Jack Sellsby/LONDON
When the euro was introduced at the start of this year, it became a huge source of new currency financing almost overnight, although the airlines were not the quickest of the corporates to take advantage. But like any other industry on the lookout for fresh, plentiful finance solutions, the commercial airline sector is gearing up to exploit the euro as it becomes a more commonplace basic financing option.
Many bankers think the euro will give the US dollar a run for its money and challenge traditional methods of airline and aircraft finance. The euro is second only to the US dollar market in terms of depth of available funds. Airlines, in particular those based in Europe, have strong revenue flows in the euro and are likely to use them to repay euro-based borrowings.
Even though euro financing requires currency hedging if it is used for aircraft finance - because all aircraft sales are denominated by the US dollar - this extra cost can be absorbed and cheaper financing can still be made available for a large group of airlines. The demand is starting to take shape: "Many of my clients are asking me for finance proposals in the euro," says a German aircraft financier. "They are keen to offset their euro revenues by taking euro debt on to their balance sheets. It is new, but straightforward."
If airlines are looking to raise general working capital in euroland and are not specifically looking to fund dollar-bound items - such as fuel, aircraft and spare parts - raising funds in the new euro currency could prove attractive. For example, for the many European carriers where increasing levels of euro revenues are generated in their primary passenger markets, fixed-income specialists and corporate finance bankers say there will be a large increase in activity in euro financing.
Two of the strongest carriers in Europe, British Airways and Swissair, have perhaps set the pace in airline corporate finance circles by launching their own innovative debt issues in the euro for the first time.
natural gravitation
Barry Zins of the fixed income department of Warburg Dillon Read, the international bank and lead manager in the deal, says BA's 300 million euro ($3.1 million) preferred security issue gravitated naturally to the euro market. "When we first came to the market for BA we were looking at the US and the euro markets," he says. This was because the fixed coupon rate, or interest rate that BA would pay to investors who bought into the financing for 300 million euros, was 6.75% as opposed to 7% if it were denominated in the US dollar.
The BA transaction has no voting rights for investors and, as such, is treated by them as a fixed income bond. In this case, the investor base was made up of European institutions and a handful of US offshore funds, says Zins. For BA, this type of issue has the appearance of equity on its balance sheet. It also reduces the airline's percentage exposure to the US dollar by adding the euro facility, spreading currency risk. BA defines it in this way through the financial calculations of its balance sheet gearing.
At the time of issue, at the end of April, BA had a debt to capital gearing of just over 60%. With the issue, BA was able to reduce that figure by 1.3%. As a result, credit rating agencies, like Standard and Poor's (S&P), which had downgraded the carrier from A to A- in its credit grading (made for investment purposes) might view the carrier differently and would obviously help BA to support future financings. The airline issued the securities under an offshore subsidiary called British Airways Finance Jersey.
BA group treasurer Chris Willford explained the airline's position at the time of the issue: "We were downgraded in the last couple of months by S&P and, although we are not expecting to retrieve the situation, this issue should help us to support the existing ratings."
The added feature is that a preferred security issue does not dilute the number of shares an airline has issued. It is also good from the perspective of repeat deals because investors are not taking an equity risk in the airline and so, in theory, they would be willing to invest in more preferred securities from the airline in the future. Like a bond, a preferred security has a defined life, unlike equity, which has no expiry date unless it is sold on.
The type of finance product that an airline opts for depends largely on the airline's balance sheet requirements and capital needs for daily operations or planned expenditure. Many airlines raise money in the bond markets. The bond market chosen by an airline for a bond issue will depend on the specific economic benefits offered by that market at any one time.
Swissair has always favoured the depth and availability of the Swiss bond market. But since the opening of the eurobond market this year, financiers have been waiting for the financially astute carrier to go euro. "The euro is gradually becoming an increasingly important currency," says Ferdinand Brugger, Swissair's head of financing and capital markets. "We wanted to have a benchmark in euroland - it's a good transaction for us."
The transaction Brugger refers to is the airline's 400 million euro bond issue launched by joint-arranging banks Credit Suisse First Boston and Dresdner Kleinwort Benson at the end of May. SAIR Group Finance, a subsidiary of the SAIR Group, raised the funds which were then transferred to the airline.
euro-dominated deals
It is not surprising that airlines like Swissair join the ranks of BA in issuing high-profile, benchmark euro-denominated deals. But it is not going to be the same for every carrier, particularly the weaker ones. Raising funds and the integral cost of borrowing will always depend largely on the carrier's credit rating. Swissair and BA are in the premier division of airlines when it comes to financial prowess. But this does not mean that airlines with lesser credit ratings would not be able to follow suit, it just means that the cost of borrowing would be proportional to their individual financial standing. Again, it poses the question of what finance option to take, which is dominated by the cost of borrowing.
Brugger takes the euro debate a little further by considering tapping this currency market for the carrier's forthcoming aircraft deliveries. Although the airline plans to take seven A330-200s, the fact that the aircraft are European-made has nothing to do with opting for euro financing. Manufacturers like Airbus have made it clear that, for the foreseeable future, they will continue to sell aircraft in US dollars (see box on manufacturers). "The euro is a distinct currency option for our aircraft finance," says Brugger. "It's a kind of natural hedge for us because many of our ticket sales are in euro and so we would be able to make debt repayments from this revenue." Swissair would still have to find favourable hedging of the euro against the US dollar to prevent logistical problems.
