IN FOCUS: Regional demand drives growth of Asian lessors

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"Rapid growth in the demand for leased aircraft among Asian airlines points to the further expansion of Asian investor interest in leasing," Fitch Ratings says in a recent report on lessors.

This is backed by Boeing's 2012 Current Market Outlook, which indicates the Asia-Pacific region will represent 35% of all commercial aircraft deliveries through 2031.

"We expect changing ownership structures to drive more investment, both through acquisitions and organic growth, as Asian carriers look for new sources of financing to support rapid fleet growth in the coming years," says Fitch.

No doubt the purchase of International Lease Finance, the second biggest aircraft lessor in the world, by a consortium of Chinese investors will give China instant mass in the market. ILFC accounts for 14% of the world's leased fleet, according to Flightglobal's Ascend Online database.

And just as importantly, a "local" lessor could provide Chinese airframer Comac with the necessary platform to eventually market its C919 indigenous single-aisle airliner.

ILFC was founded in 1973, so the lessor is able to provide its buyers with valuable market experience, which is just as crucial as deep pockets in the leasing industry.

"The Chinese would gain the 'best in class' knowledge through the purchase," says a leasing source.

ILFC also presents a much-needed investment opportunity for Chinese investors, which have pent-up cash piles padded with US dollars.

Refinancing with ease

A financier notes that after the purchase of ILFC, the buyers "can easily" refinance a good portion of the portfolio and "improve their economics almost immediately".

For parent company American International Group (AIG), the deal allows the insurance giant to finally offload a non-core asset, which has been incurring ongoing, serious impairment charges since 2009.

In the third quarter, ILFC wrote down $98 million related to its fleet, on top of another $30 million in the second quarter. In addition, the lessor incurred fleet-related charges of $1.7 billion, $1.6 billion and $51 million in 2011, 2010 and 2009, respectively, according to a regulatory filing with the Securities and Exchange Commission.

In addition, proceeds from the sale will help AIG to pay down its $182 billion bailout from the US government after the 2008 financial crisis.

AIG had planned to divest ILFC in an initial public offering. However, those plans dried up once the Chinese group showed interest, so it is safe to say the agreed sale price is probably the best deal AIG could get.

The insurer plans to sell up to a 90% stake in ILFC to the investor group in a transaction that values the lessor at about $5.28 billion. ILFC employs 560 people and manages 1,000 aircraft. It holds orders for 225 units.

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 an additional 9.9% stake.

However, AIG had a book value for ILFC of $7.9 billion at the end of the third quarter. The insurance giant said it will record a non-operating loss of $4.4 billion on the sale, including a charge for tax-related items.

Out with the old

The potential sale of ILFC follows two other lessor purchases last year to Japanese buyers, involving smaller aircraft fleets. Emboldened by the strong yen and solid cash reserves, these banks acquired a solid slice out of the aircraft leasing sector.

In October 2012, Mitsubishi UFJ Lease & Finance acquired Jackson Square Aviation (JSA) for about Y100 billion ($1.17 billion). The Japanese team beat bids from China Development Bank and Hong Kong Aviation Capital (HKAC), which were also looking to beef up their Asian leasing presence.

JSA has a fleet of 76 aircraft in service valued in excess of $4 billion, the lessor says. The fleet originated through sale-and-leaseback transactions, according to JSA.

Sources indicate that the purchase of JSA could be linked to growth plans the Japanese financier has for its Dublin-based MUL Aviation Capital subsidiary, which was established in January with the aim of growing a portfolio of narrowbody aircraft.

Mitsubishi UFJ is Japan's largest financial group and the world's second-largest bank holding company with about $1.7 trillion in deposits as of March 2011. It has a four-aircraft portfolio, according to Ascend's database.

JSA's primary shareholder, Oaktree Capital Management, a Los Angeles-based private equity fund, mandated Deutsche Bank to manage the sale of its major shareholding in the lessor. The sale is compatible with the Oaktree Capital's business strategy of selling rather than maintaining its investments in aircraft lessors.

