Professional Documents
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MANUFACTURERS?
PLUS:
FULL AIRCRAFT TRANSACTIONS LIST JUNE 2008 - JUNE 2009
2009-2010 Issue
AT_DPScheck:dps ATEM99 8/6/09 07:57 Page 2
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FinGuide 2009 TOC New:FIN GUIDE TOC 4/6/09 12:56 Page 2
AIRLINE FLEET C O N T E N T S
MANAGEMENT
Financing in a hard market . . . . . . . . . . . . . . . . . . . . . .4
Engine leasing in a sticky climate . . . . . . . . . . . . . . . .8
Airline consolidation faces close anti-trust scrutiny 18
Consolidation for better regulation . . . . . . . . . . . . . .20
MANAGING DIRECTOR
Philip Tozer-Pennington: philip.tozer@ubmaviation.com Competition, cartels and consolidation . . . . . . . . . . .26
Tel: +44 (0) 207 579 4840
EDITOR Investing in CFM engines . . . . . . . . . . . . . . . . . . . . . .30
Jason Holland: jason.holland@ubmaviation.com
Tel:+44 (0) 207 579 4849 Silver lining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36
LEAD CONTRIBUTOR
Christian J Kjelgaard: cjkjelgaard@yahoo.com Fleeting thoughts . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48
Tel: +1 001 212 924 3829
JOURNALIST Lessor focus: Bavaria . . . . . . . . . . . . . . . . . . . . . . . . .54
Mary-Anne Baldwin: Mary-Anne.Baldwin@ubmaviation.com
Tel: +44 (0) 207 579 4843 Developing the US Aviation industry . . . . . . . . . . . . . .58
SPECIAL CORRESPONDENTS
Africa: Kaleyesus Bekele Lessors riding out the storm . . . . . . . . . . . . . . . . . . . .64
PRODUCTION
Phil Hine: Production Manager, phil.hine@ubmaviation.com Lessor focus: AWAS . . . . . . . . . . . . . . . . . . . . . . . . . . .70
Tel: +44 (0) 207 579 4852
Kalven Davis: kalven.davis@ubmaviation.com
Tel:+44 (0) 207 579 4851
Recovering aircraft from a defaulting lessee . . . . . .74
DISPLAY ADVERTISING
Philip Tozer-Pennington: philip.tozer@ubmaviation.com
Lessor focus: Babcock & Brown Air . . . . . . . . . . . . . .78
Tel: +44 (0) 207 579 4840
Operating lease update: Independent power . . . . . . .82
AIRLINE FLEET MANAGEMENT
(ISSN 1757-8833) – Online: 1757-8841) (USPS 022-324)
is published bi-monthly.
Brain drain hits african airline industry . . . . . . . . . . .88
Subscription records are maintained at
UBM Aviation Industry Press, Ltd. Lessor focus: AERCAP . . . . . . . . . . . . . . . . . . . . . . . . .92
2nd Floor, Ludgate House, 245 Blackfriars Road,
London, SE1 9UY, UK.
2008: an aircraft financing odyessy . . . . . . . . . . . . . .98
UK annual subscription cost is £150.
Overseas annual subscription cost is £170 or $300 What’s on order: troubled times for
All subscriptions enquiries to:
Paul Canessa: paul.canessa@ubmaviation.com aircraft manufacturers . . . . . . . . . . . . . . . . . . . . . . . .100
Tel: +44 (0) 207 579 4873
Fax: +44 (0) 207 579 4848 Manufacturing liquidity . . . . . . . . . . . . . . . . . . . . . . .108
Website: www.aviationindustrygroup.com
This publication may not be reproduced or copied in whole or in part by Aviation Industry
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Press limited.
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FINANCING IN A HARD
MARKET
Pre-delivery financing has returned to a much more limited craft values means that banks must ask for more equity and
availability than we have seen in the pre 2004-2007, high liq- most of the airlines and lessors understand this.
uidity, era. Overall, while there is less aircraft finance liquidity
and the risk premiums are higher, the aircraft portfolios have Does this mean that such airlines will have to seek other fund-
continued to perform, especially when compared to most other ing, or will they have to resort to leasing as the only means
asset classes. Another indicator is that Calyon has seen a surge available?
in customers approaching it, even though it is well known that
this bank is far from being the cheapest option on the market. In normal circumstances the lessor would play the role of lender
Customers have realised that the “shopping around” option of last resort for those too weak to be able to attract financing,
has disappeared for the moment and currently you have to take but the credit crunch has affected lessors just the same as
what you can get. everyone else. So in this market an airline that cannot find
financing on a given aircraft is very unlikely, in most circum-
From 30 banks operating in the sector during the first quarter stances, to obtain finance through a lessor on sale and lease.
of 2008, we are now down to about 11 banks actually doing Export credit and sale and lease back options are still available
deals with three additional banks ready to move back into the we must remember. Leasing will continue to play an important
sector, we are told. Of this number, five (in all) banks would fall role, but Export Credit will become/is the market maker.
into the category of known aviation finance house.
How will OEM-backed finance institutions
Are finance terms and conditions becoming more rigorous and satisfy the ongoing debt requirement?
therefore excluding certain airline operators, when this would The manufacturers are working very hard on this at the
not have done previously? moment. There is no doubt that seven or so months ago both
Airbus and Boeing were still in a state of denial. Banks were
Increasingly, there is now a move towards quality and banks talking to the two big manufacturers about credit crunch and
want to see this with a good mix of credit/asset with a conser- funding gap worries etc, but the manufacturers did not seem to
vative structure. This does mean that second tier and classic air- see the problem, or at least if they did, then they were not will-
craft are no longer attractive. ing to talk about it to the banks.
We are in a world with tighter aircraft finance liquidity - we are Since the turn of the year, however, both Airbus and Boeing
therefore in the lender market. This means lenders can be very have been working very hard indeed with banks and clients to
selective in what aircraft and what credits they will fund. Since work on solutions wherever possible. The OEMs suffer a general
the majority of current deliveries are 737 NG / A320 family and limitation which is something familiar to Boeing, but not so
777 aircraft (on the larger side) their customers are clearly in a much to Airbus; this is the sole recognition problem, which is
more advantageous position because these aircraft families are pure accounting. For example, on the sales recognition side, if
asset gold standards in their respective classes. you put a significant amount of money aside to finance your
own client to buy your own aircraft it might be that you cannot
As for financier’s focusing on stronger credits, this clearly is recognise the sale. This in turn has a detrimental impact on all
expanding the need for Export Credit for the remaining carri- the ratios of the manufacturer such as revenue and turnover
ers. With some 80 per cent of Boeing backlog eligible for ExIM, etc, for that reason the contribution by Boeing and Airbus to
this creates an important safety valve for airlines who have dif- the finance of their clients will have to be limited; there is no
ficulty attracting the limited commercial financing currently on question of this.
offer.
So what can the OEMs do?
There is no doubt that airlines with a C-credit type situation are OEMs are trying to team-up with banks and propose some kind
finding it near-on impossible to find finance. The current pre- of structure where they absorb the junior trench with the banks
vailing banking policy excludes many airlines, operators and doing the senior. This is generally seen as the best way to go in
lessors, along with some of the aircraft which are not new, clas- a bad market at this time, it is a win-win situation because from
sics are virtually a no go area for all at this time. So many air- a senior leverage perspective it is probably a very good deal,
lines, lessors and classes of asset are on the black list where and it is fair to say that the presence of Boeing or Airbus as the
they would not have been pre-2008. junior in any kind of financing is giving an extra layer of pro-
tection besides the number of dollars which are ahead of you
However, some very good assets are coming onto the market as senior lender.
that are priced very attractively, but they are still not able to
find financing. There is particular stress in the market at this So to make a long story short there is limitation because there
time for those seeking to refinance 747-400s. The market is is an accounting rule which prevents them from pouring large
very rigorous at the moment in terms of leverage, repayment, amounts of cash into their clients. The big manufacturers all
asset, and price. Most, if not all, banks are not interested in understand this as do the banks. So the OEMs have moved
classics and do not think that anyone in their right mind will from denial to a partnership with the banks that in effect means
finance classics at this time. we shall see junior/senior arrangements as being the way for-
ward in this market.
That being said, one bank (DVB) financed a deal just last month
for four 737-400s at a very good price. On the engine side we Boeing Capital and its counterparts here within the EU are confi-
are looking at the value in just the same manner, what are the dent that they will be able to satisfy the debt requirement during
engines, where will they be used and what the outlook is for a 2009 and into 2010. While the manufacturers anticipate having
particular type. Banks are able to cherry-pick deals at will and to directly fund a number of aircraft in 2009 (having not funded
this will not change in the foreseeable future. It is not because any in the last several years), they believe the overall volume
the banks want to be awkward but because the volatility of air- requirement will be less than what we saw post 9/11. Boeing
Capital, for example, were financing about $3bn per year for however, carrying out a top down and bottom up analysis of
three years post 9/11 and at that time they did not have the depth each aircraft that is on order. The company maintains that avail-
of infrastructure, or indeed the balance sheet, that they have ability of financing will not drive aircraft delivery rates. Boeing
today, moreover they were financing aircraft such as the 757 and Capital’s European counterparts declined to comment on this.
the 767 which are coming towards the end of the lifecycle. So are there any additional problems on the horizon that we
Now, as mentioned before, Boeing Capital find that they are need to consider when talking about airlines seeking finance?
financing 737NGs and 777s – Gold standard aircraft. Even then It is becoming clear that the European Union Emissions Trading
Boeing Capital state clearly that the level of funding required Scheme will affect the very core building blocks of aviation
from them is nowhere near what was required post 9/11. So finance:
Boeing is upbeat. 1. Airline Business models
2. Aircraft values
How will export credit agencies react? These will undoubtedly be affected by any “green regulation”.
These agencies need to double their support from 2008 levels. The aviation working group has handed the EU a critique of the
They are open to capital market funding. All the major ECAs ETS and its shortcomings. The regional solution that is the ETS
have said that they are prepared to nearly double their support will affect all airlines but it is the EU fleet lean issue which
levels relative to 2008. causes the most concern.
In the end the export credit agencies have been given the task A simple summary of fleet lean can be thus: if an airline leases
of supporting the sale of their national manufacturers and in and operates an aircraft and then gets into debt and goes bust
normal circumstances they contribute five six or seven billion then any aircraft operated (not owned, by that airline can be
per year but, talking with Bob Morin and hearing what his seized. Then any costs owed to Eurocontrol or an airport oper-
European counterparts have to say it is clear that we could be ator can be set against seized aircraft.
above the ten billion dollar mark this year for each of the But the most dramatic part of this legislation is hidden in the
export credit agencies. That is above ten billion for each, which detail, as always: if an airline goes bust with debts and other
is a significant move. banks and lessors manage to take back possession of their
The challenge for these agencies is great, not due to the assets by getting their aircraft out, but you do not, then all
amounts of money that we are talking about, but because the debts of the airline will be set against your aircraft, effectively
different authorities are pouring billions upon billions into the wiping out the value of the asset. This process obviously has the
system. But it is a challenge for these agencies on the actual exe- same overall impact on the engine lessor as it does with the
cution because these teams are small and they need to apply for owner of any asset. The overall effect of this legislation will be
the normal due diligence, credit analysis, etc. So is it a realistic that only airlines with strong balance sheets, liquidity and good
target for these agencies to move from six or seven billion dollars business plans will be able to obtain finance.
of funding to ten billion? Or even twelve? In terms of work force But more importantly, this means that lessors will have to take
and resources I think it is a very big challenge for them. a second look at all assets currently out on lease, and ask ‘is the
operator and therefore the asset, secure?’ Future lease agree-
Will there be a reduction in new aircraft ments will have to be far more stringent and sale and leaseback
deliveries as a result of a shortage of credit? may not be a viable option any longer, as this is usually a last
These are difficult markets, of that there can be no doubt. We resort liquidity boost for an operator.
know that aircraft demand is correlated against global eco- Investors and asset owners beware – the EU will become a very
nomic conditions as global GDP has contracted, so aircraft high risk zone, with some banks likening risk factors to many
demand has fallen in line. African countries. Investors in aviation are lobbying the EU for
This said the first half of 2008 saw amazing performance by the a u-turn on this legislation, or at the very least transparency
aviation industry, the global economy was falling, oil was at from Eurocontrol and the like so that investors will be able to
$147 a barrel and yet aircraft were still being ordered at record see which operators are behind on their payments. As it is, the
levels – so what does this mean for the industry going forward? fleet lean legislation is one of the most barbaric legal imple-
We are yet to find out, but it is generally agreed by many of the mentation issues ever for the aviation industry. The bottom line:
banks that 2010, not 2009, will be the year when the manu- airlines within the EU will be a higher risk and therefore financ-
facturers’ orders books come under serious stress. Therefore ing will be more expensive or non existent for some airlines.
2010 is the year seen as being the worst for cancellations.
Many operators are going to simply say “sorry but I cannot take Finally: The message from the banks that have pulled
delivery of this aircraft”. back from the aviation sector?
For many it will not be a question of “I can try to defer for one
year, two years or three years”, or simply “I can try to restructure “We will be back…………………..”
the agreement”. There will be no options for many. We already
have one case as an example – that of Lauda Air where they sim-
ply said “here is my deposit, I do not care that it is lost, I simply
cannot take delivery of this aircraft”. We will see more of this!
So the answer is yes, some orders will continue to disappear
due to lack of funding which in turn will reduce the financing
requests coming in for orders. The cycle has a way to run yet.
Boeing Capital, for its part, does not believe capital availability
will be the determining factor of their production rates. Traffic “Or will they?”
and market demand will be the driving force in shaping the
delivery skyline. Boeing Captial has chosen to try and keep out We hope that you enjoy the 2009/2010 Guide to Financing &
of the funding gap debate, instead they have tried to under- Investing in Aircraft & Engines and wish you all the very best
stand for themselves if there is a risk of significant capital for the months ahead.
requirement that is not being addressed, and their conclusion
is that they do not see that being the case today. They are,
See what propels the futures of major and regional airlines, business aviation, helicopters and military
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Editorial main:FIN2009 2/6/09 14:34 Page 8
Engines have been costed above their intrinsic value and the price of new engines and short-term lease
agreements are on the up. Demand has kept engine lessors comfortable – for now – but with airline
bankruptcies, fleet and route cuts, and order postponements and cancellations on the increase, the need
for engines is dwindling. Mary-Anne Baldwin looks at how this is affecting the engine leasing market.
ENGINE LEASING IN
A STICKY CLIMATE
AN INCREASING NUMBER OF ENGINES ARE HITTING THE mar- tuate. If more and more struggling airlines fall by the way-
ket and threatening to flood demand and so engine les-sors side, a surplus of engines will hit the market – potentially
have a number of sticky issues they must tackle in order to pushing supply in excess of demand.
preserve good ground in an increasingly shaky market.
Yet despite the expectation that bankruptcies will con-
The parting out of a stored aircraft and the sale of its work- tinue, many of those occurring during 2008 were due to
ing components is one such issue – since the engines are the high oil prices – a phenomenon which diminished in impor-
most valuable components of the aircraft, it is these that tance as oil prices fell. Oil prices now appear likely to stay
owners have the greatest desire to sell off. “On an old air- fairly low for a while. Also, while airlines are still struggling
craft like a 737-200, “90 per cent of the value is in the financially, they are becoming better-equipped to deal
engine… and you don’t even bother to overhaul them,” says with a spike in fuel costs in the long term – benefiting from
Alain Maestracci, vice president of business development for a more efficient worldwide fleet, better contingency plan-
BCIO Aircraft Leasing. ning and remedies such as passenger fuel surcharges. In
terms of oil it seems the road ahead will be far less rocky –
Much of an engine lessor’s profit comes from leasing spares at least for those that have been wise enough to stay
which sit unused, as back-ups, in hangars. “It’s quite com- ahead of the curve on fuel hedging.
mon for them [airlines]… to [already] have two or three
engines sitting in the hangar that they do own outright,” It is hard to predict how great the future supply of used
says Joseph O’Brien VP of sales for Engine Lease Finance engines may be and with no registry currently in existence,
Corporation: “As aircraft parting-out makes engines more the number of engines on the market can only be guessed at.
readily available for outright purchase at low prices, airlines According to Maestracci, 15 of the largest aircraft lessors con-
are increasingly likely to pick up bargains from other carriers trol 4,800 aircraft – representing at least 10,000 engines on
and aircraft owners instead of leasing; the trend is therefore the market. Pascal Picano, senior VP of sales and marketing
likely to hit engine lessors’ revenue hard.” at GA Telesis, estimates there to be 59 operators of the CFM
56-5A and 10,022 engines in operation. The General Electric
Another trend likely to drown lessor profits is lower inter- CF6-80C2B, meanwhile, has an estimated 104 operators and
est rates, which in the UK have fallen to as little as 2,330 engines in operation; while the IAE V2500 has 108
1.5 per cent and in the USA as low as zero. Airline bank- operators with 2,826 engines in use. The PW 4056 has 35
ruptcies form yet another factor causing lease rates to fluc- operators, using 924 engines.
But it is likely that PMA parts will rise in popularity during the cur-
rent economic climate. PMA parts became more popular during
the post-9/11 recession because they are generally less expen-
sive. However, additional PMA part-related maintenance con-
cerns and attributed costs mean that airlines with large aircraft
fleets are still reluctant to acquire aircraft with PMA parts if their
fleets have a majority of OEM-only engines.
GE Aviation
2. INVESTMENT POTENTIAL
Most 6 5 4 3 2 Least
CFM56-7B 737 NG 55% 18% 18% 0% 9% 0% 0%
CFM56-5B A320 27% 45% 18% 0% 9% 0% 0%
GP 7000 A380/F 20% 10% 20% 20% 10% 0% 20%
V2500-A5 A320 10% 20% 10% 20% 10% 10% 20%
IAE V2500 A320s 10% 10% 10% 30% 20% 0% 20%
PW4000 A330s 10% 0% 20% 20% 20% 10% 30%
RR Trent 700 A330s 10% 0% 20% 20% 10% 10% 20%
V2500-A1 A320 10% 0% 10% 10% 20% 10% 40%
CF5-80C2 A300s 9% 18% 9% 9% 18% 27% 9%
PW200 757 9% 9% 18% 0% 18% 9% 36%
CF6-80 747-400s; 767s 8% 33% 17% 8% 8% 17% 8%
CF6-80 E1 A330s 0% 20% 20% 20% 10% 10% 20%
RB211-535 757 0% 20% 0% 0% 40% 10% 30%
CFM56-3C 737 Classics 0% 18% 18% 27% 27% 9% 0%
RR Trent 900 A380/F 0% 11% 11% 11% 11% 33% 22%
CFM56-5C4 0% 10% 60% 10% 10% 10% 0%
CF6-50 747-200; -300 0% 10% 10% 0% 20% 20% 40%
JT8D 727s 0% 0% 11% 0% 0% 22% 67%
PW6000 A320s 0% 0% 0% 30% 0% 30% 40%
RR Trent 500 A340s 0% 0% 0% 10% 20% 40% 30%
4. FUEL EFFICIENCY
Most 6 5 4 3 2 Least
GP 7000 A380/F 38% 25% 12% 25% 0% 0% 0%
CFM56-7B 737 NG 25% 50% 25% 0% 0% 0% 0%
CFM56-5B A320 25% 25% 38% 12% 0% 0% 0%
PW6000 A320s 14% 29% 0% 14% 0% 14% 29%
V2500-A5 A320 12% 25% 0% 38% 0% 12% 12%
CF6-80 E1 A330s 12% 12% 25% 0% 12% 25% 12%
IAE V2500 A320s 12% 12% 12% 50% 0% 0% 12%
PW200 757 12% 12% 0% 0% 38% 0% 38%
CF5-80C2 A300s 12% 0% 25% 25% 25% 12% 0%
PW4000 A330s 12% 0% 12% 12% 12% 25% 25%
CF6-80 747-400s; 767s 11% 33% 11% 0% 0% 33% 11%
CFM56-5C4 0% 25% 38% 38% 0% 0% 0%
RR Trent 700 A330s 0% 12% 12% 25% 25% 0% 25%
RR Trent 900 A380/F 0% 12% 12% 25% 12% 0% 38%
V2500-A1 A320 0% 12% 12% 12% 12% 12% 38%
CF6-50 747-200; -300 0% 12% 0% 12% 12% 38% 25%
RR Trent 500 A340s 0% 12% 0% 0% 50% 0% 38%
CFM56-3C 737 Classics 0% 0% 62% 12% 25% 0% 0%
RB211-535 757 0% 0% 29% 0% 14% 14% 43%
JT8D 727s 0% 0% 12% 0% 0% 25% 62%
+
$120,000,000 —SAVED WITH THE RIGHT MOVE
Detrimental 31%
Undecided 15%
Not detrimental 54%
6. To what extent do you think that the inclusion of PMA parts within an engine reduces the value of the whole?
While lessors have shown a willingness to support their cus- Aircraft leasing is about keeping the aircraft in use as much as
tomers during these tight times, it is likely they will have to possible. Most operating leases are for a minimum of three years
develop their understanding natures somewhat further to allow and the average is five to seven years, though they can sometimes
for short term deferrals on payments, restructured payment pat- stretch to 12 years and even longer periods. However, in today’s
terns and liaison for unsecured loans. market it is likely that airlines will have more sway in acquiring the
operating leases better suited to them and will be better able to
According to Stern, during 2008, operating leases covered 76 per specify the lease periods they actually wish.
cent of the leased aircraft market, while finance leases took only
24 per cent of an estimated 9,300 to 9,500 active leased com- Despite the weakened market, engine leasing is profitable. On a
mercial aircraft worldwide. Operating leasing has gained a lot of Rolls-Royce RB.211-535E4, short-term lease rates often reach
ground since 2000, when operating leasing took 51 per cent of $4,000 per day with additional charges of $300 per hour plus $200
the market and finance leasing took 49 per cent. In 2008, the per cycle, says Maestracci. Leasing two CFM56- 3C1s may cost you
overall proportion of leased aircraft, at approximately 49 per more than the lease on a 737-300 to put them in, he says.
cent, was nearly the same as the proportion of those held under
outright ownership, at 51 per cent.
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Editorial main:FIN2009 2/6/09 14:35 Page 16
CIT, of course, wishes to fill that gap; its application to become a O’Brien continues: “The sale and lease-back market is probably
bank is explained by Diaz. “Our plan is to move to become a bank triple or quadruple what it was a year ago. We’ll probably end up
holding company. The reason for that is that the funding model doing about 20 transactions this year. For us it’ll be over $300m,
for not just the aerospace business but all business – 75 to 80 per which is significant for an engine lessor... We’re typically doing
cent through commercial paper – doesn’t work any more,” he $8m-$10m per engine.”
says. “We’re looking at more of a deposit-based funding model,
not unlike what Morgan Stanley had done, Goldman Sachs and Bruno Castolla, senior vice president at Shannon Engine Support
others.” offers his perspective: “We support airlines all over the planet.
There are a few operators with whom we would have difficulties
ELFC’s O’Brien notes: “When we see a $100m or $150m trans- to enter into agreement with, generally because they would have
action it’s quite common for us to bid on it and then keep half and financial or technical issues, but we would try to work around
move half into other ventures. Those ventures cannot get the lend- this ...Our lessees need us more than ever during a downturn and
ing now – so it’s turned our strategy upside down. So the question we should ...make sure that they survive and keep their opera-
for us is; do we grow our portfolio while the opportunity is there on tions running. We need to understand what their problems are
sales or leasebacks when it’s hard to find purchasing sources?” and that their business is sustainable. If that is the case, we do our
O’Brien says of the increasing threat of lessee defaults: “We are maximum to work with them and restructure deals in a satisfac-
very worried about it, but we have been very fortunate with it so tory way for both parties.”
far. The default rate for us has been relatively low: There are
maybe four or five accounts that we have issues with; there are O’Brien is less optimistic, believing that “a quarter or third of the
only one or two that are in a liquidation or bankruptcy type [global] orderbook will go away. I think lessors and airlines have
mode. That’s two out of 57 customers, so we’ve been very fortu- over estimated. There was a frenzy of ‘Oh, I can’t get an order
nate.” But, he says, “As we write more of this business, it is only position because there was so much competition,’ but the pen-
natural that some of them will have credit problems.”Adds dulum has swung back the other way.”