When airlines examine the funding proposals they receive from banks to finance their aircraft deliveries, deals are not always pre-defined. Some deals are likely to filter into the market this year featuring a combined element of euro and US dollar debt financing. It all comes down to how the airline wishes to repay or amortise its debt schedules for a specific transaction. Swissair is weighing up the relative merits of such a hybrid structure for its A330 deliveries. Once again, airlines do not finance just for variety of structure and currency -even if they do wish to spread risk - they look forthe best pricing on the deal.
So far this year, a number of airlines have taken the plunge into euroland and raised euro debt to pay for deliveries. Among these, Air Mauritius financed its March delivery A340-300 with euro debt. The carrier had a good reason: most of its revenues come from its European routes and, according to bankers close to the carrier, euro ticket sales have been hefty in comparison to other currencies since the launch of Europe's new currency this year.
Transactions like this are good for the airline but raise some concern for bankers providing the funds. "The issue you have is a 12-year exposure to the euro," says Geoffrey Yarrow at Barclays in London, the bank that arranged the export credit agency-supported Air Mauritius deal. Most aircraft financings, supported by the European export credit agencies, run for 12 years. Bankers are concerned about the risk associated with such deals in the very early repayment years. Until substantial repayments have been made, the mismatch between financing the aircraft in one currency with a sales contract in another causes one of the biggest potential headaches in such deals: financial security over the aircraft. "It is something I think bankers are going to have to live with," says Yarrow.
cheaper exports
The cost of borrowing in the euro versus the US dollar for export credit agency-backed transactions is much cheaper at present, however. The US and European export credit agencies, supporting Airbus and Boeing deliveries respectively, support sales either through pure cover or through the Large Aircraft Sector Understanding (LASU) agreement between the USA and Europe: easily comparable to variable- and fixed-rate mortgages. LASU is presently the most attractive variation on export credit financing. But denominated in euros, it is around 100 basis points or 1% cheaper in terms of interest payments. Calculate the compound interest on a $30 million debt loan over 12 years and this shows why some bankers are pushing euro deals for their clients.
Bankers are always quick to highlight the potential blocking points in starting a major trend in euro financing. Again and again they point to the added currency risk in the deal. But airlines, especially those with limited US dollar revenues, have had to hedge their revenue currencies against the industry's dominant currency since they started operations. So, banker caution seems to be taking over again.
"Some aircraft finance deals are problematic enough without the need for further hedging. But the hedge between the euro and the US dollar is not a complicated device," says a London banker. "Although bankers are complaining now, I think they'll have to get over the obstacle because in a couple of years time it'll probably be so common they won't be able to refuse the euro finance option."
In the complicated financial transactions of the defunct Japanese leveraged lease market (once a strong aircraft finance option for many airlines), one set of investors went for a euro-denominated deal because the interest rate was better in the euro than in the yen, says Michael Krammer of West LB in Tokyo. The deal was for a United 767-300 delivery, arranged last year in line with the Japanese tax authority's deadline on such deals, but completed this year.
Typically, these tax-based leases would comprise 80% debt and 20% equity and were in the 10 years of the lease as complicated as anything else in the Japanese banking market. While the equity element had more or less always been in yen, the investors, generally known to be shrewd, at least with a little help from their bankers, swapped their yen investments for euros. Any explanation beyond this takes us into the realm of complicated banking law but, suffice to say, the investment benefits would have been comparably greater under the euro.
While some carriers actively seek a range of diverse currency-denominated deals to fill their finance portfolios, all airlines will go for the deal that yields the best return. So, this may mean an airline will wait three or six months before it can return to a particular market.
Other carriers expected to dip into euro financing include many countries neighbouring the European Union whose own currencies are now linked to the euro. Financiers are looking to airlines in North Africa and the Middle East; in particular, Emirates is believed to be keen to use some revenues on its strong London route to finance its 16 A330s. The list is far from limited and could include any carriers in the world with strong European links, including US and Asia-Pacific carriers.
Although the euro's value has fluctuated since its launch this year - as much as two cents on some trading days - most financiers believe the infant currency will find its feet. "You have to realise that the euro is young and when it is young it will be volatile," says Zins.
dollar challenge
The birth of the euro is the nearest currency challenge to the US dollar. In its relatively short life, Airbus has notched up its share of the commercial aircraft sector to equal Boeing's stronghold. So why the US dominance? Some aerospace analysts are pointing to the euro as the tipping weight to help Airbus achieve that much-vaunted single corporate entity status. So, if this is achieved, surely the world is big enough and the airline industry diverse enough to support a dual-currency approach? If a US carrier wants to buy aircraft in euros to offset its revenues but cannot, the inverse scenario has been true for European carriers for years.
Other European banks are looking at developing a European capital markets product to finance aircraft using euro funds. Although this concept has been bandied around for much of the 1990s, some confident financiers believe European Monetary Union could help promote a real challenge to US capital markets products, used extensively to finance aircraft for years. But again, many legal issues need to be resolved before this kind of financing could ever become a real option. If hedging the euro against the dollar is a daunting prospect for some financiers, capital markets financing in the euro would seem to be terrifying.
Source: Flight International
