The Federal Aviation Administration (“FAA”) grants authority to operate scheduled air service in the form of Federal Aviation Regulations (“FAR”). Air carriers authorized to operate under Part 121 are generally large, U.S.-based airlines, regional air carriers, and all cargo operators. Most would consider the General Aviation (“GA”) category to include only light, small-engine private aircraft but even a jet or cargo aircraft that are operated under Federal Aviation Regulations may be considered GA aircraft. General aviation typically encompasses Part 91 and Part 135 operations. Part 91 operations fall into the category of a private pilot flying with friends or family. Part 135 operations detail the regulations for commuter operations and on-demand air charter operators. Part 135 only applies to aircraft with 30 or fewer seats or a maximum payload capacity of 7,500 pounds (including private jets). General aviation aircraft account for 92% of all aircraft in the U.S. and more than 65% of flight hours flown. More than 5,000 local and community airports are exclusively built to service general aviation aircraft. Flight training is governed under one of two parts: Part 141 pilot schools offer structured training suiting full-time students with an aviation career in mind. Part 61 schools provide the flexibility to train at your own pace with a personalized program.
On May 16, 2024, the President signed legislation reauthorizing the FAA through Fiscal Year (“FY”) 2028 stating; “It will expand critical protections for air travelers, strengthen safety standards, and support pilots, flight attendants, and air traffic controllers.” The reauthorization includes aviation workforce development grants to help flight schools prepare students to become aircraft pilots which can also be used to support the professional development of teachers delivering eligible aviation curriculum. It authorizes more than $105 billion in funding for the FAA as well as $738 Million for the National Transportation Safety Board for fiscal years 2024 through 2028. It left in place the requirement of a minimum of 1,500 hours of flight time as a Pilot in Command before receiving a commercial airline pilot certification (the Airline Transport Pilot, “ATP” certificate is the highest pilot license the FAA issues). Older commercial airline pilots continue to face a mandatory retirement age of 65 which was put in place in 2007 when it was raised to be consistent with international rules that prevent pilots older than 65 from flying internationally.
As new Boeing aircraft deliveries have been scaled back commercial air carriers are slowing or pausing pilot hiring. Flight schools are exploring alternatives that will get students on a flight deck sooner[1]. The Aircraft Owners and Pilots Association (“AOPA”) reports commercial airline pilot hiring softened in the first months of 2024. As a result, the outlook for pilot supply looks better than a year ago. But it’s the regional carriers who are short pilots in Command Captains. The Regional Airline Association reports FAA pilot certifications of 11,225 in 2023 while major airlines hired 12,193; in 2022 the majors hired 13,128 pilots while only 9,491 new pilots qualified[2]. The majors are hiring away regional airline Captains (Pilots in Command). Compounding the pilot challenge is the fact that over the next 15 years, 50% of commercial airline pilots will be forced to retire at age 65.
With the recent acquisition of the assets of Brown Aviation Lease, RESIDCO plans to actively support aircraft lease financing for flight school and university aviation training programs. To investigate other General Aviation investment[3] opportunities, Call RESIDCO.
Glenn Davis 312-635-3161
[1] Pilots operating a Part 135 (Private Charter) aircraft need at least 500 total flight hours, 100 cross-country, and 25 hours at night.
[2] Regional Airline Association statement released February 7, 2024.
[3] For 2023, the General Aviation Manufacturers Association (“GAMA”) reported new deliveries of 1,682 single-engine piston aircraft, 638 turboprops, and 730 business jets. At the end of 2022, the FAA reported a total of 164,567 fixed-wing GA aircraft in service.
Year to date Rail carloads through the end of April totaled 3.63 million, down 4.8% from last year. Total carloads have fallen year over year in each of the first four months of this year. Excluding coal however, total carloads are up 2% over April 2023 and have risen year over year in each of the last three months. April coal averaged 46,303 carloads per week, down 28% from April 2023. Coal accounted for 21.8% of non-intermodal U.S. rail volume in April, coal’s smallest share for any month as reported by the AAR Policy and Economics Department. Unseasonably early warm weather resulted in record low natural gas prices which resulted in a significant decline in coal demand. However, low natural gas prices benefit plastic producers who use natural gas as a feedstock and/or an energy source (rail carloads of plastic are up this year). Rail Labor issues loom as Teamsters Canada may simultaneously strike both of Canada’s large railroads (CN, CPKC). Under Canadian labor law, the unions cannot begin a strike until the Canadian Industrial Relations Board issues a decision regarding whether the two roads must continue to transport essential goods during a strike.
