All The Trouble Isn't In The SkyKevin Kelly and Michael Oneal
Ryder Chairman M. Anthony Burns doesn't talk much about aircraft leasing these days. Who can blame him? When Ryder System Inc. plunged into the business in 1984, Burns thought it was a sure bet. Leasing companies were soaring, and Ryder eagerly bought a fleet of narrowbody aircraft, including aging Boeing 727s and McDonnell Douglas DC-9s. By 1989, Ryder had leased 47 planes to such expansion-minded carriers as Continental, Midway, and America West. Business was booming.
Then the airline industry crashed. Ravaged by recession and high fuel prices, Midway Airlines Inc. and bankrupt Continental Airlines Inc. stopped lease payments to Ryder. Its leasing unit began losing $1 million a month, while an aircraft glut, caused partly by the demise of Eastern Air Lines Inc., eroded resale values. In February, Burns wrote off the business, which handed Ryder a $25 million loss for 1990's fourth quarter.
STAGGERING LOSSES. Burns may have stubbed his toe, but he certainly isn't alone. With the airline industry in a serious slump, the aircraft finance business faces a major shakeout. "The market at this point for virtually any aircraft is depressed," says Kenneth A. Raff, managing director of fleet planning at American Airlines Inc. Most at risk is anyone with money in older narrowbody craft, which are less economical than newer widebody planes. That's particularly true of lessors with old planes at the growing roster of shaky airlines.
Losses from leasing transactions could be staggering. More than 700 planes are leased to the most troubled airlines by scores of leasing firms. The biggest names in the business--Ireland's GPA Group and International Lease Finance Corp. (ILFC), a unit of American International Group--aren't that involved in the market for aging, narrowbody planes. But some other heavyweights are. Polaris Aircraft Leasing Corp., a unit of General Electric Capital Corp. and the syndicator of six public aircraft limited partnerships, has broad exposure. Smaller syndicators such as Pegasus Capital Corp. and Integrated Resources Inc. also have portfolios of planes at troubled airlines (table).
Some individual investors are exposed, too. They poured $1.8 billion into 17 public limited partnerships syndicated by leasing companies, and millions more into private deals. During the go-go `80s, some of these partnerships leased planes to airlines of dubious credit quality in order to generate junk-bond type yields. Many partnerships "invested in a lot of old, crappy planes," says Scott Hamilton, editor of industry newsletter Commercial Aviation Report. "Most investors won't get their money out."
GOLD MINE. Then there are the banks. As leasing companies hit hard times, banks that lent to them risk not being able to recover their money. Falling plane prices are reducing the value of their collateral. ILFC President Steven Udvar-Hazy estimates that as much as $4 billion worth of bank loans are at risk.
Just a few years ago, such a slump seemed impossible. In the mid-1980s leasing was like mining gold. With fuel prices low and new planes in short supply, older jets were rising in value. Lessors and banks rushed in to buy the planes and lease them back to airlines.
But last year, manufacturing capacity caught up with demand. Passenger traffic began to slow. And as planes flooded the market from the bankruptcies of Braniff and Eastern, a glut developed, cutting prices of older 727s and DC-9s. It didn't help that a new national noise standard limited the useful life of old, noisy planes--unless the owners added pricey kits to quiet the engines.
Then war and recession battered the industry and aircraft values. Airlines with $2 billion in fourth-quarter losses trimmed schedules and grounded planes. Used aircraft on the market shot to 837 by Feb. 1, up from 200 in 1989. The price of a 727-200 has fallen 20% since last summer, to $3.5 million (chart).If all this weren't enough, leasing companies got another jolt in January, this time from the judge in the Continental bankruptcy. Until now, an airline in Chapter 11 has had to resume lease payments within 60 days of filing. But Continental persuaded Bankruptcy Judge Helen S. Balick to distinguish between two kinds of leases: those used by airlines to expand fleets and those used by airlines to raise cash by selling planes they already owned and leasing the planes back. The judge ruled that the second type of lease isn't protected by the 60-day rule. Continental, which has many of these leases, doesn't have to pay the rentals. The ruling also prevents leasing companies from repossessing their airplanes.
Lessors, who thrived on such sale and leaseback deals, are now shaking in their boots. The ruling has been appealed. But in the meantime, Pan Am Corp. has asked the judge in its bankruptcy case for similar treatment, hoping to avoid $33 million in missed lease payments.
VULNERABLE. Despite the turmoil, lessors have to be viewed selectively. GPA, ILFC, and GE's Polaris unit are the industry's dominant players. But unlike the other two, Polaris has specialized in old planes. It has 103 aircraft at the nation's most troubled airlines and 64% of its jets don't meet current noise standards. Polaris President Marc P. Desautels insists GE's return on Polaris assets hasn't declined. But as part of an attempt to limit its exposure to the aircraft industry, GE is trying to sell half its stake in Polaris.
