After emerging from the crisis of the last year, leading lessors are finding new business opportunities for themselves in the downturn
After the roller-coaster of the past 18 months, the world's major lessors at last appear to be catching their breath. While none are talking about a recovery, it seems that the worst of the firefighting may be over. Most now believe that the market is bottoming out and are preparing to sit tight and weather what could still be a long storm. But despite the uncertainties ahead, some operating lessors have found opportunities as carriers and banks alike seek to free up cash by getting aircraft off their books.
In the immediate aftermath of the terrorist attacks, lessors were left scrambling to ensure that their fleets stayed in the air even as airline customers slashed capacity and renegotiated lease terms. Most leasing companies were affected in some way by the collapses at Ansett, Sabena and Swissair, which spilled more airliners back on to the market.
Aircraft values also plummeted in the wake of 11 September 2001, although after the initial shock they have remained fairly steady throughout 2002. This point is demonstrated by the annual survey of the Top 40 Lessors compiled by Airline Business and the Airclaims consultancy. A year ago the survey revealed how the average value of aircraft in the leasing fleet had spiralled down by more than 17% in the immediate aftermath of the crisis. The latest snapshot, taken in January 2003, suggests that values have more or less remained level since then. So while the overall value of the aircraft held by the top 40 lessors has risen by more than 15% over the past year, that comes on the back of a similar rise in the size of the leased fleet. However, even with an extra 700 aircraft or more, the current value of the fleet at $87 billion is still $3 billion below where it stood before the US terrorist attacks.
The first priority for all lessors was to keep their metal flying, says GATX Air, whose joint venture with Swissair's Flightlease was an early casualty of the crisis. "We worked with all our lessees to restructure leases and help our operators keep flying. We worked with the airlines to understand what they needed," says Dave Thompson, GATX managing director marketing. "Most requests from lessees were for rent relief. Traffic fell off the cliff in Europe and the USA, which precipitated the need for cash flow. We never provided a loan to a carrier, most typically we provided six-month cash flow relief in the form of reduced rent."
He stresses that many lessors entered similar arrangements with clients. These funds were later recouped but the deals struck provided immediate relief. "The first priority is the equipment has to keep flying," adds Thompson - a comment echoed throughout the industry.
Another characteristic of the cyclical downturn is the emergence of start-up carriers in the past year keen to take advantage of low rentals. A surplus of equipment meant that carriers who were not traditionally seen as good credit airlines would have access to relatively new aircraft coming off lease, being repossessed or even fresh from the production line. Placing aircraft during the crisis led many lessors to sign deals with carriers that they would not necessarily have considered attractive in better times.
Ansett Worldwide's executive vice-president strategic development Crispin Maunder says: "Certainly lessors are becoming far more active in the lower credit sector now. Many start-up carriers are emerging today seeking to take advantage of the current depressed rent levels, and benefiting from starting with a clean balance sheet." However, he warns that as and when rental rates rise to "more realistic levels" it remains to be seen what impact this has on the business models of this new breed of carriers.
He adds, though, that lease rates have not been helped by the large "speculative orders" that some lessors have with the manufacturers. "They are having to discount rentals significantly to move aircraft - this is naturally having an adverse impact on the industry," he says.
Leaseback potential
The crisis in airline cashflows has also opened up opportunities for lessors in another way. Many banks retrenched in the wake of the 11 September crisis, with internal advisory boards putting restrictions on lending and holding a magnifying glass up to all airline deals. This tightening up of the bank market left airlines looking for alternative sources of cash and one familiar option has been the sale-and-leaseback deal. Selling equipment to a leasing company and then renting it back not only helps cashflow but also adds some fleet flexibility and reduces balance sheet exposure. Lessors see this as a growth area for 2003 but warn that it will depend on the type of equipment on offer.
Singapore Aircraft Leasing Enterprise (SALE) is one major lessor that is using its access to funding facilities to launch into more sale and leaseback deals. Like other lessors, it completed a few transactions in 2002 but sees the potential to do much more in 2003.
SALE's managing director Robert Martin says: "When banks pull back from the market, carriers look for other sources for financing. When the market is very hot we can't compete with the banks. As long as we have US Airways and United Airlines in Chapter 11, we expect the banking market to be tight."
