Despite statements by Cessna’s Jack Pelton during NBAA that credit is loosening up, it is still very tight according to NEXA Capital Principal Tulinda Larsen, who added overall bank lending through August has continued to contract, seriously impacting the aircraft leasing market for both commercial and business aircraft.

Indeed, the relief expressed by the millions raised in airlines liquidity moves to ensure capital is available to provide for upcoming loan due dates, belies an increasingly troubled picture in the aircraft leasing market. Commercial leasing is on the wane while corporate aircraft leasing represents an emerging market, said Larsen.

Over the past six months, all loans and leases have contracted 8%, despite the fed’s attempt to get credit flowing. Indeed, banks are investing in safe assets, Larsen noted, including treasury and other securities.

Larsen confirmed what Aviation Today’s Daily Brief heard at NBAA, that banks are hesitant to lend anything in what they see as a risky credit market. Citing a fed report that banks are tightening credit requirements, Larsen noted that banks are more cautious because they have to hold the loans rather than packaging them to sell in Asset Backed Securities (ABS) which have dropped 72% since 2007. Coupled with the contracted credit supply is business hesitancy to invest in expansion because that would mean borrowing.

Financial companies at NBAA put it succinctly pointing to the old axiom -- if you don't need credit you can get it.

The outlook for credit, she said, shows that the fed will keep the target interest rate at zero for the foreseeable future with credit remaining tight for commercial-grade companies through the second half of next year. Still, corporate borrowing has a heart beat, she said, citing the fact that corporate bond issuance, for both investment-grade and high-yield bonds, is running well ahead of last year.

“Sovereign guarantees are playing a vital role in financing the order book for leasing companies,” Larsen told Aviation Today’s Daily Brief. “The Export-Import Bank is very active in aircraft finance for U.S. manufacturers. Aviation Capital Group (ACG) announced plans to use a new financing structure in conjunction with the Ex-Im for aircraft financing. This transaction provides for the capital markets issuance of more than $850 million in debt backed by Ex-Im to support the financing of 22 Boeing 737s to be delivered to ACG during the next two years for lease to U.S. airlines.”

Likewise, said Larsen, the Export Credit Agency (ECA) is very active in financing for Airbus aircraft, In addition, Airbus, ATR, Bombardier, Embraer, Piaggio, and other manufacturers outside the U.S. are using similar programs to get aircraft placed in the U.S. Finally, engine manufacturers also participate in sovereign guarantees. For instance, Pratt is tapping the Export Development Bank of Canada for support while the EDC is making direct loans, not just providing guarantees.

Noting the commercial aircraft leasing industry is fragmented and includes many companies with varying size and asset focus, Larsen said the two largest lessors, ILFC and GECAS, represent about half of the global commercial aircraft operating lease market and the top 20 leasing companies represent more than 90% of the total leased aircraft fleet.

“The remainder of the industry includes special vehicle companies or small trading and leasing outfits focused on a selected number and type of aircraft,” she said. “This includes Boeing Capital and GE Commercial Aviation Services. Running leasing businesses can support the use of manufacturer’s products and enhance financing alternatives to otherwise marginal customers.”

This, she said, is coupled with four leasing companies – AerCap, Aircastle, Genesis and Babcock & Brown – going public since 2006. Larsen also noted that most leasing companies are backed by larger conglomerates. “AIG owns ILFC, the world’s second largest aircraft leasing company,” she said. “CIT Aerospace, the world’s fourth largest lessor of aircraft, is part of a major commercial finance company, CIT Group. Other aircraft leasing operations have recently been formed with quasi-government funding, such as BOC Aviation , formerly SALE (owned by Bank of China) and DAE Capital, partly owned by the Government of Dubai.”

However, their strategies were formed in a different market making it problematic as to which will survive. “Aircastle, Babcock & Brown Air and Genesis launched IPO’s with business and financial strategies that planned for annual visits to the aircraft securitization markets,” said Larsen. “The strategies relied on access to shorter-term bank financing and revolving credit facilities. Since the credit crisis first hit in the summer of 2007, aircraft securitization markets, as they previously existed disappeared, and traditional aircraft financing banks have severely limited lending capacity or exited the market altogether, leading to dividend cuts and scaled back growth plans due to much more restrictive access to capita.”

