Will New Lease Accounting Bring On the Apocalyse?

In Monday's Wall Street Journal, congressmen Brad Sherman and Peter King claim that the proposed changes in Lease accounting will cost 3.3 million jobs. This seems a bit extreme. Furthermore Emily Chasan writes that changes are coming soon.  In a separate article she writes the change could add $2 trillion (yes that is with a "T") to corporate balance sheets and that "adding assets and liabilities for store leases, airplanes and the like could force companies to renegotiate the terms of their loans with lenders. Banks and lenders often require companies to maintain covenants, such as a specific debt-to-equity ratio, fixed-asset ratio or earnings metric, which could all be thrown out of whack by such a significant accounting change"

America's airfleet getting long in the tooth.

Carol Massar on Bloomberg TV reports the America has the oldest fleet of commercial aircraft:



The video was on Bloomberg Television's "Bloomberg Rewind," January 18th.

Farnborough, Jobs, and Wichita

Wichita's unemployment rate is 8.0 percent.

The national recovery is starting to come to us. Wichita's unemployment rate was 8.0 percent June, down from 9.0 percent in June, 2009. Dan Voorhis reported in this morning's Eagle.   "'Given that it's for June, that's a positive sign for Wichita,'" quoting Mammon Among Friends' own Malcolm Harris, Professor of Finance at Friends University.

Note the data is not seasonally adjusted. The national unemployment rate, which is, fell to 9.5 percent (from 9.7 percent.) The national rate fell as fewer folks were in the June labor force. That was in part because of the seasonal adjustment and in part because those census workers who took the work for a few extra dollars but were not looking for permanent work left the labor force. He also quoted "Jeremy Hill, director of the center for Economic Development and Business Research at Wichita State University, [who] said the bulk of the new jobs has come in the medical sector and professional and business services."

As I told Dan Voorhis, "We're 12 months into a national recovery and some of that is spilling into the local economy." One big area of improvement is the aircraft industry.  New aircraft orders are up for the five months through May according to Commerce Department data.   Although well below the boom years of 2007 and 2008, there is a distinct recovery showing up.  Both Boeing and Airbus have been conservative in their production planning.  Boeing is now slowly stepping up its 737 production, a sign it is growing confident.  Increased production also protects Boeing from potential cannibalization of the 737 market by its and Airbus's new planes.   Spirit Aerospace largely avoided layoffs by using a shortened workweek during the worst of it.  By thus spreading the work around, it conserved its younger workers who are the manufacturer's future.

Which brings us to Farnborough:

The Farnborough International Airshow is this week: 19-25 July 2010. The biennial show was last held at the peak of the boom in aircraft orders.  The 2008 show (pictured on the right) set a record of US$88.7 billion worth of orders announced during the show.  Note planes are priced in dollars not Euros.

Boeing's Dreamliner made a splash. The 787 flew into Farnborough Monday and returned home yesterday.  Gulliver, the Economist's Business Travel commentator blogged, "The Dreamliner is much more than just another incremental upgrade to Boeing’s fleet: its revolutionary lightweight carbon-composite wings and fuselage mean much-improved fuel efficiency (20% better than comparable planes made from aluminium, according to Boeing). This could well persuade airlines to open some direct routes around the globe that they previously deemed uneconomic."

Today's Eagle carries an AP report by Jane Wardell and Emma VanDore that orders have totaled $25 billion.

There is life among the aircraft lessors. Halleluja!

I knew the aircraft industry was in trouble when I learned AIG was Boeing's and Airbus's biggest customer.   AIG required a federal bailout, CIT entered bankruptcy and GE Financial was in trouble (the piggy bank that Jack Walsh built was broken.)  Lessors' share of aircraft orders dropped from 40 percent to 2 percent.

The Financial Times' Pilita Clark reported that "Steven Udvar-Hazy made a notable re-entry into the field.  He is one of the biggest names in aircraft financing who founded and ran ILFC, AIG’s aircraft leasing arm, until his departure earlier this year. He announced a $4bn order for 51 Airbus A320 family aircraft for his new leasing company, Air Lease Corporation."

"That news was swiftly followed by Boeing’s announcement that GE Capital Aviation Services, the aircraft leasing arm of General Electric, was ordering 40 of its best-selling 737 jets valued at around $3bn, according to the manufacturer’s published prices."

