Aviation's operating lease pioneer and controversial oracle Steven Udvar-Hazy is back after a 37-year career at International Lease Finance. He may be 64, but retirement does not feature on Udvar-Hazy's agenda. This is positive for the industry, but a worrying sign for the manufacturers that have had to redraft their aircraft designs in his wake.
Udvar-Hazy's reputation meant nobody flinched when he created a new corporation, Air Lease, in March, with initial equity financing of $3.3 billion, despite the extremely fragile financial environment. After all, Udvar-Hazy created the phenomenon of operating leases, which earned him his unabashed reputation as a visionary in this business. These traits and his continued influence also helped him scoop the 2010 Airline Business Strategy Award for industry achievement.
Nevertheless, some shouted "crazy" even though Udvar-Hazy's love affair with narrowbodies is well-known
, along with his almost instinctive knowledge of when to flip an asset and when to hold on to it. However, to re-create the successful marriage of infatuation and profits as he did at ILFC in a weak global economy, scarred by a battered and slow-to-reform financial system - well, to certain critics, it seemed ambitious and even unnecessary.
But Udvar-Hazy sees it differently. "I have passion for this business. My personal and business life are very intertwined because of aviation; I still love to fly as a pilot," he says. Sitting in ALC's temporary offices with the late Los Angeles afternoon sun on his face, Udvar-Hazy reflects on his decision not to hang up his hat and stare at the trophy room. "I didn't feel like retiring. I am too restless."
When ILFC's parent company, American International Group, announced in February that Udvar-Hazy was retiring with immediate effect, few industry observers were surprised. AIG's and Udvar-Hazy's failure to close a buy-out deal meant the two-year merry-go-round of negotiations between the parties was finally over. It was time for him to move on.
POWER & INFLUENCE
A highlight of Udvar-Hazy's long-spanning career has been his influence on the design and creation of airlines and aircraft. "It's fun to see how we contributed to the industry by creating new vision and new thoughts," he says. "We were involved in starting Morris Air and it was fun to convince June Morris of Morris Travel to start an airline with David Neeleman. Later that became part of Southwest Airlines. This then fed into the formation of WestJet and then New Air and later JetBlue." In 2006, Udvar-Hazy also stopped Airbus production plans in their tracks when he told a conference that Airbus should scrap its current A350 design and create an all-new fuselage and wing to make it bigger and faster. And it did. He also helped influence the A330-200 and Boeing 777-300ER.
Udvar-Hazy has also helped transition a number of overseas airlines from government to private ownership. "We re-did their fleets as part of the process, by totally overhauling their airline networks and aircraft." Reflecting on these achievements, he says: "Those were all fun and exciting opportunities."
But, for Udvar-Hazy, relaxing on a sunny beach in the Pacific Ocean did not appeal. Udvar-Hazy says after "four or five days" he is "studying the OAG to see which airline flies where, rather than wondering whether to extend the vacation for two more days". Instead, he saw his future in the aviation leasing business, back where he started - literally - as ALC's offices are just around the corner from ILFC's headquarters.
He explains: "The world's airlines right now have almost 20,000 Western-built jets, excluding the smallest regional aircraft. What we saw when taking ILFC public in 1983 was that about 2% of the world's fleet was on operating lease. Since then, the percentage of aircraft leased has grown to almost 40%. We see this trend continuing and we anticipate approximately half of the world's aircraft will be on lease by the end of this decade. To accomplish that you need some really well-financed, well-capitalised lessors that have a really sound and effective strategic plan."
However, the financial crisis rocked the business plans of many lessors, crippling their outlook. "Look at what has happened to the industry in the last three to four years," says Udvar-Hazy. "Look at ILFC, which was taking as many as 100 new aircraft in the middle to the end of the last decade. Now it really has no single-aisle aircraft on order as much of its focus has been on resolving this AIG issue. General Electric lost its triple AAA rating right after the financial crisis, which meant they had to deleverage GE capital, which owns operating lessor GECAS. CIT Group, the number three player went through a Chapter 11 bankruptcy proceeding last year. RBS Aviation was taken over by the UK government and Babcock & Brown's parent company went through a restructuring.
