutionary fl y-by-wire technology, side-stick MD-80) with an improved version of the JT8D controllers and containerised belly cargo space. engine; the Series -200. Boeing responded with a Initially only powered by the -5A derivative of stretched and modernised version of the 737-200, the CFM56 engine, the fi rst Airbus narrowbody, called the -300. The 737-300 was the fi rst of the designated A320 made its fi rst fl ight in early 1987. 737 generation now known as the Classics (-300, While some of the European flag carriers -400 and -500). One of the major contributing where ‘natural’ launch customers for the A320, factors to the success of the 737 Classic was its it took more effort to find customers outside new, clean, quiet, and fuel-effi cient GE/SNECMA of Europe and with the bankruptcies of early CFM56-3 engine. While the 737 Classic was North American A320 customers (including Pan slowly gaining market share compared to the MD- American and Braniff) a number of early A320s 80, Airbus planned an attack on the American were parked in the Arizona desert. manufacturers dominating the single aisle market. Eventually North America and the rest of the These plans eventually took the form of a truly world warmed to the A320 and Boeing was forced high tech aircraft featuring among other things; to modernise its narrowbody offering. Sticking

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to the familiar 737 designation and other typical Boeing well as strategic and political reasons, fi nal assembly of the narrowbody characteristics, in 1997 Boeing introduced the 737 A320 Family was expanded from the traditional factories in Next Generation (NG). Toulouse and Hamburg to a third line in Tianjin (China). The Although both manufacturers had victories in the battle for Tianjin factory is reportedly a copy of the Hamburg plant market share, one win for Airbus proved a breakthrough in and Airbus has assured all interested parties there will be no an increasingly important market segment. In 1999, JetBlue difference between Europe- and Asia- produced aircraft, hence introduced the low-cost carrier (LCC) market to the A320 – a there should not be any difference in the ability to finance market segment that was traditionally dominated by Boeing’s these aircraft. 737, largely because Southwest Airlines (the role model for all After the 737NG was launched to match the A320 the LCC’s) was a dedicated 737 operator. 150-seater narrowbody market enjoyed a balanced duopoly Today, the A320 family aircraft can be found on all – neither of the types were able to claim a decisive market continents, flown by operators with business models from advantage over the other. For fi nanciers as well as investors, corporate Jet to LCC, and from leisure charter to scheduled this stability has provided a strong stimulus to commit funds network. With the new order intake almost exploding as, until recently it looked like the obsolescence risk for the just before the outbreak of the downturn, Airbus claimed A320 and the 737NG was very low. However, things may production capacity was their main challenge. For this, as change.

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the A320 family aircraft under the same type rating. Cross crew qualifi cation allows A320 pilots to fl y the in-production Airbus widebody models as well. Although they are not always a perfect match in terms of capacity, each A320 family member is effectively competing head-on with a matching member of the 737NG within roughly the 100-200 seat market segment. In addition, most A320 versions face competition from some outsiders. However, neither Airbus nor Boeing can claim complete superiority in the narrowbody market. Both families have their own problem children (the 100-seaters), and both have their superstars (the A320 and 737-800). Despite attempts from Toulouse and Seattle to demonstrate technical or commercial superiority, most asset based fi nanciers are equally happy to fi nance the mainstream Airbus and Boeing products, but it certainly requires a more in-depth analysis to distinguish between the more and the less suitable variants of both families.