Larsen noted that AerCap Holdings N.V. and Genesis Lease Limited just announced a merger in an all share-for-share transaction. “Genesis will become a wholly-owned subsidiary of AerCap in a no cash deal,” she said. “Based on Genesis’ balance sheet, the transaction has a value of $1.75 billion. The combined company will have a total fleet of 358 commercial aircraft and 83 engines that are either owned, on order, under contract or letter of intent, or managed.”

Meanwhile, other events in the financing industry have raised significant questions. “Allco Finance receivers are in the process of selling the 64 aircraft portfolio to HNA, which owns Hainan Airlines,” she said, adding that Bank of China Aviation (BOC) acquired SALE. And, questions remain about the fate of the Babcock & Brown portfolio.

Perhaps the biggest question is the fate of aircraft leasing giant ILFC, she said. “ILFC historically employing a strategy that leveraged the scale and the cost of capital advantage from the AAA credit rating of parent company, AIG,” she said. “AIG’s severe troubles and government bail-out have pressured AIG to put ILFC up for sale.”

Larsen ticked off the problems:
• ILFC has seen increased capital costs as AIG’s credit rating has deteriorated. ILFC’s $47 billion balance sheet holds some 1,000 aircraft.
• AIG's sterling credit rating meant ILFC could issue debt at a low cost of just 4% to 5%, buy aircraft and lease them at higher rates.
• The business was so solid that AIG invested some surplus capital of one insurance subsidiary – used to back policies – directly into ILFC.
• The credit crisis pushed ILFC's borrowing costs up by nearly three times and about $18 billion debt is due over the next three years with $30 billion debt overall.
• Though ILFC still produces significant annual cash flow – and has the explicit backing of AIG for 11 more months – the company is in a clear liquidity crisis, with a shortfall of around $5B to $6B.
• Steven Udvar-Hazy, the chairman and CEO of International Lease Finance Corp., said reports that he is planning to acquire and spin off a portion of ILFC's aircraft portfolio from parent AIG are "premature.“

“ILFC is not alone, compounding the problem,” said Larsen. “Once aggressive Royal Bank of Scotland (RBS) is now 70% owned by British taxpayers. Goldman Sachs has been hired to broker the sale of RBS Aviation Capital with roughly 400 aircraft in fleet and it will be difficult to get anywhere near the $12 billion the portfolio value. Finally, CIT is looking at options for its aircraft fleet”

Meanwhile, corporate aviation leasing looks like an emerging market, presenting interesting opportunities in the future, she predicted. .

Noting that, historically, the only leases available to professional operators of corporate aircraft resembled mortgage style aircraft loans with high security deposits – 10% of the aircraft value required up front – and often personal guarantees. Operating lease financing like that available to commercial airlines has not been available to business jet operators

“These rapidly growing professional aviation companies found the deposits were prohibitively expensive if available at all,” she said. “Traditionally, financing to business jet operators has been offered on a recourse basis in which credit terms were determined by the corporate or personal owner’s credit risk, rather than the asset value of the aircraft, again requiring substantial up front security deposits.

While private equity will remain limited, in NEXA Capital’s experience there are private equity funds with a strong appetite for aviation financing out there. “They like aerospace and they are patient,” she said. ‘There will not be much of a role for private equity in the big leasing companies, except if AIG splits up ILFC and Udva-Hazy starts a spin-off. Private equity works for special purpose leasing companies with either commercial or corporate aircraft portfolios.

What will the future hold,” she asked. “The financial crisis has led to a global economic downturn has increased concerns about global airline financial distress, lessee defaults, lower lease rates, lower fleet utilization and depressed aircraft asset values The depressed shares of publicly traded leasing companies, arguably oversold, reflect the severity of these concerns. Sovereign guarantees are becoming essential to get the debt deals done and there will be more consolidation in the leasing industry in which the strong will get stronger with likely acquirers being GECAS, ACG, BOC, and Macquarie.”