At his May 1 press conference, Fed Chairman Jerome Powell said, “While the economic outlook is ‘uncertain’ growth to date has been solid,” citing robust consumer spending, improving supply conditions, and a labor market that remains relatively tight. Interest rates were held steady at that meeting and the Fed is expected to hold rates steady at their next meeting June 11-12. Average hourly earnings for non-supervisory and production workers were 4% higher in April than a year earlier. With consumer inflation not yet under control the Conference Board’s Index fell to 97.0 from 103.1 in March, the third consecutive decline and its lowest level since July 2022.
Records were broken at U.S. airports over the Memorial Day weekend. The Transportation Security Administration said they screened nearly 3 million people on Friday alone, breaking a single-day record. U.S. airlines expect to carry a record number of passengers this summer, 271 million between June 1 and August 31, which would break the 255 million record set last summer. Airfares are down 6% from a year ago so there has been no slowdown at airports. American is offering its most ambitious summer schedule ever – 690,000 flights between May 17 and September 3rd. United had expected nearly 10% more Memorial Day passengers than last year, Delta expected 5% more. Delta is scheduling its heaviest summer international flight schedule ever (London, Paris, Rome). New aircraft delivery delays continue as Boeing continues to slow production to resolve production quality issues, delivering only 67 737 Max in the first quarter and 16 in April. Boeing’s total aircraft deliveries (24) in April were the lowest in a month since February 2022, which of course tightened demand for existing aircraft.
Summer uncertainties create market opportunities. Turn those uncertainties into opportunities by obtaining more information, measuring probabilities, using models to look for patterns, seeking to diversify exposure, stress testing, ensuring you are getting paid for the risk you are taking, and that the investment risk you take remains within tolerances set by the firm’s stakeholders.
This summer, Aero and Rail opportunities that deliver excess returns per unit of risk exist. For additional details Call RESIDCO.
Glenn Davis 312-635-3161
The U.S. economy expanded 2.5% in 2023 (3.4% in Q4). While growth slowed to 1.6% in 2024’s Q1[1] the International Monetary Fund expects U.S. GDP to expand 2.7% in 2024, up from their October forecast of 1.5%. Global economic output (in the face of geopolitical strife) is expected to expand by 3.2% in 2024 (up from an October 2.9% forecast). With air travel rebounding, Domestic Aviation’s Spring 2024 Air Travel forecast 167.1 million passengers between March 1 and April 30 (2.7 million per day)[2]. Delta expects strong summer demand. Overall IATA forecasts a 2024 record year of 4.7 billion passengers. Air carriers would like delivery of newer more fuel-efficient aircraft but both Boeing and Airbus deliveries are months late. The average age of airline-owned passenger aircraft was 16 years in 2024 (up from 14 in 2019). Planes typically are used for 25 years and many fly longer with proper maintenance. To keep up with the recovery of air travel air carriers are extending the service lives of existing mid-life equipment. Delta has not retired any aircraft in 2022 or 2023[3]. Lufthansa is bulk buying parts and developing their own in-house repair solutions. Delta’s maintenance and repair operations business (Delta TechOps) is currently focused on maintaining the in-service reliability of their existing Boeing 717s, 757s, and 767s. Industry-wide, a little under 200 Boeing 757s remained in service in 2023, and slightly over 200 767s are in service in 2024.
Newer aircraft are grounded due to the ongoing Pratt & Whitney engine issues. Cirium data shows 637 GTF-powered aircraft parked as of April 1. Repair capacity limitations and parts shortages are constraining supply. Manufacturers’ higher prices on new engines have reduced the incentive to switch to newer equipment. The resulting undersupply of aircraft and engines has led to increased values and increasing lease rates. Typical lease rates for a 10-year-old Boeing 737-800 (which preceded the MAX), were around $220K per month in January 2024, up from $183K in January 2023 and $156K in 2022. In a recent KPMG Aviation Industry Leaders Report, Avolon CEO Andy Cronin stated “2024 markets are positive and likely to drive lease rates and residual values higher”. Some carriers are buying aircraft they have been leasing rather than negotiating lease extensions. Per Cronin, the industry is some 3,000 planes short (15% of global capacity) of what was expected pre-Covid due to pandemic disruptions and OEM equipment delivery delays. With the added 737 MAX delivery slowdown existing mid-life aircraft equipment will remain in service.
