Funding fleets

Leasing in the region is on the up, as airlines become more commercially minded. Local banks are also becoming more interested in leasing as an investment, writes Ian Sheppard.

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By  Ian Sheppard Published  September 6, 2005

|~||~||~|Aircraft leasing has never been a common option in the Middle East and North Africa. The vast majority of carriers are owned by cash-rich governments, which means that they have traditionally been aircraft buyers rather than lessors. The financial conservatism of Islamic Sharia’a law, which puts certain constraints on transactions, reinforces this tendency further. However, the rapid growth of airlines in the region and their increasingly business-like approach is driving up interest in leasing planes. Gulf Air was the pioneer of aircraft leasing in the Middle East. As far back as 1997, it helped the launch of Oasis International Leasing by completing a sale and leaseback deal for six planes with the Abu Dhabi-based leasing company. By 2001, 17 of its 32 aircraft were on leases. Other Middle East airlines are now catching up with Gulf Air in their use of leasing, and the proportion of aircraft on operating leases is slowly climbing. According to Airclaims’ CASE database, the Middle East fleet at the end of August totalled 619 Western-built jets and turboprops, and of these 15%, or 96 aeroplanes, were leased. This is more than double the percentage recorded in 1990, when only 7% of planes in the Middle East commercial fleet were leased, and up on 2000’s figure of 12.2% as well. However, the Middle East’s proportion of leased aircraft is still well below the global figure of about 26%. “The basic trend is upwards, but [the Middle East is still] behind the world average,” comments, Lance Hooks, account manager, Airclaims. As would be expected, the most protected and least commercially minded airlines in the region make the least use of leasing. Saudi Arabian Airlines, for instance, which has the largest fleet in the Middle East, owns all of its 115 aircraft outright. By contrast, nearly a third of Emirates’ current fleet of 78 aircraft are leased. The Dubai-based carrier has agreed deals with a range of financing companies for 20 of its aircraft, comprising four A330s and 16 of its 26 Boeing 777s. It also has outstanding orders for more leased aircraft including two A380s from ILFC. Aside from working with the major leasing companies, Emirates has also been active in developing new sources of funding. Last month, for instance, the carrier signed a US $119 million deal with China Construction Bank to finance an A340-500, which was its first ever deal with a Chinese bank. In June, the airline also successfully closed a US $550 million seven year sukuk, an Islamic finance bond, in Dubai. The issue, which was the first airline sukuk worldwide, was heavily oversubscribed. “The huge success of the issue is a testament to the investors’ confidence in Emirates and the UAE, and will lead the way for many more landmark deals in the future,” comments Richard Amos, general manager of the investment banking division of the National Bank of Abu Dhabi, which was one of six joint lead managers for the sukuk. In Abu Dhabi, leasing has been key to the fast growth of Etihad’s fleet, as it was the only way the carrier could get the planes it needed as fast as it wanted. As such, half of its 10 aircraft are leased. Gulf Air also continues to use leasing for eight of its ten Airbus A320s and its four 767s. Qatar Airways also has seven of its ten A300s on operating leases, as well as an A320 and four of its A330s. Other major users of leasing in the region include Royal Jordanian, which leases 10 of its 17 all-Airbus fleet, and Yemenia, which flies seven leased planes. Air Arabia also follows the global low cost model by leasing all of its five-strong fleet of A320s. However, the rapid growth of the Middle East fleet means that it is likely that more aircraft will be leased in the years ahead. Boeing, for instance, forecasts that 600 new aeroplanes will be required in the region over the next 20 years, of which about 60% will be widebodies. “There is such fast growth here,” comments Kostya Zolotusky, managing director, capital markets development at Boeing Capital Corporation (BCC). The traditional carriers in the region may also be pushed towards leasing in a bid to cut their costs, especially as they face the threat of low cost competition from Air Arabia, Kuwait’s Al Jazeera and other start-ups in the future. “Airlines [in the region] are looking at their balance sheets more now,” notes Zolotusky. Moves towards leasing in the region, and expanding fleets in general, are being hampered though, by the difficulties local bureaucracy creates. Flag carriers, which have government support and financing, are usually able to get round these problems. By contrast, private carriers, which are the ones most in need of leasing, often face the greatest problems. To take one example, in Jordan, only a very limited number of carriers are allowed to place aircraft on the register, which makes it hard for other airlines to start up operations and to get financial backing. The only way round the problem is to use an AOC from an obscure country, such as Swaziland. However, with lessors unfamiliar with processes there, deals take a lot longer to arrange.