ILFC in perspective

Update, March 26, 2:20PM PDT: Bloomberg News moved this piece in which ILFC’s CEO says he’ll get the lessor out from under AIG’s “cloud.”

Original Post:

Mega-lessor International Lease Finance Corp. filed its 2009 10K annual report March 25 with the Securities and Exchange Commission. In it, the company discussed possibilities that could create what’s called a “going concern” situation.

In accounting-speak, the reference is all about bankruptcy. If a company or its auditors raise questions about the ability to continue as a “going concern,” this means there is a possibility the company could seek protection in the US bankruptcy courts. This almost always is a Chapter 11 reorganization filing rather than a Chapter 7 liquidation action.

In ILFC’s case, management raised the going concern issue; its auditors did not (thus, the auditors gave what’s known as a “clean” opinion.) The auditors did make note of the liquidity discussion raised by management, which is noteworthy in itself. But otherwise, the auditor’s opinion was unqualified.

Naturally the media focused on the management discussion of going concern and the liquidity issues facing ILFC. Our phone was very busy with calls from media to add perspective.

We told the Los Angeles Times, for example, that ILFC’s business fundamentals are sound and that the company is well managed and profitable. We said that the entire aviation community knows that ILFC’s troubles are not of its own making, but rather imposed upon it by the troubles at its parent, AIG. (We should have added the the financial community knows this as well, but one thinks of some of these things after the fact.)

We added the analogy that ILFC was an innocent bystander waiting for the stoplight to change when it got mugged by AIG.

Because of the problems at AIG, compounded by the world financial crisis, all the financial issues at ILFC are trickle-down effects from the parent. ILFC is the only unit of AIG that is profitable.

Still, the media focused on the dire language in the ILFC 10K, forcing AIG and ILFC to attempt damage control–largely unsuccessfully. ILFC pointed out that AIG has advanced nearly a billion dollars to ILFC in the first three months (a portion of which was still subject to approval by the Federal Reserve, but this is expected). AIG is committed to providing additional funding as required until ILFC is sold.

(The AIG funds, of course, are flow-through funds from the $173bn bailout by the Fed to AIG.)

We’ve told every media that called that there is no chance, in our view, that the US government will allow ILFC to fail, regardless of the dire language in the 10K.

Naturally the Seattle media focused on the fact that ILFC is Boeing’s largest customer. When the news broke in the US, it was already evening in France, past the print media deadlines, but we have no doubt similar headlines will follow and report that ILFC is the biggest customer for Airbus.

ILFC at December 31 had 168 outstanding orders from Airbus and Boeing, including 74 Boeing 787s and 10 Airbus A380s. The balance of the Airbus orders are for the A320 family; the Boeing mix is mostly 737s with a few 777s as well. ILFC is considered by observers certain to cancel the A380s come January 1, when it is permitted to do so under the contract with Airbus.

ILFC has more than 40 Airbus and Boeing airplanes schedule for delivery this year. ILFC revealed in the 10K that only four of the A320s have been financed by the European Credit Agencies (ECA). Because of credit-rating downgrades, the ECA won’t finance the remaining Airbus’ until certain additional conditions are met. We believe that this will happen; given the European propensity to do what it takes to support Airbus, we would be stunned if the ECAs deny further financings.

The US ExIm Bank, however, did deny ILFC’s application to finance the Boeing deliveries this year, amounting to fewer than a dozen 737s and 777s. This was stunning, given that the ExIm Bank is widely considered to be “Boeing’s bank.” Boeing, ILFC and ExIm met during last week’s ISTAT conference to try and reach an agreement.

The reporting was, for the most part, factually correct, straight-foward write-ups of the 10K. By close of business on the 25th, Google News showed roughly 60 stories and we know of several in the trade press that Google did not pick up. By the morning of the 26th, when European and Asian media are awake, we expect a lot more.