Trinity Industries[4] reports improving railcar lease fundamentals (their future lease rate differential is +23.7% and fleet utilization is 97.5%. Full-year average renewal lease rates were approximately 30% higher than expiring rates with average lease renewal terms of 54 months. GATX[5] similarly reports 99.4% fleet utilization, lease renewal rates 33% higher, and average renewal terms of 64 months. High steel prices have elevated the pricing of new railcars and led to increased scrapping of idle equipment.
Even with economic, political, and trade uncertainties, higher lease rates and strong secondary markets are creating opportunities. Call RESIDCO.
Glenn Davis 312-635-3161
[1] U.S. Bureau of Economic Analytics, March 28, 2024.
[2] Airlines for America, Spring 2024 Air Travel Forecast.
[3] Aviation Week, April 22, 2024, Delta Eager to Grow Third-Party MRO Business.
New Equipment Quality Control Issue, Bolsters Demand for Midlife Aircraft
Moving pieces. Third Quarter U.S. GDP growth was revised down to 4.9% from November’s 5.2% second estimate. The National Association for Business Economics is expecting 2024 GDP growth to slow to 1% with a recession risk in the next 12 months under 50%. As inflation slows and with a “soft landing” in sight, the Fed is leaving interest rates unchanged. The federal funds rate is expected to be 4.6% at the end of 2024 down from its current 5.5%, which implies three quarter-point cuts in 2024. Those rate reductions are dependent on the impact current rates have on economic activity and whether inflation is sufficiently close to the Fed’s 2% target (the Fed’s personal consumption expenditures index is expected to approach
2.4% by the end of 2024). The Bureau of Labor Statistics reported 2.7 million net new jobs created in 2023; 672,000 in government, 654,000 in health care, 298,000 in food services, 266,000 in social services, 197,000 in construction, and 12,000 in manufacturing. Transportation and warehousing lost 63,000 jobs[1]. The Index of Consumer Confidence rose to 110.7, in December up from 101.0 in November, reflecting more favorable consumer views of inflation, levels of personal income, and job availability.
U.S. Rail carload traffic for 2023 was 11,701,875, up .7%, the most for a full year since 2019. Carloads were up in 10 of the 20 AAR categories led by motor vehicles and parts, petroleum products, and crushed stone and sand. Intermodal at 12,667,354 units (containers and trailers) was down 4.9% for 2023 but up 5.5% in the fourth quarter over the fourth quarter of 2022, its biggest quarterly percentage gain since the second quarter of 2021. Coal remains the largest U.S. rail carload commodity accounting for 29.2% of total originated carloads. Lease fleet utilization and renewal rates remain favorable.
Boeing’s manufacturing quality control challenges continue as a door plug of a recently delivered 737 Max 9 blew out on January 6th shortly after takeoff. The next day, the FAA issued an emergency airworthiness directive, temporarily grounding 170 of the type to allow investigation and immediate inspection. The door plug involved in the incident was manufactured in Malaysia, and installed by Spirit AeroSystems in Kansas (Boeing’s fuselage supplier), and then apparently removed and reinstalled by Boeing at its Renton, Washington assembly facility[2]. The grounded jets are being allowed to resume flying after mandated inspections are completed. But there are now broader concerns regarding Boeing’s manufacturing assembly, supply chain, and inspection compliance as demonstrated by the FAA Administrator Mike Whitaker’s announcement, “We will not agree to any request from Boeing for an expansion in production or approve additional production lines for the 737 MAX until we are satisfied the quality control issues uncovered are resolved”[3]. As oversight increases Max 9 deliveries will be delayed, further delaying certification of the Max 7 and Max 10 and impacting 2024 air carrier fleeting plans as they consider alternatives[4]. New aircraft may have the latest technology, but OEM airframe and geared turbofan engine quality controls and supplier oversight issues are making air carriers and the flying public more comfortable with the reliability of existing midlife equipment. Identifying placement opportunities for Aero and Rail equipment investment requires expert market insight. Call RESIDCO.
