Hazy ponders tactics as Fed hands AIG breathing space

When the first signs of financial crisis appeared just over a year ago, few would ever have thought those troubles would eventually lead to the US government effectively becoming the owner of American International Group (AIG) and its aircraft leasing arm, International Lease Finance Corporation (ILFC).

But now, following the US government’s rescue of AIG, the market awaits the next move in this somewhat unbelievable scenario. Will ILFC be sold off to private equity or hedge fund money? Is a merger likely with another lessor? Or will ILFC chairman and CEO Steven Udvar-Hazy buy back the company he helped found 35 years ago?

There is certainly plenty of support for the buy back of the lessor by the aviation enthusiast, who became a likeable Horatio Alger rags-to-riches story by mastering the art of aircraft leasing. His ability to successfully lead ILFC through downturns while turning a profit has made him an icon in the aviation industry.

“Some things are more important than money and I think this is the case with Hazy and ILFC.  He wants to do the right thing and that would be to rescue ILFC,” says a lessor source. “Remember this guy loves aviation. It is his life. He even gave the Smithsonian Institution $60 million, its largest donation ever, for its Air and Space Museum at Dulles International Airport.”

Although Hazy may want to save ILFC from the current debacle brought on by its parent company, difficult financial markets may prevent such a move.

Also, the government’s bailout of AIG further complicates ILFC’s future, says an analyst who requested anonymity.

Top Dollar

“Efforts by Hazy to buy ILFC were going to be complicated enough by the sheer size of the deal and the current credit market environment,” says the analyst. “The underlying question before the bailout by the Fed was where would Hazy get the billions of dollars needed to buy ILFC? Would any banks step up? Would they want to add to the debt levels, which are already high? Or would he find equity players, and if so, from where?

“It’s possible Hazy could cobble together a group of private equity funds to form a syndicate,” this analyst says. “The larger problem now that the Fed is involved is the sale price.”

When AIG’s board of directors was in control, Hazy might have been able to strike a deal at the lower end of the price valuations assessed by Wachovia and Citicorp. Wachovia’s aerospace analyst Gary Liebowitz estimates the value at between $5 billion and $8 billion, while Citicorp places the valuation at $7 billion to $10 billion. Strapped for liquidity, AIG’s board may have been willing to price for cash rather than full value, enabling Hazy to strike a deal at a discount.

With liquidity no longer a concern, the Fed is going to want to get top dollar, and Hazy will likely find it much more difficult to buy ILFC at the price he wants, CAO’s analyst says.

The US government is supplying AIG with a two year revolving credit facility that is secured by all of the insurer’s assets and material subsidiaries, in return for a 79.9% stake in the company.

Another source says since AIG has 24 months to sell assets a “fire sale” is unlikely.

“Remember, US taxpayers own most of the company now and will want a proper auction process to get maximum dollars. The level of interest in ILFC demonstrates the ‘smart money’ and the massive opportunity in this type of enterprise.”

A banker says, “unravelling the tax maze with AIG may take time and it is equally possible that would-be purchasers would prefer to wait until there is more blood in the water.”

But with the aviation market in a downturn and with airlines selling newer aircraft on a regular basis, “ILFC is no longer as attractive of a buy as it was even a year ago, particularly at top dollar,” says a financier.

“Only a few will want to take on the debt, the obligations and the $17 billion in orders now. Furthermore, who can realistically raise top dollar financing? The more you look at the portfolio, the debt and the orders, the harder it is to justify paying anything but a discounted price,” says the source.

He adds: “Remember, any buyer needs to be able to secure cheap financing because this is what helped make ILFC so attractive in the first place.”

AIG and ILFC have enjoyed a symbiotic relationship in which the lessor enjoyed favourable debt ratings due to its parent’s AAA rating, while the insurer was able to benefit from ILFC’s significant tax benefits driven by accelerated depreciation of aircraft. As AIG’s debt ratings were downgraded during the long fall from grace, so were the ratings at the healthier ILFC on the principle espoused by the agencies that no subsidiary should be rated higher than the parent.

ILFC’s rising cost of funds may be seen through a series of medium-term notes issued this year. According to ILFC’s 424B filings with the Securities and Exchange Commission (SEC), interest rates on ILFC’s debt have increased to nearly 8.4% this month from as low as 3.85% in January 2008.

Exposure

According to ILFC’s latest 10-Q filing at 30 June, the lessor has commitments to buy 179 new aircraft for delivery through 2019, 18 of which will deliver during the remainder of 2008. It will receive a total of 73 this year, 42 next year, and then the delivery stream slows significantly until 2015 before it picks up again.

ILFC’s largest exposure is to the Boeing 787 with 74 orders. The first aircraft is now scheduled to deliver in November 2011.

Next, the lessor has orders for 38 Airbus A320-200s followed closely by 37 orders for Boeing 737 aircraft. It also holds orders for 22 Airbus A319s and 20 Airbus A350 XWBs.

ILFC’s orders for 10 Airbus A380 aircraft may be cancelled up until 30 June 2010, a potentially significant risk for Airbus since by then AIG’s two-year clock for orderly disposal of assets—including ILFC—will have less than three months to run. Off-loading the A380 commitment, an aircraft  that for all its raves in passenger service, simply does not have the same investment attraction as Boeing’s 787, will save any potential transaction involving ILFC at least $1.5 billion to $2 billion in acquisition costs based on assumed early pricing received by the lessor.

In the filing, ILFC says it anticipates financing the estimated $17.6 billion in purchases through a combination of operating cash flows and debt. The lessor has signed leases for all its new aircraft deliveries through the end of 2009.

At the end of the second quarter, ILFC owned 947 aircraft, had nine additional aircraft in the fleet classified as finance and sales-type leases, and provided fleet management services for 99 aircraft.

The lessor has 45 aircraft coming off lease this year, but that figure jumps to 138 aircraft in 2009, but then decreases to 115 in 2010, and holds steady at 124 in 2011 and 123 in 2012.

ILFC declined to comment on this article.

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Aircraft Commitments at 31 December 2007

Source: ILFC 10K

 

Source: Commercial Aviation Online