Reduced availability of bank debt has allowed industry giant GE Capital Aviation Services (GECAS) to capitalise on its in-house financing services - furthering its ambition to become a "one-stop shop" for airlines. The lessor currently manages and owns over 8% of the world's commercial fleet, but in 2002 its focus shifted. In the past year debt financing contributed to around half of its business volumes. "It may not pay the same returns, but metal in this market is stressed and cash is not," says GECAS chief executive Henry Hubschman.
"The drive to be a one-stop shop has become more meaningful since 11 September than ever before," he says, adding that the volume of debt financing deals struck with airlines over the past 18 months has "risen at a ridiculous pace" growing four- or five-fold. "Airlines in general have been looking to generate cash and have some form of lease flexibility. They have been looking for someone to take residual interest and provide debt." Either out of "necessity" or to reduce their exposure, carriers have been asking for financing, he adds.
Although the emphasis of the past year has been firmly on the financing side of the business, GECAS has nevertheless continued to build its fleet. The company has struck a number of sale-and-leaseback deals and also taken delivery of new aircraft, although Hubschman says the focus has been on taking up opportunities to acquire aircraft from airlines rather than buy new from the manufacturers. He points out that GECAS only has around a third of the order backlog of its nearest rival International Lease Finance (ILFC), which for its part continues to focus on the aircraft marketing side of the business.
Niche management
Lessors have been looking at other ways to survive the current crisis. Dublin-based lessor the Pembroke Group has taken the opportunity to develop its niche third-party management business.
"Our core business is owning and leasing aircraft and in that area, there was little to celebrate during 2002,"says Pembroke chief executive capital markets Brian Goulding. "However, we were able to generate significant fee income from third-party management services, particularly from our banking clients who were coping with bankruptcies at Swissair, Sabena, US Airways and Ansett." Goulding adds that Pembroke signed up leases for over 80 aircraft last year - a record for its marketing activity.
Despite its severity, this crisis finds the major lessors themselves on a more stable footing than in the last downturn, argues Goulding. He was himself an executive at the giant Irish lessor GPA which was allowed to run aground in the early 1990s. "One material aspect of the current downturn, which is measurably different to the last, is that just about all leasing companies in the top 10 today have robust shareholders. Not all may be overwhelmed with joy, but they are unquestionably robust," he says.
By contrast, GPA had found itself in 1992 with an owned fleet worth around $6 billion and another $12 billion of aircraft on order, but with no dominant shareholder to protect it. "Arguably the leasing industry is overextended today, much like it was in 1992, but today shareholder strength can make a difference to overall confidence. Unlike the last time around, the stability of shareholders to the lessor community can be expected to give a more structured response," says Goulding.
Leasing giants GECAS and ILFC both have strong support from their parent companies: GE Capital and the American International Group respectively. But not all shareholders are happy to continue their support of the aircraft leasing subsidiaries. In recent years some financial institutions have sold out while other finance houses have enthusiastically bought up second-tier lessors.
The biggest changes came in 2001, starting with Deutsche Bank's sale of Boullioun Aviation Services to WestLB, just over three years after acquiring the company from Sumitomo Trust & Banking. The transaction was swiftly followed in April by The Royal Bank of Scotland's acquisition of small Irish lessor and arranger IAMG, merging it with its own leasing services to form Lombard Aviation Capital. Within a month, UK bank Abbey National embarked on its own growth plans for the sector, acquiring IEM Airfinance from Dutch bank ING.
Following the terrorist attacks, the enthusiasm from some shareholders to build a leasing portfolio has waned. The first casualty of the crisis is IEM Airfinance. Abbey National confirmed in November after months of speculation that it would leave aircraft leasing and was looking at other options for IEMas it prioritised its core businesses. Both the bank and the leasing company once had big ambitions in aircraft leasing.
New contenders
Lombard has been the most bullish of the up-and-coming leasing companies. In the final quarter of 2002 it radically boosted its portfolio, signing a deal with GECAS for 25 aircraft with leases attached: acquiring Airbus A319s and Boeing 737s, along with Bombardier CRJs and one Boeing 777. At the same time, it completed a separate deal with GECAS to buy delivery slots that were attached to an Air New Zealand acquisition for five A320s, with deliveries starting later in 2003.