Glenn Davis 312-635-3161
davis@residco.com
[1] The Employment Situation, January 10, 2024, Rail Time Indicators, American Association of Railroads.
[2] Wall Street Journal, “FAA Clears Path for MAX 9”, January 25, 2024.
[3] Federal Aviation Administration, January 24, 2024.
[4] United, Boeing’s biggest customer, is considering fleeting alternatives that do not include the Max 10 which is five years behind its original delivery date.
The Fed’s preferred inflation measure, the core personal consumption expenditures price index (“PCE”) fell to 1.9% in November. This latest data confirms inflation is slowing. On a year-over-year basis, the PCE was 2.6%, the lowest since February 2021. With the full impact of interest rates yet to be felt (housing is struggling, and the Conference Board’s index of leading economic indicators is down 3.3% in the past six months) the Fed remains concerned. “It’s far too early to declare victory and there are certainly risks“[1]. The Fed held rates steady at its December meeting but is now anticipating three rate cuts in 2024. The pivot makes a recession less likely. December projections see the federal funds rate ending 2024 between 4.5% and 4.75%, down from the current range of 5.25% to 5.5% (.75% lower than today). The markets have responded. The S&P is up 14% over the last two months, the 10-year Treasury yield has fallen nearly a percentage point (to 4.03%), and the dollar has dropped 3% against major currencies[2]. The Fed’s estimate of the long-term “neutral” policy rate remains unchanged at 2.5%. That implies that a lower interest rate environment will return even though the Fed is continuing to allow $95 billion a month in proceeds from maturing bonds to roll off its balance sheet (with no indication of stopping).
Aviation capacity issues continue. Airbus and Boeing will have delivered around 1,400 aircraft in 2023 (a 27% increase over 2022). However, the Aero industry continues to grapple with costly and time-consuming quality control issues. Regulators require close monitoring of parts for authenticity and quality. Dealing with manufacturing defects, the certification of aircraft engine components, and airframe maintenance is leading to the grounding of delivered aircraft as well as delays in new equipment deliveries. The resulting shortage of capacity leads to better returns on existing mid-life equipment. Out-of-production single-aisle aircraft have shown meaningful increases in lease rates as the lessor idle fleet returned to service (and there’s not a lot of existing equipment left). New equipment supply remains constrained, underpinning existing equipment values & lease rates. The result is mid-life single-aisle equipment remains in high demand (current OEM backlogs mean the first available delivery slots for new equipment will be in the 2030s).
Even with flat loadings, railcar prices up 12% to 15%. Scrap rates remain elevated. In the last twelve months, railcar lease rates are up 26% to 33%, with lease terms extending to five years[3]. Both GATX’s Lease Price Indicator and TrinityRail’s Forward Lease Rate Differential continue their upward trend. “Forward-looking metrics continue to point toward consistent strength in lease rates[4]. ”Key commodity market demand across all railcar types is driving substantial new equipment order backlogs at both Trinity and Greenbrier. The eleven North American railcar assembly plants have an estimated industry build capacity of up to 55,000 cars annually (FreightCar America’s new production facility in Mexico is expected to deliver 3,150 to 3,300 railcars in 2023). With a soft landing in sight for the U.S. Economy, concerns surrounding inflation and interest rates are subsiding. But, elevated geopolitical risk and 2024 election year dynamics require expert Aero and Rail equipment investment insight. Call RESIDCO.
Glenn Davis 312-635-3161
[1] Fed Chief Powell’s Post Meeting Press Conference, December 13, 2023.
[2] The Wall Street Journal, December 14, 2023 “Capital Account”.
[3] Railway Age, Sea Change in Railcar Supply, December 5, 2023. Higher new railcar prices drive higher lease rates on existing equipment.
[4] Trinity Industries, third-quarter 2023 earnings statement.
