Video"It was an incredible transaction," he recalls. "But the big danger is, when you get these types of deals, you are caught up by the complexity for the sake of complexity. We did it once—c'est bon. Intellectually it was fun. But it is a danger. At some point you are losing control of what you are doing."
In short, the approach at Airbus was not to develop a separate financing company but to keep financing as an integral part of the commercial operation, says Debains. "We do the deals that nobody else wants to do. Then we sell them into the market when we can."
This led to tension when the finance side of the market was booming. In 1998, Debains says, he wanted to sell the United and American Airlines financing exposure. "We said we were going to sell all our exposure to United and American. Some people in the company said, 'Why should we spend money to do that; after all, there is no risk.' The big difference between the Boeing strategy and our strategy—which I call 'hold-and-sell'—is we take the exposure when nobody wants to do it, or when the cost of doing it is far too expensive, and we sell it when we are able to. It is not our business to be in financing."
The exposure to United and American was removed "synthetically" through a complex financing arranged by Lehman Brothers and Salomon Brothers and sold as more than $1 billion of securitised bonds, dubbed AIR 2 US, in 1999.
"Now, of course, selling United and American exposure looks like genius!" says Debains.
Lift Off
Things took a different turn at Boeing. As part of CEO Condit's strategy to diversify after the commercial aircraft slump ten years ago, the company bought defence contractor McDonnell Douglas in 1997. The purchase included MD Financial Services (MDFS), a diversified vendor-financing unit that Condit initially wanted to sell. But Deborah Hopkins, who in 1998 arrived as CFO from GM Europe, where customer financing was a well-developed business, argued that MDFS could help diversification by being a vehicle for Boeing to develop its own financing unit, similar to GE Capital Aviation Services (GECAS). Lease- finance specialists such as GECAS, and insurer AIG's subsidiary ILFC, captured about a quarter of the world commercial aircraft market through a buy-and-lease strategy, bankrolled by sophisticated financing.
As one industry observer put it, "Boeing developed 'GE envy.' They developed the view that vendor financing could be a 'stand-alone' business that could grow returns for the parent."
Thus BCC was created, incorporating MDFS and two other financing units. Hopkins became chairman of the new unit alongside her job as CFO of Boeing, until she left 18 months later for Lucent Technologies. The financing portfolio, which had been coasting along at between $2.6 billion and $3 billion up to then, more than tripled between 1999 and 2001 to $9.8 billion. Net income doubled from $78m to $152m in the same period. But as the world economic slowdown in late 2000 and the September 11th terrorist attacks a year later hammered the airline industry, BCC's portfolio kept on growing—to more than $12.5 billion by the end of 2002. Soon the profits turned to losses.
Down to Earth
Boeing's management has now decided that, in the future, the company will copy the Airbus approach. "The leadership of the company has taken a look at the environment, taken a look at BCC and decided to operate within a band of risk that they feel comfortable with," says Skowronski. "It is a change of course."
The new "two-pronged" strategy, Skowronski explains, will focus on facilitating financing for customers, mainly by arranging third-party financing, as well as "managing down the risk"—that is, offloading the existing loan and lease portfolio. Neither of these tasks is helped by an environment that is tough for both aircraft sales and financing.
As the end of 2003 approached, there were some tentative signs of improvement in the airline industry—United Airlines' restructuring was on track and American cut its loss from more than $3 billion in 2002 to $1 billion in the first nine months of 2003.
But many in the industry are bleak about the near term. Even after cutting production to 280 aircraft from 527 in 2001, Boeing executives say they still see industry over-capacity of between 15 percent and 20 percent, and Skowronski predicts commercial aircraft deliveries in 2004 will be flat. Airbus did not reduce its capacity at all in 2003, churning out 300 aircraft. And while some analysts are forecasting an industry recovery in 2005, Goldman Sachs sees no meaningful upturn until 2007. With industry losses still running at between $5 billion and $10 billion, according to analyst forecasts, aircraft purchasers will find it hard to source financing.
In a downbeat report in October, Moody's aircraft finance analysts wrote that the decline in air travel since the September 11 terrorist attacks "has sent the aircraft leasing industry into an unprecedented decline. As a result, Moody's has downgraded the vast majority of bonds issued in pooled aircraft lease securitizations." It said, overall, this meant that lease rates had fallen by between 25 percent and 60 percent. The lease companies, so important to financing in the market, weren't likely to be big financiers of aircraft purchase until rates pick up again.
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