The global financial crisis can seem a distant hallucination, given today's strong global economy and seemingly endless liquidity. But to those who did experience it first-hand, it was all too real.
Ten years ago, financial markets took a deep dive as bank executives and regulators began untangling a web of sub-prime lending and complex financial instruments like derivatives, credit-default swaps and collateralised debt obligations. These esoteric financial instruments contributed to a crisis that threatened to take down the global banking system.
Like dominoes, banks began to tumble. Freddie Mae and Fannie Mac were nationalised on 7 September 2008; Merrill Lynch was sold to Bank of America on 14 September; and – underlining the scale of the problem – Lehman Brothers filed for bankruptcy on 15 September.
Meanwhile, US mega-insurer AIG – then owner of the second-largest aircraft leasing company in the world, ILFC – found itself at the centre of the liquidity crisis. Deemed "too big to fail", it required a $185 billion lifeline from the government in the form of bailouts.
Within the month, the S&P 500 had lost 30% in market value and the US Congress had approved the $700 billion Troubled Asset Relief Program (TARP) to purchase failing bank assets.
All industries suffered, including aviation. IATA said the downturn in the aftermath of the financial crisis was "the deepest experienced by the commercial airline industry since the 1930s", adding that "early 2009 marked the low point for international air travel markets".
Premium travel fell 25% while economy bookings dropped 9%, IATA figures show.
Prior to the financial chaos of that September, however, airlines had already been struggling through the summer, with demand slowing and costs rising. In July, Brent crude peaked at a record high of $145 per barrel.
Airline revenues were slashed by $85 billion – or 15% – representing "a two- to three-year backward step for the industry", IATA stated at the time.
The $4.6 billion global loss that IATA figures show for 2009 was actually substantially lower than the previous year, in which the airline sector lost more than $26 billion. That figure, though, was heavily affected by extreme fuel price volatility – itself not helped by the financial crisis – as airlines first suffered from high fuel prices and then booked losses in settling unfavourable fuel hedges as the oil price tumbled.
Lower fuel prices would ultimately help offset lower revenues in 2009, while traffic demand improved relatively quickly. The drop in traffic in early 2009 was steep – in fact, more severe than just after the 9/11 terrorist attacks – but by the end of the year, premium travel had risen 11% and economy 7%, IATA stated in its 2010 annual report.
FUNDING-GAP FEARS
But even as traffic recovered, the airlines faced a liquidity crunch, not least in financing planned new aircraft. This left many wondering who or what could fill the funding gap left by banks and lessors in crisis.
During the darkest year of the recession, 2009, Airbus and Boeing delivered nearly 950 new aircraft, according to Flight Fleets Analyzer.
"The liquidity crisis put the fear of God into airline CFOs," one Wall Street analyst tells FlightGlobal. "It was a reminder that the economy can turn quickly and you need to be ready."
In the aftermath of 9/11, the airline industry endured a significant drop-off in passenger demand and had to cope with major operational changes and associated costs. Those airlines that survived the recession – casualties had been more plentiful in the previous one – learned the necessity of having liquidity cushions. So, while the wounds to airlines during the financial crisis were deep, they were not fatal for most.
"From our perspective, while the financial crisis was bad, it was not nearly as impactful as 9/11," says United Airlines' chief financial officer Gerry Laderman, who was senior vice-president and treasurer at its future merger partner Continental Airlines in 2008 when the financial crisis hit. "For better or worse, we made sure after 9/11 that we would be prepared for whatever kind of crisis hit."
Laderman says Continental had enough liquidity to withstand the shock of the financial crisis, and this helped the company survive while the capital markets were closed.
For US carriers, when the capital markets reopened in 2009, they were able to issue bonds to fund equipment – but they came at a price. United, Continental, Delta Air Lines and American Airlines all issued secured bonds in 2009 between 7.75% and 10.4%. In most cases, the cost of secured money dropped quickly by 2010, with deals issued at more stable coupons, between 6% and 8%.
European banks, which had established themselves as the primary providers of commercial aircraft loans, continued to lend to their customers – but at a higher cost.