Rail traffic volumes remain challenged while Air Carriers face capacity constraints as they attempt to meet the rebound in domestic and international flights. United reported solid domestic and record-breaking international performance with third-quarter revenues up 12.5% year over year. The company set a record for the highest-ever daily average of revenue passengers carried in a quarter (more than 482,000 passengers)1. Delta reported record September quarter revenue ($15.5 billion), a double-digit operating margin (12.8%), and pre-tax income of $1.5 billion. American Airlines reported a third-quarter loss2 resulting from higher costs and a new pilot union contract. Higher labor and maintenance costs and delayed delivery of new aircraft are impacting available capacity and profitability for all three carriers. While fuel costs per available seat mile are lower3 than last year Air Carriers expect oil prices will be volatile over concerns the Israel-Hamas war might escalate.
Airframer delivery delays are being caused by supply chain and new engine reliability issues. In August, Boeing discovered manufacturing defects in the rear of 737 fuselages (mis-drilled fastener holes in a key structural part). That followed an earlier April production disruption caused by incorrectly installed brackets that connect the MAX’s aft fuselage with its vertical tail. As a result, Boeing’s September deliveries of their 737Max jets fell to their lowest level4 in more than two years. The delivery delays and durability problems with the Geared Turbofan and LEAP engines are increasing the values and lease rates of existing mid-life Aero equipment and engines (in August the value of an Airbus A320-200 rose 10% and lease rates for the jet were up 6%).5
On the rail side, total U.S. carloads were down .3% in the third quarter. Union Pacific reported declining freight rail volumes and revenue across their key commodity groups6. UP’s revenue from coal, metals, industrial chemicals, and energy products fell. Carloads of forest products fell 13% as rising mortgage rates impacted home sales (thirty-year mortgage rates are 7.5%, the highest in 23 years). U.S. carloads of grain through the third quarter were down 12.7% from last year, the lowest for the first nine months since 2013 (due to lower exports). Levels of freight rail traffic imply a risk of an economic slowdown (the Manufacturing PMI remains in negative territory for the 11th straight month), but consumer spending isn’t collapsing. Third quarter U.S. GDP grew 4.9% compared to 2.1% in the second quarter. In September, motor vehicles and parts had the biggest carload gains. Consumer sentiment remains stable supported by a strong labor market (a preliminary 336,000 net new jobs were created in September). The Services PMI remains in expansion territory while spending on services is rising faster than spending on merchandise.
More than 300 suppliers are needed to build a Boeing 737 Max. Parts come from more than 50 countries. Geopolitical conflicts are not helping. To better understand and deal with current and expected values and lease rates for Aero and Rail assets, Call RESIDCO.
Glenn Davis 312-635-3161
[2] American lost $545 Million in the third quarter. Revenue was flat with last summer and costs rose. United reported $814 million of expenses during the nine months ended September 30, 2023, associated with agreements with their Pilots Union and other Aerospace Work groups.
[4] Boeing reported 15 new 737 jets, 10 787s, and two 777s for a total of 27 deliveries for the month of September. Reuters, October 2023.
[5] Wall Street Journal, Heard on the Street, October 2023.
[6] Union Pacific Profit Declined as Freight Demand Weakens, Wall Street Journal, October 2023.
Most Aircraft operating leases provide that the lessee is responsible for maintaining leased aircraft to required industry standards. To ensure flight safety the FAA issues Airworthiness Directives (ADs) and aircraft manufacturers issue Service Bulletins (SBs). ADs are legally enforceable regulations meant to correct unsafe conditions. Airframes, engines, avionics, and other aircraft components (landing gear, auxiliary power units, hydraulics, electrical, etc.) must be properly maintained to ensure flight safety.
Maintenance reserve payments are a critical part of Lessor/Lessee lease negotiations. These ‘supplemental rents’ are generally calculated on a flight hour, flight cycle basis and usually paid on a monthly in arrears basis. New equipment OEM warranties do not cover scheduled maintenance or major inspections. A current example is the troubles with new Pratt & Whitney Geared Turbo Fan (“GTF”) engines which are used in about 40% of Airbus A320neo single-aisle jets. Pratt & Whitney’s parent RTX (formerly Raytheon) Chief Executive Greg Hayes recently made calls to customers[1] (this past July 18th) announcing an investigation had determined that contaminants in a powdered metal used to produce the PW1100 engine’s high-pressure turbine discs (part of the engine core) could lead to premature failure. “Engines delivered between the fourth quarter of 2015 through the third quarter of 2021 will need to be inspected to determine whether repairs are required.” Given time in service, an initial group of 200 engines is scheduled to be checked by mid-September, and up to an additional 1000 engines will need to be removed from service over the next year. Inspection and possible replacement of affected discs requires removing the engine, disassembling, inspecting, and then reassembling; a process that can take up to 60 days for each engine. Air carriers have complained that the GTF engine has had durability issues since introduced. In May, Bloomberg reported about one in eight A320neos and other aircraft with the GTF was in storage for 30 days or longer awaiting repairs (spare parts shortages continue).