The A320s and the 737s are the workhorses of much of commercial aviation and seem to be commodity most easily leased.  Udvar-Hazy largely created the air leasing business with International Lease Finance Corporation (ILFC), now owned by AIG.  When AIG lost its AAA bond rating, ILFC got shut out of the commercial paper market and was hard pressed to buy new planes.  Udvar-Hazy's solution?  He left ILFC and started a new company and now he has ordered 40 Boeing 737-800s.  That should be good news for Spirit Aerospace here in Wichita which makes fuselages for 737s.

Is the market developing according to Boeing's view of the world or Airbus's?

The first step to understanding an industry and a company's business model is asking who the customers are. On the commercial side, Airbus and Boeing (and Bombardier and Embraer) sell to commercial airlines and air freight companies. The customers' business models will drive the demand for their planes. As the busiest airports get more and more congested, the airlines will either have to fly bigger planes with more seats into those hubs or fly longer point-to-point routes to relieve pressure on the hubs. Airbus in the A380 bet on the former, while Boeing in the 787 bet on the latter.

Pilita Clark reported from Farnborough Monday that "Emirates, the Dubai-based airline, on Monday announced a $9bn order for 30 Boeing 777 passenger jets, making it the biggest deal so far at the show."

This follows the the Berlin airshow where she reported on June 8th that "the Dubai-based airline, placed one of the largest civil aircraft orders in history on Tuesday when it said it would buy 32 A380 superjumbo passenger jets from Airbus in a deal worth $11.5bn."  That Airbus claimed was the biggest commercial aircraft order by dollar value ever.

At the time the FT's Clark further reported, "Emirates already had 58 A380s on order, with Tuesday’s announcement taking that number to 90, firmly cementing its position as the largest operator of the superjumbo.


"The deal is a big boost for Airbus, which now has 234 orders from 17 buyers. The programme is far from making a profit, however, after it was affected by numerous delays and cost overruns.
In addition to its A380 orders, Emirates has 70 Airbus 350s, 18 Boeing 777-300s and seven Boeing air freighters on order, totalling 143 wide-body aircraft worth more than $48bn.

"The world’s largest passenger jet, which typically has 525 seats, costs $346.5m at list prices, although large customers receive sizeable discounts."

While the luxury airlines can offer has been much commented on in the press, Airbus is stressing that the A380 is a money maker for airlines:  "The big news for operators is that the A380 is earning hard dollars at the same time. Introducing this next-generation jetliner is saving customers millions in operating costs annually while creating thousands of extra seats on long-haul routes. With the lowest cost per seat and the lowest emissions per passenger of any large aircraft, the A380 provides a competitive edge."


Molly McMillan reports in Air Capitol Insider, Hawker Beechcraft has found some business and Bombardier brags "it has captured 50 percent of net orders in the 100- to 149-seat marekt segment over the past two years. The program is on schedule for entry into service in 2013."

In a video report, Richard Milne reports from the Farnborough Airshow on the rise of emerging market manufacturers and the challenge posed to Airbus and Boeing from the Bombardier C-Series.  (3m 5sec) 

Separately,Molly McMillan reported in the Eagle, that "Hawker Beechcraft is looking at states that might be suitable for developing facilities to build parts for the company and has narrowed the field to two — Mississippi and Louisiana" according to its CEO, Bill Boistur. Molly McMillin reports that he said, "'The market for our products has decreased dramatically over the last 18 months...Our view is that this is not a momentary decrease, and we believe strongly it's necessary to adjust the cost structure of the company to be able to be profitable in a small market.'"

The Good the Bad and the Ugly: The Weak Dollar, CIT's Bankrupcy, Aircraft Leasing

1) The economic recovery: Real GDP grew at a 3.5 percent seasonally adjusted annual rate in the third quarter after falling five of the previous six quarters. Jeff Bator in the Wall Street Journal writes, "[A]fter a bullish report on manufacturing suggested the smokestack sector is in a hiring mood., ...U.S. factory goods orders rose in September...0.9%, the Commerce Department said Tuesday, the fifth increase in six months. Orders fell an unrevised 0.8% in August."
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World trade bottomed out in April and our national economy's recovery started in June according to my best estimate.

2) The main opportunities and threats to recovery here in Wichita: the weak dollar is helping make American aircraft more competitive vis-à-vis Airbus and Embraer.  In the Wall Street Journal, Mike Spector Vanessa O'Connell and Kate Haywood reported that CIT filed for bankruptcy "in New York, listing assets about $71 billion and nearly $65 billion in liabilities." CIT's bankruptcy shows the fragile financial shape of the aircraft leasing business.  CIT Aerospace is a major aircraft lessor with aircraft worth something in the vicinity of $10 billion.