Since the fi rst A320-100 Airbus has refi ned and expanded its original single-aisle design. Shortly after the launch of the A320-100, the A320-200 was proposed. The short range A320-100 featured a low MTOW, wing fuel tanks only and A320 FAMILY MEMBERS no wingtip fences. All 21 A320-100s built are equipped with AND THEIR OPPONENTS CFM56-5A1 engines. A marginal aircraft from the start, the The basic 150-seater A320-100 made its first flight in A320-100s received 20 orders — only seven of which remain February 1987 but this version was quickly superseded by in operation. The type has never been seen as suitable for asset the more capable high maximum take-off weight (MTOW) based fi nancing. -200 version. In 1993, a 185 seat, 6.93 m. stretched version This can not be said for the A320-200, which from an asset called the A321-100 made its fi rst fl ight. In 1997, the -100 was based finance view point is close to perfection. However, effectively superseded by the more capable A321-200. and in within the 2250 A320-200’s fl ying today, there are a few niche June 1995, the A320 and A321 was given a sister in the form versions that differ enough from the popular mainstream of the 124 seat A319-100, featuring a 3.73 m. shorter fuselage aircraft to affect their suitability for fi nancing. compared to the A320. In 2002, the fourth and fi nal family Firstly, the A320-200 has a wider choice of engines compared member made its fi rst fl ight; the 107 seat A318-100 ‘double to the 737NG. While Boeing elected to offer only CFM56-7B shrink’. The A318 was aimed at operators with a small engines (at different thrust levels), Airbus offered a choice requirement for 100-seat aircraft but a desire to maintain between the International Aero Engines (P&W/RR/MTU/JAEC) fl eet commonality. Cockpit commonality has always been V2500-A1/A5 series and the CFM International (GE/Snecma) a major strength of the A320 family and a pilot can fl y all CFM56-5A/5B series, both at different thrust levels. From a

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STEP CHANGES IN TECHNOLOGY Engine technology has evolved since the A320-200’s first fl ight over 23 ago. While there is a clear difference between the 737 Classic and the 737NG, there is no sharp distinction between early and late A320s. One differentiator that is used by financiers is to call CFM56-5A powered aircraft ‘A320 Classics’, contrasting them from the more modern -5B powered aircraft. There is a trend that increasingly discriminates the older -5A powered aircraft as less desirable for fi nancing. Both CFMI and IAE continue to improve their products. The fi rst generation CFM56-5A was succeeded by the -5B and later the -5B was improved with a new 3D Aero package. In mid- 2007, CFMI introduced a tech insert upgrade, which includes changes to the high-pressure (HP) compressor, combustor, HP turbine, and low-pressure turbine nozzle. These have been designed to improve fuel burn and durability, increase time on wing, and give the engine more margin over CAEP 6 emissions levels. New tech insert components can be installed at engine overhaul except for the combustor and tech insertion has fi nancing perspective, it can be argued that the split of the A320 now become the production standard. The CFM-56-5B/P is fl eet into CFMI and IAE powered aircraft is a negative factor. available at various thrust settings, ranging from 21.6 Klb (B8) Although the competition between the two engine consortia to 33 Klb (B3). A ‘bump’ version for ‘hot and high’ airports is may result in a little more initial discounting, for remarketing also available. purposes the A320 fleet is effectively divided into two. In response, IAE also introduced an engine upgrade for their Fortunately, both engines each enjoy a substantial market base, V2500-A5, dubbed SelectOne. The upgrade includes high and hence the negative impact of the split is not too severe. low-pressure turbine improvements, an upgraded compressor, Staying with the engine selection, a few versions seem less a new variable stator vane system, and new engine control preferable. The well-publicised problems with the initial software. IAE claims up to one per cent lower fuel burn and 20 IAE V2500-A1 negatively stigmatised this version despite per cent longer time on wing from the upgrade. On October 1, successful attempts by IAE to improve the performance of the 2008, the V2500 SelectOne upgraded new engine entered into -A1 with the so-called Phoenix kit. With the -A1 fl eet largely commercial service with its launch customer. The V2500-A5 is concentrated by two big operators in India and Mexico, the available at various thrust settings, also ranging from the 22.0 future of the -A1 powered fl eet is at best uncertain. While the Klb V2522-A5 to the 33 Klb V2533-A5. A bump version for hot V2500-A5 has been performing well in general, recently a small and high airports is also offered on specifi c V2500 versions. sub-fl eet of this engine type encountered a problem. It seems Financiers generally prefer aircraft with higher thrust engines a number of A5’s operated by airlines in India have started as the cost of an engine thrust upgrade during remarketing to developed stress-cracks in a section of the high pressure can be avoided and lower thrust settings do not require compressor, most likely because of the interaction of certain additional cash. For the same reasons, fi nanciers prefer higher chemicals in the local environment with certain metallic parts MTOW variants. It should be noted that extreme thrust levels in the engines. IAE has worked out a structural solution – or MTOW’s (needed for a few market niches only) do not the replacement of some parts. For those engines that do not add much additional value. The A320-200 is available with have any cracks, a special cleaning action is required. Once MTOW’s ranging from 66,000 to 78,000 kg., with the basic implemented it should not have any long-term impact on the MTOW 73,500 kg. Extra range can be obtained by adding one or value or ability to fi nance the aircraft. two additional centre tanks (ACT) of 3000 litres each. While IAE had its -A1, CFMI had its double annular While most of the niche aircraft are so-called because of combustor (DAC) as its somewhat stigmatised engine. The DAC engine-related issues, for a small group of A320s it is because was CFMI’s answer to the request from some Northern and of the airframe. This group consists of a sub-fleet of A320s Central European carriers for an ultra-clean engine to reduce operated in India – the so-called ‘double bogies’. To lower the environmental charges imposed by the local governments. runway loads, these aircraft are equipped with four-wheeled While the DAC clearly met that requirement, it came at the main landing gears as opposed to the standard two-wheel main expense of slightly higher operational costs. Bankruptcies of gear bogies. It is thought unlikely that these aircraft will ever the original operators released a number of DAC to the market leave the Indian register. and fi nanciers were confronted with negative reactions from More recent A320s feature product improvements such as potential new operators, either for real reasons or as leverage LCD instead of CRT monitors in the cockpit, upgraded and in the negotiations. This experience created a bad name for lighter interiors as well as aerodynamic improvements (new the DAC. The DAC can be converted to normal single annular pylon shape, redesigned belly fairing etc.). None of these combustor (SAC) status by swapping the engine core however, improvements has yet seriously affected the acceptability of the this requires a signifi cant investment. previous designs regarding fi nancing.

