Jack Sellsby/LONDON
Financing aircraft can be a nightmare for some airlines and a hazard for lendersAirlines spend billions of dollars on new aircraft deliveries each year, and manufacturers - aided by their ever-willing and export-minded governments - ensure comparable amounts of commercial jets are financed.
Airlines with good credit never need to worry about financing their aircraft as there always appears to be a willing group of backers, whatever the state of the funding markets. But many carriers are not so lucky and must search more widely for finance.
As Airbus and Boeing continue to top last year's sales in a busy year, with more than 800 scheduled deliveries of narrowbody and widebody jets, many finance arrangers are looking at the safer option of government-backed deals. This caution stems mainly from bleak economic growth forecasts in many parts of the world, apart from Western Europe and the USA. The banking community can avoid commercial or country risk which would otherwise throw them out of the finance equation.
Maintaining commercial jet sales is not exclusively the domain of export credit agencies such as the US Eximbank in Washington DC or the European export credit agencies (ECAs) - ECGD in the UK, Coface in France and Hermes in Germany - but there is a greater reliance on them when the finance community's confidence shrinks. This type of finance, by no means a last resort, has been typically used by airlines with middle-to-lower ranking credit or by carriers unable to raise backing effectively in the commercial markets.
"When the finance markets dip and it becomes difficult to finance aircraft on a fully commercial basis, I think it's fair that airlines and bankers ask for more support from export credit agencies," says a financier in New York. "After all, governments want to ensure as many export contracts as possible, so why shouldn't they step in?"
Export credit sought
It is generally accepted by bankers and airline finance departments that Europe and the USA will support around 30% of Airbus and Boeing annual sales at the most buoyant point of the industry cycle. But, given the current low point and the shrinking number of available finance products over the last year (see P49), some market players suggest that the run on the Eximbank and the European ECAs could represent 50% of all civil aircraft finance demand over the next two years.
A senior source in the aerospace department of the Eximbank says there is little doubt that 1999 is going to be the bank's busiest year. In 1998, the bank supported $2.6 billion-worth of large aircraft deliveries compared to $2.17 billion in the previous 12 months. Boeing alone is scheduled to deliver 620 jets this year, compared with 550 last year. More deliveries will be covered this year because of the withdrawal of Japanese banks in aircraft finance, an apparent withdrawal by local banks in the Asia-Pacific region and the high volume of Boeing deliveries this year.
The European ECAs have been just as active. Over the past two years, France, Germany and the UK have collectively supported in excess of $3 billion in annual civil aerospace sales. Their reporting methods do not break down coverage on Airbus deliveries, which is by far the main tranche of their export sales business. Their figures include various Rolls-Royce and AI(R) programmes, for example. But an indication of the expansionary mood is reflected in estimates by officials at the ECAs that support for Airbus aircraft could total $5 billion this year. This trend is also likely to continue through 2000, with similar levels of support.
Essentially, export credit agencies provide cover to finance deals. This shifts the hazard from a bank's own pure commercial risk to a government guarantee in the form of insurance protection. If an airline defaults on finance payments, the agencies take the hit - in theory. If ECGD, Coface and Hermes decide to provide cover for an Airbus aircraft delivery, the support normally guarantees 85% of the financing which is raised through bank debt markets. The remaining 15% either comes from a commercial loan or the airline's own equity injection. Some problem cases only receive about 60% cover, however.
As banks take a cautious approach to financing, because either saturation point may have been reached for certain company or country risk or the banking sector has virtually deflated, such as in Japan, it is safer to take the government support. For the few Japanese banks still active in the aircraft finance market, following the heavy losses they experienced last year, export credit-backed transactions are among the only deals they can consider. Many other banks are also adopting this approach.
Companies posting healthy profits have more finance options at their disposal and bankers eager to lap up the commercial risk. Airlines in the high-flying credit leagues, including Swissair and Qantas, for example, do not need to rely on export credit support.
Nevertheless, some airlines with higher credit ratings are viewing export credit-backed deals with a fresh appeal. "Some top-tier airlines are finding their traditional sources of finance are becoming very expensive, so ECA deals are more attractive," says Chris Leeds, director of aerospace underwriting at ECGD in London. "We're now doing more business for them."
Regional risk
As the ECAs do not impose ceilings on aerospace cover, but on country exposure, there is still scope to accommodate the top tier and the natural customer base of medium to lower tier carriers, explains Leeds.
This will be honoured where airlines have requested support and an agreement, in principle, has been offered, he says. But, in an attempt to curb cover, the ECAs may suggest to carriers with large order books that other forms of finance are found.