Aggressive action was also taken by Boeing's leasing arm Boeing Capital Corporation (BCC) which appears for the first time in this year's survey moving straight in at number three - it had previously been classed as a aircraft financing house. Lessors for years have been talking about who would fill the number three spot and BCC has emerged since 1999 as an aggressive contender, with a mandate to grow its business. The company is well placed to take advantage of the crisis as the leasing arm of a manufacturer.
In the past year it has grown its portfolio in leaps and bounds through finance and operating leasing activities in commercial aircraft deals as well as in defence and space equipment. BCC values its total portfolio at $11.5 billion. Looking only at commercial aircraft in the survey, Airclaims includes $3.8 billion worth of commercial equipment and over 260 aircraft.
After a difficult 2002, lessors are now looking towards the next big crisis to hit the market. Firmly on the horizon is the impact of the US Airways and United Airlines bankruptcies. Both carriers filed for Chapter 11 bankruptcy protection in the second half of 2002. Fears have grown in the leasing community of the negative impact on values and rental rates if the two US heavyweights release hundreds of aircraft on to the market.
Banks, lessors and suppliers are busy working with US Airways and United over which aircraft they plan to keep and which will be returned or sold off as part of their restructuring plans.
"What happens to the US Airways and United fleets will be the focus for everyone this quarter," says Airclaims consultant Eddy Pieniazek. "What these carriers keep or release can impact on values. If, for example, they were to release large blocks of Boeing 757s and 737s, that will add additional pressure on these types."
While such decisions will affect aircraft values, Pieniazek notes that the market declines are bottoming out: "We are flattening out at the bottom of the cycle, but which of the modern types will surface as winners and losers is still up in the air, depending on what US Airways, United and others do." He anticipates that aircraft values will follow the trends set in the early 1990s, although some declines are not as great.
Pieniazek gives the example of the biggest casualty in the last downturn, the McDonnell Douglas DC-10-30. The aircraft tumbled in value from $40 million in 1990 to $15 million three years later. He adds: "A few types had a much larger percentage drop in value in a shorter timeframe, but it was a fall from a much harder market. This time around there were fewer types overvalued, so the fall was less hard, although it may be more sustained."
In today's market, Airclaims data reveals that as well as aircraft values falling, rental rates on the lessor's favourites - Airbus A320-200s and Boeing 737-800s - have dropped. Comparing January 2003 with the position two years earlier at the start of 2001, companies saw average rentals of A320s drop by 25-41% and those of 737-800s by 22-26%, depending on the age of the equipment. The figures are based on five-year fixed operating leases from youngest to oldest airframes of the type and variant.
Value declines
The lessor's twin-aisle favourite, the Boeing 767-300ER, saw its rentals fall dramatically during the same period averaging a 46-57% dip. At the same time, the younger Airbus A330-200 offering suffered a less dramatic drop with monthly rates down by 35-38%.
Market recovery is expected to follow a similar pattern to the early 1990s. Pieniazek says that following the Gulf War in 1991, some of the bigger year-on-year falls in value were in 1992 and 1993 with the market beginning to bottom out a year later and stabilising through to 1996. "If the industry is to repeat itself, we are two or three years away before it stabilises," he says.
There is general agreement among lessors that the market will start to recover somewhere from late 2004 through to 2006. SALE's Robert Martin points out that lessors with older models expect recovery at the tail end of the general forecast while ones with newer models are clearly more optimistic.
GECAS's Hubschman adds that even though no one could have foreseen the 11 September terrorist attacks, "the writing was on the wall" in 1999 and 2000 that the industry was headed for a downturn in the cycle. "We are at, or near, the bottom and a combination of factors support this. Subject to a war in the Middle East, 2004 we will see a small upturn and in 2005 we will start to see recovery," says Hubschman.
Pieniazek at Airclaims is cautious:"All the ingredients have to be right for recovery: on the supply side, an increase in permanent retirements and a decrease in new production and on the demand side airlines improving yields, which themselves depend on a sustainable recovery in the world's leading traffic- generating economies." He adds that if the industry is to see an upturn, then the trick is to get all of these factors working together all at the same time.
REPORT BY MARIA WAGLAND IN LONDON
Source: Airline Business