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Like the A320, asset based financiers prefer the more for the PW6000 delayed introduction of that engine range-capable A321-200 to the A321-100 (of which only substantially and the CFM56 became the preferred engine 81 were produced). The A321-200 features structural for the A318. Currently, the PW6000 is only operated by one reinforcements, a higher weight schedule, and provisions for airline, which makes the combination rather unique but at the additional center tanks. While initially there was a structural same time, unsuitable for asset-based fi nancing. Recent market difference between the A321-100 and the A321-200, it is our experience has proven that, at least for as long as the current understanding that as of the manufacturer’s serial number downturn lasts, even a relatively young CFM56 powered A318 (MSN) 633, all -100 aircraft are effectively low MTOW -200’s could not be sold for prices that exceed the break-up value and a (paper) upgrade to -200 levels is possible. The original of the aircraft, or rather the value of its engines. From that -100’s lacked the range for US coast-to-coast operations. While perspective, the CFM powered aircraft at least have another the A321-100 has all characteristics of a niche aircraft, the edge over the unfortunate PW6000. With new technology -200 (although not as remarketable as the A320-200) enjoys geared turbo fan (GTF) replacement technology on the horizon, a sizeable market base. From that viewpoint, it can still it remains to be seen if the PW6000 story will ever have a happy claim superiority over its (much younger) opponent, the 737- ending. For the time being our conclusion has to be that the 900/900ER. The A321-200 is offered with MTOW’s ranging A318 does not make a popular asset from a fi nancier’s point from 89.000 to 93.500 kg., with the basic MTOW 89.000 kg of view. The A318CJ corporate jet version does have a certain although some airlines are known to operate lower MTOW popularity in the corporate jet market. to benefi t from reduced landing and navigation charges. Up to two ACT’s are optional. There are also a small number of DAC-powered A320s. The second most popular member of the family is a simple shrink from the baseline A320. The operator base is split between CFM56 and V2500-A5 operators. Apart from some DAC powered planes, the A319 has relatively few problem variants. A wide range of operators, from traditional network carriers to LCC’s and even corporate and private jet operators use the type. The A319 is well-suited to asset based fi nance, albeit some of the older -5A powered aircraft may be ending up at second or third tier airlines as result of the current market downturn. For transactions involving well-maintained, standard specification A320s there seem to be few things that can go wrong — as long as realistic valuations and value projections are assumed. The A319-100 is available with MTOW’s ranging from 64.000 to 75.500 kg. and up to two ACT’s are optional. VALUES AND RISKS Last and least is the A318. The double-shrink A318 is the With its production history spanning over 20 years, the problem child of the A320 family in terms of market acceptance A320 is an ideal aircraft to track long-term aircraft value and the ability to remarket. With 100-110 seats, the A318 is dynamics. Interestingly enough, since the fi rst A320-200s effectively a competitor to the big regional jets, such as the were delivered in 1988, the ‘historic’ current market values E190 and E195 and to a lesser degree the CRJ900 and 1000. (as reported by appraisal fi rm Ascend) have largely fl uctuated As always, a shrink version and especially a double-shrink with the ups-and-downs of the market, without much of a version suffers from an over-dimensioned heavy structure, clear upward or downward trend. This is indicated by the which seldom results in an efficient aircraft. The 737-600 almost horizontal trend-line in the value graph above. While suffers from the same problem. The A318-100’s MTOW ranges these appraised value figures are not the same as the net from 56.000 to 68.000 kg. While not as effi cient as the stretched fl yaway prices paid by Airbus’ airline and lessor customers super-regionals, the main advantage the A318 had to offer was (a carefully kept secret), they should give a good indication its commonality with the other family members. While the about the price dynamics of a new A320-200. So, while engines powering larger members of the family are obviously Airbus and the engine OEM’s have improved their products too heavy for the little A318, offering a more optimised engine signifi cantly over the last two decades, the price has stayed type would jeopardise the important commonality benefit. fairly fl at with fl uctuations largely driven by the condition Airbus decided to offer both options: Airlines that already of the market. For an asset based fi nancier this is important operated CFM-powered aircraft and preferred the commonality to keep in mind. It must be said that the A320 was launched element could select a CFM56-5B8/9 powered A318, while some years after the era of hyperinfl ation. Should infl ation airlines preferring an optimised power-plant could select the increase signifi cantly in the coming year as a result of the Pratt & Whitney PW6000 engine developed uniquely for the billions of dollars injected in the global economy, this could A318. Unfortunately, no commonality could be offered with result in an upward trend for new aircraft prices as well. V2500 powered aircraft. It should be taken into account that the above is not to be With the A318 already a slow seller, development problems confused with the so-called escalation clauses in airline

