We were at the ISTAT conference this week, one of the largest aviation conferences in the world, where 1,000 aviation professionals gather for the Spring Annual General Meeting to assess the current state of the market. And the state of the market is dismal.
ISTAT stands for the International Society of Transport Aircraft Trading.
A major topic, perhaps the major one, was the so-called “funding gap” that exists this year: with $68 billion in aircraft financing required, nearly all observers believe there is a funding shortfall, or gap, of $10 billion to $28 billion, depending on who’s talking.
Except that Boeing, as well as Airbus, doesn’t subscribe to this theory. (Neither does the leasing company AWAS, but this firm is not out front about it.)
Boeing has been much more aggressive than Airbus on this issue in conveying the message that nearly all of the “skyline” set for delivery this year is funded. Boeing has appeared at several conferences expressing its judgment that the gap today is $3.8 billion to $5 billion, a not insignificant amount but a far cry from the $10 billion-$28 billion expressed by some aerospace analysts and bankers. Boeing believes that the capital markets, virtually shut down at this time, will open up sufficiently by year end to cover the gap as defined by Boeing. Boeing expects that it will have to provide $1 billion in customer financing.
Airbus more or less agrees, although in its case the amount of customer financing it expects to provide is 1 billion Euros, or about $1.4 billion to $1.5 billion depending on the exchange rate at any given time. Yet there are signs that the Airbus positioning might be softening a bit–it’s too soon to say for sure, but we’ve been told Airbus is exploring some new funding mechanisms to help its customers.
In any event, Boeing Capital Corp. (BCC), the Boeing subsidiary that provides customer financing and performs the financial needs analysis, made the case at ISTAT that the financing gap is not only not as bad as others suggest but that such talk is “hysteria.” BCC President Walt Skowronski chaired a finance panel in which he stood alone among his own panelists. Mark Streeter, an aerospace analyst at JP Morgan, Bertrand Grabowski of the German DVB Bank and Robert Morin, the top financial officer of the ExIm Bank, firmly disagreed with Skowronski.
So did the CEOs of the lessors DAE Capital, BOC Aviation and International Lease Finance Corp., the latter being the largest single customer of Boeing and Airbus. These CEOs were participants on a panel we chaired. ILFC’s Steven Udvar-Hazy, one of the most powerful voices in commercial aviation, said Airbus and Boeing haven’t woken up to the financial woes the airlines, lessors and banks see in the capital markets.
Hazy, DAE’s Bob Genise and BOCA’s Robert Martin each told the crowd of 1,000–as well as the large contingent of Boeing Capital personal ands the smaller Airbus representation in attendance–that the airframers’ plans to provide 1 billion dollars/euros in customer financing is woefully inadequate. The lessors estimated the funding gap at between $10 billion and $20 billion.
Their disagreement with Boeing, led by our questioning, was so ferocious that a BCC official protested from the floor and implored the panel chairman (us) to mention Airbus more. (The Airbus presentation at the conference was a product update and not about the funding gap; we weren’t picking on Boeing, per se–it was just that BCC made the relevant presentation and Airbus didn’t.)
We’d like to add a personal observation. We have, from time-to-time, criticized Boeing executives and corporate communications publicly and privately for being far too vague and general in its messaging (to our immense frustration), leaving the company open to credibility issues. In the case of Boeing’s messaging on the funding gap, BCC bases its conclusions on information it considers proprietary and therefore confidential, but BCC is admirably becoming more detailed about its methodology in presentations and, in an off-the-record conversation, with us at ISTAT.
This off-the-record conversation we had with BCC at ISTAT was extremely helpful to understand how Boeing reached its conclusions. Given the setting at the time, the conversation was incomplete and we look forward to an additional briefing opportunity. Based on our off-the-record conversation, we’re pretty well convinced that BCC–which, if nothing else, researches things to death–truly believes its messaging on the funding gap and is not simply maintaining a smiling face. This is not to say that there isn’t concern within Boeing that a large funding gap could yet materialize, because there is. But based on what they know now, the conclusions are what have been described.
