The aircraft leasing industry has been through a torrid time, but the survivors may be able to contemplate decent returns in the not-too-distant future
The nerves of aircraft lessors have been tested to the limit over the past three years, but there are clear indications that the bottom of the cycle has at last have been reached. "After more than two years of difficult conditions, we're now seeing many signs of optimism," says Robert Genise, chief executive of Bouillion Aviation Service, echoing the sentiments of many.
The leasing sector may even start to attract fresh interest from investors fishing for bargains, argues DVB, the specialist German transport bank. "With a number of medium-sized leasing companies more or less discretely offered for sale by their owners, the improving equipment market may offer good opportunities for investors with deep pockets and an appetite for aviation risk," it reports.
Those who had their fingers badly burned over the past three years may be unlikely to make a quick return to the market, but there may be opportunities for those prepared to live with the risk, argues Colin Sach, managing director of airline financial advisers Sach & Co. "The economics of operating leasing are simple. When two lessees chase one aircraft, good returns are made. When two lessors chase one airline, poor returns are made," he says. The balance is unlikely to shift in favour of the supply side until the end of this year or early next, he concedes. "Then for a period of five to seven years good returns can be made as an operating lessor," he says.
"At the current time all the major banks have withdrawn to a greater or lesser degree from aircraft finance either because of a general cut in lending business or because they are pulling out of aircraft lending," Sachs adds, suggesting that this will mean that through to 2006, even good-quality airlines will not be able to secure financing at attractive rates, leaving the operating lease as the alternative. "There is a window of three to four years from late 2004 for operating lessors to earn above-average returns from good-quality airline credits," says Sachs. "After that, banks will start to enter the markets, orders will rise, manufacturers will increase production and the cycle starts all over."
While 2004 may show the first signs of a real upturn for the leasing industry, the first glimmers were already there over the last year. GECAS, the world's largest aircraft leasing company, expects to show an improvement in its 2003 results when they are posted next month. "Nobody would have expected that at the beginning of the year," says Moshe Orenbach, financial analyst at Credit Suisse First Boston.
Many leasing companies are waiting to see what happens over the traditionally weak winter season before they call the upturn. GATX saw increased activity, a stabilisation in lease rates and less lease renegotiation over the summer, but GATX chairman Ronald Zech warns: "Defining recent activity as a trend is premature until we see how airlines perform during the more challenging fall and winter seasons."
Bucking the markets
Although times have undoubtedly been hard, there have been those prepared to hold their nerve and grow through the downturn. Among them is RBS Aviation Capital, the leasing arm of the Royal Bank of Scotland. It has shot up the world rankings, as shown by the Airline Business annual survey of the Top 40 operating lease groups, compiled from fleet and value data from the Airclaims consultancy. The business was rebranded under the RBS banner last year, bringing together Lombard Aviation Capital and Irish lessor IAMG, which had both been acquired by the Scottish bank over the past few years.
CIT Capital too has soared up the rankings. The New York leasing business had briefly been absorbed by the Tyco group but re-emerged under its own name when its parent fell foul of an accounting scandal. Putting that firmly behind it, CIT went on to hold an initial public offering in mid-2002 and has since gone on to build the world's fourth most valuable leasing fleet. Valued at nearly $3.5 billion, it is not far behind a retrenching Boeing Capital Corporation (BCC) in third place.
Other major names concede that the going continued to be tough over 2003. Ansett Worldwide reports that it had nearly 9% of its fleet idle by mid-year, representing around 18 aircraft. But even here, the lessor has shown a marked improvement, more than halving the tally of idle units by the start of 2004 to just eight aircraft. Of those, two Boeing 757-200s are being converted to freighters by Precision Conversions, and Ansett claims there is already significant interest from potential lessees, while an A330-300 is due to be delivered to a new operator, subject to a signed term sheet. Of the remaining five aircraft, Ansett says there is considerable interest in a pair of 767s.
The tough market conditions have scared some investors off completely. Abbey National, which made an ill-timed entry into aircraft leasing in early 2001 with the purchase of IEM Airfinance, finally bailed out of the market towards the end of last year. IEM, which was itself formed from an earlier spin-off from the Dutch ING Group, saw its portfolio outsourced to Bouillion.
Raising capital at a time when airline losses have gone off the scale has also posed problems for some. Oasis International Leasing in Abu Dhabi reports that it has not been able to attract interest for its next tranche of capital and chairman Mohammed Saif Al-Mazrouei warns that without this the company will stagnate.
"Lease financing is a capital-intensive business and until the company has achieved the critical mass necessary to generate growth for ongoing operations, fresh equity funding is a prerequisite," he notes. Against this background, the board is looking very closely at the options available, presumably including options to quit the business. The general feeling, however, is that there are, as yet, more willing sellers than buyers in the leasing sector.