In 2007, Oaktree Capital sold its interest in operating lessor Pegasus Aviation Finance to Terra Firma for $5.2 billion.

The JSA transaction follows the long-anticipated sale of RBS Aviation Capital to Sumitomo Mitsui in January 2012 for $7.3 billion. The business employs 69 people and owns 206 aircraft and has commitments to purchase a further 87 by 2015.

The Tokyo-based group fended off bids from China Development Bank and Wells Fargo in order to secure a home for its lofty yen reserves and to counter slowing growth in the Japanese market.

Previously, in 2010, HKAC, a consortium that includes HNA Group and Bravia Capital Partners, completed the acquisition of Allco Aviation and 68 aircraft from Australia-based Allco Finance Group after the financier went into receivership. HKAC has committed financial support from Chinese banks including the Agricultural Bank of China and China Development Bank. Financial terms of the transaction were not disclosed.

But it was the Bank of China's purchase of Singapore-based BOC Aviation (previously Singapore Aircraft Leasing Enterprise) for $965 million that kick-started this wave of Asian investors in 2006. At that time, the lessor owned a fleet of 63 aircraft and managed another 14 units. Now, the lessor has a portfolio of 203 owned and managed aircraft.

End of the wave

This show of banking money in the leasing market differs from the wave of private equity investors apparent during the past couple of years. It also signals the emergence of longer-term investment in the leasing sector.

According to Fitch, acquisitions of lessors by larger banks create "certain benefits" in terms of lower funding costs, consistent single-shareholder strategy and cross-selling opportunities with the parent company.

The combination of airlines' increasing reliance on operating leases globally, along with the expected growth in air travel, also makes aircraft lessors an attractive acquisition target for financial institutions, the rating agency indicates. Fitch expects to see further consolidation activity in the sector, especially among those lessors that are owned by private-equity sponsors.

"Private equity investors are realising the 15-20% return is no longer possible, so these funds are looking at other assets more closely," says a financier.

"This has led to the migration of investors into leasing which are willing to settle for an 8-10% return and match long-term liabilities with long-term investments."

Last August private equity firm Fortress Investment Group ended its investment in operating lessor Aircastle through the latter's 9.25 million common shares offering. The Ontario Teachers' Pension Plan purchased 6.2 million common shares of Aircastle, while undisclosed investors assumed the remaining amount. Aircastle repurchased 2.5 million common shares from Fortress Investment in a separate transaction at a cost of $28.5 million.

In the same month, AerCap repurchased an additional $120 million in common shares from Cerberus Capital Management, reducing the private equity firm's holding to 10% of outstanding ordinary shares. The lessor, which is heavily backed by private equity money, disclosed in a market announcement last year that its board of directors decided to "explore a range of strategic alternatives to enhance shareholder value, including continued execution of operating strategies, further share repurchases, aircraft portfolio sales, or a sale or merger of the company".

Operating lessor AWAS has also seen a change in its investor base. Last year, Canada Pension Plan Investment Board provided $266 million to help bankroll expansion at the lessor, increasing its stake in AWAS to 25% from 16%. Private equity firm Terra Firma owns 60% of AWAS and co-investors own the remaining 15%.

In October 2011, Irish aviation firm Avolon diversified its investor base by securing an equity investment of $300 million from the Government of Singapore Investment Corporation, a sovereign wealth fund.

The change in investor base is a recent occurrence, considering private equity and hedge fund backing for operating lessors was the norm just years before.

When JSA was formed in March 2010, the lessor secured a $500 million equity commitment exclusively from investment funds managed by Oaktree Capital.

In the same year, Avolon was launched with $1.4 billion in equity and debt backing from the private equity firms of Cinven, CVC Capital Partners, Oak Hill Capital Partners as well as bank partners DVB and UBS.

Industry godfather Steve Udvar-Hazy's venture, Air Lease, which came to market in early 2010, secured $1.3 billion in equity capital and approximately $2 billion of committed debt financing.

Chinese investors' move to buy up to 90% of ILFC is the latest in a string of trades, reflecting a changing investment base for aircraft lessors and the growing prominence of Asian finance