Airlines and lessors face decreasing pool of capital

By Laura Mueller

Raising capital will be a major concern for the aviation industry this year as the financial crisis continues to weaken global financiers, leaving few available to fund the sector's stunning demands.

No doubt aircraft manufacturers, helped by European export credit agencies and the US Export-Import Bank, will provide financial support to the airlines. But they will also be called on to provide financial aid to the operating lessors and to a level perhaps never seen before. But even so, this support is unlikely to be enough to fund this year's $65-70 billion new aircraft financing bill as capital will also be needed for refinancings, used aircraft deals and various corporate purposes.

Certainly some deals, such as a bridge loan in need of refinancing or near default, or a portfolio sale that requires serious backing, could have a more disastrous impact on the industry if unfunded than perhaps some brand new Airbus A320s that can't attract capital. But during a time of wide-scale de-leveraging, declining credit ratings and rising bad debts, financiers will be busy worrying about their own positions and unable to pick the financings that perhaps make most sense for the overall health of the aviation industry. This, unfortunately, will be the new reality airlines and lessors must face as they chase the same capital from the same limited ­financial sources this year.

At the close of 2008 maybe a handful of banks were still active in the sector and even fewer were open to new business. This year 15-20 aviation banks and various regional banks should be available for funding but most market observers anticipate that number will shrink as the year progresses.

"Some banks could shut down if they are caught too heavily in a couple of airline or lessor bankruptcies which cause provisions or losses," says Calyon global head of ­aviation and rail Jose Abramovici. Also, he warns that consolidation could lead to fewer ­financiers, particularly "if some new buyers of distressed banks decide that aviation is not ­strategic any more".

Already the market has witnessed the scaling back of funds from WestLB and Alliance & Leicester. Other banks have also pulled back support, but have been less vocal about their moves. DVB board member Bertrand Grabowski anticipates European banks, the main provider of funds to the industry, will contribute 30% less capital to aviation globally this year compared with 2008. Another banker puts that figure closer to 50%.

Manufacturers say they will be available for customers who come to them cap in hand. Airbus anticipates that it will double the amount of vendor financing on offer to about €2 billion ($2.62 billion) to support commercial aircraft sales and maintain deliveries.

Boeing Capital plans on offering up to $1 billion in new financing this year. However, it has filed a shelf registration with the US Securities and Exchange Commission to sell up to $5 billion in debt securities, which suggests it is preparing to offer more than what it is saying. "That is a good start, but it won't be enough," says a banker, who believes a ­doubling of the figures suggested by the ­manufacturers will be necessary in 2009.

Still, Boeing believes there will be less of a shortfall in available financing to the sector during this downturn than following September 2001. "We have done a bottom-up analysis and the figures we get are smaller than those post-9/11," says Kostya Zolotusky, managing director of capital markets development at Boeing.

But by offering support to their customers manufacturers are putting themselves in a tricky position due to the issue of sales recognition. "Sales recognition is a powerful mitigant to a significant increase of customer finance," says DVB's Grabowski. "The issue is very simple: under US GAAP [for Boeing] or IFRS [for EADS], the seller of the equipment can only claim for a true sale if the transfer of title and payment comes with little or no strings attached. Thus, any direct financing, but also residual value guarantee, back stop financing et cetera, can prevent Airbus or Boeing from increasing their ­revenues on a given sale."

Robert Morin, vice-president of the Ex-Im Bank's transport division, believes 2009 "will be a record selling year in aviation". The bank's busiest year on record was in 1999 when it guaranteed $6.3 billion to help finance 122 aircraft.

PEAK PERFORMANCE

Morin says it is "quite possible" that Ex-Im will "match its peak performance" or issue "slightly more" guarantees this year. However, he doesn't believe a doubling of the $6.3 billion mark is realistic. "It would be unusual for there to be such a large demand for Ex-Im bank support and probably it would be impossible to accommodate it. Hopefully, Ex-Im will not be needed to support $10-12 billion of aircraft financings this year and I don't think we will see those levels. I think ­somewhere in between $7-9 billion is more likely," says Morin.

