The leasing business has boomed for over three years creating a buoyant and confident industry with plenty of new players. But will the champagne continue to flow for the next few years?
Making a dispassionate assessment of the aircraft leasing business is a paradoxical task at the beginning of 2008. On the one hand the industry is riding the crest of a wave: lease rates are at new highs and still climbing lease renewals for existing aircraft and for new acquisitions are running months and even years ahead of industry norms interest rates are relatively low, the dollar is weak, and up until a few months ago money was pouring into companies eager to raise finance to buy airliners.
Today there are new and negative factors at work. However, their impact is not universal, yet, and not expected to be severe. Firstly, five years of record world economic growth looks to have come to an end. But while the peak may have been reached, the down slope is predicted to be fairly gentle. The International Monetary Fund, for example, says the global economy will still grow at 4.8% this year, down from 5.2% in 2007.
More worrying is the price of oil with it crashing through the $100 a barrel mark earlier this year (but since retreating), the poor performance of the US economy, and how these factors will affect air transport demand. The influence of high fuel prices is starting to affect some players, especially in North America, where several have been trimming their growth plans this year.
Specifically for those involved in the financial world there is the troubling global credit crunch, which has tightened the supply and raised the price of aircraft and lessor funding.
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"We have complete visibility of what airlines are prepared to pay and what they want in 2010" Klaus Heinemann Chief executive, AerCap |
The simple explanation is that demand for their aircraft remains robust. "As a lessor, 2008 is done for," says Klaus Heinemann, chief executive of AerCap. "We have fixed everything delivered in 2008 or that comes off lease in 2008. In fact, 2008 and 2009 are done. We are now entering discussions on aircraft whose leases expire in two to three years, and we have complete visibility of what airlines are prepared to pay and what they want in 2010," he says. "2010 is where we are marketing at the moment."
However, as one executive puts it: "There is a bit of suspended animation going onthere is a rising concern amongst banks with interests in airplanes and lessors. The availability of financing at some point is going to become more difficult."
Then there are those who have been through the up and down cycles at least once. Two industry veterans and gurus, ILFC chairman Steven Udvar-Hazy and GECAS chief executive Henry Hubschman, have seen it all before. "I know one thing: GECAS has been through it," says Hubschman. Their experience tells them to be wary about where the market goes now. "The further out we look the more cautious we are by nature," says Hubschman. "Particularly when coming off three of the greatest years in history," he says, referring specifically to the buoyant leasing sector since 2004.
"We are putting our seat belt on, getting ready for the downturn," says Udvar-Hazy. "This boom cannot happen for ever." For companies with the financial strength of ILFC and GECAS any slowdown can be weathered well. In the case of GECAS, which provides financing to distressed airlines in times of trouble, it can be an even more lucrative business than leasing aircraft. In fact, Hubschman points out that "at least 50% of our annual volume is in financing".
The consensus among lessors is that the peak of the market has probably been reached. However, on a global basis "demand still exceeds supply pretty dramatically", says Tony Diaz, CIT executive vice-president and general manager commercial airlines. "We don't see a sharp downturn. We see more of a plateau rather than a peak and a decline."
Adds Lease Corporation International chief executive Crispin Maunder: "It is a very fluffy area in the cycle." But he says LCI, which is now looking to buy aircraft using the proceeds from its sale last November of 20 aircraft to fast-growing lessor Global Aviation Asset Management, is "still comfortable with the market and feels there's opportunities". If it didn't, LCI would have used the opportunity of the sale to exit the market.
Leasing survey
A look back at the Airline Business annual surveys of the world's top lessors shows how much the industry has grown. The 2005 survey of the top 50 lessors, conducted when the recovery was kicking off, put their total fleet value at just over $150 billion covering some 6,000 aircraft. This year's survey (based on ACAS data and Avitas estimates) has a total fleet value of $150 billion, a 16% rise over the previous survey covering some 6,400 units.
Lessors placed substantial orders for new types in 2007, helping yet another record-breaking sales year for Airbus and Boeing. For its part, ILFC stayed mostly with the mid-sized widebodies, ordering 52 Boeing 787s and 20 Airbus A350 XWBs. GECAS preferred to augment its narrowbody backlog with commitments for 60 A320s and 53 737s.
A host of others, including AerCap, Aircastle, AWAS, Babcock & Brown and CIT placed substantial orders in 2007, but the main event was reserved for late in the year when Dubai Aerospace Enterprise signed letters of intent for 100 Airbus and 100 Boeing aircraft. The late year rash of orders surprised commentators who feared some were in danger of paying too much for their metal at a time of booming aircraft values and soaring demand for new generation types. Frank Pray, chief executive of AWAS, acknowledges that this was a potential worry as it made its first new aircraft order in December for about a decade.
"Frankly I did not think we were going to order any new airplanes [in 2007]. Up until the end of September it was my firm opinion it was probably not good timing to exert good prices from Airbus and Boeing," says Pray. "We were very surprised what we were able to achieve with them." In the end it went for deals for up to 50 737s and 75 A320s at the end of 2007 and early this year. The narrowbody deliveries are planned to start when an order stream it inherited after buying Pegasus Aviation last year runs out in mid-2010. Pray also reveals that it is planning a fairly large widebody order.