"So you look across the spectrum of lessors out of the top-10 players, virtually all of the large ones have had to readjust their game plan. We feel very strongly about the demand for leased aircraft, with the growth in the developed and undeveloped markets, that there is a need for another lessor that has the deep airline relationships, has the clout with the manufacturers, has the respect of the financing community and Wall Street, to grow a successful leasing company."
Gazing towards the Santa Monica Mountains on the distant horizon, Udvar-Hazy places his fists on the table, pauses, and offers another explanation for ALC's existence: "There are a lot of challenges ahead and I think I know what it takes to build a successful company in this industry. Look at Apple; there's always room to innovate. This industry needs leadership and creativity. It needs a few people that can tell Airbus and Boeing when they're full of it; that sometimes they are way off base. It needs people that can take an independent view of what is going on and not be afraid to tell it the way it really is."
In particular, he sees ALC as having a key role in the launch of a successor in the 150- to 250-seat range. "We are very much involved in this, as it will change the whole make-up of the industry," says Udvar-Hazy. "We are in talks with the manufacturers and the airlines, designing, as we did with the Airbus A330-200, A350 and Boeing 777-300ER. This next step is really exciting and it is a huge leap forward. I don't see the other lessors engaged in that type of activity. We are thinking 10-20 years ahead, not about what we did yesterday. I think that is a huge differentiation between this company and some of the others."
While a proven track-record, overwhelming passion and dreams of paper airplanes are all very well, they will not keep the blood pumping through a new operating lessor in a volatile, post-crash global market in which the price of money has skyrocketed. However, access to cheap funds will - and Udvar-Hazy claims he has that too. After all, better priced funds compared with your competitors translates into more attractive deals for the airlines and, ultimately, more leasing business.
"Our cost of financing is cheaper than any other lessor. It's less than 3% and that's the current average to date, if you consider all the debts we have taken on," says Udvar-Hazy. "What will it be next year? I don't know - a lot depends on Fed and monetary policy - but those are our costs now."
Critics of ALC are quick to point to ILFC's cheap funding scenario pre-crash as a major obstacle in Udvar-Hazy's ability to achieve similar financial success this time around. AIG and ILFC had a symbiotic relationship in which the lessor enjoyed favourable debt ratings due to its parent's AAA rating, while the insurer was able to benefit from the lessor's significant tax benefits, driven by accelerated depreciation of aircraft.
But Udvar-Hazy stresses it is important to know the facts behind ILFC's financing. "I think there is a myth that AIG somehow guaranteed the obligations of ILFC, but ILFC was independent and a separate Securities and Exchange Commission public filer and ILFC raised its own financing. In perspective, ALC's cost of financing is very competitive, both on a secured and unsecured basis."
Airbus is likely to be the first manufacturer to step ahead with a new engine response in the single-aisle category, but Hazy believes this might not be the right strategy. "It is an unnecessary move, but I think there are three motivating factors at Airbus: one, I think the threat of the CSeries is an implied threat. Number two, in case oil prices go up in the next five years, it wants to have a product that has lower unit fuel burn than the 737. Third, the truth is I don't believe Airbus could launch a new aircraft today, as financially the A380 is not a profitable programme, the A350 is just starting to consume money and then they have this wonderful project called the A400M, which is a disgrace to the European taxpayer, also consuming tremendous resources.
"I think, based on talks with airlines, Airbus is much more reactive to the CSeries because it feels the A319 and A320 are a little bit vulnerable to this aircraft on a pure direct operating cost equation. I don't see the same level of anxiety at Boeing that the 737 is going to be vulnerable to the CSeries."
Udvar-Hazy believes Boeing is taking the "right approach" with its "wait and see" attitude to re-engining. "It is better to see how things play out, the A320 family is still a good workhorse, so there's no need to prematurely obsolete it." He believes Boeing will not re-engine the 737. "They are looking at major structural changes, major design changes that go beyond just putting new engines on. I don't think they could get it certified because its type certificate goes back to 1967 and today's new aircraft air worthiness regulations mean that a derivative may not be certifiable."