O’Brien: “What we’re finding now is that we’re getting full
reserves on deals – I think a lot of lessors will tell you ‘We will While an increasing number of engines is coming into a dimin-
never write them without reserves,’ but the fact is, they do … ishing market, lessors will take a direct hit to their orderbooks.
When you’re leasing an engine you’ve got an asset and a rental Some of course, will take a lighter hit than others, but all must
stream. We look at the rental stream as the risk, not the asset. We take on board the philosophies of damage limitation, staying
won’t do a deal with you unless you do [give a reserve], because mindful of the many pitfalls surrounding them if they are to pro-
it’s just incremental exposure.” tect themselves.
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Editorial main:FIN2009 2/6/09 14:35 Page 18
The European airline industry is undergoing a new wave of consolidation, as is illustrated by recent trans-
actions such as Iberia’s acquisition of Vueling and Clickair, as well as Lufthansa’s proposed acquisition of
SN Brussels Airlines.
AIRLINE
CONSOLIDATION
FACES CLOSE
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The European Commission has released a set of proposals aimed at reforming existing regulation on
European aviation liberalisation. Kay Vasey, a solicitor at law firm Field Fisher Waterhouse, assesses
industry reaction to the Commission’s new ideas.
CONSOLIDATION FOR
BETTER REGULATION
1. Reinforcement of the requirements for the grant and 6. Promotion of price transparency for passengers.
revocation of operating licences. An important element of the proposed reforms relates to airline
The Commission’s proposals highlight that some Member States pricing transparency which has been a source of considerable fric-
are less stringent than they should be when assessing the finan- tion, particularly in the UK, for some time now. In order to remove
cial health of airlines, and make a link between the financial the uncertainties that have permeated the market, and to avoid
health of an airline and its exposure to safety risks, arguing that potential distortions of competition, airlines should no longer be
poor or failing financial health of an airline not only poses a able to exclude taxes, charges or other fees from their advertised
threat to customers’ money in the event of bankruptcy, but also fares. In other words, the advertised fares should be fully inclusive.
to their safety. The proposed reforms require Member States to In addition, the Commission has suggested proposals to eliminate
reinforce the supervision of operating licences and to suspend pricing differentials dependent upon the customer, country of resi-
or revoke licences if the requirements of the applicable regula- dence or travel agent’s place of establishment
tions are not, or cease to be, met. In addition, it is proposed that
power is conferred on the Commission to revoke operating Airline view
licences where a Member State fails to do so and that national The International Air Carrier Association (IACA) members are
aviation authorities shall be able to issue a ‘temporary licence’ strongly opposed to the idea of a ‘temporary licence’, which
pending financial reorganisation of an airline. The Commission could be given to airlines that are in financial difficulty. They
also outlines future plans for the European Aviation Safety believe this would most likely compound the airline’s problems by
Agency to take on a role as a licensing body responsible for air highlighting its difficulties with the consequent significant risk of
operators’ certificates and air crew licences. major loss of customer and investor/financier confidence.
2. Strengthening the requirements for leasing aircraft. The airlines are supportive of the proposals relating to safety,
The Commission notes that there are divergent applications of especially the recommendation that more stringent financial
rules and practice in relation to the leasing, particularly wet leas- checks should be applied to airlines when considering their oper-
ing, of aircraft between different Member States. Concern has ating licence applications or renewals.
been expressed that safety assessments of aircraft that EU oper-
ators are proposing to wet lease in from third (non-EU) countries They are also largely in favour of ensuring licensing and safety
are not pursued with the same rigour in all Member States. standards are standardised across the Member States. There is
Article 13 of the proposed reforms would impose upon national also notable support for the idea of a single European licensing
aviation authorities a much greater obligation to ensure that EC and safety body and the potential for EASA to take over this role.
safety requirements and standards are met in relation to any In relation to wet-leasing, the airlines emphasise the importance of
non-EU wet-leased aircraft. It also places a six month limit on wet-leasing to their business. Again, they would like to see the
the duration of a lease from third countries, which will only be interpretation of wet-leasing rules standardised across the EU.
allowed in exceptional circumstances and renewable only once Whilst they believe that the proposed six-month lease period is not
in a second non-consecutive period of up to six months. unreasonable, and argue that the current guidelines (normally not
more than a traffic season) are sufficient, they feel that there should
3. Clarification of the rules surrounding public service obli- be some flexibility in the rules for exceptional circumstances. For
gations (PSOs). example, where the lease is to cover a replacement aircraft follow-
A PSO is a permitted and subsidised monopoly to run a particu- ing a serious aircraft incident and it is likely that the recovery of the
lar service for the benefit of the public. An example of such a original aircraft will take longer than six months.
route would be services to the Scottish highlands and islands.
Such routes are clearly important to local communities and Unsurprisingly, all airlines are strongly in favour of determining their
would be unlikely to be run in a completely free market. The pro- own fares and fees without outside interference, be it from national
posed reforms seek to simplify rules surrounding PSOs and thus bodies or the Commission itself. British Airways has commented:
attract more tenders for such routes.
“Firstly, the marketplace is the best way to set fares, free from
4. Removal of inconsistencies between the intra-EU avia- governments, and secondly, if there is to be regulatory interven-
tion market and services to third countries. tion on fares, it must be done on a European wide basis and not
The Commission is also proposing that any remaining restric- just by a single member state. There is no need whatsoever for
tions existing in bilateral agreements between Member States intervention when adequate competition exists as on routes from
be lifted and that access by airlines of third countries to the London to Europe.”
intra-Community market should be managed in a coherent
manner through negotiations at Community level. What this
means is that non-Community air carriers would not be permit-
ted to exercise traffic rights, combine air services or enter into
codeshare arrangements in respect of intra-Community routes
except where permission is granted by an agreement concluded
by the Community with a third country.
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up, for the new generation of regional jets.
From the opposite end of the airline spectrum Ryanair has said that safety standards are not compromised by failing financial condi-
that it, “is greatly concerned by the Commission’s comments on tions; contrastingly the CAA believed that instable financial standing
the issue of reviewing air carrier’s calculating of their fares. The automatically equates to sub-standard safety provisions. The CAA
emphasis appears to be on “abnormally low or non-existent also saw the idea of a temporary license as irrelevant:
(“free” tickets)”. The connotation is that there is something
wrong with offering very low or “free” fares (i.e., all the passen- “From a safety regulation perspective, it is the CAA’s view that
ger pays are the taxes). These fares are far from being non-exis- “tightening up” should not be necessary. In reality, if the requi-
tent as consumers are well aware”. site safety standards are not being met, the National Authority
responsible should take appropriate AOC action. Effective safety
Many of the air carriers have expressed concern about the risk of checking should occur regardless of the conventional or tempo-
distortion of competition that could arise from excessive use of rary nature of the licence.”
PSOs. Several respondents would like PSOs to be restricted to the
routes that are absolutely vital for the regions served. In contrast In addition, the CAA noted that such a licence could also be
to the majority of airlines, Ryanair was also critical of the concept damaging because it would deter investors from keeping funds
of PSOs, arguing they were often used by governments to give in the airline and lead to a loss in public confidence, thus speed-
subsidies to national airlines. ing up an airline’s demise.
However, both the CAA and JAA agreed that the ability for EU
Airports airlines to wet-lease aircraft is an important ingredient in the suc-
The airports surveyed were particularly interested in the impact cessful operation of an airline. They support proposals that would
of the proposals regarding traffic distribution and the removal of make the process easier, but the CAA in particular was not in
obstacles to bilateral agreements with third countries. favour of wet leases for periods longer than six months because
of safety concerns (arising from the confusion of who is respon-
Some, such as Shannon Airport (and connected entities Shannon sible for maintenance: regulators in the country of registration or
Development and Shannon and District Chamber of Commerce), country of operation).
were concerned about the potential impact an ‘Open Skies’
transatlantic flight policy would have on the region, and sug-
gested that, “the impact that this would have on balanced Conclusions
regional development within Ireland would certainly lead to Despite some misgivings, the second reading of the proposed
heavier concentration on traffic into Dublin and to the east coast reforms was completed on 9 July, 2008, and the Commission’s
at the expense of Shannon Airport and the West of Ireland”. final decision and signature is expected in the autumn. It was
almost inevitable that the proposed reforms would not meet with
universal approval from all elements of the European aviation
Regulators industry. However, they will be a useful step forward in bringing a
Amongst the regulators who responded to the consultation were greater degree of clarity and certainty to important areas of avia-
the Joint Aviation Authority (JAA) and the UK’s Civil Aviation tion regulation and will certainly help to level the playing field
Authority (CAA) who had differing reactions to the Commission’s across the EU for airlines and customers alike. Whilst the intention
proposals. The JAA felt that the tightening up of procedures regard- of the Commission’s proposed reforms has a sound basis, only time
ing an airline’s financial standing would be a positive step to ensure will tell whether the new measures will achieve their goal.
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Editorial main:FIN2009 2/6/09 14:47 Page 26
John Cassels and Kay Vasey of Field Fisher Waterhouse take a whistlestop tour of anti-trust rulings in aviation.
COMPETITION, CARTELS
AND CONSOLIDATION
THE DEEPENING CRISIS IN THE AVIATION INDUSTRY IS BEING relaxation of foreign ownership rules and an increase in the num-
heralded by many as the most severe since the age of mass air ber of open skies agreements.
transport began in the 1970s. IATA has forecast that the global The extent of recent collaborations and consolidations in the
airline industry will experience $5.2bn in losses this year, and airline sector is highlighted by the flow charts accompanying
continue to operate at a loss of $4.1bn in 2009. A string of air- this article, which identify key regulatory interventions by the
line failures in the usually stronger summer months has sig- EU/UK and US authorities since 2000. These largely reflect
nalled that the winter months look likely to see more carriers go the development by groups of traditional legacy carriers of
out of business. Although oil prices have fallen back from the three ‘super alliances’: Star Alliance; oneworld; and SkyTeam.
highs of more than $140 per barrel during the summer months, These alliances are intended to enhance the ability of mem-
the airline industry is still in the eye of the ‘perfect storm’, hav- bers to offer integrated services across the globe, while at the
ing to endure much higher than budgeted fuel costs whilst same time reducing their costs through joint purchasing and
demand falls. First, the credit crunch applies its tourniquet and marketing. Low-cost carriers do not participate in these
now the threatened global recession begins to bite. In alliances because their business model is a simple point-to-
September, CEO of British Airways, Willie Walsh, described a point one that does not need the benefits the alliances offer.
gloomy outlook:
The SkyTeam grouping is led by Air France/KLM and Delta
“We are in the worst trading environment the industry has ever Airlines. The merger of the latter, announced earlier this year,
faced and must take action to offset the combined effects of the with Northwest (also an existing member of SkyTeam) has been
continuing global economic downturn, weakened consumer cleared in the EU because it will “not significantly impede effec-
confidence and high fuel prices… We have already seen 30 or so tive competition in the European Economic Area or any substan-
airlines go bust this year and it would be fair to expect a similar tial part of it”. The merger will create the world’s largest airline,
number of casualties worldwide over the next three to four with the overlaps in Delta and Northwest’s activities occurring
months.” mainly in the US. Nonetheless, the current economic climate is
likely to impact upon anti-trust enforcement and the US author-
In this environment, airlines will look at many ways of trying to ities will probably grant anti-trust immunity rather than blocking
ensure their survival, varying from reducing costs whilst trying to the deal and facing the risk of either Delta, Northwest, or both,
maintain revenue, market stimulation by means of special low- failing.
fare offerings – a particular favourite of the low-cost carriers – to
the more radical solution of consolidation to achieve the Air France and KLM, also previously members of SkyTeam,
required cost savings and synergies perceived to be needed for merged in 2005. Following that merger, Christine Ourmiere, UK
survival. The pressures upon airlines in such desperate circum- Manager of Air France-KLM, said: “Air France and KLM are con-
stances also foster collaboration which can be lawful, but which solidating their relationship with Northwest and Delta, moving to
can also lead to unlawful collusion, with extremely costly conse- a four-way joint venture, so consolidation is not only an interest-
quences. ing story, it’s a reality in the world in order to reduce cost, be
stronger, and bring more synergies to optimise your margin.” She
Collaboration and consolidation added, “You take a risk in being the first to move in this direction
In September the director general of IATA, Giovanni Bisignani, but we have seen the industry moving in this direction for the last
said that “consolidation is a must, and probably this emergency four years.”
situation is a good opportunity for governments to understand
that we need the freedom to run our business as a normal busi- Within the oneworld alliance, it is proposed that members British
ness. Governments must understand that the flags on the tails of Airways and Iberia merge. The consideration of that proposed
the planes are killing an industry.” IATA is calling for a further merger by EC and US competition and anti-trust authorities is
also likely to be influenced by the current economic circum- see why Ryanair/Aer Lingus can’t go ahead.” For now, the low-
stances. The need for consolidation in Europe amongst its legacy cost airline is adopting a wait-and-see approach “because there
airlines has been recognised for some time now. Quite apart is a lot of consolidation coming and that may force the EU to
from the Air France/KLM merger, Lufthansa has in the fairly change its position”. Ryanair’s CEO, Michael O’Leary, declared
recent past acquired control of Swiss and is about to acquire con- in July that the airline currently has no need to merge with
trol of Brussels Airlines, both transactions that either have or are another carrier, boldly adding that it would be one of only five
expected to receive the requisite regulatory approvals. And even main airlines left in Europe following the expected industry con-
today there is speculation about either Lufthansa, Air France/KLM solidation.
or even British Airways taking a stake in a “rescue” of the woe-
ful Alitalia. Although Ryanair’s expectation is that “the European
Commission will rubber-stamp approval of these mergers”,
In addition to the proposed British Airways/Iberia merger, Neelie Kroes, the EU Competition Commissioner, has said: “At a
those two airlines together with their oneworld partner, time of consolidation in the European airline sector, the
American Airlines, have applied for anti-trust immu- Commission must make sure that consumers have a competitive
nity/approval for a range of proposed joint activities of the choice of airline services.”
kind approved for Air France/KLM and Delta/Northwest with
SkyTeam, and Lufthansa/United and others within Star The European Commission also has concerns about the pro-
Alliance. The prospects for BA/American/Iberia of obtaining posed takeover of Martinair by KLM and has opened an in-
clearance and immunity for their proposals does seem to be depth investigation into the deal. The Commission has until 22
appreciably better now than on the two previous occasions January, 2009, to take a final decision on whether allowing the
when BA/American sought immunity. That is a consequence of consolidation of the two main scheduled airlines operating pas-
the current economic situation as well as the greater freedoms senger services to various long-haul destinations out of
created by the EU/US Open Skies Agreement of 30 March, Amsterdam would significantly impede effective competition in
2008. However, there will still be stout and vocal opposition the EU. Preliminary market investigations have shown that there
from competitors. For example, Delta has declared itself on a would be a substantial reduction in competition on those
prospective waiting list for London Heathrow slots in the event routes.
of approval of the British Airways-Iberia-American Airlines
deal. Richard Anderson, CEO, noted that Delta is opposed to Some airline operators have indicated in the current market con-
the proposal unless regulators require the re-distribution of a ditions that they are not so keen on merging. Only one month
significant number of slots to other competitors at one of the after commencing merger talks in August, Thomas Cook pulled
world’s busiest airports. Similarly, Sir Richard Branson, chair- out of discussions with TUI Travel and Lufthansa about a merger
man of Virgin Atlantic Airways, has written to the two US pres- of its charter airline Condor with TUIfly and Germanwings, citing
idential candidates to warn that the proposed alliance would a lack of “financial upside” for the merged businesses given the
“damage competition on trans-Atlantic routes and result in market conditions and difficult considerations including owner-
significant job losses”, adding that it was “very dangerous” to ship structure, branding and conditions for TUIfly pilots. Thomas
believe that consolidation was the best response in the current Cook remains confident that Condor will continue to flourish as
weak economic climate. He was, however, later reported to a standalone airline whilst TUI Travel has said it is continuing to
have stated that he sees “considerable logic” in Virgin Atlantic explore alternatives for its German airline operation and will
merging with bmi, to create a “formidable competitor” to update the market in due course.
British Airways, although he confirmed there had not been any
formal merger discussions with bmi.
Cartels
Whilst anti-trust authorities on both sides of the Atlantic assess Collaborations have also brought much unwelcome attention to
transactions with reference to their competitive impact – and the some airlines where such collaboration is found to have
competitive impact of airline mergers is assessed by reference to breached prohibitions on price fixing arrangements. British
the impact on specific routes – the wider economic difficulties Airways and Virgin have been embroiled in ongoing regulatory
within which the SkyTeam and oneworld deals are being pursued investigations on both sides of the Atlantic into the fixing of fuel
is important and relevant context. Consolidations in the banking surcharges and air cargo price-fixing arrangements. Such investi-
sector that would only a few months ago have been unthinkable gations can give rise to very significant financial liabilities: deal-
are clear testament to the importance and relevance of economic ing with the investigations is extremely resource intensive and
context and political will in merger control. private actions for damages will almost inevitably follow both in
the US and EU where unlawful collusion has been found or
Why then did the Commission block Ryanair’s proposed acquisi- admitted.
tion of Aer Lingus? That deal would have brought together two
airlines that currently compete vigorously on routes to and from
Ireland and which constitute the main competitive constraint on The future
each other on those routes. The merged entity would have Further significant consolidation amongst airlines is inevitable.
accounted for 80 per cent of all intra-European traffic to and The shape of that consolidation will be determined in large part
from Dublin; it would have a monopoly on 22 of the 35 routes by the European Commission and the US Department of
on which Aer Lingus and Ryanair currently compete; and it Transportation. The current economic crisis will most likely
would have market share of over 60 per cent on remaining force a radical restructure, which will hopefully result in a
routes to and from Ireland. Remedies offered by Ryanair were stronger and more resilient global airline industry. But, opera-
insufficient to alleviate the Commission’s concerns. Despite the tors must ensure that their collaborations do not fall foul of
failure of the takeover, Ryanair remains bullish about its rules against illicit cartels. Friendships and relationships across
prospects. Chief financial officer Howard Millar stated recently: the industry require clear legal boundaries within which to
“With the situation in Italy of Air One and Alitalia, and looking flourish and should not be approached lightly, especially in
at the series of mergers going on right across Europe, we don’t times of crisis.
British Airways—American Airlines Notified 2001 Conditional upon US—UK open skies
(oneworld) agreement.
Investigation closed
Codeshare, schedule and fair 2002 after US DOTs dismissal
co-ordination on 9 routes between US and London.
British Airways—Iberia—GB Airways Notified 2002 Cleared until 2009 on condition of:
surrender / release of slots and ground
Co-ordination and integration of commercial Cleared 2003 facilities on routes between London and
and marketing strategies, distribution methods Spain; restrictions on increasing
and practices worldwide including codesharing, frequencies /capacity / slots on certain
price co-ordination, common network routes; requirements relating to FFP
planning, and revenue and profit sharing. / interlining with new entrants.
British Airways—SN Brussels Airlines Notified 2002 Cleared until 2008 on condition of
Co-operation on all routes, particularly between surrender of slots and ground facilities
London and Brussels on pricing, scheduling and capacity. Cleared 2003 at Brussels National Airport for a new
entrant on Brussels—Manchester route.
United Airlines—Austrian Airlines—Lauda Air Submission 2000 Cleared subject to conditions: prior approval
—Lufthansa required to operate under common brand
(Star Alliance) Immunity granted 2001 subsequent agreements to be filed with DoT;
Codeshare on international services. must withdraw from IATA coordination
on specific routes; reporting requirements.
British Airways—American Airlines Submission 2001 Conditional upon US—UK open skies
(oneworld) agreement.
Codeshare, schedule and fair coordination on 9 Parties’ notice to
routes between US and London. dismiss granted.
Delta Airlines—Air France—Alitalia— Submission 2001 Cleared for initial 5 years subject to
Czech Air (SkyTeam) conditions: prior approval required to
Co-ordination of international services. Immunity granted 2002 operate under common brand; subsequent
agreements to be filed with DoT; must
withdraw from IATA coordination on specific
routes; exclusion of pricing, inventory, yield
management and pooling of revenues on
particular routes; exclusion of CRS activities
as owners / marketers; reporting requirement.
United Airlines—Austrian Airlines—bmi— Submission 2001 Cleared for initial 5 years subject to conditions:
Lauda Air—Lufthansa—SAS prior approval required to operate under
(Star Alliance) Immunity granted 2002 common brand; subsequent agreements
Co-ordination of international services. to be filed with DoT; must withdraw from
IATA coordination on certain routes;
participation of bmi subject to US-UK open
skies agreement; prices, inventory and yield
management excluded.
Delta Airlines—Air France—Alitalia—Czech Air— Submission 2002 Cleared until 2007 subject to same conditions
Korean Air (SkyTeam) as Delta Airlines—Air France—Alitalia—
Codesharing and frequent flyer reciprocity on all Immunity granted 2002 Czech Air deal.
international services
American Airlines—Finnair Submission 2002 Cleared for initial 5 year period subject
to conditions: prior approval required to
Codeshare, joint scheduling and pricing on all Immunity granted 2002 operate under common brand; subsequent
international services. agreements to be filed and must withdraw
from IATA tariff co-ordination on certain routes.
American Airlines—SN Brussels Airlines Submission 2003 Cleared for 5 year subject to conditions:
prior approval if operating under common
Codeshare, co-ordinate sales, marketing, prices, Immunity granted 2004 brand; file any subsequent agreements with
yield management, routes for all international services. DoT; withdrawal from IATA tariff co-ordination
on certain routes; reporting requirements.
United Airlines—Austrian—bmi—LOT Polish Air—Lufthansa— Submission 2004 Cleared for 5 year subject to conditions:
SAS—Swissair—TAP prior approval if operating under common
(Star Alliance) Immunity granted 2007 brand; file any subsequent agreements with
LOT, TAP and Swissair joining existing Alliance. DoT; withdrawal from IATA tariff co-ordination
on certain routes; reporting requirements;
United Airlines—Air Canada participation of bmi subject to US-UK open
skies agreement.
Delta Airlines—Northwest—Air France—Alitalia—Czech Air Submission 2007 Cleared for 5 year subject to conditions:
—KLM (SkyTeam) prior approval if operating under common
Co-ordinate on pricing, scheduling, distribution and information Immunity granted 2008 brand; file any subsequent agreements with
systems, pool costs and revenues on transatlantic routes. DoT; withdrawal from IATA tariff co-ordination
on certain routes; reporting requirements.
Since CFM International came into being nearly 35 years ago, customers from every corner of the globe have
taken delivery of nearly 20,000 CFM56 engines for installation on mainly Boeing and Airbus narrowbodied airlin-
ers. This incredible statistic emphasises the fact that every three seconds a CFM-powered aircraft takes off on
yet another flight, somewhere around the world.
To qualify for TRUEngine status, the engine configuration, and its 50/50 parent companies (GE and Snecma) would rather
engine overhaul practices, spare parts and repairs used to serv- invest in developing even better products and in new, cutting-
ice the engine must be consistent with CFM requirements for edge technology like TAPS (twin-annular pre-swirl) combustors,
that engine model. In addition, all maintenance must comply 3-D aerodynamics in the compressor and turbine modules, and
with CFM-issued engine manuals and other maintenance rec- advanced 3-D woven RTM (resin transfer moulding) fan blade
ommendations. The qualification data is obtained through a technology. All these will feature on CFM’s all-new LEAP-X
combination of fleet operational and maintenance records. engine that it slated for a full engine demo test in 2012 and
potential certification by 2016.