Having said that, The Financial Times of London went over the top. It reported that should ILFC be forced to cancel the 168 orders, valued at $16.7bn, this would be “devasting” to Airbus and Boeing.

Pish-posh.

Nobody likes to lose $17bn in orders but let’s get real: the two companies have a backlog of around 7,000 jets; 168 equals 2.4%.

Since nobody seriously believes ILFC will be forced into Chapter 11 bankruptcy, what is the real meaning of its current situation?

It is that ILFC has become a microcosm of what is going on in the financial markets. Access to commercial funding is nearly impossible, and when it is available, it is expensive. Here is a business that is profitable, one that is the largest lessor in the world (by asset value), that is reduced to including language about being a going concern, all because of problems out of its own control at its parent that created a worldwide financial crisis and liquidity concerns for a stellar subsidiary. Selling ILFC is problematic because of the financial crisis.

We hate to use the term “poster child” of the world’s financial crisis, but in many respects, that’s what ILFC is.

This is the real perspective about ILFC.

ILFC’s global competitor, GECAS, the mega-lessor subsidiary of GE Capital Services (itself a unit of GE Corp.), has similar issues, even if they are not as dire. (Perhaps we should add “yet.”) Other lessors have found access to capital an issue. All this hurts the airline industry and puts more pressure on Airbus and Boeing to step up and provide customer financing. Airbus says its planning to fund EUR1bn and Boeing figures $1bn. Many observers, including ILFC’s CEO Steve Hazy, figure each company will have to do substantially more than that.

ILFC’s challenges are far from over. But we just do not believe the Fed will allow ILFC to default on its obligations.

14 comments on “ILFC in perspective

  1. Good post Scott. Lots of information and good perspective here that I wasn’t able to find in most other print media. Now I understand the situation much better. Thanks!

  2. Scott,
    Since the leasing of planes has been a very profitable business and ILFC is has been successful at it, don’t you think that a sale will ultimately result.

    There are rumors of discussions with several funds including KKK. AIG is in desperate need for capital and this is one of their key assets. You say a sale is “problematic” but certainly not impossible.

  3. The only problem with this analysis is any consideration of the possibility that the success of ILFC’s business model was built on the ready availability of cheap finance. You assume that they are unwitting victims of the current credit crisis, but perhaps they were actually beneficiaries of the preceding credit boom?

  4. The other point I would make is that you are very sanguine about the Chapter 11 possibility for ILFC. Surely the point about ch11 is that it gives a company shelter from its creditors. That’s great if you’re a factory manufacturing widgets because it means that you can carry on making them without fear of your plant being repossessed. Seeking shelter from your creditors is considerably less great if your business model is based on borrowing money as cheaply as possible…

  5. Jerry: Yes, we think a sale will occur. While at ISTAT, we talked with a person involved in the effort (who is not employed by ILFC). He believes there could be a transaction as early as the second quarter.

    “B”: You are correct that ILFC’s business model is predicated on cheap money. When AIG was rated AA or better, the halo effect to ILFC provided similar credit ratings and the cheap money. (We don’t know where ILFC would have been rated without the halo effect.) Industry observers and competitors to ILFC believe that the profit margins at ILFC are insufficient to sustain more expensive debt. For example, by September last year, ILFC was pricing debt at 8%+ compared with about 3.5% the preceding January. The conclusion of observers and competitors was that at 8%, ILFC would not be profitable.

    As to “B’s” other point on Chapter 11, we are sanguine on Ch 11 only to the extent that (1) we don’t think it will happen and (2) even if it did, ILFC would continue operations and restructure the debt, with the possibilities of reamortizing it and/or converting some to equity. The unsecured debt would be most at risk, as is the case in a Ch11.

  6. Very good post, thanks very much for alerting.

    Second round closes in two weeks. Three bidders left. I agree that a sale looks likely.

  7. Scott, Is it known if the treasuries TALF program might have a role to play here?

    And my guess is there are now a couple of congressional delgations just getting wound up to attack the problem.

