The operating lease market has been highly active with a spell of merger and acquisition activity, as well as new initiatives to create full service players and to broaden out portfolios with regional jets and freighters

There is little doubt that the operating lease sector has come a long way over the last decade or so. What once may have appeared as a niche market for carriers who were too small or poor for other forms of aircraft finance has today emerged into the mainstream. Operating lessors now account for at least a quarter of the world airliner fleet and can name most of the world's major carriers among their client. Perhaps its not surprising then that a round of consolidation and restructuring has been taking place in this increasingly high-stakes market.

Analysts often describe the operating lessor sector as a pyramid. At its pinnacle sit the two mega-lessors - GE Capital Aviation Services (GECAS) and International Lease Finance Corp (ILFC). These two giants dominate the leasing landscape. Whatever measurement one uses to judge the leasing market - fleet size, asset value, customer base, new aircraft on order - these two companies are miles ahead of their nearest competitors. Each year they buy and sell billions of dollars worth of aircraft and, as such, have established the aircraft as a tradeable commodity.

These giants have also played their part in taking leasing away from its traditional reliance on the short-haul fleet. Today, leasing companies hold orders for more than 1,000 new aircraft, and while the majority of these are indeed for the popular Boeing 737NG and Airbus A320 families, lessors have also placed speculative orders in the widebody market. Others are also beginning to turn their sights to the regional jet (RJ) market. Earlier this year, GECAS placed firm orders for 150 in the 50-90-seat categories, and Germany's Deutsche Structured Finance (DSF) is now poised to follow with its own large order for RJs.

Market dominance

The extent to which these two giants dominate again shows through in this year's leasing company survey compiled for Airline Business by the Airclaims consultancy from their CASE aircraft database (see pages 62-64). The survey covers just over 40 leasing companies which together hold over 3,200 jet aircraft worth close to $78 billion. GECAS and ILFC together account for half of those aircraft and, with assets of some $20billion a-piece, comfortably over half of the value.

Moving down the pyramid, there is a large step to the next tier of lessors sometimes dubbed the ILFC/GECAS "wannabes". This is a fairly diverse and dynamic group. Their portfolios vary enormously in size and shape, ranging from around 25 widebodies to a mixed fleet of over 200 and with valuations in the $1-4 billion range. What they have in common is a determination to expand, either organically or through acquisition. This group includes, Ansett Worldwide Aviation, Boullioun Aviation Services, CIT Aerospace, Debis Airfinance Services (AWAS), GATX Flightlease, Pegasus Aviation and Singapore Aircraft Leasing Enterprise. Notably, many of these already have a significant number of new aircraft on order ready to swell their portfolios.

Finally, at the base of the pyramid are a number of smaller companies, covering niche specialists or new entrants. Included in this grouping are those such as Oasis International Leasing, DSF and Bavaria International Aircraft Leasing.

While GECAS and ILFC have continued to develop their position at the top, further down the pyramid, change has been frenetic as consolidation becomes the leasing industry's new byword. A sampling of recent merger and acquisition activity demonstrates the point:

Ansett Worldwide Aviation Services, with its portfolio of 105 aircraft, was sold to Morgan Stanley Dean Witter Aircraft Holdings as former Australian owners News Corp and TNT Post extracted themselves from the whole Ansett group business; Germany's Debis Airfinance acquired the AerFi Group, adding another 124 aircraft to its portfolio and bringing its total fleet to 222. Just one year earlier, Debis had already acquired another leasing company, Sweden's Indigo; CIT Group merged its aircraft leasing activities with Newcourt Capital to form CIT Aerospace, which has a portfolio of 285 aircraft; DSF was sold to the DePfa Group by former owners the BfG Bank. DSF manages German Operating Leasing, a German investor vehicle created primarily for aircraft operating leases; Unicapital, after only two years in the market, sold its 40 aircraft portfolio to Lehman Brothers. It had been badly hit by special charges and write-downs; Boullioun Aviation Services is also set to change owners. WestdeutscheLandesbank (WestLB) is to acquire it from Deutsche Bank subject to regulatory approval.

So what is behind all this activity? "In part, it's driven by the need for funding," says John Willingham, chief operating officer at Boullioun Aviation Services. He quotes three fundamental keys to success: funding, sales/marketing expertise and asset management skills. "Successful mergers are the ones that put all three elements together so that they can manage its success," Willingham adds.

Access to low-cost funding undoubtedly helps provide a competitive edge, particularly during times of downward pressure on lease rates. Both GECAS and ILFC (owned by US insurance giant AIG)benefit from the investment-grade rating of their respective parents, which provides useful access to the capital markets. For example, ILFC has some $20 billion of funds with an average cost of debt of only 6%. With this magnitude of low-cost funding at its disposal, ILFC can acquire large volumes of new aircraft (on average $3 billion each year) at deep discounted rates, and beat the competition by offering lower lease rentals.

Financial backing

Therefore, it is not surprising that most leasing companies are now owned by a strong financial partner. Debis counts DaimlerChrysler and several German banks among its shareholders, CIT Aerospace is owned by the CIT Group, a $50 billion commercial finance company, and Boullioun Aviation will soon exchange one German bank for another.

Of course, not all lessors have or want a major institutional owner. Pegasus Aviation has no single, large shareholder but, instead, relies on its track record as the largest private aircraft lessor with 17 consecutive quarters of profitability. Allen Della, Pegasus senior vice-president of marketing, says his firm has credit lines in excess of $2 billion, much of this obtained through warehouse financing facilities, non-recourse finance from commercial banks and asset-backed securitisations. "All these funding methods have allowed us to grow rapidly and will continue to be used," says Della.