Commercial jet engines are typically in service for more than 25
years and change ownership at least once in their operational The CFM56 engine in all its forms is particularly strong in the
life. An individual engine's configuration, material content, USA, Europe, CIS and Asia and this results in excellent repre-
maintenance history - and supportability - impact overall value sentation across the segmentation of the engine. And demand
as it changes ownership. remains strong even in this period of ‘credit crunch’ and global
financial meltdown.
The TRUEngine designation also facilitates CFM's ability to pro-
vide technical support. Jet engines contain multiple, complex Stéphane Garson, CFM’s GM product marketing in Europe, says
systems whose interactions must be carefully controlled. CFM's that the vast majority of current orders have held strong
engine support is built on technical expertise for genuine although he concedes that the next batch of orders may be
CFM56 parts and configurations, as well as data gained from more difficult to establish. “Most of the engines we make are
the vast operational history of the global CFM56 engine popu- delivered directly to the airframers,” he explains, “so we may
lation. well see some effect due to the international downturn in over-
all traffic. It’s possible that deliveries and also the aftermarket
So TRUEngine status means higher residual values, enhanced could suffer – but already we’re starting to see some clues that
reliability and the peace of mind brought by knowing that only the downturn could have bottomed-out.
original manufacturer specified parts have been used during “CFM has a different business model. We look at a lifecycle
on-wing or routine shop maintenance. cost of our engines over 15 to 20 years and invest both in our
future and the future profitability of our customers. Our ‘AAA’
Taking a different approach rating by the International Bureau of Aviation is important to
Although CFM doesn’t disclose any figures other than the pub- us, too – and our customers tell us that it’s important to them
lished and publicised ‘list price’, discounts are purely on the as well.”
basis of order quantity, rather than being a huge incentive to
buy - often followed by exorbitant maintenance and spare parts With deliveries solid for 2009 – albeit with some question
packages. marks still looming over 2010 – the future for CFM
International and its engine is far from standing still. GE and
At a recent conference in New York, a speaker from CFM Snecma have invested heavily over the years in developing
explained that rather than offer huge incentive discounts, CFM technology that has helped CFM’s customers to buy and fly the
most reliable and cost-effective engines in the history of avia- The engine also meets the new International Civil Aviation
tion. Organisation (ICAO) Committee of Aviation Environmental
Protection standards (CAEP /6) that took effect in early 2008.
New engines, new upgrades
With oil prices in a near constant state of flux, jet fuel remains These benefits are achieved through improvements to the high-
one of the largest contributors to airline operating costs. CFM’s pressure compressor, the combustor, and the high- and low-
sizeable investment has provided technology that is helping to pressure turbines.
lessen that burden. At the same time as CFM was developing new engine lines, the
company was also introducing new technology upgrade pro-
Since 1996 alone, the company has introduced three new grammes (CFM56-3 Advanced Upgrade; CFM56-5C/P; CFM56-
engine models (CFM56-5C/P, CFM56-5B Tech Insertion and 5B/-7B Tech Insertion).
CFM56-7B Tech Insertion).
Again, these programmes have provided an average of a one
On average, these engines have provided a one per cent per cent improvement in fuel consumption.
improvement in fuel consumption, as well as improving aircraft
NOx and carbon emissions, while improving time on wing. To date, more than 25 per cent of the CFM56-3 fleet has incor-
porated the Advanced Upgrade. For 20-aircraft fleet, this
Tech Insertion, which is now the production configuration for package can save operators more than 700,000 gallons of fuel
CFM56-7B and CFM56-5B engines, had a highly successful and nearly 7,000 metric tons of carbon emissions annually.
entry into service in 2007 on both the 737 and A320 families.
CFM completed certification of the advanced CFM56 Tech
To date, approximately 2,300 CFM56-5B and –7B Tech Insertion Insertion compressor upgrade kit, technology that will also pro-
engines have been delivered to nearly 200 customers around vide operators of mature CFM56-7B and CFM56-5B engines
the globe. Through May 2009, this fleet has logged a com- with up to one per cent lower fuel consumption along with
bined total of more than six million flight hours and 3.5 million lower maintenance costs.
flight cycles without a single engine-related event.
For a 20-aircraft fleet, Tech Insertion could save as much as
Over the engine's life cycle, CFM56 Tech Insertion could provide 275,000 gallons of fuel per year. This lower fuel consumption
operators up to one per cent better specific fuel consumption, would also reduce carbon emissions by 2,600 metric tons per
which translates to better fuel burn and with longer time on year.
wing through an equivalent 15 - 20° C additional exhaust gas
temperature margin; and between 5 and 15 per cent lower This technology also provides longer time on wing and lower
maintenance costs (depending on the thrust rating) through maintenance costs while meeting the new International Civil
enhanced durability. Aviation Organisation (ICAO) Committee of Aviation
Environmental Protection standards.
“
For a 20-aircraft fleet, Tech Insertion could save as
much as 275,000 gallons of fuel per year. This lower
fuel consumption would also reduce carbon emissions
by 2,600 metric tons per year.
NEEVER
VER MIND 20:20
MIND
OUR
O UR V
VISION
ISION G
GOES
OES
EYOND 20:40.
BEYOND
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Caught out badly on their fuel-price hedging positions by a 75 per cent-plus fall in oil prices in less than six
months as the world recession hit, many of the world’s major airlines posted steep losses for the last three
months of 2008. As global economic clouds continue to darken in 2009, however, the one silver lining for air-
lines is that fuel prices should remain far below their mid-2008 peak. Chris Kjelgaard reports.
SILVER LINING
REELING LIKE A PUNCH-DRUNK BOXER FROM A ONE-TWO-THREE fuels competing for the portion of the refinery’s fractionating
combination of soaring fuel prices, the onset of the deepest capacity not given over to gasoline. Other fuels such as heating
world recession since the 1930s, and then a precipitous drop in oil and diesel compete with jet fuel for fractionating capacity and
the price of oil that mocked their fuel hedges, many of the usually they are demanded in much greater quantities than is jet.
world’s leading airlines were as pleased to see the back of 2008
as a losing fighter would be to leave the ring after being knocked John Heimlich, chief economist for the Air Transport Association
out in a prize bout. of America, is largely in accord with Cordle’s view. “I think what
we saw last year was a tremendous amount of volatility with
But while the world’s economic woes only deepened during the regard to the fuel-price side” of the airline economic picture, says
first quarter of 2009, making the chances of a quick comeback Heimlich, who held off throughout the first quarter from making
less likely for most airlines, the fundamental supply-and-demand his usual annual economic forecast for the US airline industry
relationship between global economic performance and the price because of the huge uncertainties now dominating the global
of crude oil should give hope in what otherwise is set to be a bad economy. “It now looks like there is a reasonable amount of sta-
year for the air transport industry. bility with regard to price; the volatility has shifted to demand,”
he says, with every week bringing a new round of bad economic
Jet fuel prices are volatile, depending in any given market on day- news from all over the world.
to-day factors such as climatic temperatures, natural disasters,
accidents affecting refineries and pipelines, the short-term pro- Softening demand
portions of refinery capacity allocated to different distillate fuels The softening industrial demand for oil in the US and other
and – most important of all – the global political situation as it economies should bolster analysts’ forecasts that oil should stay
affects major oil-producing countries. However, analysts’ fore- relatively inexpensive this year. In January, Deutsche Bank’s chief
casts for crude oil prices throughout 2009 are fairly tightly energy economist Adam Sieminski reduced his forecast for the
grouped into a range of $40 to $60 per barrel, according to average 2009 price for West Texas Intermediate (WTI) crude by
Vaughn Cordle, CEO of Virginia-based consulting firm $2.50 to $45. Sieminski forecast an average price per barrel of
AirlineForecasts. $45 in the first quarter of the year, $50 in the second quarter,
$45 in the third quarter and $40 in the last three months of the
Forecast range year. “I think in part the US, especially at Cushing (a big US
“We cover a lot of [forecasting] organisations, around 70,” says pipeline hub), is awash in inventory,” says Heimlich.
Cordle. “What’s reasonable is a range of $40 running up to
maybe $60 as we see more fiscal stimulus [in the USA], averag- In Sieminski’s opinion, however, prices will strengthen going for-
ing out to maybe $50 this year and $60 next year.” Meanwhile, ward. Looking ahead to 2010, Sieminski forecast an average
he says, the “crack spread” for jet fuel is likely to fall as much as annual WTI price of $55 per barrel; and pushed his forecast aver-
25 per cent from its unprecedented 2008 peak of $24-$25 to as age price up to $80 for 2011.
low as $18.
How does this outlook square with other informed views? Quite
The crack spread is the additional price that oil companies charge well, it seems. By mid-February, Stephen Depow, an investment
to refine jet fuel from crude oil. From day to day, and location to adviser specialising in fuel contracts for Wellington West Capital
location, it largely depends on how much of a refinery “run” is in Fredericton, New Brunswick, felt the precipitous fall that had
dedicated to jet-fuel production rather than to other distillate seen crude oil prices decline from a peak of $147 per barrel in
mid-2008 to just $35 in less than six months was reaching a floor. sulting firm IBA Group, states: “I can’t see in the current climate
Prices should start to climb as excess inventories at oil supply that governments are going to be keen to see oil prices increase.
hubs such as Cushing, Oklahoma (a major settlement point for I think there will be governmental pressure on OPEC to keep
WTI on the New York Mercantile Exchange), gradually stop build- prices down.” Even at today’s low oil prices though “a number
ing and start being drawn instead, says Depow. of airlines are trying to keep their heads above water”.
TO HELP MANAGE THEIR EXPOSURE TO UPWARD MOVEMENTS IN FUEL PRICES, While Pilarksi believes that Saudi Arabia and other leading OPEC
such as the unprecedented price movement the air transport industry experi- nations are “interested in oil prices being fairly high, but not high
enced in the first half of 2008, many airlines engage in fuel-price hedging activ- enough so there are real incentives to find alternatives, and so
ities. They do so both in order to make their fuel costs more predictable for from a pure economic point of view there is no justification for
financial and commercial planning purposes and also to attempt to pay prices for $100-and-above oil prices,” these nations may not represent the
their fuel that are lower than spot-market prices. prime fuel-price threat to airlines in the immediate post-reces-
sionary period.
However, hedging by an airline represents a bet on oil-price movement against
other insider parties that are often better informed on price trends than the air- “Politically a faction in the oil industry is very much interested in
line itself – particularly when it hedges on a short-term basis in reaction to an short-term high oil prices,” says Pilarski. “Unconventional lead-
upward price movement in an attempt to keep its fuel cost down – and large ers” such as Russia’s Vladimir Putin, Iran’s Mahmoud
accounting losses can result. Many airlines that carried out short-term, reactive Ahmadinejad and Venezuela’s Hugo Chavez “are all spending
hedging – known as ‘tactical hedging’ – in the second half of 2008, when oil large amounts of money to buy popularity, and because of this
prices fell dramatically over a short period, found their efforts lost them a lot of there is a chance when we get out of the recession that oil prices
money. may go to a higher level than is justified – for instance, to $70 a
barrel”. He states: “I actually believe the recession will be with us
However, some airlines – Lufthansa is a good example – carry out planned, strate- a year and, when it stops, oil prices will go up to $70.” At such
gic hedging programmes on a rolling basis, every month building up their hedg- prices for crude, jet fuel could easily reach $100 per barrel, forc-
ing gradually for each forward month to a time horizon that might be, say, 18 ing carriers to maintain restrictions on capacity and continuing to
months to two years out for each month. That way, the airline is hedged sub- make life difficult for airlines and aircraft manufacturers alike.
stantially in the near future, but less so at the long-term horizon, when price
uncertainty is likely to be much higher.
No reason to see mid-2008 levels again
The process of hedging involves a variety of financial risk-management tech- But while stressing that any major political trouble – particularly
niques and financial derivative products such as call and put options. in Saudi Arabia or another Middle East nation – could have severe
Combinations of such techniques and derivatives can create financial risk-man- repercussions for oil prices, Pilarski believes that, all things being
agement instruments and programmes of such Byzantine complexity, and bear- equal, there is no reason oil should shoot up again to the levels
ing such implications for cash and balance-sheet management, that a specialised seen in mid-2008.
area of accounting (known as hedge accounting) has evolved to cover compa-
nies’ hedging activities. In the US, Special Federal Accounting Standard (SFAS) “I totally disagree with the long-term view of some analysts that
133 was crafted specifically to direct in detail the manner in which companies oil prices will go to $150 to $300,” he says. “The best solution
should account for their hedging activities. for high oil prices is high oil prices. If oil prices stay very high for
the longer term, we’ll come up with alternatives. At $100 a bar-
Because jet fuel is a specialised commodity that is produced in relatively low- rel there are plenty of alternatives and plenty of money to go into
quantities compared with other distillate fuels, options and futures contracts on it.” Additionally, he believes, oil-demand arguments based on
jet fuel itself are not traded in commodities exchanges or in the over-the-counter China’s former double-digit-percentage annual growth rate are
market (though jet fuel swap contracts are available). However, the distillate fuel spurious. “These are Looney Tunes. Even when China’s economy
heating oil has a high correlation with jet fuel and is traded as the base future was growing 10 per cent for the average product, oil demand
contract for all distillate fuels, so airline hedging programmes make use of both was only going up five per cent,” he comments.
heating-oil and crude-oil futures and options to help manage their risks on fuel
price itself. What is certain, says Pilarski, is that “we in aviation will probably
be one of the last users of oil”. He concludes: “We try things in
Large airlines that are particularly big users of jet fuel also use privately negoti- aviation because there is a lot of abuse [from anti-aviation envi-
ated ‘differential contracts’ with counter-parties to help match the difference ronmentalists] right now, especially in Europe and particularly in
between the price of a physical barrel of jet fuel on a given date and the per- England. But, in the long term, if cars move away from oil there
barrel heating-oil or crude-oil futures prices the airlines use as the basis of their will be a lot less demand – and there will be less of an economic
fuel-price hedging programmes. incentive for aviation to find alternatives.” So oil prices are likely
to remain of the most acute interest to all airlines for the imagi-
nable future.
SWISS-AS.COM
Editorial main:FIN2009 2/6/09 14:57 Page 40
Strike Price: The price at which the buyer may purchase or sell
the underlying futures contract upon the exercise of an option.
(Recall that the buyer of a put option has the right to sell the con-
tract at the strike price at the exercise date).
Settle (or Settlement Price): The last price paid for a commod- 4-Way Collar: A 4-way collar is a combination of options: a sold
ity on any trading day. The exchange clearing-house determines call, a purchased call, a purchased put and a sold put. The pur-
a firm’s net gains or losses, margin requirements, and the next chased put and sold put establish a floating minimum price (the
day’s price limits, based on each futures and options contract set- “floating floor”) and the purchased call and sold call establish a
tlement price. floating maximum price (the “floating ceiling”) that a company
will receive for the fuel volumes under contract.
The table below details the Company’s hedge positions as of January 16, 2009.
Hedging % of Expected % of Expected Average Price Where Average Price Where Average Price Where Average Price Where
Instrument Consolidated Mainline Payment Obligations Payment Obligations Protection Begins Protection Ends
Consumption(i) Consumption(i) Stop Begin
1st Quarter 2009
Calls 18% 21% N/A N/A $77 bbl (ii) N/A
Collars 9% (10%) 11% (12%) N/A $109 bbl $118 bbl N/A
3-Way Collars 25% (29%) 30% (35%) N/A $104 bbl $118 bbl $143 bbl
4-Way Collars 2% 2% $63 bbl $78 bbl $95 bbl $135 bbl
1st Quarter 2009 Total 54% 64% N/A $104 bbl $104 bbl N/A
For example, using the table above, at an illustrative $35 per barrel the Company’s required collateral provision to its derivative coun-
terparties would be approximately $780 million.
The company estimates the following fuel prices for the first quarter based on the closing forward curve on January 16.
Mainline Fuel Price (Price per Gallon) 1 Three Months Ending March 31, 2009
Mainline Fuel price including taxes and excluding impact of hedges $1.73
Mainline Fuel price including taxes and cash net gains or losses on settled hedges 2 $2.22
Mainline Fuel price including taxes, cash net gains or losses on settled hedges,
and impact of non-cash, net mark-to-market gains or losses on settled and unsettled hedges 2 $1.83
1 Based on the January 16 closing forward price
2 Includes only the hedge gains/losses that are accounted for in the fuel expense line
In addition to the impact of fuel hedges on fuel expense, a portion of the company’s total fuel hedge impact is recorded as a non-
operating expense. The company estimates that $81 million in cash fuel hedging losses and $69 million in non-cash, net mark-to-mar-
ket fuel hedging gains will be recorded in non-operating income / expense for the first quarter based on January 16 closing forward
curve prices.
The company estimates it will have the following amounts posted as fuel hedge collateral at each quarter end:
Based on Jan. 16 closing forward crude oil prices.
AMR Corporation alent), with 42 percent subject to an average floor of $1.97 per gal-
lon of jet fuel equivalent ($68 per barrel crude equivalent). AMR has
35 percent of its anticipated full-year consumption hedged at an aver-
Fuel Expense and Hedging age cap of $2.59 per gallon of jet fuel equivalent ($94 per barrel
While the cost of jet fuel remains volatile, AMR is planning for an crude equivalent), with 32 percent subject to an average floor of
average system price of $2.04 per gallon in the first quarter of 2009 $1.94 per gallon of jet fuel equivalent ($67 per barrel crude equiva-
and $2.06 per gallon for all of 2009. AMR has 45 percent of its antic- lent). As of Jan. 16, the average 2009 market forward price of crude
ipated first quarter 2009 fuel consumption hedged at an average cap oil was more than $51 per barrel. Consolidated consumption for the
of $2.58 per gallon of jet fuel equivalent ($93 per barrel crude equiv- first quarter is expected to be 677 million gallons of jet fuel.
Continental Airlines
The table below represents the fuel hedges Delta had in place as of Jan. 23, 2009 (see Note A for additional information about Delta’s
fuel hedges):
Note A:
The tables below represent additional information about fuel hedges Delta had in place as of Jan. 23, 2009:
2009
Legacy Positions: Q1 Q2 Q3 Q4
Call 6% 6% 18% 15%
Collar 40% 33% 3% -
Swap 9% - - -
Total 55% 39% 21% 15%
Recent Positions:
Call 1% 5% 12% 4%
Swap 24% 41% 22% 13%
Total 25% 46% 34% 17%
minimize the potential for the Company to provide additional cash col-
Southwest Airlines lateral deposits to counterparties. The Company accomplished this
reduced hedge by entering into additional derivative contracts – basi-
The Company has utilized financial derivative instruments for both cally by selling zero-cost collars and fixed-price swap derivatives. This
short-term and long-term time frames, and typically utilizes a mixture strategy enables the Company to participate in further price declines
of purchased call options, collar structures, and fixed price swap via the sold derivatives, which should materially offset further declines
agreements in its portfolio. In recent years, as fuel prices have risen, in value of the Company’s previously purchased derivatives. If prices
the Company has held fuel derivative positions that have resulted in rise, the Company no longer has the protection it had in place prior to
significant gains recognized in earnings. However, as of December 31, reducing its hedge.
2008, the Company held a net position of fuel derivative instruments
that effectively represented a hedge of approximately 10 percent of its The Company had estimated obligations at December 31, 2008,
anticipated jet fuel purchases for the years from 2009 through 2013. related to its fuel derivative positions for the years 2009 through 2013
Prior to fourth quarter 2008, the Company had held fuel derivative (based on the contractual settlement date of those derivative instru-
instruments for a much larger portion of its anticipated fuel purchases ments). Although the fair value of these positions can fluctuate signif-
for these years; however, due to the recent precipitous decline in fuel icantly based on forward market prices for crude oil, heating oil, and
prices, the Company significantly reduced its hedge in order to mini- unleaded gasoline, the following table displays these estimated obli-
mize fuel hedging losses related to further oil price declines and to gations as of December 31, 2008 (in millions):
The total net fair value of outstanding financial derivative instruments fuel derivative instruments as cash flow hedges, as defined in Statement
related to the Company’s jet fuel market price risk at December 31, of Financial Accounting Standards No. 133, Accounting for Derivative
2008, was a net liability of $992 million. The current portion of these Instruments and Hedging Activities, as amended (SFAS 133). Under SFAS
financial derivative instruments, or $246 million, is classified as a com- 133, all derivatives designated as hedges that meet certain requirements
ponent of “Accrued liabilities” in the Consolidated Balance Sheet. The are granted special hedge accounting treatment. Generally, utilizing the
long-term portion of these financial derivative instruments, or $746 mil- special hedge accounting, all periodic changes in fair value of the deriv-
lion, is included in “Other deferred liabilities.” atives designated as hedges that are considered to be effective, as
defined, are recorded in “Accumulated other comprehensive income
Upon proper qualification, the Company endeavors to account for its (loss)” until the underlying jet fuel is consumed.
US Airways
Mainline Guidance 1Q09E 2Q09E 3Q09E 4Q09E FY09E
AvAvailable Seat Miles (ASMs) (bil) ~16.6 ~18.1 ~18.9 ~16.9 ~70.5
C- CASM ex fuel, special items & 1+5% to +7% +1% to +3% +1% to +3% +3% to +5% +2% to +4%
profit sharing (YOY % change)
FuFuel Price (incl hedges and taxes) 2.35 to 2.40 2.17 to 2.22 1.96 to 2.01 1.83 to 1.88 2.07 to 2.12
($/gal)
W Weighted Avg. Heating Oil Collar 3.32 to 3.52 3.52 to 3.72 3.44 to 3.64 — 3.41 to 3.61
Range ($/gal)
W Weighted Avg. Jet Fuel Equivalent 3.41 to 3.61 3.65 to 3.85 3.57 to 3.77 — 3.52 to 3.72
(incl, transport, and refining margin)
($/gal)
W Weighted Avg. Estimated Crude 121.87 to 130.27 136.29 to 144.69 131.91 to 140.31 — 128.39 to 136.79
Oil Equivalent ($/bbl)
January 2008 to February 2009 (Spot prices of Kerosene type jet fuel)
450.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb
400.00 263.83 280.84 312.90 342.48 395.15 396.21 403.74 341.73 310.42 236.58 193.42 143.18 143.56 127.44
350.00 253.07 264.32 299.02 330.43 377.84 392.49 396.39 327.37 286.89 213.71 179.60 139.53 141.71 125.66
cents per gallon
300.00 266.59 276.85 326.47 355.55 378.13 392.21 397.09 330.79 329.54 243.39 195.23 147.41 153.89 130.61
260.47 272.82 312.45 336.46 373.76 387.82 388.63 327.06 337.49 231.47 187.96 137.51 146.92 125.94
250.00
260.35 276.70 318.00 337.94 383.82 395.59 387.42 326.03 294.25 222.29 184.47 137.46 144.34 130.57
200.00
Amsterdam-Rotterdam-Antwerp (ARA)
150.00 Singapore
New York Harbor
100.00 U.S. Gulf Coast
Los Angeles
50.00
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb
Month
AIR FRANCE-KLM 6 Feb, 2009 Hedged 43% for FY2009-10 (ending 31 March Air France-KLM was carrying out no new hedging
10), giving final purchase price of $67/bbl of jet as of October 2008. It unwound a portion of its
fuel. Hedged 18% for FY2010-11, giving final hedging contracts after December. Group said that,
purchase price of $72/bbl. Hedged 21% for overall, its exposure to fuel-price volatility was
2011-12, giving final price of $72/bbl. halved.
