ILFC Fails to Sway Bond Market as Standalone: Corporate Finance
International Lease Finance Corp.’s debt reductions and maturity extensions are failing to convince investors the plane-leasing unit of American International Group Inc. (AIG) should stand on its own in a worsening global economy.
Credit-default swaps on ILFC have more than doubled since May 19, even as Standard & Poor’s raised its senior unsecured debt rating to BBB-, the lowest investment grade. The company’s bonds have lost 5.02 percent this month, compared with 3.53 percent for all high-yield debt, according to Bank of America Merrill Lynch index data.
ILFC is being punished in the bond market as airlines come under pressure from rising fuel prices and deteriorating economic growth prospects. The Bloomberg U.S. Airlines Index has fallen 22 percent since the start of July and jet-fuel costs reached a two-week high in New York yesterday. A spinoff or initial public offering of ILFC would leave the Los Angeles- based company more vulnerable to market volatility, according to DoubleLine Capital LP’s Bonnie Baha.
“They’ve turned around their financial situation only to head into another downturn from a global growth perspective, which is unfortunate,” said Baha, head of global developed credit in Los Angeles for the DoubleLine Core Fixed Income Fund (DBLFX), which has performed better than 99 percent of its peers this year. “While ILFC is in a good position to fly on its own, without a backstop from AIG and more importantly from the government, it’s a little bit unnerving to the market.”
Credit-default swaps on the company climbed this month as global stocks tumbled and speculative-grade debt issuance all but evaporated. The cost reached as high as 663 basis points on Aug. 11, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts have held at prices that imply ILFC’s debt should be rated B2, according to Moody’s Corp.’s capital markets group.
“Widening of spreads are not ILFC-specific but simply reflect trends in the broader markets,” said Mark Herr, a spokesman for AIG, in an e-mail. “Moreover, ILFC’s new funding and liquidity strategy implemented since early 2010 makes it less vulnerable to market volatility than ever before.”
ILFC has cut outstanding debt by almost 20 percent to $25.8 billion over the year through June 30. It sold five-year notes after the upgrade at a 5.75 percent yield, 2.88 percentage points less than similar-maturity debt issued in 2010, after being shut out of the bond market in 2009.
The unit’s ratio of debt to trailing 12 months earnings before interest, taxes, depreciation and amortization fell to 5.33 at the end of the first quarter from 7.85 at the end of the third quarter of 2008, according to data compiled by Bloomberg.
New York-based S&P boosted ILFC’s senior unsecured debt grade one level on May 19 to BBB- from BB+ and affirmed its BBB- corporate credit rating, saying it had “significantly improved” liquidity and could meet its 2011 and 2012 maturities and fund capital expenditures. S&P cut its credit grade from A- in January 2009 as the worst recession since the Great Depression slowed demand for planes.
ILFC said in an Aug. 11 regulatory filing that AIG may sell it, float it in an initial public offering or spin the business off. A partial IPO may raise $2 billion, according to a person familiar with the plans, who declined to be identified last month because discussions are private.
The plane lessor, which relies on debt financing to purchase aircraft, was unable to sell bonds after AIG’s losses on mortgage bets squeezed liquidity at the entire company and led to downgrades. After being bailed out by the U.S., which now owns a 77 percent stake, AIG said it would back the leasing unit if secured financing, aircraft sales and other funds didn’t meet its need for liquidity.
That support was suspended as ILFC regained access to outside funding. The unit sold $2.25 billion of notes in a two- part offering in May after S&P’s upgrade and used the proceeds to retire higher-yielding debt.
ILFC is being affected in part by a repricing of risk across the finance industry, said Kathleen Shanley, a Gimme Credit LLC senior bond analyst in Chicago. Financial companies are sensitive to market conditions, in particular if they are lower-rated or have to turn to the debt markets often; both conditions apply to ILFC, she said.
“It doesn’t necessarily have anything to do with fundamentals inside of ILFC,” Shanley said in a telephone interview. “Because ILFC over time will need to keep going back to the market to obtain financing, if financing becomes more expensive, that’s negative to them as it is with other companies.”