Similarly, Oasis International Leasing, a newcomer with a diverse shareholder base, negotiated a $200 million umbrella facility to advance its aircraft acquisition programme at the end of last year. After an unsuccessful bid for the AWAS portfolio, Oasis is now focused on gradually building up its portfolio of 11 aircraft, comprised of A320s, 737s and one Boeing 777. "If a portfolio opportunity arises, then we are ready to accelerate the growth process. Otherwise we will grow aircraft by aircraft," says Oasis finance director Michael Darch.

Commitment by the parent to the leasing business is also paramount. Although on paper AWAS had two strong owners, the uncertainty over their long-term involvement with Ansett had left the leasing company stagnate. Crispin Maunder, executive vice-president for sales and marketing at AWAS says the biggest change to come out of new ownership is that it now has one shareholder instead of two. Not only that, but the new owner - US investment bank Morgan Stanley - is already active in leasing and plans to develop the AWAS business.

Economies of scale also play their part in building a successful leasing business. Paul Steinhardt, chief executive at DSF notes that those who are not big lessors like, instead, to stress that they have "flexibility" on their side to offer the customer. However, he argues: "You cannot neglect size as you do need a certain number of aircraft to support your infrastructure."

Although DSF has a relatively small portfolio (23 aircraft), Steinhardt hopes to increase the fleet to 80 aircraft by 2005. DSF's acquisition at the end of last year by the DePfa Group, one of Germany's biggest mortgage banks, will bring a fresh infusion of cash to carry out the expansion programme - another c15 million ($14.1 million) in equity and a $120 million credit line. In 1999, DSF reported net income of €4 million.

Consolidation and growth

Frank Haspel, chief executive with Debis Airfinance, points out that consolidation in the leasing industry is just a reflection of what is already taking place among the airlines: "Alliances in aviation are creating bigger airlines and, in order to respond to their needs, lessors need to have a certain size portfolio."

Haspel says that following its string of acquisitions, Debis now has a balance sheet approaching $5 billion and his strategy is to build up to a $10 billion company over the next five years. The company will report a $58 million operating profit on revenues of $345 million last year, which exceeds shareholder targets. This year, Debis is expected to announce its first speculative order for Boeing aircraft, namely 737NGs and, possibly, some 767s.

A large portfolio usually brings with it more diversity in aircraft types. "This is important for two reasons," says Robert Brown, vice president for finance at Pegasus. "We offer our customers a full range of narrowbody and widebody aircraft, both from a service point of view as well as a way to diversify our asset risk." Pegasus has a portfolio of 215 aircraft, including Boeing, Airbus and McDonnell Douglas (MDC) equipment.

Debis' Haspel admits that one of the benefits the AerFi acquisition brought to his company was not simply more aircraft, but instant diversification. Heavily weighted with Airbus aircraft prior to the AerFi portfolio acquisition, the Debis portfolio now includes Boeing and MDC types as well as some regional offerings such as ATRs and Fokker 100s.

Although consolidation drives forward the viewpoint that bigger is better, leasing companies are eager to differentiate themselves, as well as provide value-added services. "The days of just leasing and collecting rent are winding down. Airlines want a fixed cost, "says Della at Pegasus. "That means offering not just a broad spectrum of aircraft, but also a full array of services - from spares, maintenance and flight training to route/revenue yield planning and aircraft management."

Full-service offering

The development of the "full service" leasing company is already taking hold. GECAS has led the way by offering a number of these services through its joint venture on spare parts as well as flight training. Last year, it also acquired a significant stake in the aviation consultancy GRA. Pegasus holds a 40% stake in aircraft maintenance company Hamilton Aviation and owns spare parts company International Aero Components.

GATX Flightlease, the joint venture formed by GATX Capital and the SAirGroup, is another example of integrating a full range of services under one roof. While GATX Flightlease focuses on asset management services (for a mix of part-owned and third-party aircraft) the joint venture also offers access to the services of its partner companies. For example, SAir brings on board its SR Technics maintenance business and the Swiss group also recently acquired a stake in engine lease company, Willis Lease Finance. For its part, GATX Capital can offer financing solutions in the tax lease and capital markets.

Adding new types

Once wedded to the idea that only modern, single-aisle aircraft have a secondary market, operating lease companies are now broadening their portfolio to include other aircraft types. The regional jet has been one of the fastest growing market segments, but operating lessors have been content to sit on the sidelines until residual values have been more firmly established in the market.

However, this passive stance is likely to change following last year's bold move by GECAS. It ordered aircraft from all three RJ manufacturers - Bombardier, Embraer and Fairchild - although notably General Electric supplies the engines for all three types.

Paul Steinhardt, DSF's chief executive, says his company, too., expects to announce a firm order for 36 regional jets this year. These would presumably make a good fit for DSF alongside the nine Bombardier CRJ-100ERs already in its portfolio. Unlike GECAS, the German company will stay with just one manufacturer to avoid a conflict of interest.

Another area ripe for further development is the freight lease market. Like the regional jet market, cargo air transport is experiencing explosive growth. Indeed, both Boeing and Airbus are forecasting a doubling of the world's freighter fleet over the next couple of decades.

One of the first specialists in this field was C-S Aviation, which acquired second-hand Airbus A300B4-200s and had them converted for freighter use. Today, C-S has the largest fleet, with 24 of this type, and hopes to securitise the entire portfolio this year.

Another company that has already made its mark in freighter leasing is Pegasus Aviation. It has a total of 27 freighters, all acquired from the second-hand market and reconfigured for cargo use. It has chosen to focus on the Boeing 727 and the MDCDC-10/MD-11, but is beginning to add Boeing 757s

As elsewhere in an expanding leasing market, the current mood appears to favour fleet growth and perhaps just a little innovation.

Source: Airline Business