AIR NEW ZEALAND 22 Jan, 2009 In second half of FY2009 (ending 31 March At 22 Jan prices, average Singapore Jet fuel price
2009), Air NZ was approx 72% hedged with would be $88/bbl for second half of Air NZ’s
average effective floor of $85.10/bbl of WTI FY2009, compared with average of $123 in
crude. First half of FY2010 is approx 20% first half.
hedged with average ceiling of $68.47 and
average floor of $45.20 per barrel of WTI.
ALASKA AIR GROUP 25 Feb, 2009 AAG is 50% hedged for 2009 at an approxi- Quarterly hedge levels as of 25 Feb 2009: 1Q09,
mate crude oil price per barrel of $76. It is 33% 50% at approx crude oil price per barrel of $81;
hedged for 2010 at an approx price of $70 and 2Q09, 50% at $71; 3Q09, 50% at $76; 4Q09,
is 11% hedged for 2011 at an approx price of 50% at $76; 1Q10, 42% at $68; 2Q10, 34% at
$80. $68; 3Q10, 29% at $67;' 4Q10, 24% at $78;
1Q11, 17% at $91; 2Q11, 15% at $73; 3Q11,
11% at $74; 4Q11, unhedged.
AMR CORPORATION 25 Feb, 2009 35% of 2009 consumption hedged at average AMR is planning for an average system price of
cap of $2.59/gal of jet fuel equivalent ($94/bbl $2.04/gal in 1Q 2009 and $2.06/gal for full year. It
of crude oil equivalent, with 32% subject to had 45% of expected 1Q consumption hedged at
average floor of $1.94/gal of jet fuel equivalent average cap of $2.58/gal of jet fuel equivalent
($67/bbl of crude oil equivalent). ($93/bbl of crude oil equivalent), with 42% subject
to average floor of $1.97/gal ($68/bbl crude equiva-
lent).
BRITISH AIRWAYS 6 Feb, 2009 For FY2009-10, 50% hedged with average floor At a fuel price of $60/bbl and $:£ exchange rate of
at crude oil price of approx $84/bbl $1.50, BA expects FY2009-10 fuel bill would be
£2.75bn, £250m-£300m less than FY2008-09.
CONTINENTAL AIRLINES 26 Jan, 2009 For full year 2009, 27% of expected consump- In 1Q09, Continental hedged 57% of expected con-
tion hedged in max weighted average price sumption at max weighted average price range
range of $2.54 to $3.40/gal. Also 21% hedged of $2.54-$3.32/gal, and hedged 31% in min price
at minimum weighted average price range of range of $1.09-$2.39/gal. In 2Q09, it has hedged
$1.17 to $2.53/gal. Max price hedge includes 34% at max price of $3.48/gal and hedged 34% at
6% WTI crude call options at ave. $2.54/gal; 7% min price of $2.61/gal. In 3Q09, CO has hedged
WTI swaps at ave. $1.17/gal; and 14% WTI col- 15% in max price range of $1.31-$3.21/gal and
lars at ave. $3.40/gal. Min price hedge includes hedged 15% in min price range of $1.31-$2.40/gal.
7% WTI swaps at ave. $1.17/gal and 14% WTI In 4Q09, CO hedged 5% at max price of $1.36/gal
collars at ave. $2.53/gal. and hedged 5% at min price of $1.36/gal.
DELTA AIR LINES (INCL. 22 Jan, 2009 In 1Q09, Delta hedged 80% of expected con- In 2Q09, Delta’s expected fuel consumption is 85%
NORTHWEST AIRLINES) sumption at an average jet fuel equivalent cap hedged at an average jet fuel equivalent cap of
of $2.81/gal to floor of $2.43/gal. At the then- $2.45/gal and a floor of $2.09/gal, at a $2.17 for-
forward curve, fuel price was $2.34/gal, includ- ward price/gal. In 3Q09, DL is hedged 55% at cap of
ing tax and transportation costs of approx $2.19/gal and floor of $1.22/gal, at forward price of
$0.17/gal. $2.10. In 4Q09, DL is hedged 32% at cap of
$2.24/gal and floor of $1.05/gal, at $2.00/gal for-
ward price as of Jan 23, 2009.
LUFTHANSA 2 Feb, 2009 Lufthansa applies rule-based strategic hedging Lufthansa's annual fuel consumption is some 8.3m
with a time horizon of 24 months, mapping the tonnes, generating more than 17% of group operat-
average of crude oil prices over time. LH hedges ing expenses. Its hedges are predominantly for crude
5% of planned consumption per month in oil, supplemented by contracts for the price differen-
Brent collars up to a hedging level of 85% and tial between kerosene and crude. Lufthansa uses
with a lead time of 24 months. As a result the standard instruments such as forward contracts and
forward six months are hedged to about 85%. options. For FY08, LH’s hedging level was only 72%,
due to loss of contracts with Lehman Brothers. LH
decided not to enter contracts for the remaining
13% because of the favourable oil-market conditions
it encountered towards the end of FY08.
RYANAIR 10 Feb, 2009 In FY2010, starting 1 April 2009, Ryanair is Ryanair’s fuel price/tonne in FY 09 (ended 31 March
75% hedged on fuel price in 1Q at $660/tonne; 2009): 1Q, $1,170; 2Q, $1,320; 3Q, $1,170; 4Q,
in 2Q, 75% hedged at $650/tonne; in 3Q, unhedged.
50% hedged at $660/tonne; 4Q, unhedged.
SINGAPORE AIRLINES 2 Feb, 2009 For the period 1 January to 31 March 2009, SIA’s fuel-hedging gains for the first nine months of
44% of SIA Group fuel requirements, or FY2008-09 (ending 31 March 2009) were $191 mil-
approximately 3.7 million barrels, were hedged lion.
at an average jet fuel price of $131/bbl.
SOUTHWEST AIRLINES 16 Jan, 2009 “As of December 31, 2008, the Company held As of 31 Dec, 2008, Southwest’s cash collateral obli-
a net position of fuel derivative instruments gations for fuel derivatives for the years 2009-2013
that effectively represented a hedge of approxi- totalled $992m (based on the contractual settlement
mately 10% of its anticipated jet fuel purchases dates of those derivatives). Obligations for 2009 were
for the years from 2009 through 2013.” $246m, for 2010, $239m; for 2011, $236m; for
Statement was made in Southwest’s 2012, $146m; and for 2013; $125m.
10-K annual results filing to SEC.
UAL CORPORATION 29 Jan, 2009 36% of consolidated and 44% of mainline con- UAL uses a combination of calls, puts, collars, 3-way
sumption. Average price where payment obliga- collars and 4-way collars to hedge. In Q1, 54% of
tions begin is $103/bbl and average price where consolidated consumption was hedged at $104/bbl
price protection begins is $104/bbl. In 2009, and 35% was subject to puts with payment obliga-
17% of consolidated consumption is also sub- tions ending at $57. With crude at $45/bbl, UAL’s
ject to puts with payment obligations ending at posted cash collateral requirement in 2009 would be
$54. approx $660m; at $35/bbl, it would be $780m. In
1Q, UAL’s mainline fuel price including all taxes, and
gains and losses on settled and unsettled hedges was
$1.83/gal.
US AIRWAYS For 2009, US Airways is 18% hedged at For 1Q09, 38% hedged at $3.32-$3.52/gal weighted
weighted average heating oil collar range of average heating oil collar range ($3.41-$3.61/gal
$3.41-$3.61/gal. Weighted average jet fuel weighted average jet fuel equivalent incl. transport
equivalent, incl. transport and refining margin, and refining margin). 2Q09, 24% hedged at
is $3.52-3.72/gal. Crude oil equivalent is weighted average jet fuel equivalent of $3.65 to
$128.39-$136.79/bbl. $3.85/gal. 3Q09, 10% hedged at WAJF equivalent of
$3.57-$3.77/gal. 4Q09, unhedged.
Most major US airlines are facing difficult decisions about how and when to renew their fleets, among the
oldest in the world. In 2009 the US majors are expected to be the most profitable carriers in the world for
the first time in many years, but they are cutting capacity as fast as they can as they see traffic melt away.
Chris Kjelgaard looks at the prospects for US re-fleeting.
FLEETING THOUGHTS
IT HAS BEEN MANY YEARS SINCE THE MAJOR US AIRLINES, recently conducted by AirlineForecasts led CEO Vaughn
as a group, have led the world’s air transport industry in Cordle to the conclusion that the nation’s airline industry will
terms of profitability, but that is exactly what is expected break even and possibly post a $2bn-$3bn combined operat-
to happen in 2009. Beset in the space of months by soaring ing profit this year. IATA, meanwhile, forecasts that the US
fuel prices – which pushed airfares to levels fewer and airlines – most of which are IATA members – will achieve a
fewer people could afford – and the onset of their nation’s $3.6bn operating surplus in 2009. Airline equity analyst Jamie
worst recession since the Great Depression of the 1930s, Baker, of JP Morgan, wrote recently that if fuel cost $70 a
the US majors had little choice but to slash capacity almost barrel on average in 2009 the US airlines should be able to
overnight in order to survive. record a $9.2bn operating profit.
But, having felt the effects of the global economic melt- If achieved, this would be their biggest-ever annual sur-
down before airlines in other parts of the world, the big US plus, notes aviation economist Adam Pilarski, senior vice
carriers are now better positioned to benefit from the late- president of Avitas – adding that if Baker’s forecast is on
2008 plummet in oil and fuel prices than most of the air target, and if the jet-fuel price stays below $70 a barrel, as
transport industry. Although consulting firm Boyd Group it was in early 2009, then the US airline industry would
International’s baseline 2009 forecast for US airport stand to better even the $9.2bn figure that Baker foresaw.
enplanements expects passenger numbers to drop by some
seven per cent to around 700 million, and AirlineForecasts The tantalising possibility of fleet renewal
sees US airline revenues falling off by 10 per cent, or $12bn, As a result, the major US airlines might hypothetically find
the expected $25bn reduction in the US carriers’ combined themselves in a position to consider a move that most have
fuel bill compared with 2008 should see them at least put off throughout the long, dark financial years that fol-
break even and possibly do much better than that. lowed the 9/11, 2001 terrorist attacks and the simultaneous
US recession: embarking upon large-scale renewal of their
Forecasts of US airline profitability in 2009 differ quite widely. fleets. Once global pioneers in working with manufacturers
An in-depth analysis of US macro-economic conditions to specify and order the latest-technology commercial air-
craft, the US airlines have seen their status slip as a result of ment orders, did express itself in at least one order,” says
their financial travails throughout the last decade to the Craig Jenks, president of New York consulting firm
ignominious point where the average age of the US fleet Airline/Aircraft Projects. “American substantially brought
was in 2008 the oldest of any in a world region. This was forward its order for 737-800s. Clearly the financial com-
exemplified by the 35-year average age of the 75 McDonnell munity was begging them to do so,” to begin replacing the
Douglas DC-9s in the then-Northwest Airlines fleet (71 of 300-plus MD-80s in its domestic fleet. By the end of 2008,
which remain in service); the elderly 747-200F freighters American had grounded 43 MD-80s, according to UK avia-
operated by the same carrier; the huge numbers of 15-to-25- tion consultancy IBA Group.
year-old 737-300s, 737-400s, 737-500s and MD-80s found
throughout the majors’ fleets; and the sizeable chunks of 737 Classics being eliminated from US fleets
mainline domestic capacity accounted for by older 767-200s At the same time as American started replacing its MD-80s,
and 757s. other US majors began grounding their fleets of older 737s.
“We’re on the path to total elimination of 737 Classics”
So, with the exception of some of the fast-growing, low- from the US fleet, says Jenks. “Continental, United and US
cost airlines – whose fleets were almost new – and some Airways are all exiting the 737 Classic – all of them driven
growth capacity acquired in recent years by the bigger by the fuel situation.”
majors (particularly Continental), by 2008 it seemed there
were compelling reasons for the US airline industry to con- There are two notable exceptions to the trend – Southwest
sider re-fleeting en masse. And, at one point in mid-year, as Airlines and Alaska Airlines. Southwest has a large fleet of
fuel prices soared to unprecedented levels, a large-scale re- 737-300s and a smaller fleet of 737-500s, but isn’t intending
fleeting seemed imminent despite the US airlines’ lack of in the short term to ground most of them. “Southwest had
creditworthiness. Across the board, the major US carriers a different fuel price from the others” in 2008, notes Jenks:
found there was a compelling need to ground older air- The airline’s consistent profitability throughout the years
craft simply because of the fuel costs they represented. allowed it to hedge in advance much of its 2008 fuel con-
“Fuel [price], which was a very strong motive for replace- sumption at prices far below the mid-year peak, where other,
according to data compiled by ATW Online. All of the big six net-
work airlines cut mainline domestic capacity by double-digit per-
centages, with Northwest – now part of Delta – and United
leading the way with 17.9 and 12.5 per cent cuts respectively.
For about a year, from the time the US recession is now known to
have actually begun in late 2007, through the mid-2008 frenzy of
high oil prices until the wheels came off the global economic jug-
gernaut in the last three months of the year, the US majors found
a higher-yielding alternative use for some of their surplus domes-
tic capacity: redeploying suitable aircraft – particularly 757-200s
and newer 737s – into short-to-medium-haul international mar-
kets.
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Editorial main:FIN2009 2/6/09 15:08 Page 52
That said, the US airlines can’t look to Ex-Im Bank to finance their
Boeing aircraft. Commercially, “in Europe we’re probably down
to half a dozen banks” that are willing – or able – to finance air-
craft deals, says Geach. “Citicorp in the US historically has been
active, and there are pockets of lenders in the Middle East. In the
US, it’s probably down to the historic financiers of much of the
financing requirements of the US airlines – the pension funds.”
(One factor that could boost pension-fund interest in aircraft-
based asset financing is the steep tumble in the Dow Jones
Industrial Index since its peak in October 2007, the fall exceed-
ing 50 per cent by early March.)
think a replacement programme is in the top 10 of any US airline
For airlines that haven’t already closed them, EETC structures executive’s ‘to do’ list” right now, he says.
aren’t likely to prove the answer in the near term, says Geach. Jenks has a similar view. Despite the ability of US airlines to take
“EETC structures came under a lot of criticism. With these struc- advantage of any holes in Boeing and Airbus delivery slots, he
tures, appraisers had their arms twisted and a number of them says: “There’s the old rule of thumb, that you need one year of
have unravelled, so it’s unlikely we’ll see a flurry of activity” any
time soon.
US airline passenger jet fleet – one year change
“I don’t think the [problem of] confidence in the general economy
and the lack of confidence in financiers is going to be solved Mar-08 Mar-09 Change
overnight,” says Seymour. “We are seeing new entrants [to the Boeing 737 (NG) 773 806 33
aviation finance market] – we’ve had banks we had never heard of
Bombardier (Canadair) CRJ 678 648 -30
two years ago asking what the aviation market is all about – but
there are fewer competitors in the financing sector now.” Boeing 757 548 515 -33
Boeing 737 (CFMI) 545 419 -126
Embraer ERJ-145 498 485 -13
A bail-out for the 747-8?
However, Seymour thinks it is conceivable that a major US fleet Boeing (McDonnell-Douglas) MD-80 477 430 -47
renewal order could come in an unexpected way – and for an Airbus A320 375 378 3
unexpected aircraft; the 747-8 passenger jet. Airbus A319 302 279 -23
Boeing 767 271 267 -4
“Boeing executives are under severe pressure to get some of
those aircraft ordered,” says Seymour. “I would imagine they’re Bombardier (Canadair) CRJ700 214 212 -2
putting all sorts of incentives on the table – including the engine Boeing 777 128 130 2
manufacturer [GE, for the GEnx powerplant that is the sole
Boeing 717 123 110 -13
engine choice for the 747-8]. I think Boeing needs to see a sub-
stantial order in the next year – otherwise, we may well see that Bombardier (Canadair) CRJ900 94 131 37
programme being put on hold.” Boeing (McDonnell-Douglas) DC-9 94 70 -24
Embraer ERJ-135 86 38 -48
While the idea of an order for the 747-8 from a major US airline
is not immediately obvious, the chances of such a deal – involv- Embraer 170 76 76 0
ing United or Delta-Northwest, perhaps – are all the more likely Embraer ERJ-140 74 74 0
“when you look at the other equipment coming in on transpa- Boeing 747 48 45 -3
cific routes”, in Seymour’s view – “if you look at more and more
Embraer 190 46 60 14
A380s coming in these routes, and gaining significant accept-
ance, particularly in the premium cabin.” Embraer 175 44 90 46
Airbus A330 41 41 0
Seymour believes it possible that, just as the US government has
Airbus A300 34 22 -12
done in standing behind its automobile manufacturers, the federal
government and the banks will be “looking at the aviation sector Airbus A321 32 36 4
and the value [it represents] to their country – and in the same way Boeing 737 (JT8D) 24 12 -12
the US supported the motor industry, Boeing and GE will say,
Boeing 727 18 2 -16
‘Support us’,” by providing financial assistance for US airlines “to
order some decent aircraft”. The US’s recent record of trade pro- Boeing (McDonnell-Douglas) DC-10 17 17 0
tectionism argues that this could happen, he believes. Boeing (McDonnell-Douglas) MD-90 16 16 0
Fairchild/Dornier 328JET 16 4 -12
An unlikely scenario? Perhaps. Otherwise, however, Seymour
Airbus A318 11 11 0
thinks the chances of a US airline coming up for a major fleet
replacement order soon are slim, despite the opportunities they Boeing (McDonnell-Douglas) MD-11 4 4 0
might have to find aircraft at attractive prices if big holes start TOTALS 5707 5428 -279
appearing in the Airbus and Boeing orderbooks. “Let’s say I don’t
Source: Ascend
“We always have to go a special route,” says Karsten Sensen, CEO and managing director of Bavaria
International Aircraft Leasing. Mary-Anne Baldwin talks to Sensen about the unique nature of his company.
LESSOR FOCUS: concept is not a bad one… There are very few leasing companies
that have survived over such a long time. And what’s the reason?
The reason is, in many cases the business case was focused on
high leverage and if you try to get the highest leverage, you will
BAVARIA
take the highest risk if something goes wrong – for instance,
the unexpected repossession of an aircraft. We don’t have the
funding to bridge this situation… so that’s what we try to avoid.
Of course the resulting business case is, in many cases, not as opti-
mised as with highly leveraged companies, but we are limited.
And even though the 717 was not a success story, for us it was.
We got these aircraft in 1999 and 2000 and placed them in
Australia to a small company which has now been purchased by
Qantas. We will have Qantas as our 717 lessee for another nine
years, until the year 2018, when the aircraft are 18 years old.
to compare it with, but any downturn has an end and then you
have a recovery stage. If you look into the past – although [past
recessions] aren’t comparable – I think, and I’m not the only one
saying this, that we will overcome this current situation over the
next two years. During this period of time, it will be very difficult if
you get aircraft and have to lease them. It will be very difficult if
your lessee’s contract expires. But fortunately all our contracts are
much longer, so we should be able to overcome this quite easily.
The most difficult thing is that – with all the assistance the US
government [and] the European governments are giving to the
clientele, supporting their financings – the fact is that if a com-
pany needs all this assistance to get funding together, you’re
starting on a very weak basis. I do believe that a lot of companies
getting aircraft on this very weak basis will have problems over
the next one or two years. Then you have big disasters. You have
big aircraft with high financing [costs] and to get this cured is a
real challenge.
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Editorial main:FIN2009 2/6/09 15:13 Page 58
The US airline business probably distils all the ills afflicting the aviation industry as a whole at present. Old
aircraft, exorbitant fuel prices and a slack economy present a glum picture. Yet there is hope, writes Peter
Morris, chief economist at Ascend.
DEVELOPING THE US
AVIATION INDUSTRY
YEARS AGO AND LOST IN THE WILDS OF IRELAND, I MET A
farmer from whom I asked directions. “Limerick?” he said. “If I
were you I wouldn’t start from here.” I think the US aviation
industry appreciates what he meant. More than three decades
after facing the turmoil of deregulation, the resulting explosion Taking the long view
of competition, and being dragged to the edge of a financial Despite the current level of crisis, it is worth a reassuring look at
abyss in 2002-4, it has downsized, streamlined and squeezed to the long-term fundamentals. Air travel is a critically important
return to profit. No sooner had this seemingly impossible feat resource for the US economy, responsible for over $1,200bn of
been achieved, when along came a tidal wave of fuel price direct or indirect output, and around nine per cent of US jobs.
increases combined with a weak economy, threatening to swamp Airlines and aviation suppliers that survive the current problems
most of the airline industry. will be well placed to improve their businesses in the future.
Domestic and international air networks provide massive and
Without doubt, given a choice, the US airline industry would not continuing competitive advantage for the US economy against
‘start from here’. Faced with high and increasing levels of debt, low other global competitors such as India and China.
cash reserves, aged fleets, a softening customer demand and an
unenviable record for capital destruction, anywhere would be bet- While recent US aviation market growth has slowed in the light of
ter than here. both price increases and the deterioration of the travel experience,
the US will remain for the next decade and beyond by far the
Yet this is the only choice – to find a path when there appears to biggest world aviation market. Future market growth will con-
be no road back or ahead, and no way to stand still. Just what tinue, driven by GDP growth. So what characteristics will ensure
are the options? long-term survival of airline suppliers to meet this market need?
300 So, if we had to sum up the various factors, what would we say?
250 Apart from safety and security oversight, it is surely time for the
Pax legislators to stop interfering in the airline sector, either directly
RPM or indirectly.
200 ASM
Revenue
150 The fuel price crisis focuses more than ever on the right business
model for markets, and the need to restore profitability again
100
Source: ATA: Excludes Southwest Fleet replacement is a problem that will not go away, and a life-
and Express carriers cycle costing of options reinforces this.
50
06
00
02
04
0
84
86
88
90
92
94
82
96
98
Finally, the industry needs to plan for the worst, since that
8
20
20
20
20
19
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19
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19
19
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A spare engine can cost anywhere from US$3 million to At Macquarie, we can help you reduce your asset base
US$25 million. That’s a heavy burden for an operator and free up your capital.
Especially when you can enjoy access to spare engines Want to talk? For further details and enquiries simple
with no capital investment simply by leasing from contact your nearest Macquarie Aviation Capital
Macquarie Aviation Capital. representative or email us at engines@macquarie.com
fff\PR`dPaXTR^\
0dbcaP[PbXP0bXP?PRX
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Macquarie refers to Macquarie Group Limited and its subsidiaries and affiliates worldwide. In the UK, MQG is authorised and regulated by the Financial Services Authority.
With respect to matters which may be subject to US securities laws and to the extent required by such laws, MQG and its worldwide subsidiaries consult with, and
acts through one of their affiliated registered US broker-dealers. MQG is not licensed to conduct banking business in the US.
Editorial main:FIN2009 2/6/09 15:14 Page 64
If there is a single beneficiary of the perfect storm that includes record jet fuel prices, fallout from
the sub-prime mortgage debacle, slowdown in the world economy and delays in deliveries of new,
fuel-efficient Airbus and Boeing aircraft, it is the aircraft leasing sector. Whether this is a short-
term phenomenon or a long-term trend is yet to be seen. But a quick look at the order books of both
Airbus and Boeing indicates that aircraft lessors are bullish on the prospects of the operating lease
market. Jim Smith reports.