"We were very active because of the shutdown in US capital markets and the slowdown of US banks in lending long-term aircraft financing," says one banker who was employed by a European financial institution at the time. The banker adds that business was good for European lenders as loan margins were strong given the limited lending capacity available.
IATA reports that in 2009 airlines' average cost of capital was 12%, well above its normal 7-8%.
A Boeing Capital chart shows that export credit increased from a low point in 2008 to a peak in 2012. Between 2009 and 2012, the US Export-Import Bank approved nearly $40 billion in funding for large commercial aircraft, according to the body's annual reports.
There was an immediate need as liquidity seized up, which continued as the credit crisis deepened across the globe.
As the need for export credit increased, the product was refined to become more efficient. The advent of the Ex-Im-guaranteed bond – the first of which funded two 777s for Emirates – allowed borrowers to tap the capital markets for multiple aircraft at once and have the whole deal underwritten by the full faith and credit of the USA. This was later replicated by the European export credit agencies.
PARENTAGE AND PARALYSIS
Arguably, the worst pain inflicted on any one constituency by the financial crisis was on the leasing companies – and some felt it more than others.
On the equity side, the listed aircraft leasing companies suffered, with both AerCap and Aircastle losing about 85% of market value by March 2009.
Airlines had to navigate dramatic declines in demand, though its relatively quick recovery combined with a big drop in fuel costs would offset the worst of the financial crisis. But the paralysis in the credit markets was one of the biggest hurdles to overcome for aircraft lessors, some of which were owned by the worst perpetrators of the financial crisis.
With shareholders AIG and Royal Bank of Scotland in trouble, ILFC and RBS Aviation Capital were facing uncertain futures. Both lessors had large orderbooks with Airbus and Boeing, and therefore had large capital needs. But raising debt became increasingly difficult, especially in the capital markets.
As ILFC grew, it ordered more and more aircraft. The company funded this expansion in large part through the commercial paper market, relying on the investment-grade "halo" of its parent. As the markets melted down in the autumn of 2008, however, ILFC could no longer access this market. The company had to turn to the more expensive and more rigid secured funding markets.
On the other hand, RBS Aviation Capital simply suffered at the hands of its parent. After taking over Dutch bank ABN Amro, which made it the largest bank in the world, Royal Bank of Scotland also needed a bailout from the UK government.
Like ILFC, RBS Aviation Capital's business was itself sound, but its shareholder was under pressure to divest non-core assets as it refocused under the direction of its new shareholder – the government. The result was that both lessors were paralysed.
"I don't think people really appreciated how big the problem was until the nationalisation of RBS," says SMBC Aviation Capital's chief executive Peter Barrett, who was RBS Aviation Capital’s chief executive through the crisis. "That really came as a blow to the solar plexus because RBS had become the biggest bank in the world, and then had effectively become a ward of the state.”
LESSONS LEARNED
Reflecting on that tough period just after RBS's nationalisation, Barrett says he wishes he'd been able to pick up more assets. "There was so much opportunity on the buy side in 2009 and 2010, but we didn't have the capital."
He adds: "One of the of the largest lessons we've taken from this experience is that you have to plan for the downturn not just on the asset side but on the liability side, and make sure you're well capitalised and have access to funds so that when opportunities present themselves, you can take advantage of them.”
As the airlines learned hard lessons about liquidity after 9/11, the lessors did likewise as they became a more permanent fixture in aviation ecosystem.
Most companies in the sector were touched by the financial crisis in one way or another, and some were affected more severely than others. But ultimately, the industry weathered the storm quite well, financing all deliveries and avoiding disruptive bankruptcies or major liquidations.
Ten years later, the airline industry is in its ninth year of passenger growth and liquidity is abundant. One thing is for sure, airlines were made stronger by the downturn of the early 2000s, while leasing companies have delivered greater liquidity and diversified their funding sources.
Whatever one's outlook on the current global financial realities, airlines and lessors appear to be stronger businesses today and are better prepared for another recession should one occur.
Source: Cirium Dashboard