"If you buy in bulk you still get bulk discounts," he says. After its negotiations with both manufacturers, "we felt we ended up with an opportunity too good to pass up".
The AWAS narrowbodies will begin entering the market at an interesting time. Not only is this expected to remain a period of strong demand for A320s and 737s, but the eventual replacement for both types could be on the horizon, with airlines asking for the next generation narrowbody by 2015.
"In the 2010-2013 period there is very strong competition between lessors for these aircraft," says Pray. "We needed to convince Airbus and Boeing that selling to us over others created value in terms of a nice delivery stream. We felt there was significant scarcity in delivery positions in that timeframe." He says that in the 2010-2013 time frame the narrowbody order backlog that is held by lessors stands at around 20% of the total, compared with a more traditional situation of 25-30%.
The entry of AWAS and DAE into the market for deliveries in this period shows that the "lessor base is dispersing from the two major players to some very strong secondary players", believes Pray.
For CIT's Diaz, the arrival of Middle Eastern players, as well as lessors in China, is inevitable as these cash-rich nations seek to invest in new markets. "It is a natural progression that they not only want to fly aircraft but to own and lease them and move into financial products," he says. And it is ironic, he adds, that while they are competitors, the new entrants help improve the overall market by making it more liquid as they take aircraft deliveries. "The big picture is that their arrival does continue to make the aircraft attractive assets," he explains. "We need each other."
"There is a lot of competition in this industry - probably more so than at any point in the past," says Hubschman of GECAS. But whether the new players attracted to the business will be there for the long-term will depend on how they weather the down cycle. "The question is, will they feel that way if the market turns down - will they be able to re-lease their aircraft?" asks Hubschman.
For another executive, it will be the market behaviour of DAE that demonstrates its market impact. "They are a risk factor. We don't know how they are going behave - are they an Emirates or an Etihad?" he says, with the comparison being to see the former as a rational long-term player with the latter an upstart chasing volume and doing whatever it takes in pricing terms to win business.
As the market downturn begins to bite, leasing executives predict that some of the more speculative orders made in the past couple of years will be cancelled. "When things get really tight we see about 10% of the narrowbody orderbook being thrown back into the pot," says one. "India, for example, has clearly got some pretty flakey orders."
This will prove of some relief to Airbus and Boeing, which are, according to one source, "embarrassingly over-ordered". "There will be airplanes that become available, giving opportunities for lessors," says CIT's Diaz. "Boeing and Airbus have an expectation that not all of their orders will be taken."
Hubschman at GECAS has watched the order rush with interest, particularly those making commitments for aircraft in the 2014-2017 timeframe. "We are seeing many more people ordering further out, both lessors and to some extent airlines. It hasn't made us change our strategy," he says. GECAS prefers to mitigate its risk by concentrating its orderbook two to three years out, with the maximum timeline up to five years. Its longest lead time orders are for a handful of Airbuses in 2013, he notes.
These numbers are "still small compared to the 1,500 aircraft we have in our existing fleet", says Hubschman. This is a huge fleet in the constant flux of lease and re-lease. With airlines unable to get new narrowbodies from either manufacturer until 2010/11 at the earliest, the lessors are often the only game in town. Demand is so strong that GECAS has leased nearly all of its 2008 availability and a lot of 2009, says Hubschman.
Lessor war chests
Several lessors managed to put their current funding plans in place before the credit crunch bit into the market. This means there are some pretty large war chests of money available to buy new aircraft or conduct sale and leaseback deals. Babcock & Brown Air, for instance, secured credit of $1.2 billion in August to help fund its plan to grow to a portfolio of some 100 aircraft in the next couple of years, says Colm Barrington, chief executive.
"We refinanced all of our warehouse [funds] and bonds in May 07," says AerCap's Heinemann. This included a long-term $1.7 billion bond issue that is "not repeatable today at that price", which expires in 2032. In addition, AerCap secured $1.2 billion in warehouse financing for short-term funding needs giving it significant "undrawn firing power", he says.
Others, like CIT, had their plans thwarted during 2007. "We had looked at doing an Initial Public Offering on a number of aircraft, not unlike what GE did with Genesis," says Diaz. In these arrangements, a special purpose company is formed, and then floated, which owns the aircraft. As is the case with Genesis Lease, the actual lease management of the aircraft is handled by the parent. CIT's launch was planned for the fourth quarter of 2007 but put on hold when the parties looking at providing both debt and equity as part of the deal pulled out. "We may go back to it this year if the market improves," says Diaz.
So far four big lessors have launched IPOs and gone public, with Aircastle starting the ball rolling in August 2006, followed by Genesis Lease and AerCap later that year and Babcock & Brown's B&B Air in September 2007.
Although public offerings like these are likely to be rare in the current market conditions, it does appear that if any downturn is going to shake the leasing industry it will have to be pretty severe. And for most it is not until 2010 that the slope could turn really slippery. For the time being, the industry will continue to celebrate its success.
Read the full survey results online at http://www.flightglobal.com/leasingsurvey
Source: Airline Business