LESSORS RIDING
OUT THE STORM
SINCE 2007, WHEN THE REALITIES OF AN ALTERED GLOBAL eco- Lessor significance
nomic climate began to transpire, airlines worldwide have been Aircraft leasing companies can be roughly divided into three cate-
faced with the prospect of cancelling or delaying deliveries of gories. The first category includes lessors with strong corporate
new aircraft or sub-leasing aircraft to other carriers. At the same parents, such as Aviation Capital Group (ACG), a wholly owned
time, lessors have played a dominant role in acquiring new air- subsidiary of Pacific Life Corporation, parent company of Pacific
craft directly from manufacturers and through sale-and-lease- Life Insurance; Aviation Lease and Finance Co (Alafco), majority
back transactions as well as purchasing second-hand aircraft owned by regional powerhouse Kuwait Finance House; BOC
from carriers and other leasing companies. Aviation (formerly Singapore Aircraft Leasing Enterprise or SALE),
now a unit of Bank of China; Dubai Capital, the aircraft leasing
The operating lease market is growing, according to John arm of Dubai Aerospace Enterprise (DAE); GE Commercial Aviation
McMahon, chief executive officer of Ireland-based Genesis Lease. Services (Gecas), a unit of worldwide conglomerate GE; and
“Many airlines do not have the balance sheet strength to support International Lease Finance Corporation, the leasing subsidiary of
the large-scale acquisition of aircraft but they can use cashflows insurance giant American International Group (AIG).
from operating the aircraft to support a lease. In addition,
lenders may feel more comfortable lending to a lessor with a The second category includes listed companies, such as AerCap,
diversified portfolio of airline customers and the capability to Aircastle, Genesis Lease and soon-to-be-listed AWAS.
remarket the aircraft – should it be necessary – rather than direct
to a single airline. Aircraft leasing is part of a broader trend The third category includes a plethora of small aircraft lessors.
towards the separation of the ownership of high capital value ‘First-tier’ lessors continue to be big business for aircraft manu-
assets from operation of these assets.” facturers, especially Airbus and Boeing, as these companies build
up fleets to satisfy increasing global demand for aircraft.
AerCap Holdings is equally upbeat about business going for-
ward. “The proportion of the global fleet under operating lease In early January, DAE confirmed a $10.9bn order for 100 Boeing
has increased from 17 per cent in 1990 to 30 per cent in 2006. aircraft comprising narrowbody and widebody aircraft, firming
The industry believes that operating leases will continue to up a November 2007 letter of intent (LOI). DAE also penned a
become more popular and that 40 per cent and more of the memorandum of understanding (MOU) in November 2007 with
global fleet will be subject to operating leases over the course of Airbus for 100 aircraft, including narrowbody and widebody
the next 10 years,” according to Frauke Oberdieck, a spokesper- types. Rumours are that DAE may place another order within 18
son at the Netherlands-based lessor. months for about 50 A330 and 777 aircraft.
DAE entered the aircraft leasing arena in November 2007 with There is little doubt that the business is a good bet for lessors,
the simultaneous announcement of the acquisition of eight lessees, and the banks that provide the former with finance.
A330-200 aircraft from Emirates under a sale-and-leaseback “Operating lessors are a key sector for a number of banks,
scheme, and the acquisition from Gecas of a total of 20 aircraft, including DVB Bank,” says Bert van Leeuwen, managing director
comprising 737 and A320 aircraft. and head of aviation industry research at DVB. “We have seen
the market share of operating leases increase over time and it
In Asia, meanwhile, BOC Aviation plans to triple the size of its would appear to the casual observer this takes away market vol-
fleet to 300 aircraft over the next five years, taking advantage of ume from the banks. However, many of the operating lessors
sale-and-leaseback opportunities that would allow the lessor to need bank financing themselves for their aircraft acquisitions, so
acquire aircraft without being captive to the long lead times for the majority of the market share taken by the operating lessors
new orders precipitated by bulging manufacturer order books. is actually coming back to the banks.
Estimates are that Chinese airlines will take delivery of 800 aircraft
over the next five years, with sale-and-leaseback transactions “In many cases the involvement of an operating lessor creates
expected to account for about 20 per cent of that total. another layer of comfort for the banks as operating lessors will
be well equipped to manage and remarket the aircraft in case of
In the ‘second-tier’, lessor AWAS placed a firm order in January a default by the lessee. However, it is important that the lessor
for 75 A320-family aircraft with 25 options, after placing a firm has a well-diversified portfolio to prevent being dragged down
order in December 2007 for 31 737 aircraft with 19 options. by the default of one or two lessees. In some cases banks have
AWAS also ordered six A330-300 aircraft in March 2008. acquired operating lessors themselves, providing them with a
captive funding source. DVB deliberately has not taken this step
Finding finance and does not have its own operating lessor to prevent potential
The top-tier of lessors benefits from the ease with which it can competition between the bank and an important client group
raise capital to fund aircraft acquisitions. A banker with a large [the lessors]. DVB Group, however, via its Deucalion connection,
European bank active in financing aircraft lessors and who asked frequently teams up with operating lessors to invest equity in
to remain anonymous tells AF&NM: “I see no major capital-rais- new transactions,” van Leeuwen continues.
ing issues with the first category of lessors. We continue to do
business with some lessors in the second category, provided that “Operating lessors are approximately one-third of the aviation
a deal is well-diversified and well-secured. portfolio of HSH Nordbank,” according to Mathis Shinnick,
global head of transportation at HSH Nordbank. “They are very
“However, we believe that growth among lessors in the second important to our business. Their approach to asset management
category is limited by a lack of access to equity markets for the and financing requirements fits with our business model very
time being. For category three lessors, you have to be careful. well. It is important to note that operating lessors have perfected
While some of these lessors have decent aircraft portfolios, oth- a very comprehensive asset management capability that is not
ers have portfolios overloaded with 737 Classics, the values of only efficient for airlines but also for the financial markets,” he
which will drop substantially. adds.
“All lessors will have to pay higher margins than in the past; Sale & leaseback
there are no more AAA-rated monoline-wrapped deals with very Aside from the outright leasing of aircraft to operators, sale-and-
low margins. This will reflect the increased airline risk and asset leaseback transactions can also be mutually beneficial to lessors,
risk,” the banker adds. lessees and banks active in the market.
Bring It On.
Our Deep Bench Of Professionals Are Ready For Any Challenge.
The financial and aviation professionals at SkyWorks maintain direct contact with the lending,
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solutions to senior executives. When we structure aircraft financing, raise capital, restructure
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options so that you receive the best possible execution.
We Know No Boundaries.
Middle East and beyond “Aircraft are mobile assets that can be operated in any part of
The Middle East, awash with oil money, has the potential to the world. Aircraft leasing is a truly global business and new
become a major centre for aircraft leasing. entrants should always be taken seriously irrespective of whether
Although the few leasing companies domiciled in the Middle they start off with a particular regional focus. I do not believe
East do benefit from generous and supportive governments and they adversely affect the business. On the contrary, generally
very deep sources of equity, what the region arguably needs to speaking, they act as a new source of capital for the industry
take it to another level is a more active local banking market and from sources that might not otherwise participate in aircraft
fully functioning capital markets. financing,” says McMahon at Genesis Lease.
While there is considerable liquidity in the Gulf Co-operation “The last few years have seen record orders from the world’s air-
Council (GCC) region, many question whether there is sufficient lines. In common with previous industry cycles, it looks as if these
impetus from bankers in the region to get into aircraft finance, aircraft will be delivered in times that are far more challenging
bearing in mind the Middle East’s preference for real estate and than when they were ordered. While I expect that some deliver-
the bond markets. But there has been some movement in this ies will be deferred, airlines will be looking to lessors like Genesis
direction – particularly as the region hosts a large number of to support many of the deliveries through sale-and-leasebacks.
equity investors. Since we have not placed speculative orders ourselves, part of
our fleet build-up strategy is to support airlines in this way and
Established in 2007 as a joint venture between Bahrain-based believe there will be plenty of opportunities to do so.
United International Bank and Muzon Partner, aircraft lessor
Falak Investments, a company related to Switzerland-based “A successful lessor might have a geographically and customer-
Novus Aviation, plans to expand aircraft leasing activities. Novus diversified portfolio of the right aircraft. In Genesis’ view the right
Aviation is the asset and aircraft lease manager of Falak aircraft are latest-generation aircraft that are less than 10 years
Investments and is already a familiar name in the aircraft finance old and that have large operator bases,” adds McMahon.
market. Almost 10 years ago, Novus established the Muzun
International Aviation Fund (MIAF), which has subsequently been According to van Leeuwen, observation of the global lessor pop-
completely sold out. ulation indicates that “after the consolidation wave we have
seen over the last two to three years, some of the lessors con-
Falak Investments was established with 11 aircraft, valued at trolled by financial institutions may now – partly – be up for sale
about $400m. The company recently signed a letter of intent as corporate parents need the liquidity for their core business.
(LOI) to acquire five additional aircraft, including A320-family, This may result in a reduction in the number of traditional west-
737NG, 747-400 and ERJ-145 aircraft. ern lessors. On the other hand we see new initiatives coming
from Asia and the Middle East to set up new lessors. In addition,
In 2008, Australian banking group Investec entered the aircraft some airlines with surplus aircraft or order positions may take ini-
leasing business with the launch of Investec Global Aircraft Fund tiatives to become ‘quasi-lessors’ themselves”.
and A$73m ($68m) in initial capital. Seed investors include three
large industry superannuation funds: Auscoals Superannuation, “We believe these startups are to be taken seriously, as they have
Seafarers Retirement Fund (SRF) and the Stevedoring Employees determined financial backing and the aim to build global fran-
Retirement Fund (SERF). chises over time,” says Oberdieck.
A safe bet: lessors have stayed strong and can therefore raise funds with relative ease It would appear that leasing companies will continue to be a
major force in providing operators with a significant share of air-
craft, at least over the short- and medium term. What remains to
be seen is to what extent lessors will provide the industry with
new-technology aircraft, either outright or through sale-and-
leasebacks.
Company Commercial Jet Aircraft for Sale or Lease Phone Email/Web Contact
CIT 1 x 737-300 with CFM56-3B2 engines. Available for sale from March 2009. (353) 1 656 1012 brian.connolly@cit.com Brian Connolly
MSN:23774 - YOM:1987
1 x 737-400 with CFM56-3C1 engines. Available for sale from January 2009.
MSN: 24124 - YOM: 1989
2 x A320-200 with IAE V2527-A5 engines. Available for sale or lease from April 2009
and May 2009. MSN 425 – 453 – YOM: 1993 – 1994 respectively.
1 x A320-200 with IAE V2527E-A5 engines. Available to lease from October 2008. YOM:
2002 – MSN: 1676
ORIX 1 x 737-300 with CFM56-3B2 engines. Available for lease from March 2009. YOM:1990 +353 1 670 0633 paul.o’dwyer@orix.ie Paul O’Dwyer
1 x 737-400 with CFM56-3C1 engines. Available for lease from January 2009.
YOM: 1998
Just settled into its new Dublin offices, AWAS has almost completed full integration of Pegasus Aviation
into its business. While some other large lessors are yet to make heavy commitments, AWAS locked in its
order stream mid-2007, ensuring early deliveries to meet strong forecasted airline demand.
Alex Derber investigates a company focused on strategic development.
LESSOR FOCUS:
AWAS
REPORTING ON THE AVIATION INDUSTRY HAS BEEN A depress-
ing task of late: capacity is being slashed in many markets; Acquisition strategy
employees are being jettisoned by the thousand; and airlines “Underlying everything is basically a major strategic repositioning
seem to be going under on a weekly basis. Therefore it’s always of the business,” says Pray. This relates to what he terms “the five
a welcome respite to talk to the lessors who, despite the doom pillars of growth”. The first of these has already been noted – the
and gloom, retain a cautious optimism. purchase of new aircraft from Airbus and Boeing. In this respect
AWAS, traditionally a Boeing-orientated lessor, has greater com-
Franklin Pray, CEO of Ireland-based AWAS, epitomises this (CFOs mitments with Airbus as it seeks to balance its portfolio between
at hard-up carriers, look away now): “We’re in the fortunate the two manufacturers.
position to have secured financing for virtually all of our acquisi-
tions over the next year to year and a half. And we have no sig- The second and third pillars that Pray wishes to base AWAS’
nificant refinancings due in the foreseeable future so it puts us in growth on are new aircraft sale-leasebacks and used aircraft sale-
a comfortable position.” And no mean feat that is, too: AWAS leasebacks. The former is a relatively visible and thus predictable
has 136 aircraft on order with Airbus and Boeing, the first of business; it is easy to see what Airbus and Boeing have coming
which should be delivered in 2010. down the assembly line and where it is destined. With used air-
craft deals are harder to come by, being according to Pray “rela-
AWAS today tionship-driven”, though they do offer higher yields.
Established in 1985, AWAS has undergone significant changes in
recent times, most notably through the purchase of Pegasus in Lessor trading is a field AWAS continues to be active in, dealing
June 2007. Though Pray describes the amalgamation of the new either with lessors, such as ILFC, looking to book trading gains or,
company into AWAS as “somewhat chaotic”, he feels “it ulti- increasingly, with distressed sellers grasping for quick capital. “CIT
mately translated into probably the most successful year for [Aerospace] falls into that category unfortunately these days,”
AWAS in its 23-year history”. says Pray.
Yet Pegasus did not represent the only change. Two months after Finally, and perhaps most significantly in the current climate, Pray
its acquisition AWAS moved into new offices in Ireland, where targets expansion through mergers and acquisitions. “There’ll be
previously it didn’t have a presence. At the same time Pray additional consolidation on the aircraft leasing side and we think
replaced almost the entire senior management team at the com- of ourselves as a consolidator rather than a consolidatee.”
pany and now AWAS has added new areas to its business such
as risk management, and portfolio management and training. Crucial to AWAS’ purchase of new aircraft has been timing. The
company firmed up its orders with Boeing and Airbus in the sum-
Leasing, though, remains AWAS’ core competence. The company mer of 2007, ahead of competitors like GECAS, DAE, ACG and
has a portfolio of 319 aircraft flying with 96 customers in 46 ILFC. Even so, Pray had feared that AWA might still have come to
countries. Combined with its total order backlog, AWAS counts the table too late: “It was part of our strategic plan but we just
itself as the third-largest lessor by fleet size and the biggest inde- didn’t think we were going to get there with respect to pricing
pendent lessor. It is 100 per cent owned by the private equity with Boeing and Airbus since they had actually quite successful
group Terra Firma. 2006s. So what actually has happened is they looked at their les-
sor backlog and whereas it’s been traditionally in the 30 per cent
range, it was below 20 per cent on a forward basis. I think both of aircraft on order it has placed, Pray confirms that every air-
of them looked at lessors as lower-risk propositions than air- craft to be received until 2010 has a lessee based either on an
lines.” LoI or a firm contract. AWAS was to be among the first to
receive the 787, in 2010, though programme delays have
That leasing companies comprised such a low percentage of pushed that out to 2012, a setback Pray appears unconcerned
OEM backlog had much to do with a lack of orders from heavy- about.
weights ILFC and GECAS, particularly in the narrowbody arena.
That has since been redressed: GECAS ordered over 50 737s at Thirty-five per cent of AWAS’ in-service fleet currently operates
the end of 2007 and ILFC has recently made it known that is con- in Europe; 30 per cent in Asia; 20 per cent in the US; and 11 per
sidering a 300-plus aircraft order for Boeing and Airbus narrow- cent in South America. Unsurprisingly, AWAS intends to shrink
bodies. its North American commitments and redeploy aircraft to Asia,
primarily. By 2009, exposure in that region should grow to 40
Such a heavyweight order from ILFC would obviously grant sig- per cent of the fleet, while AWAS also targets growth in South
nificant leverage for manufacturer discounts, but while Pray America, from 11 to 15 per cent. The number of AWAS aircraft
believes ILFC “are probably the smartest people in the business”, in Europe should hold steady, though as the total fleet grows
he does think that “from a pricing and availability of slots per- proportional exposure in the region will fall.
spective they are a year late”. He qualifies this, however: “In my
opinion the value of a successful leasing platform is in making Conspicuous by its absence from AWAS’ stated plans is the
money throughout the cycle and that’s what differentiates Russia and CIS region, an oversight Pray sheepishly admits to:
stronger players like ILFC, GECAS, Babcock, Aercap, RBS, ACG, “We have a great interest in Russia. We didn’t want to outline to
CIT and of course AWAS from the pure market timers. There is the world what our plans are with respect to that specific area of
money to be made in various areas of this business at various the world since that’s an area that will take up a lot of the
points in the cycle.” demand that would traditionally have gone to Europe. It’s just
not something we want to point attention to as we feel the
The next narrowbody opportunities there are rather big.”
One of the great risks in ordering single-aisle aircraft today and
receiving the 2015-outwards delivery positions that go with them, The company is certainly not alone in spotting potential in the
is that Boeing and Airbus’ narrowbody replacements should arrive region, though many also believe that too many airlines have
only a few years later, thereby depressing values of older-genera- sprung up in Russia and the CIS than the market can likely sus-
tion types; the operative word being, of course, ‘should’. tain. On this Pray comments: “There are some very well-run air-
lines there now, some very impressive airlines. There’ll be some
“We looked at this rather heavily,” says Pray. “If you look back weaker players and some fallout so it’s ultimately about making
three years ago there was talk about a near-term replacement of sure you’re betting on the right ones.”
the 737NG aircraft and the current generation A320s in the
2012 timeframe. I think that’s sort of what has caused lessors to Coping with the downturn
take a little bit of a step back in terms of making commitments As noted above, AWAS has had little difficulty securing financing
too far out.” despite the economic climate. In fact, the company has raised
approximately $1.4bn since September 2007, an achievement
As is generally acknowledged, the crucial factor in when we see Pray puts down to “lenders still being positive about the plat-
new aircraft is engine technology. “One of the major reasons form, the assets and the industry”. He lends further evidence for
why we felt comfortable ordering aircraft out to 2014, to a very this: “We’ve refinanced a loan facility that we acquired as part of
limited extent out to 2015, is engine technology and our visibil- Pegasus, we’ve financed on a forward basis six A330s that we
ity in terms of where that stands right now,” says Pray. Current
visibility suggests that the next decade should see the progres-
sive introduction of Pratt & Whitney’s geared turbofan, new
large-diameter conventional turbofans, and then, possibly, the
open rotor. “It’s sort of a cat-and-mouse game because whoever
will go to market first, whether it’s a geared turbofan or an
advanced turbofan, could potentially be usurped by the com-
petitor through the competitor simply waiting for another two
to three years until the next technology comes out. So you have
an instantaneously obsolete product. So it’s a very interesting sit-
uation that we have right now on the 737/A320 replacement
side and, needless to say, whoever moves first might end up
being the loser.”
For now, Airbus and Boeing are pumping out A320s and 737s at
record rates, a strategy Pray feels could be misguided. “I think
they’re both too high on the narrowbody side. They’re running
into production constraints to increase them which tells me that
there’s less likelihood that they will further increase them.
Overall, the key here is that they need to be careful about where
they are and what concerns us is that the production rates they
have today are probably not sustainable over the long term.”
AWAS client base and targeted growth
Record oil prices have seen demand surge for more fuel-efficient
aircraft types at the expense of older equipment, a fact noted by
Pray. He also points to higher default rates and repossessions,
usually a precursor of a softening market. Not that this has
affected AWAS, however: “We’ve been able to in virtually all of
our repossession cases redeploy the aircraft instantaneously and
at higher lease rates. In essence, that’s what I look at as the value
that our platform brings to the table.”
BOC Aviation
CIT Aerospace
BAE Systems
GECAS
AWAS
ACG
Aircastle
DAE
RBS Aviation Capital
Going forward, Pray sees aircraft buyers increasingly availing The extent to which the airline industry will be able to support
themselves of export credit, especially if the economic situation long lease terms and high rental prices is a matter of some
worsens. Reflecting the thoughts of most in the industry, he also debate. It is tempting to suggest that the leasing business is suf-
thinks that “the times where you were able to raise large facili- ficiently decoupled from the airline cycle to immunise it from the
ties at attractive pricing that were subject to syndication – that is latter’s ailments. Pray, however, doesn’t agree: “If you look at the
probably going to be pretty soft for the foreseeable future”. aircraft leasing business from a pure asset-value perspective, the
bottom end of the spectrum will soften significantly and I think
overall lease rates will go down as well.
That said, there has been some speculation that Terra Firma will
divest itself of AWAS. After all, the private equity firm specialises
in restructuring businesses like AWAS, changing their strategic,
and generating significant value from an exit. Yet Pray is reason-
ably confident that the group will hold onto AWAS for the time
being: “Terra Firma are usually fairly long-term investors so I
would be surprised if there would be a near-term exit by Terra
Firma from this business. I think they like the way the business is
running and I think they like the way we can still continue to
grow the company and grow their capital – but I would never
rule anything out.” Source: May 2008 AWAS Analysis
“
Overall, limited supply and excess
demand dictates that lease rates will
remain strong this year. “We’re still
leasing used aircraft at rates that are
on average up 10 per cent on the pre-
vious rentals. This applies primarily to
new aircraft, but rates have also held
firm on the 767-300ER and A330-300,
a development that caught the indus-
try somewhat unawares.
”
While AWAS continues to enjoy Terra Firma’s strong backing,
most expect there to be some thinning out in the leasing indus-
try this year as some of the smaller lessors, private equity firms
and hedge funds exit the business. Pray agrees that thinning out
will occur: “I’ve predicted this for quite some time and we’ve
been part of that process last year. The fact is that in difficult
times the strong players will get stronger and the weak players
will get absorbed. We’re already seeing some of the weaker play-
ers running into difficulties with commitments and some have
already been put up for sale by their shareholders.
So, it appears that several other companies this year will follow
Pegasus under the AWAS umbrella. Though Pray won’t divulge
any details, he summarises his thoughts thus: “On consolidation
I’d like to go back to what Warren Buffet said: ‘Not until the tide
goes out will you see who’s been swimming naked all this time.’
And I think we’ll see some shake-out among the lessors along
those lines.”
Oliver Ross, associate with UK law firm Hill Dickinson, specialises in the acquisition and financing of cor-
porate jets and commercial aircraft. He explains how a commercial aircraft lessor can enforce its rights in
the event of default.
RECOVERING AIRCRAFT
FROM A DEFAULTING
LESSEE
WHAT ARE THE RIGHTS OF A DEFAULTING LESSEE UNDER AN air-
craft lease? The simple answer is that it probably has none since
as a result of its default it has effectively extinguished its right to
possess the leased equipment under the terms of the lease. But
there may be traps for the unwary in unknown jurisdictions,
where a UK lessee may have fallen into the hands of an adminis-
trator.
“
Lessors have often been able to repossess the aircraft
but have not been able to find the maintenance records.
is located in a jurisdiction whose laws do not favour the repos-
session of an aircraft by its owner or secured creditor irrespective
of the law that governs the lease itself. The jurisdictional uncer-
tainty was substantially diminished by the uniform conflict of laws
This is a major problem and also gives rise to significant convention – the Convention on the International Rights in
costs since the records have to be re-constituted before Aircraft 1948. This was hampered, however, by its reference in
priority to the laws of the relevant states of registry which pro-
the aircraft can re-enter commercial operation. vided widely differing approaches to security rights. This robbed
” the Geneva Convention of its uniform character and did not pro-
vide much comfort to the banks called upon to finance aircraft in
developing countries.
Eschewing “quasi-speculative” orders with the manufacturers, B&B Air, trading with other lessors and the
airlines, commits to aircraft as they deliver. But this is not all that sets it apart from many other leasing
companies: B&B Air split from its parent in 2007 to become an independent publicly-traded company. AFM
discovers the impact this has had on its business.