Still, Polaris has plenty of resources. Though halted lease payments have cut into cash flow, Desautels says lack of debt and a strong marketing team will shield it from the downturn. With future access to capital limited, Desautels figures airlines will salivate over his inexpensive planes. "Low cost capital assets have a great deal of merit in a capital-starved industry," he says.
But smaller companies with older fleets can unravel quickly. Pegasus Capital Corp. was formed in 1988, just as jet values were soaring. The company built a portfolio of 41 aircraft and syndicated two limited partnerships. Its formula was simple: Pegasus would buy an airplane with 100% financing from a bank. It then sold the jet to a limited partnership of individual investors and repaid the lenders. It collected fees from the partnership, including an up-front management fee. Investors were promised a 12% return, based on lease payments and estimates of the jets' residual values.
Pegasus made lots of money. But unfortunately, it invested heavily in Continental planes. When Continental filed for Chapter 11, Pegasus got nailed. Sources close to the company say Pegasus, with $400 million in debt and only $25 million in equity, had leased to Continental a number of planes it had bought with bank bridge loans. But it had not yet been able to raise money from a new partnership it was forming to pay the banks back. The sources say Continental stopped payment on its leases and Pegasus couldn't meet loan demands. Last fall, two of Pegasus' three principals unloaded much of the company to International Air Leases Inc., a Florida lessor, for $2.5 million. Pegasus' banks are still working out over $100 million in loans.
Following a lengthy interview with Pegasus President Richard S. Wiley, BUSINESS WEEK received a letter from the company's general counsel claiming that the magazine's information about Pegasus was incorrect. The letter did not challenge any specific statements.
Most leasing executives are hoping that aircraft values will recover as the airline industry mends. Others echo Desautels by saying that cheaper planes will be even more attractive to airlines that can't finance new jets. Some experts, however, think that hundreds of planes may be getting so old that they are simply uneconomical. United Airlines Inc. Vice-Chairman John C. Pope says that older 727s and DC-9s can still fly safely, but "the maintenance cost is what gets you."
FEW CHOICES. Even if the market rebounds, the industry's capital crunch promises to slow activity. And until the question of lease security in bankruptcy court is resolved, don't look for many sale-leasebacks. In the 1980s, buyers of old jets had their choice of eager lenders. But now, says GPA President Maurice A. Foley, "the withdrawal of the Japanese and the poor health of many U. S. banks is having a major impact."
In short, the leasing bonanza is over for now. Many old planes could simply end up in junkyards such as that run by Memphis Group Inc., a firm that buys planes for scrap. Even that may not pay, though. Memphis Group's Steve Manley notes that "there are so many planes available, the parts market is being filled by existing inventories." That's just one more piece of bad news for leasing companies desperate to find a final resting place for tired, old aircraft.
CAUGHT IN A DOWNDRAFT With values for the oldest commercial jets plummeting, many aircraft lessors are feeling the heat. Some have significant numbers of planes at the nation's most troubled airlines: Eastern (in liquidation), Continental and Pan Am (in Chapter 11), Trans World Airlines and Midway (in arrears on lease payments). Several carriers have stopped making lease payments. Here are some exposed lessors and the number of jets they've placed at carriers with financial problems GENERAL ELECTRIC 140 PLANES POLARIS AIRCRAFT LEASING: Polaris is king of the used aircraft lessors. With 103 planes at troubled airlines, it has heavy exposure. But that's offset by low debt and strong marketing GE CAPITAL CORP.: Usually a long-term lessor of newer planes, GECC has 37 jets at stricken carriers. It is stuck with several Eastern 727s. Pan Am has returned two 747s INTEGRATED RESOURCES 33 PLANES Leasing unit of bankrupt finance company has lots mf narrowbod- ies, which are less valuable than larger planes, at Continental PEGASUS CAPITAL 18 PLANES Broad exposure with old planes. Sold out to International Air Leases, a Florida lessor, just as market tanked McDONNELL DOUGLAS FINANCE 40 PLANES Helps finance the sale of Douglas planes. Holds leases on many old Midway and Eastern aircraft ELECTRA AVIATION 19 PLANES British lessor with long-term finance leases. Lots of planes at Eastern and Continental, but mostly widebodies POTOMAC CAPITAL 15 PLANES Unit of Potomac Electric. Exposed to Continental and TWA. Like Electra, emphasis on more valuable widebodies helps CHART BY PAUL GRANGE/BW