In financial circles, General Electric is often referred to as an economic bellwether as it is a company closely observed for details about the macro economy because of its involvement in multiple industries. GE has also come to mean “get everything” in reference to its ability to go into key sectors, achieve a leading position and, amazingly, stay there.
The US industrial group’s aircraft financing unit, GE Capital Aviation Services, is no exception. It is the world’s largest aircraft lessor and lender any way you measure it: revenues, net income, fleet value and size. It also serves as a litmus test to determine the health of the aviation industry.
However, to maintain its top ranking, GECAS must consistently strike the right balance between growing its fleet of more than 1,700 owned and managed aircraft, while maintaining strong financial discipline and risk management. And it is facing increasing challenges from new entrants, particularly from Asia, which want to play in the space and profit from airlines’ increasing reliance on operating leases in exchange for flexibility and leaner balance sheets.
Airbus forecasts at least a third of the 28,200 airliner deliveries during the next 20 years will be delivered via operating lessors. But this could be higher, as lessors are also active in taking over delivery slots via purchase-leaseback deals. And tighter European bank funding and less subsidised export credit financing is also helping conditions for leasing, although new sources of Asian and capital markets funds are rapidly developing.
“We expect the operating leasing market to grow to 40% from 35% now,” says Norm Liu, GECAS president and chief executive, from his London office. “Some will say the growth is more, but there are many airlines emphasising more ownership, especially in the emerging markets.”
GECAS is investing about $7 billion a year in new aircraft orders, sale and leaseback transactions or debt financings, but with caution. “Given our nearly $50 billion book and our level of depreciation, amortisation and asset sales, we are still growing,” says Liu. “But the days of double-digit growth are gone, given our scale. It’s more of a single-digit world now. And there is only so much sensible business out there. Still, we are a market leader doing close to $7 billion a year.”
A key driver for GECAS and other lessors in the operating lease market is a shift in financial power towards the emerging markets, particularly Asia.
“Aviation is focused to a major degree on the emerging global consumer who wants to tour the world,” says Liu. “Think about it… there are one billion people in the mature developed world, but six billion in the emerging markets. No, not all of them are going to board planes to travel, but every year that demographic changes.”
FIGHTING FOR A SHARE
However, this growing market has not gone unnoticed. Asian financiers have also made major advances in the operating leasing market, particularly in the past 12 months. In December, American International Group inked a deal to sell up to a 90% stake in International Lease Finance, the world’s second-largest lessor by fleet size, to a consortium of Chinese investors.
ILFC, which employs 560 people, is the world’s second largest lessor behind GECAS with a fleet of 1,000 aircraft. The investor group of New China Trust, China Aviation Industrial Fund and P3 Investments has agreed to acquire 80.1% of ILFC for $4.23 billion, with an option to buy a further 9.9% stake.
That deal follows the sale of Jackson Square Aviation (JSA) for 100 billion yen ($1.27 billion) in October to Mitsubishi UFJ Lease & Finance. JSA has a fleet of 76 aircraft in service worth more than $4 billion, according to the lessor.
But it was the sale of RBS Aviation Capital to Sumitomo Mitsui for $7.3 billion in January 2012 that proved Asia was serious about entering the leasing sector, paving the way for future deals. The business employs 69 people and owns 206 aircraft, with commitments to purchase a further 87 by 2015.
Lessors and interested investors know changes in bank and export credit regulations are also fuelling an increase in demand for operating leases.
Export credit agency (ECA) financing rates are being reset this year as the 2011 Aircraft Sector Understanding (ASU) comes into full effect. The new ASU terms are tougher to make ECA support less appealing financially to airlines and lessors which are able to borrow in the commercial debt markets.
Upfront fees on export credit loans under the 2007 ASU range from 4% to 7.5%, depending on the credit rating of the customer. Under the revised ASU, even the most creditworthy will pay 7.72% upfront and the lowest investment grade carrier will pay 14.74%. When the fees are spread over a 12-year loan term, the impact is mitigated. But net-net the pricing is still less subsidised than before. More costly commercial debt financing is also expected under the Basel III accord, which although recently relaxed, must be fully implemented by 2019. Under the regulation, global banks will need to comply with higher capital requirements leading to a rise in bank funding costs that will be passed on to the airlines.
STAYING ON TOP
Nevertheless, Liu remains undeterred by any advances by GECAS’s competitors in the operating lease market. “It’s a bit of déjà vu how money comes and goes in and out of our sector. I’ve seen this over many years, and I feel confident we will retain a leading position,” he says. “If we are around $50 billion, the next guy is approaching $30 billion, you then have others in the $5-10 billion range playing to be number three. If they play to be number one in a short time, they are likely to make some mistakes as this game isn’t as easy as it appears.”
Liu says that GECAS’s history in the aviation market as well as its financial resources are the major competitive advantages the lessor holds over its competitors.