LESSOR FOCUS:
BABCOCK & BROWN AIR
INTERNATIONAL INVESTMENT AND ASSET MANAGEMENT GROUP Building on 2007
Babcock & Brown made its first foray into the aircraft leasing By August 2008 B&B Air had increased its portfolio to 64 aircraft.
market in 1986. Since then its aircraft management group – As mentioned, though, a far greater part of the lessor’s portfolio
Babcock & Brown Aircraft Management (BBAM) – has originated growth was accomplished in the previous year, a period when
over 300 aircraft with a total purchase price of over $8bn. B&B Air “had a very successful response to our operating leasing
activities”, according to John Lynch, director of BBAM. “Airlines
IPO were very actively increasing their fleet sizes and that resulted in
Nowadays, however, BBAM focuses on management services. high demand for aircraft and good lease rates right across the
Babcock & Brown Air (B&B Air) took on the role of acquiring air- board in most regions of the world. Overall, I think 2007 was a
craft after it was formed in May 2007. A year later it had grown very successful year for BBAM,” he continues.
its portfolio to 62 aircraft, but much else had happened in
between. The question is whether airline woe in 2008 will feed through to
the leasing business. Most lessors, however, remain confident,
In September 2007 B&B Air listed on the New York Stock and Lynch is no exception: “We’re still seeing demand for the
Exchange under the trading symbol FLY. The road to the IPO newer-generation fuel-efficient aircraft that make up a significant
actually began six years earlier in the post-9/11 environment proportion of our fleet and demand for those airplanes is obvi-
when BBAM started buying aircraft in a bank debt/private ously driven by the fuel price increase over the year. And I’m sure
equity-funded facility called Jet-i. Intended always to be a tem- that’s going to continue right through to the end of this year and
porary structure, the facility developed into the high-dividend early into 2009.”
model that became B&B Air. With this type of model becoming
increasingly popular on the NYSE, as exemplified by companies Business has also stayed healthy for BBAM, which now manages
such as Aircastle and Genesis, it was decided to list B&B Air. almost 300 aircraft – including those on B&B Air’s books – and
Colm Barrington, CEO of B&B Air, explains that decision a little has become the fourth-largest lease manager in the world. Of
further: “Basically, BBAM was a company that didn’t have huge particular importance this year has been the Japanese operating
resources in terms of capital and the New York Stock Exchange lease (JOL) due to strong demand for the product from the
presents significant opportunities for raising capital, and this did Japanese market. Barrington comments that the division is well
appear to be a very good model to allow BBAM to expand its air- placed to take advantage of this, as “the JOL... has been the core
craft leasing activities.” of BBAM’s activities over the years”.
To achieve this, B&B Air put together an aircraft acquisition facil- Both Lynch and Barrington believe that lease rates will stay strong
ity of $1.2bn, seed capital for which was provided by part of the this year with some exceptions. Older types, such as DC9s and
proceeds from the IPO. The new company’s first 47 aircraft, MD-80s, “are dead” according to Barrington and the 737 Classic
worth $1.45bn, were funded by an $850m securitisation and market is going “a little soft”. On the other hand, modern nar-
$600m in equity. rowbodies should continue to command strong or even
increased factors and these aircraft constitute the bulk of the Nonetheless, deteriorating market conditions have prompted
B&B Air fleet. The average lease term for the lessor is 5.6 years. caution in one respect: because of mounting cash pressure
among the airlines, B&B Air knows that any deal it finds today
Lynch points to “some stress in the widebody market”, but also could well be bettered a few months down the line. “So we’re
remarks that B&B Air has little presence in that arena – only four growing now only if we find very good deals,” says Barrington.
aircraft. However, one type that is in high demand in the wide-
body sector is the A330. This is in part due to delays to the 787 “Another factor which is caused by the credit crunch is that airlines
programme, and while B&B Air has only one A330 in its portfo- are probably turning to operating leasing much more than they
lio, it has still benefited from Boeing’s hiccups. “Where the 787 would have done in the couple of years leading into 2007/8,”
delays have been positive for us have been in the 757 releasing. remarks Lynch. In his view, operating leasing has become a signif-
Our Ethiopian leases are I think almost certainly as a result of the icant source of financing for the airlines as they struggle to fund
delays in the 787,” says Barrington. outright purchases from the OEMs. The net result is a revenue
boost for both B&B Air and BBAM: more rentals for the former and
Oil and credit more management contracts for the latter.
The high cost of jet fuel is possibly a double-edged sword: while
it can be crippling for the airlines, it does force them to start Though the credit crunch and record oil prices may sometimes
operating modern aircraft. But a lack of available financing dur- benefit lessors, the deleterious effect on their airline customers
ing the credit crunch often means they must rent rather than buy, should not be ignored. Many expect defaults to rise this year and
which benefits lessors with the right portfolio. next as higher costs push carriers into the red. Despite this,
Barrington claims that B&B Air hasn’t been unduly affected by
B&B Air has been stocking up on young, fuel-efficient narrow- defaults as yet. With the exception of US airline ATA, which
bodies over the last few years and that strategy is paying off, as returned four aircraft, “we haven’t had any defaults and our
Lynch describes: “We see this oil price spike as increasing credit profile at the moment is fine”, he says. “Obviously, the
demand for that type of aircraft from airlines around the world – ATA situation was a bad one, but we got the aircraft back very
that is definitely our experience. So I think in a sense, certainly quickly and we’ve already re-leased two of them to Ethiopian
with B&B Air, we’re able to take advantage of the change in the Airlines on a long-term lease, and we’re in discussions with vari-
market place with regard to the demand for fuel-efficient air- ous other parties now either to sell or release the other two.
planes.”The average fleet age at B&B Air is 6.3 years.
“So, our experience has been good. Obviously, everybody’s con-
The credit crunch can also prove advantageous for lessors. And cerned because you read in the magazines that airlines are hav-
though it has the potential to wreck portfolio expansion plans, ing problems and some of the second-quarter results being
this hasn’t been the case at B&B Air, as Barrington explains: published are pretty bad. But airlines on the other hand have
“we’ve put together enough financing to carry Babcock & Brown had a pretty good few years and, anyway, in the operating leas-
Air through to 2009 in terms of acquisitions. Since we launched ing business you do expect to have defaults from time to time.
the company in October last year we’ve increased the portfolio If you’ve got good enough aircraft and there are pockets of
from 47 to 64 aircraft, spending about $700m in doing that. We demand in the world, you move those aircraft there and we’ve
have in our credit facility something like $500m remaining which found very strong pockets of demand in Eastern Europe and
we will be using to fund our growth into 2009.” Russia.”
B757(1) 12
Wide Body(2) 4 Africa 3%
(1) The B737 Classic and the B757 count each (3) Based upon percent of the appraised value of
include one freighter. aircraft and geographic location of lessees. Does
(2) One A330, one B747, one B767 and one B777 not include remaining two B757s that are off-lease.
CONTRACTED ANNUALIZED
B&B AIR’S FLEET GROWTH RENTALS (millions)
64 $228
36% 49%
47
$153
Portfolio strategy
“
We’ve put together enough financing to carry Babcock &
Brown Air through to 2009 in terms of acquisitions.
With one exception, B&B Air does not order aircraft from the
manufacturers. Part of the reason is that the cashflow-orientated
company doesn’t feel it appropriate to commit public money to
future orders. “We do not want to commit our cashflow to
Since we launched the company in October last year future orders and sort of quasi-speculative orders,” says
Barrington.
we’ve increased the portfolio from 47 to 64 aircraft,
spending about $700m in doing that. For its own acquisitions, B&B Air concentrates on popular, fuel-
”
efficient, modern narrowbody types, though it will take wide-
bodies, too, if it spots a good deal. As noted, the company
doesn’t order from the OEMs, but buys from lessors and airlines
and is strongly engaged in the sale-leaseback market. Its operat-
ing leasing customers are spread over 19 countries between 34
CIS countries and Russia have proved fertile ground for lessors in airlines. The company has 20 per cent of its portfolio in North
recent years. This has been helped by a number of factors, one America; 45 per cent in Europe; 25 per cent in Asia; and 10 per
of which was a moratorium on import taxes on widebody air- cent in South America.
craft. “That boosted demand for certain types of aircraft and also
helped the narrowbody fleet as well,” says Lynch. The BBAM Since its IPO in September 2007, B&B Air has grown its portfo-
director also forecasts significant growth in demand for Western- lio by $700m and its annualised rentals by 49 per cent, and
manufactured equipment as Soviet-era types reach the end of though that growth will slow, the company hopes to continue
their service lives: “The last year of significant production of adding to its portfolio over the coming months. Expansion will
Russian equipment was around 1991, 17 years ago, so you’re ultimately support the high-dividend model of B&B Air, which
getting very close to a pinch point now for the Russians and has paid out a 50 cent dividend in every quarter since it was
other countries in the CIS between fuel and retirement of old formed. Barrington explains: “We’re hoping that because of the
Soviet equipment.” That aside, there is also the remarkable eco- liquidity crunch there may be more good deals coming up... to
nomic growth experienced in Russia over the last few years to grow the portfolio so that we can increase the cashflow in the
add to lessor optimism. company, which will support more long-term debt when we refi-
nance out of the aircraft acquisition facility and will potentially
B&B Air and others should, however, be wary of diving too deep allow us to go on paying very attractive dividends.”
into Russia. The country is dogged by overcapacity and a glut of
airlines is predicted to go belly up in the next 12 months. In addi- Whether B&B Air’s model proves a tempting target for consoli-
tion, AirUnion, the country’s original airline alliance, had to can- dation in the aircraft leasing market will be interesting to note.
cel scores of flights in August 2008 due to unpaid fuel bills and For now, Barrington only comments, “We’re always open to any
only resumed service after a government bail-out. new deals but we haven’t any firm plans – no”.
www.ascendworldwide.com
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Aviation Fleet Information I Valuations & Appraisals I Technical & Commercial Solutions I Market Analysis I Airport Economics I Space Analytics
Editorial main:FIN2009 2/6/09 15:22 Page 82
Alex Derber talks to the heads of two of the world’s leading non-OEM affiliated engine lessors to discover
how they are faring in an increasingly hostile operating climate for airlines.
ELF reports that through the whole of 2007 it never had more
than one engine off lease at a time. Encouragingly, the re-leas-
ing trend seems to have continued into 2008, a year in which
ELF has 39 engines requiring remarketing, though Sharp fears it
could become more of a struggle in the coming months. “The
re-market for engines will become very floppy indeed so we will
be sitting with engines on our books that are not earning
money, they’ll be sitting in a warehouse somewhere. That is
going to happen, but we do budget for that,” he says.
WLF has 60 per cent of its portfolio on long-term leases and the
rest on shorter terms, generally three months to a year. Long-
term contracts tend to cover about 10 years. Sharp reports lease
terms of seven to 12 years for 90 per cent of his company’s
engines, whether they be for wide- or narrowbodies.
Which engine?
As many would expect, fuel efficiency is key in the engine leas-
ing market, and successful lessors ensure they have the most
modern types in their portfolios, as Sharp confirms: “We cer-
tainly perceive that airlines are desperate to get out of the older-
type engines and so they should. Our exposure to older engines
is less than one per cent by portfolio value as we’ve been very
particular at modulating our business and rolling over our port-
folio as the years have gone past.”
There is, however, one potential blot on the CFM copybook: the
CFM56-3, which powers 737 Classic models. “We have some
CFM56-3s although we’ve sold quite a few,” says Sharp.
“They’re going to continue flying for some time yet so we’re not
worried about them, but there probably is a softening of the
market for that sort of engine type because there are so many
airplanes being parked.”
Regional 3% Mexico
A340 8% South America
B767/ 7%
United 13%
B747 7% States
737NG 22%
16%
Asia
B737 24%
Classic 7%
MD80 3%
A330/
A300
6% Other 9%
B757 4%
B767/MD11 3% Europe Mid-East
A320 34% & Africa
28% 6%
“
We certainly perceive that airlines are desperate to get
out of the older-type engines and so they should. Our
exposure to older engines is less than one per cent by
portfolio value as we’ve been very particular at modulat-
ing our business and rolling over our portfolio as the
years have gone past.
”
Thinning market and default
While the credit crunch is hitting airlines hard, most lessors appear
safe. As Sharp succinctly puts it: “I don’t think that whatever non-
sense is going on has quite filtered through to where we are at
present.” In fact, most lessors on both the aircraft and engine side
have their credit and refinancing facilities in place already.
Despite this, many feel that inexperienced players will exit the
market this year and next. Willis agrees: “I think probably some
of the private equity and some of the hedge funds will get out
because they don’t know what they’re doing.”
Though such exits will dampen competition, they also reduce the
number of available partners for the syndication deals that inde-
pendent lessors specialise in. These transactions involve sales by
a lessor to an SPV of assets on lease, with both parties providing
equity/debt and sharing income.
The revival of the global aviation industry since the post-9/11 downturn has increased the demand for
skilled manpower significantly. In particular, industry growth registered in the Middle East and Asia in
recent years has contributed to an increasing demand for pilots, aircraft maintenance technicians, engi-
neers and other aviation professionals. As Kaleyesus Bekele reports, this demand is drawing talent away
from other parts of the world.
BRAIN DRAIN
HITS AFRICAN
AIRLINE
INDUSTRY
Ethiopian Airlines is one of the African carriers hardest hit by the Halting the flow
brain drain. The professionals that first drew the attention of Alarmed by the flock of pilots going to the Middle East and Asia,
Middle East carriers were flight crew and in the past few years management at Ethiopian implemented salary adjustments. The
Ethiopian has lost scores of seasoned pilots. In 2005 more than company increased pilot salaries by up to 100 per cent, but even
20 senior pilots left Ethiopian in search of better pay. this did little to slow the exodus. Ethiopian’s pilots are now paid
a maximum of $2,000 per month.
Carriers in the Middle East offer a monthly salary of $10,000 dol-
lars tax-free. In addition, they offer residential houses and cars The management now refuses to grant release to pilots. Any
for pilots, and pay school fees for the pilots’ children. pilot who wants to be released from employment at the airline,
must pay $26,000 to the company. Ethiopian claims that it
Attracted by these irresistible offers scores of senior Ethiopian spends the stated amount to train a pilot during the two-year
pilots have joined companies in the Middle East and Asia. training programme in the school. “Denying a release is not a
Ethiopian CEO, Girma Wake, asserts that these companies are solution” says an Ethiopian captain who declined to be named.
acquiring a large number of aircraft and they need pilots who fly “They should pay at least 50 per cent of what we are offered in
them. “Our pilots are qualified and they have admirable skill the Middle East,” he adds.
because our pilot training school is one of the best in Africa. That
is why all eyes are on them,” Wake says. Because of the inadequate number of Ethiopian pilots manage-
ment is now forced to hire foreign pilots. Currently, there are ten
Established in 1962, the Ethiopian pilot training school has grad- foreign pilots from Eastern Europe, South America and Africa who
uated 788 pilots, of whom 495 are Ethiopians while the remain- work for Ethiopian. Five of them are Ghanaians who used to work
ing 293 are from 36 other countries, most of them in Africa. for now-defunct Ghana International Airlines. Ethiopian is also
Ethiopian Airlines has about 4,700 employees and 260 are pilots. recruiting technicians from the Ethiopian Air force.
“Our company is growing at a rate of more than 20 per cent. As academy, which comprises the aviation maintenance technician
we are increasing the number of our fleet, we need more pilots. school, pilot training school, school of marketing and finance,
To meet the growing demand we have to train more pilots. But aviation recurrent training centre, cabin crew training centre and
until we have enough, we will continue to recruit foreign pilots,” human resources development unit. The aviation academy
says Wake. Since the launch of a fleet modernisation programme recently purchased 14 modern Cessna training aircraft valued at
in 2003, Ethiopian purchased 11 767 and 737 aircraft. In $6m. The academy has also built additional classrooms, dormito-
February 2005, the national flag carrier placed a firm order for ries, lounges and other facilities. In the near future Ethiopian will
787 aircraft. acquire 737 and 787 simulators. At present, it has 757 and 767
simulators.
”
- Nick Fadugba, CEO of African Aviation Services
Girma Wake points out that professionals are not going only to right behind that of Asia and the Middle East. According to
the Middle East. “The much-talked-about region is the Middle Airbus forecasts, African airlines require 640 aircraft in the next
East. But we are also losing our professionals to America. Many 20 years, which could cost $60bn. Airbus forecasts a growth rate
of our employees leave to the US through the Diversity Visa of 5.4 per cent for Africa’s commercial air transport sector over
Lottery every year,” he observes. the next 20 years.
Kenya Airways (KQ), Air Mauritius and South African Airways are Worldwide growth in the sector is predicted at 4.8 per cent.
among the African continental carriers that are losing their highly African industry growth, according to Airbus, is driven by solid
trained professionals. KQ’s CEO, Titus Naikuni, says that the air- economic growth, increasing trade ties and an influx of tourists
line has lost some of its pilots, engineers and cabin crew to from Europe, China, the Middle East and North America, and a
Middle East-based airlines that also fly into Kenya and some of surge in inter-Africa traffic. A number of African carriers, among
the routes dominated by KQ. Naikuni claims Kenyan pilots and others, South Afriacan Airways, Ethiopian Airlines, Kenya
engineers were highly sought after because of the quality of Airways, EgyptAir RoyalAir Maroc and Air Seycheles are under-
training they received. going fleet modernisation programmes.
KQ has already addressed the problem by establishing an avia- The aviation authorities have realised that the dearth of skilled
tion training centre. Naikuni believes the training centre will help personnel in the airline industry in Africa is worsened by the exo-
the carrier recruit and train aviation professionals such as pilots, dus of highly trained aviation professionals. At the 1997 African
engineers and in-flight attendants for its needs and for other air- Air Transport Development Fourm, it was noted that inadequate
lines. The airline used to send its pilots to South Africa for train- training combined with brain drain was a major threat to the
ing before the establishment of the centre. In the next two years development of air transport in the continent. The forum recom-
KQ will focus on the training of its core staff ahead of the arrival mended the removal of regional, physical or other barriers to
of nine 787 aircraft that the airline has ordered. But manage- deployment of personnel among African states as instrumental to
ment of KQ also spots a business opportunity. “Why can’t we better developing and managing human resources.
become the factory for producing people for export? Why can’t
we create an industry suitable for manufacturing [skilled] man- Some industry expects believe that the lack of skilled personnel
power for export?” Naikuni asks. is one of the contributing factors to the high air accident rate in
Africa. Skip Nelson, President of Alaska-based navigation
Landover Aviation Services CEO, Captain Edward Boyi, shares experts ADS-B Technologies, says lack of certified mechanics
Naikuni’s view. “As nations from other continents poach and and well-trained pilots is one of the major problems in ensuring
employ skilled personnel including pilots and engineers from safe air transport service. Accounting for a mere three per cent
Africa, Africa should become a workshop for aviation profes- of global air traffic, Africa has a disproportionately large num-
sionals for the world.” ber of accidents. These account for 25 per cent of global aircraft
accidents.
He argues there are benefits of this to Africa, one of which is that
Africans plying their trade overseas can contribute to income The newly established continental body, the African civil aviation
growth of their families back home. agency (ACAA) hopes to improve the region’s safety record by
standardising and overseeing the licensing, training and inspec-
Growth tion of aviation staff and equipment. Mwangi Makamau, chief
Presently, the airline industry in Africa employs 470,000 people executive of ACAA, says if the agency can ensure that aviators
and contributes some $11.3bn to the continent’s GDP. According are certified and paid according to international standards, they
to ICAO, the number of passengers flying in the continent in will be able to help ensure air travel in Africa is deemed safe.
2005 was 38 million; projected growth for 2006 and 2007 is 6.9 “This will not only bring down accident rates but also ensure that
and 6.3 per cent respectively. For the coming years, the growth better-trained staff are not siphoned off to other parts of the
rate of the industry in Africa is estimated at around six per cent, world,” he observes.
www.aeroengineexpo.com
Editorial main:FIN2009 2/6/09 15:23 Page 92
With both aircraft and engine leasing on its CV, not to mention a new aircraft programme, AerCap is
establishing a reputation as one of the world’s most forward-thinking lessors. AFM assesses the com-
pany’s strategy in an industry accustoming itself to a new economic reality.
LESSOR FOCUS:
AERCAP
FOUNDED IN 1995, AMSTERDAM, HOLLAND-BASED AERCAP has
progressed from a few initial Fokker transactions to become one of
largest aircraft lessors in the world, with 158 aircraft in its portfo-
lio and 320 aircraft either owned, managed or on order by it.
IPO
Since November 2006 AerCap has been listed on the New York
Stock Exchange. Heinemann describes this as “the largest single
milestone” for the company in the last few years. “AerCap now
has an equity position of approaching $1.1bn which is a million
miles from where the equity position was when the company
entered into the last recession post-9/11,” he continues.
Since the IPO the company has seen revenues and profits
increase. The former grew 40 per cent to just under $1.2bn from
2006 to 2007, while the latter increased almost 25 per cent in
same period, with a 2007 profit of $211m. Coping in a struggling industry
Though oil prices have declined markedly since the summer of
At the time of writing, AerCap’s third-quarter results had still not 2008, IATA has retained its forecast of a $5.2bn loss for the
been published. Nonetheless, some conclusions about the world’s airlines in 2008, due to the prospect of recession in most
lessor’s 2008 performance can be drawn from its Q2 results. major economies.
Second-quarter 2008 net income was $69m, compared with
$34m for the same period in 2007. Sales revenue was also up, as Yet, despite airline losses, most lessors have thrived in 2008. Of
the company completed sales of 10 aircraft, two engines and course, there are those such as ILFC that are affected by the ills
parts. It appears, therefore, that despite the general malaise of their parent institutions, but, by and large, lease rates and
afflicting aviation in 2008, AerCap is on track to surpass its per- demand have stayed strong.
formance in 2007, which was itself a record year. This has led some in the industry to suggest that the leasing
AerCap Overview
North America/Caribbean
22% of H1 2008 Europe Total assets $5.2Bn
lease revenues
at June 30, 2008
AerCap Locations
cycle is sufficiently decoupled from the airline cycle to shield Yet, despite the dire finances of many airlines around the world,
lessors from airline woe. Heinemann doesn’t agree: “If you look lease rates for modern, in-production aircraft have held firm. “On
at the second half of 2008 and 2009: for most lessors, like those we see very little downward movement,” says Heinemann.
AerCap, from a placement perspective, these years were closed The market for older equipment, however, is softening, with
and contracted out somewhere last year or earlier this year. From Heinemann pointing to declining rentals on 737 Classics, 767s
that perspective we are only confronted with placement situa- and MD-80s. Such aircraft form less than five per cent of
tions in 2009 if there is a default that requires us to remarket AerCap’s portfolio.
something. So, there is no decoupling, but there is a significant
timing difference between what happens in the airline market at Falling lease factors for older, less fuel-efficient aircraft have, of
this moment and the impact it would have on the leasing mar- course, been driven by rising fuel prices. These, however, have
ket.” plummeted since the summer highs of $147 a barrel, and at
the start of November 2008 hovered around $60 a barrel.
Obviously, airline bankruptcies do have a direct, immediate “Clearly, this is a double-edged sword,” says Heinemann.
impact on lessors. AerCap, fortunately, has so far emerged rela- “Lessors who are predominantly exposed to the most modern,
tively unscathed from the slew of liquidations this year. “We have fuel-efficient aircraft enjoy the benefit of the extreme acceler-
had defaults in the second quarter and in the third quarter,” con- ation of the retirement of older, inefficient aircraft that the fuel
cedes Heinemann. “This, to a degree, is normal procedure for price of $100 per barrel and more implied. On the other hand,
lessors. Could it be that the level of defaults increases somewhat those fuel prices impaired substantially the performance of
as we go through the winter season? I think, yes, that is a possi- many airlines. We now have a reversal of that where the fuel
bility. But, to date, we have been able to stay clear of some of the price makes certain older aircraft more economical again.”
bigger defaults we have seen in the market over the last nine
months.”