Seven aircraft leasing companies (GE Capital Aviation Services, AIG's International Lease Finance Corporation, CIT Aerospace, Royal Bank of Scotland Group PLC's RBS Aviation Capital, Bank of China's BOC Aviation, Pacific LifeCorp Inc.'s Aviation Capital Group, and Pembroke Group, a unit of Britain's Standard Chartered PLC) are big customers of the aircraft manufacturers.   Last fall, we were shocked to discover that AIG was Boeing's and Airbus' biggest customer. Daniel Michaels at the Wall Street Journal estimates that approximately 35% of the world's jetliners are owned by these lessors.  Thus these lessors' own $147 billion of the world's $417 billion worth of jets. The larger lessors are all in shaky financial shape.  This means the biggest set of customers for Airbus and Boeing (Spirit's customers) face severe financial constraints to their buying planes.

Earlier we wrote, " AIG has been trying to sell ILFC for a year. Steven F. Udvar-Hazy, chairman and chief executive of International Lease Finance Corp., is trying to work a deal whereby he and investors carve out a part of ILFC and go it alone.  The investors are supposed to be mostly from the Middle East and China." The commercial side of the aircraft industry has held steady so far.  With Wichita's unemployment rate at 8.6 percent, let us pray this is not the other shoe ready to drop.

AIG's Financial Crisis and Boeing's Biggest Customer

Boeing and Airbus's biggest commercial customer is not an airline but the fallen insurance giant, AIG (see my earlier  posting "Who's Boeing's and Airbus's Biggest Customer? Would You Believe AIG?") AIG's financial Götterdämmerung forced International Lease Finance Corporation (ILFC),which it owns, onto the Fed's life support system last October.  When AIG lost its investment grade rating, ILFC could no longer access the commercial paper market to roll over its short term debt.

AIG has been intent on paying off the $80 billion federal debt that keeps it in bondage to Washington.  The strategy has been to sell off assets.  The flaw in this strategy has been that you get Filene's Basement prices not Neiman Marcus prices when you dump assets at market bottoms when buyers know you have to sell and the few who have the cash bargain hard.  In the Wall Street Journal, Matthew Karnitschnig and Liam Pleven tell us AIG's new CEO, Robert Benmosche, is reconsidering its asset sales strategy. 

AIG has been trying to sell ILFC for a year.  Now Peter Sanders and Daniel Michaels also at the Wall Street Journal write that Steven F. Udvar-Hazy, chairman and chief executive of International Lease Finance Corp., is trying to work a deal whereby he and investors carve out a part of ILFC and go it alone.  The investors are supposed to be mostly from the Middle East and China.

The Hungarian born "Mr. Hazy is a co-founder of ILFC, which now owns about 1,000 aircraft, most of which are leased to commercial airlines world-wide. ILFC is the largest customer of Boeing Co.'s upcoming 787 Dreamliner, with 74 planes on order."

It is important to Spirit that a major support for the demand for commercial aircraft have the financing to buy planes and maintain its existing portfolio.  Boeing was more conservative expanding production in 2008 than its general aviation brethren seeking not to repeat the mistakes of the late 1990s.   So far Spirit has done a laudable job maintaining its workforce for the future.  We in Wichita where the unemployment rate is now 9.9 percent hope that continues. 

Steven F. Udvar-Hazy and General John R. "Jack" Dailey at the overlook of the new Center.
Photo by Carolyn Russo, National Air and Space Museum

Who's Boeing's and Airbus's Biggest Customer? Would You Believe AIG?

Our local economy here in Wichita is heavily dependent on the aircraft industry. Spirit's main customer (80% of its business) is Boeing. Airbus has a team of fifty engineers downtown.

Guess my surprise when I read that their biggest customer is AIG. I learned this reading an article by Justin Baer, Francesco Guerrera and Julie MacIntosh in London's Financial Times. I had known that International Lease Finance Corporation (ILFC) was the largest customer for the two companies' commercial aircraft. When they went to the Federal Reserve to ask for a line of credit, I discovered ILFC is a subsidiary of AIG, the insurance giant whose punting in credit default swaps led to its rescue last fall by the Federal Reserve.

The Financial Times writers tell us, "ILFC has ordered 168 new aircraft worth $16.7bn from Boeing and Airbus.
"The aeroplanes are scheduled to be bought during the next 10 years, with 49 of them - worth about $3bn - set to be delivered this year."