In its most recent fiscal year, Ex-Im ­provided $5.5 billion in financial guarantees covering 96 aircraft. In the prior six years, Ex-Im guaranteed an average of $4.3 billion worth of financing for 75 aircraft per year.

But even if Ex-Im and the European ECAs significantly increase their support this year, borrowers will still need to come up with the 15% of financing that is not covered by the guarantee. And here lies the major problem for borrowers this year, according to Christian McCormick, head of aviation finance at Natixis Transport Finance. "The guarantees aren't the issue, it is the funding. Who will fund these extra guarantees?" he asks.

Morin says Ex-Im can provide direct loans if needed. "We have always had the ability to lend directly, but we have always preferred to do guarantees so as not to compete with the commercial market," he says. "But in the current environment if the commercial banks don't want to fund the deal or do not want to fund the deal at reasonable margins, then clearly Ex-Im can step in and fund the loan itself. This is because neither of the two alternatives is acceptable to Ex-Im.

"If the alternative to Ex-Im funding the loan itself is to place the export of the aircraft at risk and thereby put US jobs at risk that is not acceptable. Also, if the alternative to Ex-Im funding the loan itself is to guarantee a loan with an unreasonable margin, thereby putting the airline and the taxpayer at risk, that too is unacceptable."

According to Abramovici, funding a 0% weighted export credit loan is not really an issue "provided that the Ex-Im or ECA ­margin is sufficient to cover long-term [10-12 years] liquidity costs of banks active in export credit [finance]".

INCREASED MARGINS

But Morin warns that banks could "price themselves out of the market" if they continue to raise pricing as the increased margins don't reflect the "underlying risk in an Ex-Im guaranteed transaction, which is the full faith and credit of the US government".

"Potentially these higher margins are transforming the banks' problems into Ex-Im's problems and the US taxpayer's problem. Banks cannot expect to keep pushing up margins, which are now at Libor plus 100 ­compared with Libor flat previously, because there are other sources of funding available," says Morin.

But even if Ex-Im does provide direct loans, there will still be a serious funding gap, according to McCormick. He anticipates a $70 billion financing requirement for ­aircraft deliveries in 2009, including regional aircraft, based on financed values. Before ­certain support measures, there will be an "undeniable, serious gap of around $23 ­billion", he says.

"Last year almost 40% of deliveries were financed by banks, but if you include ­financing for the export credit agencies, then around 60% of deliveries were actually funded by banks," explains McCormick. "Now if you consider that lessors are financed by banks, and due to difficulties in that market, we are assuming half of the ­support from that community in 2009, so actually around 70% of deliveries will need bank funding."

McCormick believes manufacturers will provide $4 billion each next year and another $6 billion will come from the Chinese banks, which would still leave a $10-11 billion funding gap to be filled.

But European banks aren't the only providers of bank debt, stresses Boeing's Zolotusky. "Bank debt is not a European domain. European banks will continue to play an ­important role, but we see other regions becoming more relevant." He points to ­Chinese, Japanese and Australian banks that have been active in aviation financing during the past several years.

Abramovici believes regional banks will play a role in financing but only for their national flag carriers, except for a couple of Chinese banks. However, Grabowski and McCormick maintain that Chinese banks will be primarily interested in Chinese airlines only. Abramovici also anticipates that hedge funds may be interested in taking debt for tier-two airlines "when margins have reached a peak".

JP Morgan Chase notes in recent research that some hedge funds are beginning to ­re-enter the market, citing the December sale-and-leaseback by United Airlines of 15 ­Boeing 757s with an affiliate of Wayzata. Also, Trilogy Capital is in the process of ­raising a $1 billion aircraft fund.