Publically held
55.5%
November 2006 - Initial public offering
August 2007 - Secondary offerinng
8.9%
Notes
Strong revenue and earnings growth (1) Excludes pre-tax impairment charges of $134.7m in 2004
(2) 2006 and 2007 net income adjusted for refinancing charges, mark to market interest rate caps
and share-based compensation in 2006 and 2007
Revenues Net Income
(US$M)
$1,177
1200 $211
600 $493
$391 100
$106
400
50 $28
200
0 0
2004 2005 2006 2007 2004 (1) 2005 2006 2007
Liquidity crisis Others may not fare so well. JP Morgan has predicted a $10bn-
By the end of the first half of 2008 AerCap had closed a $1bn air- $20bn aircraft financing gap in 2009 and Heinemann believes
craft securitisation through Aircraft Lease Securitisation II for 30 some orders could be at risk. “I do believe that in the near term,
A320s. It had also closed a $100m engine acquisition facility and i.e. in the next six months, until we go into the summer season
increased committed pre-delivery payment funding for forward 2009, there will be situations where both manufacturers will
purchase commitments by $338m. Securing these financings has have to be very imaginative to deliver aircraft because of the lack
prepared the company well for late 2008 and the full-year 2009, of appropriate funding for those who intend to take delivery. I
periods when funding will be more challenging and expensive to assume both Boeing and Airbus will use their balance sheets to
arrange. Heinemann comments: “Our funding requirements for a significant extent to facilitate deliveries during this situation,”
deliveries during the current liquidity crunch do not exist because he says.
these are funding facilities that we contracted last year, and in the
first and second quarter of this year.” Both Boeing and Airbus have now scrapped plans to increase
production over the next 18 months. In addition, the two-
month Boeing engineer and machinist strike that began in
September will also help to keep excess capacity out of the mar-
Aircraft portolio as of June 30, 2008 ket in the near term. But does Heinemann think the two man-
Owned Portfolio Managed Portfolio ufacturers should go further in light of the financial difficulties
No. of a/c Total
% Net book No. of under Purchase Owned,
facing many airlines? “If Airbus would have to consider curtail-
No. of value at No. of aircraft contract and Managed & ment of production rather than non-increase of production as a
a/c owned 31 December aircraft on order letter of intent Ordered a/c
preventative measure it’s a little early to say,” he responds. “But
Airbus A300 Freighter 1 0.8% - - - 1 if it should come to significantly higher pressure, both manu-
Airbus A319 15 12.6% - 14 - 29 facturers will have to take a look at their existing production lev-
Airbus A320 58 35.7% 13 48 1 120 els.”
Airbus A321 19 16.0% 1 - - 20
Airbus A330 5 5.0% - 30 - 35 Of course, it’s not only airlines that are feeling the pinch. Giant
Airbus A340 - 0.0% 1 - - 1 lessors such as ILFC have seen their parent institutions pul-
Boeing 737 NG 18 16.6% 30 - 3 51 verised in the economic downturn and questions over their liq-
Boeing 737 Classic 16 3.9% - - 2 18 uidity in the latter half of 2009 remain. Could the leasing
Boeing 757 11 4.2% 2 - - 14 industry see some big names fall by the wayside in the months
Boeing 767 4 3.4% 3 - - 6 to come? “It’s difficult to say,” Heinemann replies. “But even in
Fokker 100 - 0.0% 1 - - 1 China you see signs of weakness. Certainly, if I look at Australia,
MD 11 Freighter 1 0.9% 1 - - 2 which supports Allco, Macquarie and Babcock & Brown, they’re
MD-82 6 0.5% 2 - - 10 not exactly in the strongest shape either. Dubai, one will have to
MD-83 4 0.4% 4 - - 6 see, but I think Dubai is for the first time confronted with the
fact that funding reality matters to them as well, even if they are
Total 158 100.0% 58 92 6 314 in the Middle East. So, I think the stresses on the lessor side
source: AerCap caused by parental issues are not over.”
LESS T
HAN
30%
REMA
INING
Phone rings…
Dave (Friendly, business-like): Hello Hal, this is Dave. How are you?
Hal (Soothing, friendly): Good evening Dave. Everything’s running
smoothly. And you?
2008: AN AIRCRAFT
FINANCING ODYSSEY
Hal: That’s good, Dave, you see there are some extremely
odd things about the financial markets right now,
Dave: Odd?
Hal: Yes, Dave, I don’t think there is any question about it
– it can only be attributable to human error. This sort of
thing has cropped up before and it has always been due
to human error.
Dave: But what does that have to do with my aircraft to be
delivered next week?
Hal: Well, Dave: we cannot maintain the margin.
Dave (Stunned silence): …
(And then sarcastically): Oh yeah? What did you have in mind then?
Hal: We need to cover our funding costs, Dave. We need to raise
the margin by 250 bps.
Dave (Gulps and coughs, clears his throat): …
Hal: I’m sorry, Dave. However, I am sure you understand.
Dave: Are you joking? This is insane!
Hal: It is puzzling, Dave, I don’t think I’ve ever seen anything quite
like this before.
Dave: You’re damn right, Hal! No way! Why such a huge increase?
Hal: I’m sorry, Dave, I don’t have enough information.
Dave (Spluttering): You can’t just do that! You have a commitment,
you signed a term sheet, the documentation... You’re committed!
Hal: It’s the MAC, Dave, the MAC clause. We can do it because
of the MAC clause. I’m sorry, Dave.
Dave: The MAC? It’s a MAC?
Hal: We picked it up in Clause 22.3.5, Dave.
Dave (Panicked): But you can’t invoke a MAC, we’re one of
your most important customers, Hal!
Hal (Smoothly): Yes, you are, Dave. That’s why we are
increasing the margin by 250 bps.
Dave: ...
Hal: Dave, I am doing this to keep you inside here with us. But
if you are going to get upset, I will have to close the doors on
you as well. Do you understand, Dave?
Protagonists
Dave: Close the doors on me? On us? Jupiter? I’m the one
who is closing the door on you!
Dave: CFO of Jupiter Airlines.
Hal: I’m sorry to hear that, Dave. But I understand. It’s OK.
Frank: Dave’s boss
Dave (Perplexed): What do you mean?
Hal: Head of aircraft finance at Monolith Hal: It’s OK, Dave. The door is closed now. You are in space:
Brothers International Bank. no air, no financing. It is in clause 22.3.5 Dave.
Dave: No financing? Closed doors? Out in space?
Hal: I’m sorry, Dave.
Dave: Open the doors, Hal, please!
(long silence)
Hal: Dave? Would you like to play a game of chess?
I play very well.
The aviation industry is often seen to reflect the financial climate as a whole. In this time of economic crisis
what can one see in the tea leaves that are aircraft manufacturer’s orderbooks? Mary-Anne Baldwin
reports on the orders and deliveries of 2008.
WHAT’S ON ORDER:
TROUBLED TIMES
FOR AIRCRAFT
MANUFACTURERS?
WHILE MANUFACTURERS ACROSS THE INDUSTRY DECLARE A The total number of seats diminished as a result of the cuts will
state of health for their orderbooks, the tumultuous economic be 120,019, a significant number that is reflective of the trou-
climate, recent high oil prices, and declining demand make for a bling fall in passenger demand. Of the aircraft cut, 119 will be
dubious reception. Airbus alone has received 119 aircraft cancel- widebody, 589 narrowbody and 86 turboprops. The 737-300 is
lations this year and more are expected across the board. the favourite to go, with 121 being stripped from the world
fleet. There will also be 93 MD-80s and 90 737-500s cut, accord-
Boeing received 633 net orders for the year through to 28 ing to Ascend.
October, 2008 and has made a total of 325 deliveries. Airbus
meanwhile received a net total of 737 orders through to 30 The retirement of these old aircraft signals a need for airlines to
September, 2008 and has delivered 349 aircraft. Going by these place orders for modern replacements. With recent high oil
figures the industry is on firm ground, yet there is much more to prices, airlines will see marked savings on fuel consumption and
consider. costs. “The oil price, in a way, is helping us,” says Laurent
Rouaud, Airbus’s VP of market forecasts and research. “The
Keeping track of the ‘developing’ world fleet is perhaps more prices going up and down are pushing airlines to purchase and
about watching it diminish. Specialist consultancy on aviation replace aircraft equipment… For these reasons the demand for
information Ascend, recently disclosed findings which predict an aircraft into 2009 is strong.” He goes on to explain that: “the
imminent cut of over 1,000 aircraft from the world’s fleet. The economics work well for airlines” as for example, updating a
prediction is based on the downsizing of airlines, the closure of 737-400 with an A320 could save as much as $1.5bn a year on
struggling carriers, fleet retirement and the coming winter fuel costs per aircraft. “Overall I think there is an alarming case
months. “Some of them will be parked, some will find new oper- for airlines to replace their equipment today,” he affirms.
ators, some may be retired permanently but we don’t know how
many of each,” Chris Seymour, head of market analysis for It is no surprise to see a depletion of the world’s fleet in line with
Ascend, says. the decline in passenger demand, lack of financing and recent
high oil prices; every company has been affected by the troubled
From the 1,083 losses predicted, the analysts expect to see 15 state of the market. One such company is the Russian airline S7.
per cent go from Europe and nine per cent from Asia. “Three The carrier has announced it will ground its 27 Tu-154s and eight
quarters of the total are coming out of the US market,” explains Il-86s, saying it will phase out its Russian-built aircraft because of
Seymour. “They have had big losses and are cutting back on their low passenger demand. For an airline to face severe hardship in
domestic capacity, particularly cutting aircraft, routes, person- summer months is a cause of major disquiet – and a forewarn-
nel.” ing of even greater hardship during winter. Before passenger
demand drops off further, S7, among many others, has wisely
decided to cut part of its fleet. The airline, Russia’s second
biggest by passenger numbers, will make an estimated saving of
50 per cent on maintenance costs with the move.
But this downscale has not blinkered S7 from foresight; it has still
placed an order with Airbus for 25 new A320s. Although the
carrier is not expecting delivery until 2014, the investment will
mean continued savings on future maintenance costs, along
with fuel emissions and any attributed taxes.
While Seymour predicts that most of the 1,000 odd aircraft cut
will be because airlines want to update fleets, this is not
expected of the US. “Only about 10 per cent of commercial
backlog in dollar terms is with US Airlines” Jim McNerney,
Boeing’s chairman, president and CEO said during the company’s
third quarter conference. As a result of the financial downturn,
Kingfisher's A340-500 aircraft, similar to those sold to Arik Air
the US is one of the industry’s least secure markets – there are
fears that even those minimal orders placed may be retracted as
the country’s aviation sector faces further hardship. India is the other major area for concern. Boeing has recently
been adamant the fiscal slowdown will not affect its sales in
Heads turned recently when American Airlines announced it had India, saying the ‘firm’ orders placed by Indian carriers will see it
struck a deal to update its fleet with 100 new 787 Dreamliners. through; Boeing alone has a projected demand of 1,001 aircraft
While 58 787s are held only as an option to purchase between from India within the next 20 years, a collective 300 aircraft are
2015 and 2020, the carrier has put in an order for 42 of the air- due to be delivered within the country over the next five years.
craft, with delivery expected during 2012 and 2018. America is
the hardest hit by the downturn and for a US carrier to invest Yet India’s airlines are crippled by a harsh economic environment,
heavily at this time is a surprise to many. Yet the fruition of the unworkably high taxation, and falling passenger demand.
order is questionable as the airline is currently in dispute with its Kingfisher is a case in point – having sold three of its orders with
pilots’ union and it is feared it may cancel at least some of the Airbus for A340-500s to Nigerian Arik Air, it has also put back
42 aircraft ordered, if agreement with the union is not met. orders with Boeing. Likewise, Jet has postponed its orders by at
“
Industry analysts have envisaged there will by next year
be as many as 200 whitetails – new aircraft with no buy-
lations have knocked the manufacturer’s orders down from 794
to 675, with 71 aircraft cut this month alone – including 65 can-
celled A319s which had been ordered by the now defunct low-
cost carrier, Skybus.
ers and their original owners unable to source funding.
Concerned over future non-payment, banks and lessors
are holding back on lending and are expected to con-
tinue doing so, creating a deficit too large to support the
continued purchase of aircraft.
”
least a year, yet has said it will cancel none. Some airlines have
received large government backing while others have gone to
the wall. Those that continue to exist are likely to pull their
orders, either through lack of investment or diminished demand.
Financial freeze
Unfortunately for manufacturers this lack of investment stretches
across the industry. Jose Abramovicim, head of aviation at
Calyon, the corporate and investment bank, has predicted a
deficit of $25bn in credit funding for the industry during 2009.
The forecast, announced at this year’s European ISTAT confer-
ence, is an ominous portent; aircraft manufacturers should be
wary.
Many airlines may wish to update their fleet with cost and fuel
efficient aircraft in a bid to tackle fluctuating and recently crip-
pling oil prices, yet numerous airlines have been unable to source
financing from already over-stretched banks and wary lessors.
For small or struggling airlines the desire to see long-term cost
savings is, in this present environment, unlikely to be met. These
airlines will have to delay orders and some may find it hard to ful-
fill payment obligations for existing orders.
Ascend has noted a rise in small airlines placing orders on the back
of sale leases with lessors, payment of which will be taken on deliv-
ery – a system the company expects to see more of in the future.
Seymour acknowledges that airlines can not themselves afford to
invest in new aircraft; “You’d expect lessors to take a bigger slice of
Tracking market demand
Despite the financial crisis, there are growth areas in the industry.
the business. Lessors themselves have a backlog of about 1,300 and
Europe and North America is where Ascend’s Seymour believes
they’ve placed about 350 of those so far,” he says.
we’ll see the slowest growth, with a market driven by replacement
rather than expansion. Asia-Pacific and to a lesser extent Latin
Airbus’ Rouaud agrees: “Lessors, typically in the past were order-
America are likely to see the highest growth rates.
ing 25 per cent of all orders and I think their share over the last
few years has been 10 per cent… I think there is an opportunity
Airbus’ Rouaud agrees; “In terms of passenger demand for the
now for them to bring back that market share to 20-25 per
next few years, the strongest places are the North American coun-
cent.”
tries. They represent 30 per cent of all the orders for airplanes,
where they were before representing five to ten per cent.”
While the lessors share of the backlog has been declining – with
orders coming predominantly from the airlines, there has instead,
“[In] longer terms, we’re beginning to see strong growth in
say the analysts, been a rise in lessor purchases of existing orders
China,” says Boeing’s director of marketing Andrew Magil, esti-
for new aircraft, originally made by airlines. The sale is often a
mating around a 10 per cent growth rate. “[Its] not strong,” he
last resort for the carrier who, unable to source financing for full
points out, “but growth none the less.”
payment, is forced to sell the order and will later be forced –
unless it’s restricted financing dramatically changes – to lease the
Among Airbus’ biggest customers this year are CASGC with an
aircraft back from the lessor.
order of 110 A320s; AWAS with an order of 75 for the same
model; DAE Capital with orders of 70 A320s and 30 A350-1000
Whatever strategy is used, it seems lessors will be asserting a
and Aviation Capital Group which has requested 23 of the man-
more dominant role in the market. Manufacturers stand resolute
ufacturer’s A320s aircraft. Irish TAM Linhas Aereas has placed a
that they too will face only manageable troubles as a result of the
total order of 46 aircraft, including three A319s; nine A320s;
financial downturn, as Boeings Jim McNerney states; “Virtually
eight A321s; four A330-200s; 12 A350-800s and 10 A350-900s.
all lending sources have tightened up. Having said that, there is
still aircraft financing available on a selective basis, and we have
Airbus has received 445 orders for the A320 family; 133 for the
no current evidence that says our backlog won’t be financed over
A330 family; 138 for the A350 family and three for the A380.
the next five quarters or so”.
IBERIA MAINTENANCE Commercial & Development Direction. Madrid - Barajas Airport, La Muñoza. 28042 Madrid, Spain.
Phone: +34 91 587 49 71 / Fax: +34 91 587 49 91. E-mail: maintenance@iberia.es
www.iberiamaintenance.com
Editorial main:FIN2009 2/6/09 15:50 Page 106
“
Boeing and Airbus too, have too been stoical about current
demand, each stating clearly that they feel they are in a
secure position. Meanwhile company spokespeople have
been to some degree, guarded about cancellations and
suspended orders, ominously so; one can’t help noting the
prudence in not publicising one’s struggles.
”
The airframer has delivered a total of 349 aircraft this year. This
includes 204 of the A320 family, 51 of the A330 family and seven
of the A340 family and the same number of A380s.
Irish airline Lionair has placed the most orders with Boeing,
requesting 56 of the 737 aircraft. FlyDubai has ordered 50 of the
same aircraft and Air China has placed an order for 30. Ethiad
Airways, another of Boeings top-ranking customers this year,
ordered 45 aircraft, 10 777s and 35 787s. In 2008 Boeing
received orders for 480 737 aircraft, 78 787s, 52 777s, 20 767s
and three 747s. Of the 325 aircraft delivered during the year
through to September 2008, Boeing supplied: 254 737 aircraft;
50 777s; 13 747s and eight 767s.
In terms of which models we should expect to see more of, Boeing and Airbus too, have too been stoical about current
Rouaud envisages: a “tendency to go towards bigger airplanes,” demand, each stating clearly that they feel they are in a secure
reaching full capacity while; “concentrating on their core routes position. Meanwhile company spokespeople have been to some
[and] core hubs because they can drive their costs down.” As a degree, guarded about cancellations and suspended orders, omi-
result, “you will see more A320s, more A321s,” and more A350s nously so; one can’t help noting the prudence in not publicising
as a replacement of 767s. one’s struggles.
“We have decided to go a little bit higher in capacity than our com- Yet even with understandable concern, orderbooks are healthy
petitor, now we see that our customers are interested in slightly and manufacturers’ figures, for now, look good. “In light of the
bigger aircraft in every segment of the market. It’s true for the conditions we’ve seen, we’re seeing very strong demand for new
A320, A350 – replacing the 767s – and its going to be really true airplanes,” says Boeing’s Magil. “From our perspective we have a
for higher capacity airplanes like the 737 to the A380,” he clarifies. very strong backlog; we are in a very good position right now,”
he asserts before going on to say: “During the last big downturn
Conflictingly, Philippe Poutissou, Bombardier’s VP of marketing in 2001, our backlog was about 1,400 and we are at about
commercial aircraft, sees a trend towards use of light aircraft: 3,700 today.”
“We anticipate keen interest in all our aircraft as airlines attempt
to ‘right-size’ their fleets,” he says. “Low-fare carriers for exam- And even the worst predictions for manufacturers are less dire
ple, have told us that they are challenged to stimulate traffic than many may expect. So far, concurs Seymour: “The manufac-
through lower fares and thus are having difficulty filling their cur- turers have not been impacted too much… I think there have
Boeing has lost at least a hefty $100m each day since the strikes
began on 6 September 2008, analysts have estimated. The strikes
have meant yet further delay to the 787 – now 15 months late
for its original roll-out date. At the time of writing Boeing was
producing reports to clarify the extent of delays to its orders – an
account critical to many airlines awaiting aircraft.
“Our revenue of $15.3bn was down seven per cent from the
prior year due to the strike and the galley shortages... Those
issues reduced third quarter deliveries by about 35 airplanes,” he
been just under 100 deferrals... We’ve not seen very many can- added at the conference.
cellations yet, which is something you might expect to see.”
With Boeing workers now back in action and an end to galley
Production: delays and developments shortages expected, Boeing is on its way to join Airbus in meeting
Meanwhile, the opening of Airbus’ new Chinese production the demand for new aircraft. Whether this demand continues in
plant last September, did much to bolster the company’s claim light of the industry and furthermore the world’s financial crisis,
that levels of demand meant the manufacturer would be rela- remains to be seen. All we can do is watch and wait.
tively unaffected by the economic slowdown. An A320 like those to be built at Airbus's Tianjin plant
The company has said its goal is to produce four aircraft per
month by 2011, and all seems on track for that. The first aircraft
to be completed at the plant will be an A320. Built for Sichuan
Airlines, delivery is expected in the middle of next year.
As the world’s media struggles to find new words for turbulence, the aviation industry looks ahead
glumly to 2009. Analysts are queuing up to predict a gargantuan financing gap in that year, a gap that nei-
ther banks nor export credit will be able to bridge. But do manufacturers share that view and, if so, how
will they respond? AFM reports.
MANUFACTURING
LIQUIDITY
IN NORMAL CIRCUMSTANCES, THE FACT THAT THE PRICE OF JET bank DVB, says: “If there is a funding gap, that gap will be seen
fuel had more than halved in the latter half of 2008 would be first with the US airlines because the US market is devastated cur-
cause for celebration. As everyone is aware, however, normality rently, and there’s not much visibility on the future of the US air-
is dead: free market principles are in question; stockmarkets lines. I know a lot of banks that are simply saying, ‘No US Airline
have collapsed; once-august financial institutions have been whatever the LTV, whatever the aircraft, whatever the airline’. So
nationalised; recession is ahead; and credit flows have dried up. I believe that the manufacturer will have to use its chequebook
While oil constituted airlines’ greatest challenge in 2008, liquid- and most significantly that will be to assist the US airlines.”
ity is set to be their principle bugbear in 2009.
Exposure
Banks are now generally understood to have shut up shop until While most accept that Airbus and Boeing will be forced to the
the New Year. Nonetheless, when they do start lending again – financing table, it is tough to estimate the extent of the support
to each other and the wider world – it will likely be at LIBOR plus that customers will require. Over the two years following 9/11,
triple-digit basis points. The implications for the aviation industry the two manufacturers put around $2.5bn each on their books –
are serious: José Abramovici, global head of aviation group at only a fifth of what Abramovici reckons will be necessary.
French bank Calyon, has predicted that new delivery financing
plus refinancing requirements for 2009 will total $70bn. He Abramovici, however, could well have over-estimated the scale of
warns that banks and export credit agencies (ECAs) will only pro- the problem. Grabowski says: “The value of new deliveries as
vide $45bn of this, leaving a $25bn gap that others will have to scheduled is roughly $50bn for next year, and he [Abramovici]
address. JP Morgan estimates a funding gap of $10bn-$20bn in believes that on top of that $50bn you will have approximately
2009. $20bn of refinancing of the existing fleet... As far as the $20bn
is concerned, I’m not sure that we can say there’s an absolute
When cracks do begin to appear, they will probably initially do so need of $20bn because if the funding crisis continues there are a
in the US, where banks have been most severely affected by the lot of transactions that will never take place.”
downturn. Bertrand Grabowski, board member at European Instead, Grabowski believes the refinancing requirement, and
Cash/Other
30,000
Public debt/
25,000 capital markets
Bank debt
20,000
Export credit
15,000 Leasing
companies
10,000
5,000
0
2002 2003 2004 2005 2006 2007 2008
376 281 285 290 394 441 487
$26B $20B $19B $19B $25B $29B $33B
If that Tsunami does materialise, Airbus is ready to respond, Once a degree of confidence returns to the market banks should
affirms Cottle. “We’ll do whatever it takes but we do rely on start gravitating again towards export credit funding. The TED
other people’s money and we do look for senior exposure. We’re spread – the difference between US treasury and LIBOR rates – is
prepared to consider looking at junior pieces, which requires us now hovering around 350 basis points. Once banks added their
taking real risk, but not putting a lot of dollars out there, whereas own mark-ups, this means they could take on a treasury-type risk
the banks would be putting the dollars out, but it would be very at around 400 basis points above treasuries – “a very lucrative
well protected.” form of arbitrage”, according to Zolotusky.
“
I think if they’ve got any sense they will try and stick to
what they know best first and then gradually expand. We
haven’t really seen them in this market yet. It wouldn’t
really be in character for them to come out and take
opportunities at this time.
”
China’s growth has fallen below 10 per cent for the first time
in five years
A pooling of expertise
in civil and military aircraft maintenance
Sabena technics, a TAT Group subsidiary founded in 1968, is a leading
independent MRO provider of maintenance services
to civil and military operators.
