Wednesday, September 19, 2012

Lessor defends aircraft industry in accounting spat

PARIS, Sept 19 (Reuters) - The aircraft leasing industry has hit back at criticism from its lenders over the way it values hundreds of billions of dollars of passenger jets in an obscure dispute that could hit the pockets of air travellers and the world's leading planemakers.

Irish leasing firm Avolon defended the industry's accounting practices in a detailed study issued on Wednesday as a major industry gathering got under way in Rome, hoping to put to rest a debate that has been troubling the industry for some months.

For years the aircraft leasing industry, which rents jetliners to airlines and owns about two airliners in five in the global fleet, operated on a rule of thumb that passenger jets fly on average for 25 years. It wrote down the value of its assets and built up its business models accordingly.

But the practice came under fire after a few jets became unprofitable and were broken up for their parts with just a few years on the clock, due in part to soaring fuel costs.

Critics including some of the industry's top bankers say the industry should make its accounting system more conservative by shortening the depreciation period and thus driving up annual charges, a move that could directly threaten lessors' profits.

But Dublin-based Avolon, after analysing data on every passenger jet ever placed in service, said that there was no reason to alter the widely used accounting practice.

"We are not seeing seismic shifts in the way the industry is behaving or the way fleets are being retired compared to 10 or 20 years ago," said Dick Forsberg, author of the report which is likely to be discussed at the ISTAT finance conference in Rome.

On average jets have been retired after about 26 years and 60 percent of all jets ever built have still been flying at 25 years, he said. Of all the passenger jets ever built in a half-century of mass air travel, two out of three are still flying.

Analysts say a change in accounting methods could have far-reaching consequences on the economics of airlines and suppliers, starting with higher aircraft lease rates for airlines that would most likely be passed on to passengers.

The leasing industry occupies a powerful position in a food chain stretching from assembly plants to airlines and the giant-clawed machines that eventually tear up old jets for scrap.

Many airlines find it more efficient to lease aircraft than own them, spawning a specialist rental industry that now controls about 40 percent of the global fleet.

Experts say when lease rates for new planes go up, airlines tend to hold older aircraft for longer, depressing demand for newer aircraft built by Airbus and Boeing.

"The increase in costs that would have to be passed on to the airline would be significant enough that it could affect ownership patterns," Forsberg said in an interview.

But some lenders to the leasing business remain convinced of a problem. Bertrand Grabowski, managing director of aviation finance at DVB Bank, said book values had fallen out of step with real markets, potentially distorting industry finances.

"If depreciation rates do not reflect the reality of values, clearly some P+L are overstated and in the long run this is not good for the industry," he said of the risk that profit and loss accounts reflected lower depreciation costs than they should.

Under current practice, accountants write down the purchase cost of aircraft over 25 years, down to a residual value of 15 percent. This equals an annual depreciation rate of 3.4 percent.

Grabowski said a depreciation policy of 20 years down to zero would better reflect real aircraft values, a suggestion which implies annual depreciation closer to 5 percent.

The debate simmers just as the aircraft industry is recovering from fears over the availability of finance after European banks pulled back due to the region's debt crisis.

Large sums ride on the discussions, but it is still relatively unexplored territory - a reminder that the jet age began in earnest barely 50 years ago with the Boeing 707.

As with the baby-boom generation whose love affair with the jet shaped the industry, aircraft retirements are likely to soar in the next decade when Avolon estimates 8,000 will stop flying - about as many as went off to scrap since the jet age began.

When jetliners stop making money they can be sold, stored in deserts, where dry air prevents corrosion, or get converted to freighters. Eventually they retire and get broken up for parts.

Some say one of the reasons some airlines have been willing to scrap small and less sought-after jetliners after just a few years in use is to cash in on prices for second-hand engines.

These have been rising sharply as manufacturers like General Electric divert most of their resources to supporting record production for new Airbus and Boeing jets, Forsberg said, rather than keeping a supply of engines available as spares.


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