Grabowski is less optimistic about hedge funds entering the market as the "big groups" already exist in aviation and "they are ­burning through their figures". However, he sees some pressure easing in the Middle East, which is home to a record number of ­deliveries in the coming years, through state support for the carriers. "This should open new lenders to those airlines," he says.

MIDDLE EAST SUPPORT

Last year Qatar Airways obtained state ­support for the purchase of several Boeing 777s, which were financed through a diversified consortium of banks.

Morin says Ex-Im has always had the ­ability to support pre-delivery payments and pre-owned aircraft financing, but again has preferred to allow the commercial market to do so. He adds that in order for pre-owned aircraft to be eligible for Ex-Im support they need to be assets that previously were not exported. For example, aircraft that US ­airlines have recently taken out of their fleets could be supported by Ex-Im, given they have never been exported.

Also, he says the bank has had some recent discussions with airlines about pre-delivery payments. "It seems some of the aviation banks that have withdrawn from the market were providers of PDPs and we need to see if the others will step in," he explains.

Abramovici anticipates there will still be an appetite for PDPs on the most liquid aircraft arranged for short tenor [one to two years] provided that the airline or lessor is putting sufficient cash equity upfront and there is no clawback risk.

McCormick also believes PDPs will ­continue to be a "part of global finance ­packages of long-term financings so long as the clawback clause is out of the picture".

Airbus and certain aviation banks have been trying to find a solution to the clawback clause, which the manufacturer introduced into PDP financing more than a year ago to avoid speculative transactions by financiers, particularly operating lessors, which have taken advantage of airline defaults in the past. The clawback calls for the refund of equity to the airline by the financier in the event of bankruptcy or default - a risk that certain financiers aren't inclined to take.

Sources suggest Airbus will be more ­flexible with the use of clawback in future PDP financings now that funding sources are scarce and plenty of aircraft are due to be delivered in the next couple of years

Last year, Natixis Transport Finance is believed to have closed PDP financing on five S7 Airbus A320 aircraft, as the contentious clawback clause does not appear in any of the ­documentation. If this is the case, it may have been achieved through a revised ­structure that includes a bankruptcy remote special ­purpose vehicle to get around any clawback issue.

But even with increased requests for financing support, Morin warns that Ex-Im Bank will not alter its business standards. "Going forward we are custodians of US ­taxpayers," he explains. "We will not lower our credit requirements or how we structure a deal. It isn't luck that our portfolio has ­performed so well."

"European banks will contribute 30% less capital to aviation globally this year, compared with 2008"

INCREASED PRICING HITS SOUTHWEST

Southwest Airlines completed a series of aircraft deals that demonstrate the new level of increased pricing airlines seeking financing are likely to encounter this year.

In December 17 aircraft were pledged to a $400 million three-year note, in a private placement priced at an interest rate of 10.5%, which is an astonishing number for this transaction rated A- by Standard & Poor's. In comparison, Southwest was doing deals a year ago where it paid interest rates just over 5% which were not secured by aircraft.

Southwest chief financial officer Laura Wright says she was dismayed by the pricing at a time when interest rates at the US Treasury were priced at 0.25% or lower by the US Federal Reserve. "It was an extremely difficult one. If you go out and look at the number of financings done in November and December, there were just a handful, all investment grade and incredibly pricey."

In addition, Southwest and BOC Aviation committed to the sale/leaseback of 10 aircraft for $350 million. Rent for the first five totals $7.8 million semi-annually, or an average of $260,000 a month per aircraft tied to six-month LIBOR. "The spread from LIBOR to Treasuries was out of proportion," says Wright, which meant the airline paid more. Usually LIBOR and Treasury rates are in step. Since this deal LIBOR has settled down.

In a first for the industry, Southwest agreed to pledge up to 20 aircraft for collateral for fuel hedging if the company is required to pay between $300 million and $700 million to its counterparty in the fuel hedging contract.

Copyright © 2009 Aviation News Release