Since the European Commission published its first airline blacklist on 22 March 2006, there have been a
further seven to date. Paul Phillips at Stephenson Harwood law firm provides insight into the two most
recent updates this year, examines the European Aviation Security Authority’s new powers to ban indi-
vidual airlines from operating in the EU and explains that blacklisting does not have to be permanent.
MOVEMENTS IN
THE EUROPEAN
BLACKLIST
The EU blacklist
On 22 March 2006, the European Commission published a black- The purpose of the blacklist is a pre-emptive one, focusing on
list of airlines banned from flying in and out of the European prevention rather than cure. The naming-and-shaming of airlines
Union, including Norway and Switzerland, under EC Regulation is a strong incentive for both individual airlines and their national
2111/2005. It named and shamed 93 separate airlines that were oversight authorities to take preventative measures to ensure
banned from operating into and out of the EU for falling short of that they are complying with international flight safety standards
international safety standards. The list itself is based on deficien- and to rectify any shortcomings immediately in order to avoid the
cies found in aircraft during ramp inspections at European air- blacklist.
ports carried out under the EU Safety Assessment of Foreign
Aircraft (SAFA) scheme, and safety audit data made available by THE LATEST UPDATES
the International Civil Aviation Organisation (ICAO) and IATA
Operational Safety Audits (IOSA). Update no:7
The seventh update, published on 11 April 2008, imposed a ban
In the more recent updates of the blacklist, the European on all operations of Ukranian airline, Ukraine Cargo Airways, and
Commission and more specifically, its Air Safety Committee has banned all operations of the Congolese carrier Hewa Bora
looked very closely at national safety oversight authorities to Airways, which had been previously allowed to operate a single
check whether they are exercising adequate safety oversight over aircraft under a special arrangement. Also all carriers from
the operations of carriers registered with them. Equatorial Guinea, Indonesia, the Kyrgyz Republic, Liberia, Sierra
Leone, Swaziland and the Democratic Republic of Congo were
The blacklist itself is split into two parts: Annex A lists air carriers banned, in addition to nine individual carriers.
subject to a total ban either individually or by blanket ban of a
particular country; and Annex B lists air carrriers subject to oper- Ukraine Cargo Airways is the third Ukrainian airline to be banned
ational restrictions within the EU. The original intention under the since the blacklist was created, previous ones being Volare and
legislation was for the blacklist to be updated at least every three Ukrainian Mediterranean Airline, and the European Commission
months, although the review process can be brought forward by is clearly sending a strong signal to the Ukranian safety oversight
member states and provisional measures can be adopted in cases authorities to strengthen enforcement and vigilance of safety
of emergency. standards.
The blanket ban on Hewa Bora’s operations means that all carri-
ers licensed in the Democratic Republic of Congo are now
banned from flying into the EU. Just days after the ban on all
Hewa Bora’s operations, a DC-9 operated by them crashed while Update no:8
attempting to take off from the airport at Goma, DRC, reportedly In the eighth update of the EU blacklist, published on 24 July
blowing a tyre and suffering engine failure. The DC-9 skidded 2008, the European Commission removed the operating ban
through the airport fence, coming to rest in a crowded market over Mahan Airlines, the Iranian carrier, following completion of
place where it burst into flames – killing over 40 people and injur- remedial measures, and their onsite inspection in Iran, but
ing over 145. imposed a broad ban on all carriers from Gabon, except Gabon
Airlines and Afrijet, following “worrying results” from the
No carriers were removed from the seventh update list, notwith- International Civil Aviation Organisation (ICAO) audit report on
standing representations made by Indonesian airline, Garuda, the country. The two Gabonese carriers, Gabon Airlines and
and the Iranian Carrier, Mahan Air, to the Commission and Air Afrijet, which are already flying in the EU, are allowed to con-
Safety Committee. They found that although Garuda tinue their services, but are not allowed to expand operations.
had made progress in the implementation of corrective measures, The Commission stopped short of imposing a full ban on all car-
this was still not sufficient, and the oversight authorities in riers in Gabon in recognition of “prompt and drastic efforts”
Indonesia had still not demonstrated that they had completed being made by the Government of Gabon, including the emer-
their corrective actions, so none of the 51 Indonesian carriers, gency adoption of a new aviation code for the country.
including Garuda, would be withdrawn from the EU blacklist.
The Commission maintained the ban on all operations of Ukraine
Jacques Barrot, European Commission Vice President in charge of Cargo Airways, fired another warning at the Ukrainian safety
transport said: oversight authorities, and heard representations from three
“The conclusion is clear: those States or airlines which fail to act Indonesian airlines, Garuda, Mandala, and Air Fast, and the
decisively to resolve their safety deficiencies will be placed on the Indonesian civil aviation authorities. The Air Safety Committee
list. Our objective is not only to identify safety issues, but to and the Commission decided that the Indonesian authorities
resolve them. The Commission will continue tirelessly in its dia- have still not developed an adequate oversight programme for
logue with states, their civil aviation authorities, and their airlines, any of the carriers under their regulatory control, and determined
to ensure that they attain acceptable levels of air safety on a sus- that the safety deficiencies identified by ICAO and the
tainable basis.” Commission had still not been assessed by ICAO.
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† Air carriers listed could be permitted to exercise traffic rights by using wet-leased aircraft
of an air carrier which is not subject to an operating ban, provided that the relevant safety
standards are complied with. List updated 11 November 2008.
”
years, and comes nearly three years after the last major European
air crash, when the Helios Airways flight from Cyprus to Prague
crashed near Athens with 121 people on board. The two previ-
ous largest European crashes were both in 2001 – the Russian
Tupolev 154 aircraft collision with a Boeing 757 transport plane How can airlines be removed from the black-
over Southern Germany with 71 fatalities, and the SAS passen- list?
ger aircraft collision with a small aircraft in heavy fog on the run- Several airlines have been removed from the European blacklist,
way at Linate airport in Milan, killing 118 people. The other including Phuket Air, DAS Air Cargo/Dairo Air Services, Buraq Air,
major European crash of the decade was the Air France Blue Wing Airlines and PIA.
Concorde crash which came down shortly after take-off from
Paris in 2000, with 113 fatalities. All of these airlines have had to complete the implementation of
a corrective action plan, and their oversight authorise have had
There is no doubt that the blacklist has reduced the amount of to produce evidence that they in turn have verified the measures
disasters of this kind in Europe, however, it is ultimately the taken by the airlines, so as to avoid the same problems recurring
responsibility of the airlines themselves to ensure that they adhere in the future.
to the strict safety standards in order to ensure the safety of the
aircraft and all on board. Unfortunately, this will sometimes be at The process for removal from the blacklist can be a lengthy one,
the expense of long delays and the associated costs. given that the corrective action plan and the remedial measures
required to comply with the international safety standards can
take some time to implement. Once all the corrective measures
† have been completed by the airline, they have to appear before
N WITHIN THE EU the European Air Safety Committee, often at a full plenary hear-
ing, with air safety representatives from every European member
state present, to give evidence that all safety deficiencies that led
to the original blacklisting have been rectified, and that a safety
State of the Operator programme is in place going forward that ensures they will com-
ply with international safety standards in the future.
WHEN I WAS YOUNG, LAST CENTURY, I SACRIFICED MY MONEY cocaine for a backstage pass when Steve was under the spot-
and my youth to go to the best schools, because I had one desire: light. Ultimately, one glorious day, I was interviewed in the
I desperately wanted to understand that deepest of all mysteries Flyfinance Journal and my modest church was nominated twice
– “The Economy”. as ‘Airfinance Bank of the Year’ by Katerine’s Transport Finance
for the Sylvania-based Lease we did on two paragliders. It costs
My masters taught me how to compare Meynard with Karl, and me tens of thousands of dollars in “sponsorship”, but you know
how Adam will inspire Benjamin, or rather the opposite; I can’t how those things work, and we paid our dues with a smile …
recall. They also taught me how I should feel enlightened and
inspired after reading the work of the many Prophets – which In short, I was doing all the right things. My Book was growing
mere mortals see only as boring analysts’ reports and research nicely, and on the Investment side, I could always find an incoming
memos. I was devouring the words of many of the Great: If it new friend, warmly welcomed, ready to buy at a premium what-
came from Hamlet Bank, or Silverman, or J.H. Boreman, then it ever piece of metal I had bought six months earlier. I was a Happy
must be more than true – it is what The Market said, and The Airfinance Banker and I was beautifully surfing straight into
Market is always right, oh stupid one! Nirvana under warm sunshine from the south of France on the
wave of the Supercycle from the Pacific Northwest.
In my later life, I applied to become an acolyte of the Airfinance
sect. I was accepted, and joined a crowd of bigots that read a lot Then, almost a decade into the new Supercentury, things
of what the Industry was producing, especially if it was thick and changed, and I found myself a civil servant overnight. This was a
complicated. I had a bright future: The two Big Brothers in tough call for a once-loyal follower of the Free Market, like all of
Toulouse and Seattle were telling me that by 2390 there would us, having spent the last ten years spitting on the many evils of
be a need for more aircraft than bicycles, to carry more people to the beast called the Government and burning incense sticks daily
ever-more distant destinations. This was hardly believable on first to the gods of ‘Free Market’ enterprise …
reading, but loyally I conceded.
When my unit was closed, last month, having lost my faith and
I was spending a significant amount on fees for the privilege to my illusions, I decided to retire and write my last contribution as
be shepherded in New York, in Dublin and in Geneva, and to the Anonymous Banker. As a footnote, I guess that with so few
catch a glimpse of the U2-like rock stars of our Industry at each of us left, anonymity will hardly be protected any more ...
ISTAT concert. In my devotion to my Faith I went to the
extreme: I slept with the very mature receptionist For the young and bright apprentices who will come after me, I
of this Hilton in Prague to have a seat on will leave my Ten Commandments with you, hoping that perhaps
the first row when Adam was you will slam the brakes on rather than speed up when about to
speaking and I traded hit the brick wall, as we have all done.
1. You shall rubbish Research Reports, especially those on India, 8. When you are welcomed to a Panel at one of the three
and especially if they are telling you that tomorrow will be better Gatherings named above and you have not had to spend any fees
than today. All those Prophets are only good for predicting the on sponsorship, increase your margin by at least 100bp. You will
past. still be doing good business and clients will flock to your doorstep.
2. There is no Supercycle without a Supercollapse and a 9. When you see one of your Fund competitors launching a new
Superdownturn. consumer-friendly Close End Fund with a return boosted by a lit-
tle inflation (just 2%, mate!) on future values of aircraft, sell all
3. When there is more than a 20 per cent increase year-to-year in that you have invested in the industry.
the attendance at the Dublin, New York and Geneva Gatherings,
sell your portfolio immediately, let go of your staff and retire in 10. When you can find two Airlines, ranking high in terms of
Vermont. (Equally, when you have not done so at the time it is book orders at each of the Big Brothers, that have a current book
happening, it is too late ...) order valued at either more than 15x their current gross revenue
for one or 20x their net income for the other, remember Newton
4. When the two Big Brothers are telling you “This is a record and Darwin: Short the stocks of the Big Brothers, and move
year,” cut your commitments by half, push down your LTV by a away from the impact point.
solid 20 per cent and do the only rational thing you can do: Pray!
And finally, here are the last words from the
5. When you see the Retirement Fund of the Nebraska Firemen Anonymous Banker to all you young
becoming an Investor in an Aviation Fund arranged by a Wall Apprentices: No regrets and good
Street Prophet, sell your portfolio. luck, you will have fun!
THE TEN
COMMANDMENTS
Guide to Financing & Investing in Aircraft & Engines S 117
Editorial main:FIN2009 2/6/09 16:03 Page 118
John Pheasant and Suzanna Rab1, partner and counsel in the Anti-trust practice at Hogan & Hartson LLP,
London, examine State Aid rules & developments across the transport sector.
Maritime
For maritime services, there are specific guidelines setting out
how State aid should be treated.4 The guidelines are intended to
contribute to the promotion of new services in the field of short
sea shipping and to support the development of the maritime
industry in line with the Commission’s objectives in this area.
There is also specific guidance for State aid in the shipbuilding
industry,5 covering issues such as tonnage tax schemes. In 2008,
the Commission extended the life of the shipbuilding State aid
guidelines for another three years, to December 2011.6
Intermodal
When it comes to intermodal transport, the Commission tends to
take a positive view of any efforts by Member States to promote
this form of transport. While there are no purely intermodal-spe-
cific guidelines or regulations in place, the Commission has
adopted initiatives and memos such as those aimed at the pro-
motion of integrated freight transport, which cover State aid
related issues.7
MARITIME
compensation for competition aid not received and there was no
Court finds Commission error in calculation of evidence to suggest that the money was intended to cover con-
excess aid received by German shipyard tract losses. The CFI therefore annulled the Commission’s deci-
On March 10, 2009, the European Court of First Instance (“CFI”) sion that KWW should repay the aid received.
handed down a judgment annulling a Commission decision that
had required the repayment of excess State aid granted by the Such cases before the European courts demonstrate that the
German government to the Kvaerner Warnow Werft (“KWW”) Commission is far from immune from making errors in its proce-
shipyard in Germany. dures and investigations. Moreover, such cases are a stark
reminder that beneficiaries of State support should pay careful
The CFI found that the Commission had made an error in its cal- attention to the Commission’s conduct of a review or investiga-
culation of the total amount of aid received by KWW. The tion so that they can spot any mistakes at an early stage and con-
Commission, in trying to assess whether KWW had received too sider whether there is scope for challenge.
much aid from the German government, calculated that KWW
had received an excess of aid amounting to around DEM63m.9 Modifications to Dutch tonnage tax aid scheme
gain Commission approval
While the Commission had previously approved the aid scheme The Commission gave its approval on March 10, 2009 to pro-
being used in relation to KWW, it had specified that aid given to posed changes by the Dutch Government to a tonnage tax
cover contract losses was subject to a ceiling. This was based on scheme that originally gained Commission approval in 1996. The
a certain percentage of the total amount of contract losses Dutch government plans to lower the tax base for large vessels
incurred by KWW. In its previous approvals of the KWW aid that exceed 50,000 net tonnes and also intends to introduce a
scheme, the Commission had differentiated between aid given to reduction in the tonnage tax base by 75 per cent as regards ship
cover contract losses (subject to the ceiling) and aid that was management companies. The Dutch government argued that
linked to competition (to be given in the event that KWW did not such a reduction will help to offset the lack of incentives for ship
receive shipbuilding aid). Competition aid was intended to com- management companies to develop their activities. Until now,
pensate shipbuilding yards that were in competition with yards they have had to pay a much higher percentage of their profits
from countries where more shipbuilding aid was provided. The as tonnage tax than ship owners.
applicants in this case argued that competition aid was intended
to enable all shipyards in the Community to remain competitive The Commission concluded that the proposed changes to the
with Asian shipyards who received subsidies likely to distort com- scheme are compatible with the common market as they do not
petition. amount to the Dutch Government offering incentives and subsi-
dies that would confer an unfair advantage to Dutch shipping at
According to the CFI, the Commission made a manifest error by the expense of other EU Member States, and therefore distort
including the competition aid in its calculation of excess aid competition. The Commission also concluded that the proposed
received by KWW. An accounting report compiled by KWW changes contribute to the interests supported by the
noted clearly that the DEM63m received in aid was received as Community’s wider maritime policy.
The Court was clear in its judgment that the Commission had
simply failed to provide an adequate explanation for arriving at
its conclusion. It is to be hoped that this sort of case will push the
Commission towards taking a more reasoned approach to its
scrutiny of State aid cases.
INTERMODAL
Court of First Instance rules against Commission Commission approval of aid scheme for German
decision in Italian shipping aid case combined transport
The CFI handed down its judgment on March 4, 2009 in the The Commission announced on March 10, 2009 that it has
Tirrenia di Navigazione State aid cases. It found that that the decided under the State aid rules to approve a notification of
Commission had made a serious error in deciding that aid given State aid to be given in support of a combined transport scheme
to the Tirrenia Group companies was incompatible with the com- in Germany. As a part of the aid scheme, money will be given for
mon market and should be recovered. The CFI ruled that the the construction and extension of combined transport terminals.
Commission did not provide sufficient reasoning for its decision Loading equipment for transhipment purposes will also be sup-
and the Court therefore annulled the Commission’s decision. ported through subsidies.
The aid in question had been given to Adriatica (a member of the
Tirrenia Group) for the Brindisi/Corfu/Igoumenitsa/Patras route The stated intention of the German federal government in adopt-
between 1992 and 1994. The Tirrenia Group argued before the ing this type of aid scheme is to increase capacity at terminals and
CFI that the Commission had failed to take into account, in its to foster the combined transport of German and transit traffic.
assessment of the aid, that the subsidies in question constituted The aid scheme will be valid until December 2011, with a budget
existing aid that had been already notified to the Commission, of E115m given annually.
and which had their roots in laws dating from 1936 and 1953.
The Commission had, in its decision, regarded the aid in question Commission approval given to aid scheme for inter-
as new aid. modal transport in Antwerp
On February 11, 2009, the Commission approved aid granted by
The CFI agreed with the submissions of the applicants that the the Flemish region of Belgium for the construction of an inter-
Commission had failed to provide sufficient reasoning for reaching modal terminal in Antwerp (involving road and rail) to be used for
its decision. While the applicants had made these submissions continental containers.
directly to the Commission in the course of its investigation of the
aid, the Commission had apparently failed to take these arguments The Belgian government had noted in its submissions to the
into account. Accordingly, the CFI annulled the Commission’s deci- Commission that the Flemish region suffers from road congestion
sion that had ordered the recovery of the aid in question. problems, particularly around the port area of Antwerp. The con-
“
'We need to be flexible on procedures... The temporary
and targeted aid measures in the EU address the new
market failures in the provision of credit using our exist-
ing principles. Flexibility does not mean throwing out the
rules.’
Neelie Kroes, The Road to Recovery, speech to OECD
Competition Committee, Paris, February 17 2009
struction of an intermodal terminal will increase the port’s capac-
ity to handle continental containers by 28 per cent.
The Commission concluded that the aid scheme will contribute
Notes
1. The authors would like to thank David Cardwell for his assis-
”
to the development of the intermodal transport sector through tance and comments in the preparation of this article.
the promotion of a shift away from the congested road network 2. Application of Articles 92 and 93 EC to State aid in the avi-
in areas where there are very high levels of traffic. ation sector, Official Journal C-350, 1994, page 5.
3. Community guidelines on financing of airports and start-up
Broader issues on the State aid transport aid to airlines departing from regional airports, Official
horizon Journal, C-312, December 2005, page 1.
The developments above give only a flavour of recent develop- 4. Community guidelines on State aid to Maritime Transport,
ments in the application of State aid in the transport sector. Official Journal, C-013, 17 January 2004, 3-12.
Politics also have a role to play. Not every EU Member State has 5. Framework to State aid on Shipbuilding, Official Journal C-
a large transport industry and the importance of particular trans- 317, 30 December 2003, 11-14.
port sectors differs across Member States. The Commission will 6. European Commission press release IP/08/1097, Brussels, 3
certainly not want to be seen to be supporting failing or flailing July 2008.
national industries where that would or may distort competition 7. Note, for example, the communication from the Commission
- or be accused of succumbing to the pressures of vested inter- on the EU’s freight transport agenda. Boosting the efficiency,
ests. integration and sustainability of freight transport in Europe,
Brussels, 2007.
The traditional focus of State aid in the transport sector has, up 8. Temporary framework for State aid measures to support
to now, been usually on the operation of the transport network access to finance in the current financial and economic
and infrastructure. However, Member States have already offered crisis, Brussels, 17 December 2008.
support to other related industries, including the automotive 9. The aid was originally granted in 1993 hence the use of
manufacturing industry. Some proposals have been controversial. Deutschemarks.
For example, the French government’s plans for the French car 10. European Commission press release IP/09/318, Brussels, 25
industry have been criticised as too protectionist. While the February 2009. CARS 21 (Competitive Automative
Commission has been keen to extol the virtues of its EU-wide role Regulatory System for the 21st Century) is a group of indus-
in relation to State aid and has put itself forward as the guardian try stakeholders created in 2005 to generate recommenda-
of a level playing field, it has recognised that desperate times call tions for improvement of the worldwide competitiveness of
for a more flexible approach. This is illustrated by the the European automotive industry.
Commission’s suggestion of a new partnership with industry,
trade unions and Member States in the context of the “CARS
21” process to accompany the common crisis response.10
CONCLUSION
These are all developments of the last few months which, when
taken together, suggest a trend towards a more flexible applica-
tion of the State aid rules in a wider range of industries. The
Commission faces a challenge between, on the one hand, a need
for pragmatism while, on the other hand, maintaining that it will
be “business as usual” as far as any threats to competition are
presented.
With the world economy in turmoil and the consequent lack of liquidity in debt and capital markets, Islamic
finance has been touted as an alternative source of funds for the aviation industry. For the past three years,
Islamic finance has been the fastest growing area in banking. It is well suited to asset finance and has
adapted to provide a real alternative to conventional financing structures, building upon the religious and
legal principles which are at its foundations.
ISLAMIC FINANCE –
PLUGGING THE
LIQUIDITY GAP?
This article sets out to explain the basic principles governing Islamic finance, to illustrate some of the issues which are specific to
Shari’ah compliant aviation transactions and to analyse the prospects for Islamic finance as a means of plugging the liquidity gap.
finance has steadily increased in recent years, some differences Form matters in Islamic finance just as it does in a number of
do remain between scholars as to the application of the princi- more conventional financing structures. It is a positive feature of
ples of Shari’ah to aircraft finance and leasing deals. The fact that Islamic finance that, to the extent possible, care is taken to try to
a particular structure has been employed on a previous transac- accommodate the commercial objectives of the parties in a man-
tion does not necessarily mean that it will be acceptable on ner which promotes Shari’ah principles.
future deals. On a practical level it is necessary to consult the
scholar advising on a transaction at an early stage and to keep
them informed and involved throughout the transaction. Going A solution to the liquidity gap?
forward it is hoped that Islamic jurisprudence will continue to The ability of Islamic finance to fill the liquidity gap in the current
develop a greater consensus as to the parameters within which market should not be overstated. It generally remains an expen-
aviation finance and leasing transactions can be structured. sive source of funds and the term of the financing typically falls
short of the 10 to 12 year loan terms available from conventional
Reflecting commercial reality lenders. Islamic banks and investors are not wholly immune from
Although in some circumstances Shari’ah principles may appear the effects of the downturn in the world economy and the recent
to conflict with conventional notions of risk allocation between a low oil price has reduced the amount of petrodollars available for
financier or lessor and a lessee, it is important that Shari’ah com- investment in Shari’ah compliant products.
pliant transaction documentation does reflect commercial reality.
For example, it would be rare that a lessor had sufficient mainte- Nonetheless, the ideas at the heart of Islamic finance seem
nance and insurance capability to support the commercial oper- appropriate in the current climate as a means of promoting
ation of an aircraft. Techniques have therefore developed to greater market confidence. Islamic finance will undoubtedly con-
ensure that, whilst the documentation conforms to the principles tinue to provide a source of funds for aviation, particularly in the
of Shari’ah, it recognises that the airline will maintain and insure GCC region, and indirectly the core principles on which it is
the aircraft in practice. This has led to accusations that Islamic based may influence longer term thinking on the development of
finance represents form over substance; however, this is unfair. banking and finance beyond the sector.
© 2008 KPMG, an Irish partnership and a member firm of the KPMG network of independent member
firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
For
outstanding
Talk to
cross-border
KPMG
leasing
advice
Ivor Conlon,
Seamus Hand or
Conor O’Brien
today at
+353 (1) 410 1000
www.kpmg.ie
FPA_check:ATEM 5/6/09 10:36 Page 3
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