Taking equipment out of service for unplanned maintenance results in reduced capacity and disruption of flight crew and support personnel. As an OEM, Pratt & Whitney will be responsible for compensating customers for these engine inspections and repairs as planes are taken out of service. An initial charge of $500 Million has been taken to cover the cost of inspection, repair, and compensation for the first batch of GTF engines being checked. This adds to the more than 100 GTF-powered Airbus A320neo and A220 that have already been grounded due to earlier engine durability problems which included oil leak and vibrations concerns.
For rail equipment, the Federal Railway Administration (FRA) and the Association of American Railroads (AAR) published a set of rules and regulations all railroad car owners (whether private or railroad-owned) must subscribe to in order to operate equipment in interchange service. The interchange rules are detailed in two manuals, the “AAR Field Manual” and the “AAR Office Manual”[2]. The Manuals provide that Railcar Owners are responsible for repairs to their cars necessitated by ordinary wear and tear and for regulatory safety requirements set by the Association of American Railroads. Railinc is the operating arm of the AAR that is responsible for the publication of rules, regulations, and railcar equipment mechanical status. Each handling road is responsible for the condition of cars operating on their line. Railroads inspect and perform “running repairs” to ensure cars are safe to operate. The handling road has the right to send the car owner a bill for necessary repairs. Private (non-railroad) car shops (with lower labor rates) provide service for specialized car types, heavy repairs, complete refurbishment, and an alternative to higher-priced railroad running repairs. There are literally hundreds of components and a myriad of reasons for railcar repairs. Proactive management and audit of repair bills are required to ensure the right repair is being made and the right price is being charged. The Manuals also provide for damage settlement occurring resulting from unfair usage or improper protection by the handling road. With a freight car fleet of 1,625,000 cars, imagine the amount of data that is available.
Looking for answers? Call RESIDCO, a proven Aero and Rail equipment management team.
Glenn Davis, 312-635-3161
[1] Jet Blue, Spirit, Hawaiian Airlines, Wizz Air, Lufthansa, Mexico’s Volaris, and others.
[2] Association of American Railroads (AAR), Digital Field and Office Manuals.
Pent up demand from pandemic lockdowns. Government stimulus ($5 Trillion). The Fed’s past abnormally low interest rate policy. These are the causes of the current distortions in economic activity. U.S. annual Core consumer price inflation remains high, 5.3%[1]. Wage growth continues. American Airlines pilots agreed to a new contract that boosts pay by 21% in 2023. Recent Class One national labor agreements resulted in a 24% wage increase during the five-year period from 2020 to 2024[2].
Current travel demand has driven Air Carriers back to nearly 100% of 2019 operations. Even with higher ticket pricing, there has been no slowdown in bookings. The lack of currently available new equipment[3] has resulted in a strong demand for immediately available narrowbody aircraft. Air transport markets are highly competitive, with low-profit margins. Fuel and labor are significant components of Air Carrier operating expenses. Any variation in these costs directly impacts operating profits. Lower energy prices and new engine technology provide direct economic benefits allowing more competitive pricing. Crude oil prices are down. July contracts for West Texas Intermediate (“WTI”) crude recently settled at $72.58 a barrel while Brent crude (the global benchmark) was $77.14 a barrel. China’s economic restart is stalling, Russian crude is continuing to flow, and the uncertain direction of the global economy is driving crude oil down further (WTI closed at $69.51 after the Bank of England raised interest rates to 5%). Without substantial technological improvements in alternative propulsion systems (or significant increases in the cost of crude), current equipment will remain competitive.