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purchase contracts. These escalation clauses do increase the THE FUTURE net fl yaway price of the aircraft between the date of signing Based on statements from both Airbus and Boeing, it seems the contract and the date of delivery. This mechanism can in that production of the A320 and 737NG could continue some cases result in delivery prices, signifi cantly exceeding until the end of the next decade. Both manufacturers have the spot market, especially in case of long lead times. indicated that current technology, in particular engine Historically, used A320 values have fl uctuated slightly more technology, will not bring the required gains in operational than 737NG values. While Airbus is occasionally accused cost for a new generation of mainline 150-seater aircraft of a more aggressive pricing policy, allegedly resulting in required to justify the launch of a successor. Will this mean signifi cant discounts, it is unlikely to be an explanation for the that technological improvements to the A320 will only be higher volatility. Because the A320 was launched long before evolutionary? Airbus already introduced the CFM-56 Tech the 737NG the A320 has lived through more downturns. As a Insert and V2500 SelectOne engines, improved aerodynamics, coincidence, a number of A320 operators defaulted during the and will soon add a redesigned upper-belly fairing. At the time post 9/11 crisis while most of the 737NG operators survived. of writing, another potential aerodynamic improvement was Consequently, a higher number of A320s faced distressed being tested — a set of larger NG-style winglets. For existing market circumstances compared to the rival 737NG. While A320 operators, it will be important to learn which of these asset base fi nancing is focused on the aircraft, the quality and improvements can be retrofi tted, especially given the upward concentration of the operator base does play a role. As history trend in fuel prices. has proven, a high fl eet concentration with one or more weaker The prospect of a more or less radical mid-life update is causing much speculation. The main feature of the assumed update would essentially comprise the re-engining of the existing airframe. While none of the incumbent airframe and engine OEM’s in the 150-seat market have a real incentive to push this, Pratt & Whitney has much to gain and has developed the GTF with the clear intention to regain lost ground in the market. P&W’s GTF, now called the PurePower PW1000G , is already on board the smaller CSeries, the Russian MS-21, and the MRJ. It seems the Chinese narrowbody programme, the C919 will select the CFMI LEAP-X. .Both Airbus and Boeing have announced they are studying programmes to equip their existing airframes with the new CFMI and/or PurePower engines. While no immediate impact on the existing A320 fl eet is expected, should a signifi cantly more effi cient GTF or LEAP-X powered A320 or 737 become a reality, it will probably have consequences for future values of existing aircraft, and late-built A320s and 737s in particular. Asset based fi nanciers will fi nd this development worth watching as despite protestations to the contrary from