||**|||~||~||~|As such, most private aircraft deals in the region tend to be in cash, although this is not bureaucratically problem-free. Cabot Aviation, for instance, has successfully done deals with a number of flag carriers in the region, including an on-going sales and leaseback deal with Royal Jordanian. However, it has found it difficult to work with private carriers because of governmental restrictions. A deal to sell Fokker 100s to an Iranian carrier, for instance, fell through because of the time it took to get things moving. Such countries are “very difficult to deal with commercially,” complains Cabot’s CEO, Tony Whitty. “Bureaucracy makes everything so time-consuming.” This was less of a problem when the Middle East was buying planes and few other regions were. Lessors and aircraft sales companies were then prepared to put in the time needed to close a deal, as they had few alternatives. Now, however, with aviation picking up around the world, aircraft are back in demand, which means that Middle East airlines need to move as quickly as the competition to secure the planes they want. As Whitty says, the market as a whole has been “strengthening over the past six to nine months, so there is no problem placing [aircraft] elsewhere.” In particular, narrowbody aircraft are in hot demand with numerous low cost carriers setting up operations around the world using 737s or A320s. As such, the leasing rates for these planes are almost back to pre-2001 levels. In terms of widebodies, 767s are also now hard to find, and there are few A330s available in the market either. “There is an awful lot of demand,” says Zolotusky. “[Lease rates have] moved up dramatically over the past 18 months — something we would never have expected in 2002.” This strengthening demand is also causing leasing companies to get their chequebooks out again. At the Paris air show, for instance, the world’s two largest leasing companies both signed significant deals showing growing confidence in the aviation market. GECAS firstly ordered 20 Boeing 737s, with options for 20 more, and then signed up for 10 Airbus A350s and 20 Embraer 190s. ILFC, meanwhile, ordered 28 aircraft from Boeing, comprised of 20 737-700s and eight 777s. Alongside these two heavyweights, smaller leasing companies have also placed orders recently. Kuwait’s Alafco ordered 12 A350s, with options for six more, at the Paris air show, and Airbus also secured an order for five A350s and 24 A320s last month from the CIT Group. Boeing, meanwhile, has sold six 737s to Pegasus Aviation Finance Company and six 747 freighters to Guggenheim Aviation Partners in recent months as well. This demand is also attracting Middle East investors to the aircraft leasing market as well. Oasis Leasing and Alafco are leading the way, but the wider Middle East banking industry is also paying attention. For this reason, leasing companies are targeting the region more as a source of financing, particularly as high oil prices push up the reserves available locally. Aircraft leasing is also an attractive for Islamic investors, as it is a large and long term investment that easily complies with Sharia’a law. Reflecting this trend, Boeing Capital has recently added Dubai to the list of venues for its annual financial and investor conferences, alongside London, New York and Hong Kong. “The Middle East is becoming a major aircraft finance centre… [with] lots of capital being applied to aircraft,” says Zolotusky. “Lots of savyness is being acquired here by institutions… while [at the same time] airlines are tapping into global capital.” The growth of Abu Dhabi-based Oasis Leasing amply demonstrates the growing interest in leasing as an investment. In 2003, the company signed a $52.5 million revolving credit facility with a consortium of banks led by HSBC, to provide short and medium term financing. Deutsche VerkehrsBank was also involved in the transaction, as lead arranger, while Emirates Bank International acted as co-arranger. First Gulf Bank and Persia International Bank were senior lead managers. At that time, Oasis’s risk-adjusted lease book (RALB), which is used as an indicator in the market, was $227 million, after the company had recorded a 24% growth rate over the first five years of operations. Two years on, on 9th August, Oasis successfully completed a $218 million rights issue on the Abu Dhabi Stock Market, more than doubling its equity. The funds are now being applied to a deal to secure eight A330-200s for Etihad Airways, deliveries of which are due to commence in January. The company also says it is working on the purchase of a significant aircraft loan portfolio, which will be secured by aircraft less than five years old. Oasis declined a request for an interview, but according to a company statement this $900 million deal is at the documentation stage. “The completion of these two major transactions will significantly contribute to the company’s growth and reinforce our positive outlook for the rest of 2005 and for 2006,” Mohammed Saif Al Mazrouei, chairman of Oasis Leasing, said in a statement. “Rising lease rates for aircraft, fuelled by increasing passenger volumes and demand from new operators in emerging markets like India and China, will also drive business,” he added. Alafco, which is 89% owned by Kuwait Finance House, with the remainder held by Kuwait Airways, also has big plans for expansions. It presently owns 11 aircraft, but it has already ordered 12 A350s, with six options, and it is planning to expand even further in the coming years. “Our positioning for the future stipulates a strong growth trajectory to reach what we think will be a critical mass of 50 aircraft in the next four years,” says Alafco’s chairman & CEO, Ahmed Alzabin. The Kuwaiti leasing company will tap on either internal and/or external sources of financing for this expansion, but it expects no problems in finding the money. Its confidence seems well placed as well, as the growing interest in aircraft leasing means that more local capital is seeking opportunities in this field. This growing awareness may also push the more conservative airlines in the region to try out aircraft leasing as well.||**||

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