U.S. GDP data shows consumers are spending, and companies are hiring. In their June meeting the Federal Open Market Committee (“FOMC”) decided to leave interest rates unchanged (target range now between 5%-5.25%). Fed Chairman Powell signaled two more increases this year. Individual members of the FOMC expect a rate of 5.6% by the end of 2023. Rising interest rates paired with persistent inflation have led the Conference Board to predict, “A contraction of economic activity leading to a mild recession.” The Conference Board’s Leading Economic Index (“LEI”) is designed to provide an early indication of turning points in the business cycle. It’s declined in each of the last fourteen months. But 339,000 net new jobs were created in May (double what economists expected), auto sales are holding up, and April single-family housing starts were the most in four months.
Air transport is integral in the globalization of transport networks. More efficient engines and better aerodynamics have improved with each new generation of aircraft. Underlying price pressures and recession fears may lead to a slowing economy, but the U.S. economy continues to perform. The result is far fewer mid-life narrow-body aircraft are being retired. The pivot toward clean energy has begun but will take time and investment to complete.
It’s clear Aero and Rail needs will continue. Positioning transportation investment for the future requires underwriting discipline and an understanding of what drives demand for existing midlife Aero and Rail equipment. Build your portfolio strategically by focusing on practical solutions and best practices underwriting strategies. Call RESIDCO.
Glenn Davis, 312-635-3161
[1] Trading Economics, May 2023 data.
[3] “We cannot make planes fast enough to satisfy demand” Guillaume Faury, Airbus, Paris Air Show.
Locomotives, typically classified as 50-year assets, are primarily electrically driven. Despite the common label as ‘diesels,’ they are better described as ‘hybrid-electric’ vehicles. This is because their diesel engine powers an alternator which generates the electricity required to operate the electric traction motors mounted on the locomotive’s axles. As reported by the American Association of Railroads, transporting freight by rail is three to four times more fuel-efficient than highway transportation. Trains are capable of moving a ton of freight, approximately 492 miles on just a single gallon of fuel1. Yet, investing in a current Tier 4 locomotive today implies that you may still be burning carbon-based diesel well past 2050.
As both the Aero and Rail industries strive to incorporate cost-effective zero-emission technologies, there is active investigation into next-generation equipment and fuel alternatives. Among these is the application of hydrogen, a ’clean’2 fuel, either through a hydrogen internal combustion engine or via a reaction with oxygen inside a hydrogen fuel cell. These fuel cells use hydrogen to generate electricity. The world’s first passenger trains powered by hydrogen fuel cells, which produce the electric power to drive the traction motors, are already in commercial service in Germany, specifically for short-haul suburban rail services. In the U.S., companies like Caterpillar, Wabtec, Progress Rail, Cummins, and others are undertaking efforts to verify the feasibility of hydrogen as a viable substitute for traditional fossil-based fuels in line-haul services.
There exist alternatives to batteries for achieving net-zero transportation. Fuels made from non-petroleum sources, often labeled as ‘sustainable’ fuels, are derived from alternative sources in contrast to fossil-based fuels. These include oils from plants, algae, greases, fats, waste streams, alcohols, sugars, or captured CO2. Hydrogen, the simplest known chemical element, offers the highest energy density of any fuel. The byproducts of using hydrogen as an energy source are environmentally friendly heat and water.
Aviation fuels are distinctive due to their ‘specific energy’3, or energy per unit of mass. The current Jet-A fuel is a carbon-based kerosene fuel. While hydrogen offers three times the energy of kerosene per unit of mass, it demands four times the volume of the current Jet-A kerosene-based fuel to achieve the same outcome. The possibilities for hydrogen-based aircraft propulsion include electric motors powered by fuel cells, hydrogen-powered gas turbines, or hybrid systems that incorporate both fuel cells and hydrogen-based gas turbines. For short to medium-range aircraft, conventional gas turbine engines could be modified to use liquid hydrogen combustion. Hybrid aircraft, powered by hydrogen fuel cells, are currently being explored as zero-carbon alternatives. However, integrating hydrogen as a fuel source will likely necessitate the redesign of aircraft configurations4.
New technologies frequently come with high costs and are not instantly practical. The economics and investment timelines needed to transition to reduced carbon alternatives remain subjects of exploration. This transition will entail long-term efforts in designing new equipment, developing necessary material supply chains, devising cost-effective energy production alternatives, and establishing Aero and Rail fuel distribution and logistics networks. Despite the remaining challenges, investment in current midlife Aero and Rail equipment appears more attractive. Opportunities with lower risk and existing cash yielding attributes are available. Call RESIDCO.