Manufacturer financing
Among the most significant casualties of the downturn has been Boeing's ambitions to build its BCC unit into a standalone leasing giant. The group's decision to rein back on this strategy ends a period of rapid expansion that has seen BCC grow into the world's third largest lessor by fleet value with a total value of just under $4 billion. Now the aim is to have BCC play a more traditional role as a financier of last resort in support of the core manufacturing business.
BCC was born out of the Boeing takeover of McDonnell Douglas in 1997, which included vendor-financing unit MD Financial Services (MDSS). Boeing's then-chairman Phil Condit saw an opportunity to use MDSS as a vehicle to develop an in-house financing unit, along the lines of GECAS. BCC grew rapidly before the downturn when airlines were in expansionary mood, and carried on growing when the downturn hit and airlines were struggling for cash. Profits turned to losses and Boeing had already decided to refocus BCC into a lender of last resort before the management changes at head office towards the end of last year.
Airbus has been much more conservative in its approach, and has managed to pass on the risk in deals with carriers such as United and American Airlines through securitisation. However, its fleet value grew by over a third last year, suggesting more customers are turning to Airbus to provide funding that would be difficult to get on the open market.
BCC had exposure of $1.2 billion to United Airlines, which filed for bankruptcy protection in late 2002, and another $536 million with Hawaiian Airlines, which has followed suit. BCC has struck a deal with Hawaiian that will see leases extended until March this year.
Even with recent growth at the likes of BCC and CIT, there still remains a yawning gulf in scale between these and the two undisputed leaders: ILFC and GECAS. With a combined fleet worth over $47 billion, they account for more than half of the $90 billion in aircraft value held by the top 40 leasing companies. Their sheer scale gives them a formidable advantage. "They can buy new aircraft as cheap as anyone," says Sach. "Everyone else is at a disadvantage," he says, adding that it may make sense for second-tier operating lessors to specialise in certain aircraft types if they want to compete, or concentrate on slightly older aircraft. "It is probably not possible for a smaller lessor to acquire new aircraft at a price that gives an attractive return, but it certainly is possible to acquire ones that are three-to-six years old," he says.
Jeffrey Knittel, president of CIT Aerospace, says that while the rest of the industry may not have the size advantages of the big two, they do score elsewhere. "We don't have as many aircraft, but this allows us to spend more time structuring deals," he says.
Size advantage
Robert Young, who covers ILFC at credit rating agency Moody's, notes that the company has some major strengths, including a strong and focused management team. However, he goes on to raise concerns over the problems that it could encounter as its owned fleet, which is among the largest in the world, continues to grow. He highlights the potential for a dilution of management attention, particularly in periods of general economic stress. "Although large orders enable ILFC to command substantial discounts, that same large-order position is a significant liability in times of market stress and can threaten ILFC's market profile," he says, although noting that ILFC has attempted to mitigate this risk by placing ordered aircraft on lease well before their delivery.
Low-cost opportunity
While mainline carriers have generally struggled, the growth of the low-cost sector has been something of a boon for lessors. Many of the low-cost start-ups are using operating leases, and even some of the big name players in this sector are increasingly going down this road.
One notable feature of the last year or so has been the tendency for the big names in the low-cost sector to look to lessors to support huge orders for their rapidly expanding narrowbody fleets. EasyJet, for instance, signed a sale and leaseback deal with Singapore Aircraft Leasing Enterprise (SALE) last year for six Boeing 737-700s, while RBS Aviation Capital recently struck a similar deal with Ryanair for 10 737-800s. This deal is significant in that it marks the first operating lease programme for the Irish carrier, which has signalled its intention to broaden its sources of aircraft financing.
SALE, for one, sees significant opportunities in the low-cost sector going forward and has built up a customer list that includes low-cost carriers on four continents: Air Asia, easyJet, Frontier Airlines, jetBlue Airways, Valuair, volareweb.com and, most recently, JetStar of Australia.
Looking forward to 2005 and beyond, there are clear signs that the aircraft leasing industry stands to gain significant benefits from a pick up in economic activity. Some point out that this will come with rising interest rates, but most see the benefits of economic growth far outweighing the downside.
Orenbach at Credit Suisse First Boston says that while it is easier for financing companies to make money in low-interest environments, aircraft lessors should be insulated from future hikes in interest rates as markets recover. Or at least that should be the case, provided that they have borrowed long and leased short.
In the background there remain the uncertainties that continue to play on the nerves of all in the airline industry - the fall-out from terrorism, disease and war. But these issues aside, those that have braved the downturn and stuck with the leasing market, could soon be rewarded for their patience.
REPORT BY COLIN BAKER IN LONDON
Source: Airline Business