    I have a great deal of confidence in Hazy, I just try not to listen to his rhetoric. I just watch what he does and based on that, I think ILFC will come out ok.

    The local and business media are become aerospace chicken littles, another example being Fed-Ex’s overblown cancellation threat. None of it has prevented BA from outperforming the DOW lately.

  8. One Man: It is not known if BARF (oops, we mean TALF) will play a role. AIG indicated in its conference call associated with its own 10K issuance that the Fed is prepared to provide backstop financing for a sale of ILFC, but no detail was provided as to form or substance.

    Hazy certainly is known for his rhetoric and quips but history proves he is usually correct, regardless of his colorful verbiage.

    As for FDX, don’t necessarily rule that out. Remember than American Airlines also has an escape clause in its 787 contract that if it does not get an acceptable labor contract with its pilots, AA has the option to cancel the order. One can argue whether the FDX and AA threats are real or not, but remember, too, Air Canada had a similar clause in its 787 contract about its pilots–and it did cancel, only to reinstate when the pilots came around.

  9. FDX is certainly free to make whatever threats it feels are in it’s best interests, but UPS buys airplanes also, and UPS is asking congress to put FDX under the authority of the NLRA, in concert with the teamsters union.

    Boeing had best be careful, they potentially have as much to lose as to gain.

    But in my view, they either need the aircraft or they don’t, and predicting unaffordability based on potential union organizing of each individual FDX node (not a sure thing, and could take decades) is a bit of a stretch. It’s a threat that causes panic amongst some, but under scrutiny, falls to the level of foolish bluster.

    When ILFC is sold, I don’t see the need for capitol on the part of the new owner going away, unless that new owner has very deep pockets.

  10. Problem with the ILFC situation is that we in the industry tend to look at the problem through the eyes of ILFC, not from the perspective of a frantic AIG or a goofy government.
    If AIG or the government decide ILFC is too big to swallow whole, or if they think the sum of the parts is worth more than the whole, they will not hesitate to break up ILFC.
    I think this is what is worrying Hazy

  11. The article staes that ILFC is the only profitable arm of AIG.
    So what happens to AIG if its only source of profit disappears?
    The sale price of ILFC is still a drop in the bucket relatively speaking.

  12. The FedEX order for the 30 planes it says it will cancel is not on the order list of Boeing. Since it was a contingency, it is not a confirmed order and not indicated as such.

    I do not know whether the American Airline order is in the same limbo.

    I think it is widely understood that there will be a sale of ILFC in the near future

  13. ILFC is a financial institution. Financial institutions fail when they cannot raise new money to pay off maturing financings. ILFC is probably in that situation with massive refinancing requirements, so a bankruptcy is by no means unimaginable. In its favor, it is unlikely that the government will allow that without coming to its rescue, using money earmarked for AIG.

    As to its profits, as a financial institution ILFC makes money mainly from deploying capital at a positive margin to its cost. ILFC profited from having the lowest cost funding of almost any leasing company. Now that has evaporated and funding is more expensive. At the same time, revenues are falling as demand for leased aircraft declines, bringing down lease rates. So the company is definitely in distress. A 1% increase in funding costs reduces profits by $500 million.

    Since depreciation is the second largest cost item, profits can be inflated by not depreciating enough. Rosy residual value assumptions can exaggerate profits but leave aircraft values increasingly out of sync with market values. That can be concealed with equally rosy appraisals. Since ILFC does not publish individual aircraft book values, it is not possible to determine how serious of problem that might be. But I suspect if all ILFC aircraft were sold today, the company would not recover the carrying book value. By this measure, the company would be insolvent.

    Lack of financing and a shortfall of market values to book values might be two main reasons why the company has not been sold. It is probably not capable of independent existence without a strong parent to provide financing or financing guarantees, particularly in this environment when financing aircraft is virtually impossible or prohibitively expensive.

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