Glenn Davis, 312-635-3161
1. Aii – Do Longer Trains Pose Problems or Solutions?
2. Office of Energy Efficiency & Renewable Energy – Hydrogen Fuel Basics
3. Wikipedia: Aviation fuel – Energy Content of Aviation Fuel
On March 23rd, 2023, the Federal Reserve voted unanimously1 to raise the interest rate paid on reserve balances by a quarter of a percentage point to 4.9%, marking the highest level since 2007. Although the federal funds rate range of 4.75% to 5% is above the Federal Reserve’s 2% target inflation rate, the annual inflation rate in the United States remains high at 6% for the 12 months ended February 2023, as per U.S. Labor Department data published on March 14th. This suggests that the Federal Reserve will continue to raise its benchmark rate. However, for Aero and Rail borrowers, higher interest rates will affect their ability to refinance maturing debt. Moreover, the banks are not accounting for duration risk in their ‘risk-weighted’ capital calculations. According to US GAAP, the value of “held-to-maturity investment assets” can be reported on the balance sheet at maturity values, which does not reflect their lower current market values in a rising interest rate environment. This is causing the current banking turmoil, which the Federal Reserve is addressing with a new Bank Term Funding Program (announced on March 12th), lending to banks at par against their held-to-maturity assets.
According to records dating back to 1988, February rail freight recorded its lowest total carload volumes (excluding intermodal originations). The decline in rail freight demand began in mid-2022. As retailers faced declining sales, they became more cautious and cut inventory levels. This was reflected in U.S. retail sales which were down 0.4% in February, the third decline in four months. In the first 11 weeks of 2023, rail freight volumes were down 5.2% compared to last year. February container imports at the ports of Long Beach and Los Angeles (the nation’s busiest) were down 38% year over year. Intermodal truck-rail was down 9.6% in the same period, with a 15.2% dip in the week ending March 18th. There is good news though. The Surface Transportation Board approved the CP/KCS merger2 4-to-1 on March 16th. The Board expects that this new single-line service will foster growth in rail traffic, shifting approximately 64,000 truckloads annually from North America’s roads to rail, and will support investment in infrastructure, service, quality, and safety. Moreover, rising interest rates make equipment leasing more attractive for both shippers and Class Ones, as they opt to maintain liquidity. This same dynamic will also influence commercial air carriers as they face similar market conditions. Although growth prospects for rail freight are mixed, these factors may help mitigate the decline in demand.
According to Delta’s Chief Executive, Ed Bastian, the airline recently had its highest sales days3 in its history. With more normal levels of aircraft utilization returning, air carriers are finding that the latest generation turbines (the LEAP and GTF engines used on the A320neo and 737MAX) are more fuel-efficient but not as reliable as existing technology CFM56 engines. The newer engines run hot, turbine components wear more quickly, and engine time on wing before removal and maintenance is required is not meeting expectations. Once in the shop, there are long waits for parts, and the availability of engine components is being impacted by the Airframer OEMs high demand for new engines. As a result, existing equipment remains in demand, as Air Lease Corp. Chairman Steven Udvar-Hazy stated that roughly 90% of aircraft leases are being renewed due to production delays at Airbus and Boeing.
The Bank stress that has appeared results from the extended period of unusually low interest rates. Equipment valuations and lease pricing will adjust in response. Regardless of ambiguities in the direction of demand, inflation, and geopolitics, capital should be allocated to productive opportunities. Existing Aero and Rail assets provide those opportunities. Call RESIDCO.
Glenn Davis, 312-635-3161
[1] Implementation Note issued March 22, 2023 – https://www.federalreserve.gov/newsevents/pressreleases/monetary20230322a1.htm
[2] STB Approves CP/KCS Merger With Conditions and Extended Oversight Period – https://www.stb.gov/news-communications/latest-news/pr-23-07/
[3] Delta Air Lines CEO Ed Bastian: There is still unmet demand for airlines due to the pandemic – https://www.cnbc.com/video/2023/01/13/delta-air-lines-ceo-ed-bastian-there-is-still-unmet-demand-for-airlines-due-to-the-pandemic.html
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