The challenge is to convince everyone else, and for now, it’s Boeing against the rest of the world.
Bloomberg News has an excellent report on the funding gap and related production issues.
Update, March 19: Two aerospace analysts in attendance issued their post-ISTAT reports (there may be others, but these are the ones we’ve seen). Wachovia’s Gary Liebowicz has this to say, followed by JP MOrgan’s Joe Nadoll (sorry about the changing fonts):
Aero: ISTAT Conference Highlights* Production Rates Need To Fall. With global travel down ~7% YTD (worse than generally expected), positive global GDP growth not expected until perhaps Q1 2010, and airline P&Ls under pressure, Boeing and Airbus likely will need to cut build rates (contrary to the flattish deliveries now projected). Leading lessors estimate a 15%-30% cut is needed; our current estimates are near the low end of that range. The last-minute cancellation of a presentation by a senior Airbus official only flamed speculation that the company will soon cut A320-family monthly production from 34 to 24-26 units.
* Beware of the Gap. Boeing reiterated its expectation of a $0-$5B industry funding shortfall this year, with Boeing Capital expected to provide $1B of funding. Based on current and near-term market conditions, this will likely prove to be inadequate; $3+B is possible, in our view. We believe that the financing issue is still less of a concern than the downturn in air travel demand.
* Ex-Im Step-Up. One positive development in the financing market (albeit by necessity) is the expanding and evolving role of export credit agencies such as the US Export-Import Bank. Ex-Im activity is likely to roughly double this year, and the agency has relatively few limitations to increase its volume of guarantees and direct loans that preserve American jobs by ensuring Boeing export sales are completed.
Finance still in flux. Our visit to the ISTAT conference produced no eureka moments on aircraft finance, but on balance we feel that while we are still headed for a crisis of sorts later this year, some of the dramatic headlines that have been making the rounds recently, including some coming out of the conference, overstate the problem. We believe that the US government through the Ex-Im Bank could end up financing significantly more than its plan of ~$9 bln this year, and Boeing Capital likewise could be on the hook for 2-3x its outlook for $1 bln. This is not to say that conditions are in any way good or improving, but we simply believe the worst case meltdown scenario looks unlikely and is largely supported by those whose businesses (leasing companies, etc) would benefit immensely from lower supply coming out of the OEMs.
Little consensus on bank/leasing company financing, but we believe the bearish outlook will prevail. Even though we are months into the broad credit crisis that began to spiral out of control in September, industry participants still have vastly different outlooks on how much aircraft volume banks and leasing companies will finance this year and next. Conditions among the banks have nominally improved since Q4, but 2009 budgets are filling rapidly and we are only in March. The emergence of the “regional banks” has thus far been largely a dud, with the exception of some of the Chinese banks supporting Chinese airlines. Leasing companies are still in turmoil, and the entire finance community continues to watch the unfolding ILFC sale process with great interest. Many aircraft finance professionals continue to comment on the draw that the refinancing of existing aircraft maturities and sale of large portfolios will have on the credit available for new deliveries.
Governments likely to provide more credit guarantees than anticipated . . . We believe the world’s Export Credit Agencies, including the US Ex-Im Bank, will take action to prevent a steeper downturn in an industry that is critical to employment on both sides of the Atlantic. The math works in favor of greater intervention, as the additional $5-10 bln of credit guarantees that could save so many jobs in America’s number one export industry pale in comparison to the hundreds of billions directed to the financial industry and the tens of billions pouring into an automobile industry considered in grave need of restructuring. The aircraft industry, which simply faces the implications of the credit crisis and economic downturn, is relatively strong, and credit guarantees would be far less risky to taxpayers than the support provided to these other sectors.
. . . but downturn will still be painful due simply to declining underlying demand. While most investor attention right now is focused on how the financial crisis will affect the availability of credit, we believe the bottom will ultimately be determined by demand for aircraft, and the downturn promises to be painful. As we never tire of pointing out, about 2/3 of long-term demand for aircraft is driven by traffic growth, and with traffic declining this year after a flat 2008 this demand driver is essentially dead for the time being.