With founder and chief executive Steve Udvar-Hazy at the helm, leasing giant ILFC aims to continue forging ahead as it looks beyond the current downturn
The small staff of International Lease Finance Corp (ILFC), which numbers only 135 worldwide, is busy these days. But there is no hand-wringing. Despite the upheavals taking place across air transport and the uncertainties ahead in the shape of potential conflict in Iraq, ILFC continues to move along at full throttle.
When the figures are out for last year the company expects them to show another record performance, with revenues and profits running comfortably ahead of the already impressive numbers for 2001. Pre-tax profit margins will remain in the envy-inducing 25-30% range. "I don't want to sound over-confident, but our company is navigating the storm as well as it can, compared to a lot of others," says ILFC's founding chief executive Steven Udvar-Hazy - or, as he tells people to call him, "Steve Hazy because it's easier".
He and ILFC have come a long way since Hazy first set out in the leasing business30 years ago. Still only in his late 20s and the son of Hungarian immigrants to the USA, Hazy and his partners more or less invented the operating lease in the early 1970s. And it is a concept that has served them well, remaining consistently profitable ever since.
Today ILFC heads the big league of operating lessors alongside GE Capital Aviation Services (GECAS). Both stand clear from the rest with fleets valued at more than $20 billion and although GECAS takes the lead in terms of the sheer number of aircraft in its fleet, ILFC heads the rankings as the world's largest lessor of widebodies. It is also the largest lessor of new aircraft from the manufacturers and today stands as the largest single customer for new Airbus and Boeing aircraft of all types. Its fleet, with an average age of only around four years, includes all of their products currently in manufacture. It took delivery of 83 new aircraft in 2002 and expects to take another 78 this year. At the turn of the year, its owned fleet of 561 aircraft was being flown by 135 airlines in 61 countries round the globe.
The company's confidence in the future of air transport - it believes the airline industry recovery will begin in 2004 and accelerate through 2005 - is reflected in its current backlog of new orders. At the end of 2002, ILFC had firm commitments to buy 511 new aircraft valued at more than $30 billion, with deliveries scheduled through 2010. Those orders include 347 from Airbus and 164 from Boeing, adding to the existing fleet which currently runs 327 to 234 in Boeing's favour.
Possibly the most influential aircraft lessor, ILFC was the launch customer for the Airbus A319, A321 and A330-200. It was the first leasing company to place large-scale orders with airframers, beginning in 1984 - now orders for 50-100 aircraft are not uncommon.
This is not to say that ILFC was not affected by the 11 September 2001 terrorist attacks and the economic slowdown which was turned into a crisis. Many ILFC customers - probably a majority, Hazy says - approached the company seeking cash flow or rental relief, and the company negotiated various forms of restructuring with them.
Seven of ILFC's airline customers shut down or filed for bankruptcy, including Swissair, Sabena, Sun Country and National Airlines. ILFC, though, was able to negotiate new leases for 19 of the affected aircraft with successor airlines, and to lease 26 to new carriers. "We were able to place all the aircraft, every one of them, very quickly," Hazy says.
"We don't have a place to store planes here, and they don't make any money unless they're flying," he adds, speaking in ILFC's penthouse offices in Beverly Hills, which look out across Los Angeles. "So our mission is to keep all our aircraft assets deployed."
Airline focus
Achieving that goal is helped by the fact that the company is involved in no other industry, he says. "We're so focused on commercial airlines, we do everything possible to keep our aircraft flying." As such, ILFC has a higher percentage of aircraft in use compared with other lessors, he says. One advantage is the young age of its aircraft and thus their desirability - lower fuel burn, maintenance and operating costs and higher dispatch reliability - in the current cost-cutting environment.
More than half the aircraft coming off leases stay with existing customers and the remaining "used" aircraft are placed quickly with other airlines. Although lease rates for both used and new aircraft have softened, ILFC's overall revenues from rentals of flight equipment have continued to rise thanks to the increasing size of its leased fleet.
Another factor that has worked to ILFC's advantage is lower interest rates, Hazy says. Many aircraft delivered over the last four years were leased based on financing costs in 1999-2000, when interest rates were higher. Because they are somewhat lower today, ILFC is enjoying a better spread on those aircraft. "We're able to make a little better profit on aircraft that were delivered years ago - not because the lease rates were too high, but because the interest rates are more manageable," Hazy says. "It's helped offset some of the work-outs and credit problems we've experienced with some customers."