Financial debt is suffering its worst month since November, declining 0.8 percent through yesterday, Bank of America Merrill Lynch index data show, as investors flee borrowers facing more risk from a weakening economy and Europe’s spreading debt crisis. The cost of protecting debt of the six biggest U.S. banks reached the highest in more than two years last week.
“There can be some credit impairment if we have this global slow growth environment,” DoubleLine’s Baha said. “It all hinges on whether or not there is a friendly environment for accessing capital.”
An IPO would be positive for bondholders “since it reduces the potential risk of a private equity type of transaction in the minds of some market participants,” said Miguel Crivelli, a credit analyst at Barclays Plc in New York, in a note to clients on Aug. 16.
Moody’s Investors Service rates ILFC’s senior unsecured debt B1 and changed its outlook to positive in May as ILFC builds “a capital cushion to absorb potential asset-quality and performance weakness,” the New York-based ratings company said.
The rating stripped out a one-level boost based on the assumption of AIG’s support, according to the Moody’s note.
“Because ILFC has strengthened its stand alone credit profile, the B1 rating no longer relies on an assumption of AIG support,” Moody’s analysts Mark Wasden and Robert Young wrote in a note dated May 12.
Credit-default swaps tied to ILFC’s debt, which typically fall as investor confidence improves, are down from a record 1,710 basis points in March 2009, according to CMA. They eased from 809 basis points in June 2010 after it sold assets and took advantage of record-low borrowing costs to refinance debt coming due by 2012. The swaps climbed 22.5 basis points today to 632 basis points as of 9:52 a.m. in New York, CMA data show.
The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point is $1,000 annually on a contract protecting $10 million of debt.
Maurice “Hank” Greenberg, who built AIG into the world’s largest insurer in his four decades leading the firm, bought ILFC in 1990 to diversify earnings. AIG has less need for the unit now that it has been stripped of its top credit rating and has shrunk through asset sales to repay its government bailout, said Cliff Gallant, an analyst at KBW Inc.
“Back when AIG was triple-A, ILFC made a lot of sense,” he said. “They had a competitive advantage in terms of cost of borrowing and so they could earn a higher margin on the exact same business as everyone else. They’ve lost that edge and AIG is not going to be triple-A for some time now.”
AIG is rated Baa1 at Moody’s, and A- at S&P.
ILFC contributed $86 million in second-quarter operating profit to AIG, the insurer said this month, down 53 percent from a year earlier, as it took an impairment charge on planes it planned to sell or retire from its fleet. Also this month, the company agreed to buy AerCap Holdings NV’s AeroTurbine unit, which disassemblies used planes to sell the parts as spares. The $228 million acquisition will allow ILFC to make money parting out its oldest aircraft, said Henri Courpron, ILFC’s CEO.
U.S. airlines may cut back further on flying as the slowing economy hampers their ability to boost fares. At the same time, carriers are struggling with an average jet-fuel price this year through Aug. 15 that’s 47 percent higher than the similar period of 2010.
Delta Air Lines Inc. and AMR Corp.’s American Airlines have trimmed growth plans for the final quarter of this year, and Southwest Airlines Co. doesn’t plan to increase flight capacity in 2012.
“If we have a serious double-dip recession, that could affect levels of air traffic and leasing rates and demand for planes,” Shanley said. “It could affect the fundamentals on the business side.”
The U.S. economy grew in the first six months of 2011 at the weakest pace since the recovery started in 2009. After almost stalling at a 0.4 percent annual pace in the first three months of this year, the economy expanded at a 1.3 percent rate last quarter, the government reported on July 29. The pace is “considerably slower” than expected, the Federal Reserve said this month.
Volatile markets make accessing capital “more difficult, but there’s a vast difference between September 2008 and the choppiness we’re having now,” S&P analyst Christopher DeNicolo said in a telephone interview.
“The market and other external things are going against it, so the value is there in the long term, but will you get that in the market today?” he said. “There not only has to be the capital markets being conducive but also the aviation markets, and those two don’t necessarily have to be going in the same direction.”