interested parties, the potential damage to future values of existing portfolios is significant. Previously similar step- changes in engine technology were applied to create the 737NG from the 737 Classic aircraft family and so the market is not unfamiliar with the practice. With respect to the eventual successor for the A320 airlines increases vulnerability of the type. (frequently referred to as a ‘game-changer’), very little seems

There are a number of signifi cant fl eet concentrations, clear except that we are unlikely to see this aircraft in the air both for the individual types and the collective family. before 2020. Current thinking is in terms of a greener, more fuel A thorough analysis of the default probability of any of effi cient, quieter aircraft with lower maintenance costs. Radical the major operators should be a part of due diligence, designs like a small twin-aisle, a lifting blended-wing body and even for an asset-based fi nancier. open rotor engine technology also cannot be excluded. The current surplus of A320 Family aircraft (as Less in the realm of science fi ction is the future of the A320 represented by the fl eet percentage ‘in storage’) is relatively and A321 as a cargo aircraft. Airbus Freighter Conversion modest – as is to be expected for a modern, liquid single aisle GmbH, a JV between EADS-EFW and UAC-Irkut, is developing aircraft. While a little over 11 per cent of the entire Western- a passenger-to-freighter (P2F) modification programme for built jet fl eet is in storage, the highest storage of any series the A320 and A321. Certification of the cargo conversion within the A320 Family is for the A320 with only 3.8 per cent is expected by the end of 2011 for the A320 and end of 2012 (according to Ascend online, August 2) — not bad for a type for the A321. The project found a launch customer at the that has been in production for over 20 years. The storage Farnborough Air Show in 2008 when Aercap announced percentages for the A319 and the A321 are also negligible. an order for 30 conversions for its own portfolio of A320s.

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Unfortunately, the development of the project coincided with one of the worst downturns in the cargo market and cargo operators seem more focused on survival than on fl eet renewal, let alone expansion. Competing in a market used to Boeing narrowbody freighters, the A320 will have a tough job establishing itself. Clearly, the A320 will offer more modern technology as well as a larger fuselage cross section plus signifi cant belly cargo volume. As a side effect of the current crisis, feedstock passenger A320s and A321s may become affordable for conversion sooner than anticipated. From a fi nancier’s point of view the availability of an afterlife in the cargo market is without any doubt a strong positive element when analysing a commercial jet..Such programmes have engine segment can be viewed negatively compared to the traditionally improved re-marketability and had a positive competing 737NG, the absolute size of both segments is such effect on residual values. Many investors have come to view the that the impact on financing is minimal. The value history availability of a cargo conversion project as an insurance policy of the A320 confirms its suitability for financing. The main for early-build aircraft. uncertainty for the A320 Family seems to be the timing of The majority of A320 Family members are among the most the service-entry of any successor models. While Airbus has liquid commercial jets in the current market. From an asset implied this will be post-2020, the possibility of a new engine based fi nancier’s point of view, the A319, A320 and A321 are option (NEO) for the A320 Family remains the subject of much among the most attractive aircraft types. The A318 clearly falls speculation. outside of this category. Despite this, a number of ‘odd ball’ Whatever final decision materialises, a radical open-rotor A320 members will generally be avoided by fi nanciers or will powered lifting body or a simple conventional re-engining, only be considered under very conservative terms. In addition, it will be a challenge for Airbus to create an aircraft that can early-built A320 Classics no longer command the confi dence of exceed the attractiveness of the A320 for the air finance most fi nanciers. community. It will take a long time before that aircraft will also While the division of the A320 fl eet into a CFM and an IAE be referred to as a ‘no-brainer’. ■

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