ILFC's used aircraft sales have also slowed, as is to be expected during a downturn. Normally the largest seller of used aircraft, it is now holding onto its fleet a bit longer. "We have that luxury," Hazy says. "We don't have mortgages on our planes because we finance ILFC; we don't finance individual aircraft leases. So all our aircraft are free and clear, and we're under no pressure to sell any particular airplane."
The geographic spread of its customer base also helps. Only 13 of its current customers and 13% of leasing revenues are from the hard-hit US market. On latest published figures, European carriers, including a host of smaller players, made up the largest slice of leasing revenues at 47%, while Asia-Pacific stood at just over 22% - nearly half of that from China. Carriers in Latin America contributed 8%; Canada 5%; and Africa/Middle East just over 4%.
This global business all started from small beginnings back in 1973. Just five years out of university, Hazy and two partners - Louis Gonda and his father, Leslie Gonda - each contributed $50,000 to capitalise Interlease Group, the company that became ILFC. The company's first transaction was the purchase of a used National Airlines McDonnell Douglas DC-8 for $2.2 million and its lease to Aeromexico for $57,700 a month. The deal was put together after Interlease secured a loan from a California bank, a guarantee from the Mexican government and additional equity from friends to buy the aircraft. Thus the company was born, and with it what is believed to be the first operating lease in the history of the commercial aircraft industry.
ILFC went public 10 years later and then, in 1990, was acquired by American International Group (AIG), a leading insurance and financial services company. As a wholly owned subsidiary of AIG, Hazy says, ILFC operates independently, a relationship that serves both parent and its adopted offspring well.
"We're quite autonomous because our business is so different to AIG's. They like that because they want the company to be run as an entrepreneurial, highly motivated, profitable company," he says. "It's more conducive to our being successful." What AIG does not want is for ILFC to act as a "bureaucratic subsidiary" of a New York corporation, Hazy adds.
He points out that ILFC's business and its relationship with its parent differ materially from GECAS, a unit of General Electric Capital which issues securities and funds its aviation subsidiary. ILFC does not go to AIG for funding, but issues its own debt and equity securities which are not guaranteed by the group. ILFC has maintained high credit ratings for its long-term and short-term debt, and currently has a $4.8 billion commercial paper programme.
GECAS is also different in other ways. It offers customers a full range of "fleet and financing solutions". That includes finance leases and secured loans, but also engine servicing contracts, pilot training, aviation consulting and more from its subsidiaries and sister companies. "Some lessors are more like financial institutions, but we're more of an aircraft marketing company and less of a leasing company," Hazy says. "We're first and foremost aircraft marketeers; we're using leasing as a medium to market airplanes."
Although last year ILFC had to remarket aircraft leased to what Hazy calls his "problem children", all 83 new deliveries in 2002 were leased to customers lined up long before the year began. It marked the first time that ILFC took delivery of more Airbus than Boeing aircraft (45 against 38) and that trend will generally continue based on current delivery schedules. The 78 aircraft for delivery this year (39 from each maker) are all already leased, as are 77% of the 85 aircraft due to arrive in 2004 and almost a third of the 84 for 2005.
Launch partner
Hazy is proud of the role the company has played in launching new aircraft, particularly the Airbus A319, a programme originally opposed by Airbus managing director Jean Pierson because he believed programmes to shrink aircraft were not generally successful. "We felt there was a large segment of the market which had DC-9-30s, 737-200s and older 737-300s that could use an aircraft in the 120-145 seat range," Hazy says. ILFC ordered six A319s, starting a successful programme that has racked up close to 750 orders.
The Airbus A318 is another matter. ILFC ordered 20 of the A320 family's smallest member, but has since cancelled them, shifting the orders to other versions. The main reason is the Pratt & Whitney 6000 engine development programme which has run into problems and has slipped by about two and a half years, Hazy says.
In analysing the market, ILFC also decided that operating costs for the A318 were not as competitive as the regional jets being groomed for the market above 70 seats, Hazy says. "We feel the emerging regional jets at the 80-100-seat size are probably more suitable to address this segment of the market with lower operating costs - lower weights, lower maintenance costs, lower fuel burn," he says.
That brings up the regional jet, a market not yet tapped by ILFC, although GECAS in 2000 placed orders for 150 regional jets - 50 each from Bombardier, Embraer and now-defunct Fairchild Dornier.
"In the history of this company, we have studied no other subject as greatly and as deeply and as thoroughly as this," Hazy says, "and we still haven't made any definitive decision." But he admits it is again "a hot topic" at ILFC.