Working with the customer finance arm of Airbus, the ECAs may even steer some carriers to approach leasing companies to use their delivery slots and take the aircraft on an operating leasing basis. Boeing was forced into the operating leasing market last year to ensure that deliveries went through, mainly in Asia-Pacific. Although manufacturers have stated and re-stated over the years that they want only to act as financial advisors, should customer financing needs demand, the US manufacturer was forced to sign operating leases and to issue short-term funding to facilitate sales.
The Eximbank approach is to support deliveries of US aerospace products - excluding military equipment, from which it is barred by the US Government - to airlines which would normally not be able to take delivery of aircraft. A particularly difficult deal at present is Aeroflot Russian International Airlines' imminent delivery of 10 Boeing 737-400s, for which cover has been approved. But, with difficult economic times forecast for Russia, the credit considerations have to be thoroughly examined. The finance community generally agrees that this deal would not be possible without the Eximbank safety net firmly in place.
Export credit agencies, particularly in Europe, take a country-risk approach when examining the fundamentals of coverage. It is at this stage that the many-pronged approach of the European multi-agency system is manifested. Finance sources say that Korean Air's application for ECA support for its two Airbus A330-200s, being delivered this year, is running into trouble. This is because the French content is higher than the German or the UK shares, so Coface will be expected to take a larger slice of the underwriting, which invariably leads to a more cautious approach. Nevertheless, ECA willingness to take on country risk has enabled some deals to be signed, which my have otherwise have resulted in a cancelled order.
"A big plus on the ECA side has been their willingness to take on country risk and encourage bank lenders to come in and structure deals," says Peter Barker, head of aircraft finance at London-based Halifax Treasury Group. His bank recently arranged a $4.3 billion ECA-backed financing for US operating lessor International Lease Finance.
Also in Asia-Pacific, the Eximbank looks likely to support Thai International Airways' $750 million-worth of Boeing widebody deliveries this year, subject to a successful application. CIBC has been mandated by the airline to oversee the Eximbank application, which is generally accepted to be a rigorous analytical test for any applicant, following Thai's unrequited calls for open-market finance.
Thailand's economic climate does little to instil confidence in the banking community, but the Thai Government's reluctance to issue sovereign guarantees for this type of finance compounds the problem. The decisions with which Thai must then grapple are whether to cancel its order or to obtain financing of any kind.
The big question facing many players in aircraft finance is the extent to which default problems in Asia-Pacific, and in certain other deals around the world, will affect ECA or Eximbank coverage policy. "It is true that we are a little more reluctant and we are asking more questions about deals," says Jens Schnoor, legal expert at Hermes in Hamburg. "We are having a closer look at the legal opinions from banks than we have in the past. But this is not specific to Asia-Pacific - this is our approach to Airbus coverage."
Potential loss of Philippine Airlines' aircraft fleet in the face of more than $2 billion of debt, and its ensuing attempts at financial restructuring, have provided the ECAs, Eximbank and the banking community with invaluable information and experience.
The ECAs and Eximbank are in a relatively strong position and take the primary security over the aircraft. When a default occurs, they are first in line for repayment. Leeds says that the ECAs have not been suffered major harm by defaults. This is not so true for some commercial lenders involved in the Philippine Airlines deal. One German bank, lending on a commercial basis, has lost about $30 million in the fiasco. But the bad taste of default flavours the future for everyone. "We will be very wary of airlines going for any sudden mass expansion in the future," says Leeds. "This will set off alarm bells."
Political Forces
The highly competitive nature of commercial jet sales is reflected in the coverage estimates that the Eximbank and the ECAs are likely to post this year. While the airline industry may endeavour to convince the world of its commercial nature, there is no escaping the political forces inextricably clamped to manufacturer sales strategy. "Eximbank will support any deal that would otherwise go to Airbus because the ECAs have offered to cover it," says the senior source at Eximbank.
In the regional aircraft market, there has been a partial conclusion to the World Trade Organisation-monitored (WTO) dispute between Canada's Bombardier and Embraer of Brazil over aircraft export subsidies. The WTO ruled on 12 March that Proex, Brazil's export credit agency, should end its support of Embraer regional jets. Bombardier has maintained that as much as a $2.5 million subsidy was offered with each Embraer sale.
But the WTO has also asked the Canadian manufacturer to drop two assistance programmes in the same 90-day timescale. Both countries may appeal against the WTO findings, which have been more than two years in the pipeline.
Aerospace manufacturing in France, Germany, the UK, the USA and elsewhere is big business. Annual multibillion sales boost economies and, in turn, employ large swathes of workforces. Many jobs would be in jeopardy without such sales support in a market which relies heavily on the international banking community to secure finance and deliveries. On a basic level, the Eximbank's motto is telling: "Jobs through exports." Unemployment does not stimulate economies and unemployed workers do not re-elect political parties.
Source: Flight International