“We’ve been around for decades and our parent has been making jet engines since the 1940s,” he says. “So we’ve got deep domain expertise and a long-standing commitment to the aviation sector.
“We also have low overhead costs at GECAS as we spread them over $50 billion versus, say, $5 billion. And, most importantly, we have top-tier funding that far outpaces most of the competition.”
Proof of this is the ease in which GECAS can tap the financial markets, which are increasingly more selective towards top-credit companies. In December, parent company General Electric Capital issued fixed- and floating-rate notes totalling $1.7 billion, secured by 137 aircraft on lease to US airlines.
The financing includes $1 billion in three-year, fixed-rate notes, which carry a 1% coupon; a $300 million three-year, floating-rate tranche at Libor plus 60 basis points; and $400 million in fixed-rate seven-year notes, which carry a 2.1% coupon – pricing levels that hark back to the pre-crisis days of cheap liquidity.
And with experience under its belt, having weathered plenty of aviation cycles, Liu says the GECAS team has learned how to run a tighter business.
“In the past you would grow earnings by simply growing assets. Today, we have to sweat the balance sheet more. We need to book new assets that are accretive to the business return on investment by playing the cycle and volatility, we need more asset velocity or selling of assets for capital appreciation and fleet management, and we need to manage the mature assets well.”
Ultimately, better funding and overhead costs, plus broad capabilities, mean more options for GECAS’s customers, he says.
“With mature aircraft for example, we have cradle-to-grave capabilities for customers. We have secondary homes with charter, low-utilisation, scheduled and pioneering market carriers. We can convert planes to freighters or can part-out the airframes through our parts distribution business and use the engines in our engine leasing business,” he says.
GECAS is a “top player” in engine leasing having developed this part of its business from a small platform, Curtis Power, in 1999. A used airframe parts player, The Memphis Group, was acquired in 2006.
Also, GECAS can offer customers asset-based financing as a bank would through its PK Airfinance subsidiary – a tool increasingly important for customers because of the pullback in aviation lending by the European banks following the 2008 financial crisis and more expensive export credit funding.
In December 2012, PK Airfinance and DVB Bank arranged the senior debt refinancing of a 16-aircraft portfolio for Dubai Aerospace Enterprise. The portfolio consists largely of Airbus A320s and Boeing 737s.
Liu also argues that airlines increasingly want “local service” and not “fly-ins” through its extensive network of 25 global offices. “Our large scale can afford this type of presence,” he says. Liu credits this as “key” to
GECAS’s leading presence in greater China, where it has more than 190 aircraft committed in the region. “We are also the clear market leader in the Middle East, Africa and the CIS regions too, and we’ve opened offices in Ghana, South Africa and next Kenya, so we are well ahead of the field.”
However, even with economies of scale, deep financial pockets and experience, GECAS is not immune to fleet impairment charges. Its pre-tax impairments were $250 million in 2011 – or about 50 basis points on assets. But despite these charges, the net income generated was $1.15 billion. Just three aircraft were grounded during the third quarter of 2012 as they transitioned between customers. “We still have impairments, but they are at reasonable levels given our scale and because of our capabilities and conservative book and pricing policies,” says Liu.
OLDER AND WISER
To maintain the lessor’s growth, experience again plays a crucial role, adds Liu. “The key is that we have learned some lessons when ordering aircraft or doing sale/leasebacks. In the past, we probably overbought certain types and we should have sold more, but we have learned. The good thing is these changes in aircraft are typically evolutionary, not revolutionary.”
“And we are especially mindful of ‘last-of-line’ aircraft. You might get competitive pricing but, over the long-term, unless you trade aircraft out, they could be marginal investments depending upon the cycle in the future and the technology curve. Never fall in love with the planes.”
GECAS applied these hard-learned lessons during its recent ordering spree, most of which occurred at the Farnborough air show in July, where the emphasis was clearly on the latest-technology aircraft. The lessor makes it a policy to order aircraft powered by engines built by GE or its affiliates and tends to avoid those where such an option is not offered.
Among the Farnborough deals were orders for the new re-engined narrowbodies from Airbus and Boeing – 60 A320neos and 75 737 Max 8s – all powered by CFM International’s new Leap engine, as well as 25 more 737NGs.
GECAS has a “book-end” strategy of ordering more widebodies, such as the Airbus A330 and Boeing 777, as well as regional jets and turboprops from Embraer and ATR. “We have ordered over 55 units of these ‘book-end’ types in recent years,” Liu says.
“We’ve been conservative on the 737-800s with fewer in 2017 than 2015. Also, we went for a low unit count. But we had to order because we placed out our previous orders and we also needed to beef up our on-going inventory,” Liu adds.
GECAS’s current narrowbody order book is committed up to 2015 and, according to Liu, the next batch of 737-800s deliver 2015-17 while Max deliveries start in 2018.
“In today’s world, the competitive bar is being raised constantly,” says Liv. “My job is to make sure GECAS is the one raising the bar versus someone else.”