As AIG's debt ratings were downgraded during its long fall from grace, so were the ratings at ILFC on the principle that no subsidiary should be rated higher than the parent. As a result, ILFC's cost of funds increased. According to ILFC's 424B filings with the SEC, interest rates on its debt increased to nearly 8.4% in September 2008 from as low as 3.85% in January that year. In March 2010, ILFC paid interest rates of 6.75% and 7% on two aircraft secured loans, totalling $1.3 billion. "Look at ILFC's recent bond deals, and recent financings by AWAS and Aviation Capital Group," he says. "The era of really cheap money is no longer with us. I believe our financing costs will be very competitive."
To be successful in this new environment, Udvar-Hazy knows he must make some changes. "In the last 37 years we have learned a few things, both good and bad. This company will have a lower overhead operation, a more cost-efficient operation than ILFC - we won't have as extravagant offices. Sure, we will have nice facilities, but they will be very lean and will run a very productive business. I think this will offset some of what you might consider a small premium that we have to pay for financing." He also confesses that at ALC he must "work much harder" as the lessor has a small team. "We don't have as deep an infrastructure as we did before, so we are all wearing many hats." Currently ALC has 29 employees and looks to add "as few as we need" as the goal is to have six aircraft for every member of staff.
ALC is planning a fleet of 100 aircraft by spring. Its fleet now totals 31, including Boeing 737s (mainly -800s), A319s, A320s, A321s, two A330s and a new 777-300ER, which will be delivered to Air France in December. At the end of the year ALC will receive another 777-300ER, followed by another in January from Boeing, which will be leased to Air Austral.
Udvar-Hazy explains ALC's aircraft are being sourced "from three different buckets". These are direct purchases from manufacturers, seven different leasing companies which include "virtually all of the major ones except ILFC" and airlines. These airlines are "long-term clients that we have long-term relationship with that said 'look we have this new delivery position, why don't you step into it and we will lease it from you'," he says.
Although extremely fast-paced, Udvar-Hazy acknowledges these early days at ALC are "a lot of fun". He continues: "It almost reminds me of the days of ILFC before we merged with AIG in the 1990s. That's the sort of the spirit around here." And he still flies a business jet, just like his days at ILFC.
"We bought a Gulfstream IV and ordered a new Gulfstream 650 a couple of years ago and which will deliver in 2012. The Gulfstream is a workhorse. A lot of people in Washington think it is a luxury, but last week I visited 20 different airlines in six countries. If I try and do that commercially, I would be on a three-week tour, not one just one week. We look at the corporate jet, not as a luxury, but as a mobile office." Unlike other lessors, ALC does not have regional offices. "That was our philosophy at ILFC as well."
Udvar-Hazy hopes ALC will become an investment grade issuer in a relatively short timeframe. "I think we are on the right track in terms of the capital structure. We need to show a year of performance to the ratings agencies, despite the long track record in the management team."
An initial public offering is one of the options for ALC, but Udvar-Hazy says the company has the advantage of flexibility and he is confident that many of ALC's existing shareholders would be willing to put more money in. "One of the luxuries of ALC, compared with anyone else in the leasing spectrum, is that is we have a clean sheet of paper, we can stay private." No firm decision has been taken, but Udvar-Hazy admits that an IPO would be an "interesting way to increase the capital of the company". ALC must file a registration of shares with SEC by 30 April if it intends to become tradable by mid-2011.
While the lessor would look at additional equity as part of its capital structure, Udvar-Hazy says the company's existing shareholders and management are very motivated, meaning that would want to buy more shares, rather than sell them. He stresses that the IPO would not be an exit strategy. "It would be to build the balance sheet, to build the strength of the company financially, to have a broader capital base. We want to build the foundation for a very successful company, so selling out is not something we aren't looking at."
No doubt, Udvar-Hazy's pivotal role in the history of aviation is well-established. However, in this brave new world, post-crash, this old innovator is still setting the pace and the agenda in this sector.
This year Udvar-Hazy scooped the Airline Business award for industry achievement: flightglobal.com/AwardsWinners2010