Regional jets
The company was close to a decision in the summer of 2001 to purchase 100 aircraft from Embraer and then had "an intuitive feeling we should just wait a bit". Although the deal had merit, Hazy says, ILFC felt that because they were so thin in management ranks - and the effort required to place five regional jets was as much as to place five A320s or Boeing 777s - that they should wait a few months and "think about it a little more before we go to the altar". Then 11 September happened and ILFC's caution seemed prescient, as its energies were needed to help existing customers.
In the last two months, though, the subject has once again "risen to the surface", Hazy says. ILFC is less interested in 50-seat regional jets because the market is already well served and because most customers - affiliates or regional partners of US majors - have already decided on Embraer or Bombardier aircraft. "But it is at the upper segment of the market, in the 70-75 seats and more, that we could have potential value," Hazy says. "We're thinking about it very carefully, and if the right deal comes along, with the right risk profile, we may get our feet wet." ILFC is leaning toward Embraer if it goes forward.
Hazy admits there are differing views within ILFC about the regional jet. Some think it would complement ILFC's portfolio and expand its customer base. The opposing view is that ILFC should concentrate on what it is already doing well and not spread itself too thin. Hazy says that ILFCis also asking itself whether the move is something that it is "compelled" to do. "Another question is can we achieve the level of financial success with these aircraft that we do with the aircraft we currently handle?" he adds. "Can we achieve 25-30% profit margins? What would be the residual value of these aircraft if kept 15 years? These are all unknowns, so there's a lot of crystal ball activity going on right now."
The crystal ball was more clear on the new Airbus A380 large-aircraft programme. ILFC placed firm orders for 10 A380s - five passenger and five freight - and has no doubts it will be successful. "The way I look at the A380 is quite simple," he says. When the Boeing 747 took to the skies, it more than doubled the size of the Boeing 707 and DC-8 aircraft it was replacing. When the first A380 is delivered in 2006, it will have been nearly four decades since first deliveries of the 747 began to Pan Am in December 1969. And although the 747-400 has marginally more capacity than earlier 747s, there hasn't been a "leapfrog change in 37 years", Hazy says.
Since then, though, the growth in traffic in high-density markets has been huge. And now, a number of key international airports, such as London and Tokyo, are slot- and terminal-constrained and growth will be circumscribed. Assuming even a stable economy in the next five years and very low rates of growth, Hazy says, there are a number of city-pairs - currently served with high frequencies by large widebody aircraft - where additional capacity will not be possible without increasing the average aircraft size in the peak periods.
"I don't see the A380 as revolutionising air travel. I see it relieving some of the pressure in very high-density, long-haul markets," he says. "There aren't that many cities that will get A380 service." He expects 90% of the A380 flying will be to 15-20 airports, including London, Paris, Frankfurt, Dubai, Singapore, Hong Kong, Tokyo, Sydney, Los Angeles and New York. As a result, he does not see a huge market for the A380 - maybe 20-30 aircraft a year.
Industry must restructure
In the more immediate future, Hazy believes the airline industry must restructure to address issues that have been building for decades, particularly in the USA. For years, average ticket prices and yields have been coming down, while labour costs, fuel, insurance and airport costs have been rising faster than inflation. "We have deflationary revenue characteristics in this industry, with highly inflationary cost characteristics," Hazy says. "And finally, I think it's coming to a head."
The only way to restructure is to cut costs, change the basic business model or improve revenues, he suggests. But improving revenues will not be easy. "I think people are more value-conscious, and the industry is headed in that direction - as basically a commodity product." The quality of service is considerably below what it used to be. "But unfortunately, that's a trend and can the large airlines adapt quickly enough? I don't know."
Interestingly, ILFC's customers do not include the two high-profile bankrupt carriers, US Airways or United Airlines. That, says Hazy, is "by design". Such carriers are examples of what he calls the "misfits of the industry". They have developed huge infrastructures and have high-wage employees with very low productivity because of narrow job descriptions and unreasonable work rules. They also never had peaceful labour relations because of the multiple workforces brought together through mergers. "It's got to the point now where there is no way to solve these issues in a normal negotiation between two sides," he says. It took an event like 11 September to magnify the underlying problem.
"What will happen? I just don't know, but the industry has taken on interesting new characteristics. We're certainly not at equilibrium right now, and that's good for ILFC," Hazy says. "In good times, airlines need our airplanes - they need the incremental lift - and in bad times, they need our financial strength because we can use our balance sheet to provide them airplanes. If every airline had everything perfectly figured, I don't know what role ILFC would play so, in a sense, the dynamics of the industry are a great asset for us."
REPORT BY CAROLE SHIFRIN IN LOS ANGELES PHOTOGRAPHY BY ROGER FOJAS
Source: Airline Business