Understand that many airlines have credit ratings that are too fragile to allow their borrowing funds to buy planes on their own and consequently they lease them. Given airlines' propensity to lose money, a lessor can be more likely to benefit from the tax shields of depreciation and interest payments than they are. The biggest player in this market is ILFC.

AIG is trying to sell ILFC, presumably to raise capital. No one will buy it without a secure form of short term finance. According to AIG's 10K, the bulk of ILFC's debt is long term. As of the end of 2008, however, $1.7 billion of its $50 billion in assets were financed with commercial paper. In 2008, ILFC had to raise $4.7 billion to pay off maturing debt and repayments.

J. Lynn Lunsford and Daniel Michaels report in the Wall Street Journal, "ILFC's fleet is valued at roughly $50 billion. The company had outstanding debt of $32.5 billion and listed shareholder equity at $7.63 billion at the end of last year."

A particularly scary prospect is if ILFC were forced to dump some of its 955 planes onto the market. We certainly do not need discounted used planes competing with Boeing's and Spirit's backlog.

The Financial Times article:

AIG aircraft unit seeks $5bn Fed credit line

By Justin Baer, Francesco Guerrera and Julie MacIntosh in,New York
Published: April 8 2009 03:00 | Last updated: April 8 2009 03:00

AIG's aircraft-leasing unit is in talks over a $5bn credit line from the Federal Reserve that could be used to facilitate its sale - an unusual move that would raise the stakes in the US government's bail-out of the stricken insurer.
People close to the situation said discussions between International Lease Finance Corp, AIG and the New York Fed were still ongoing and no decision on whether the facility would be provided, and how big it would be, had yet been taken.
ILFC, a profitable company and a top customer to both Boeing and Airbus, is in advanced talks with three private equity consortia but it needs extra liquidity because AIG's collapse has choked off many of its traditional sources of funds. A bitter downturn in demand for air travel has made the task of raising extra funding even more daunting.
People close to the situation said the credit line from the Fed would come from the billions of dollars worth of loans the monetary authorities have already extended to AIG.
But even if ILFC's credit facility comes from existing resources, the Fed's involvement in the sale of an AIG subsidiary could deepen criticism of the authorities' role in the insurer's rescue. The New York Fed declined to comment.
AIG, with the Fed's blessing, has pledged to support ILFC until its separation from the insurer. But the company's efforts to raise several billion dollars through a new credit facility have met with tepid demand from European banks and other traditional sources of aviation finance, people familiar with the matter said.
AIG said ILFC's fundraising efforts were "making normal progress given the tough market conditions", and declined to comment further.
ILFC is in advanced talks with several consortia of potential buyers that include Carlyle Group, Thomas H. Lee Partners and Greenbriar Equity Group. But without reassurances that ILFC's short-term financing needs could be met, it may be unlikely any of the bidders would be willing to take on such a capital-intensive business.
ILFC has ordered 168 new aircraft worth $16.7bn from Boeing and Airbus.
The aeroplanes are scheduled to be bought during the next 10 years, with 49 of them - worth about $3bn - set to be delivered this year.

Copyright The Financial Times Limited 2009

Although Commercial Aircraft Orders Are Down, Backlogs Are Still Growing. What About the "Flake Out Factor?"

The Department of Commerce's latest data show new orders for commercial aircraft are down 36.7% from last year. Is that a worry for Wichita? Not yet. The month to month data are very volatile and new orders are down from a very high level last year. The level of new orders was high enough that unfilled orders are still up and I estimate the backlog now represents a healthy 35.4 months of shipments. The new planes, particularly the more fuel efficient planes built of composite, are made to order for today's rapidly rising fuel prices.

But Will it last?

J. Lynn Lundsford and Susan Carey warn in today's Wall Street Journal that "As rising oil prices cause even the strongest airlines to struggle, Airbus and Boeing Co. face the possibility that as many as a third of their orders for new jets could be postponed or canceled." One very savvy observer is Steven Udvar-Hazy, the chairman and founder of aircraft-leasing giant International Lease Finance Corp. which buys many of the planes airlines lease. He "predicts that 25% to 30% of the two makers' order books ... could be subject to what he called the 'flake-out factor' if oil prices continue their unprecedented rise."

This reminds us of a fundamental truth. Orders for aircraft are ultimately tied to the demand for airlines and their profitability. Rising fuel costs make the new generation of aircraft attractive, but they rob airlines of their ability to pay for the newer planes. Financially, U.S. airlines are far from healthy. Christopher Hinton of Market Watch tells us that airlines are cutting back on capacity and laying off workers: