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Financing outlooks point to white tails for Boeing, Airbus

 - June 9, 2009, 9:22 AM

Notwithstanding Boeing’s announcement in April that it will cut 777 production from seven to five per month starting next June, the world’s two big airliner manufacturers appear out of touch with the harsh reality of their ability to fund aircraft deliveries this year, according to investment banks familiar with the lending environment. That at least appeared to be the consensus reached during the March 16 and 17 International Society of Transport Aircraft Trading (ISTAT) Conference in Phoenix, Arizona, from where Merrill Lynch and UBS each reported that a yawning funding gap will force Boeing and Airbus to modify their respective plans for maintaining production rates this year or find themselves building dreaded “white tails.”

“All but the manufacturers foresee a $10 billion to $20 billion funding gap, equivalent to 15 to 30 percent of 2009 forecast production, mainly attributable to much lower commercial bank funding,” said the UBS report. Merrill Lynch, meanwhile, cited projections for the same 15- to 30-percent cut in production rates, but by mid-2010.

“The OEMs are still wearing a brave face when confronting the economic downturn,” said Merrill Lynch. “This may because both Boeing and Airbus need to feed over-budget, bloated and behind-schedule R&D programs with cash. The promise of “assured” cash flow may be blinding the OEMs to the reality that the world is in the worst contraction of the jet age and possibly since the Great Depression.”

Of course, Boeing changed course with its plans for a 29-percent cut in 777 production starting next year, and in an April 13 research note UBS said it viewed the move positively because it mitigates cash-flow risk. UBS added, however, that rates must move still lower and that “we don’t think Boeing works on a relative basis prior to an improvement in airline traffic.”

Although earlier in the year Boeing Commercial Airplanes CEO Scott Carson admitted to “a lot of activity in terms of people wanting to defer aircraft,” he said the numbers of airplanes involved and the relatively brief postponements have left him and the rest of Boeing management “feeling good about 2009” and “cautiously optimistic about 2010.”

In fact, a UBS fleet survey, also dated April 13, showed that financing conditions had actually worsened from January and that nearly one third of respondents would likely defer the delivery of aircraft now on order. The survey also showed, however, that a similar percentage of respondents would attempt to move their deliveries to earlier slots should they become available–seemingly supporting Boeing’s assertions that a mobile backlog will allow it to “backfill” delivery slots left vacant this year. But UBS also noted that only about half its respondents indicated that they had secured financing for this year, while Boeing has said that virtually all its customers had secured financing for their 2009 deliveries. “Overall, financing looks to have deteriorated from our prior survey, with now 60 percent [of respondents] indicating that they don’t believe financing is currently available,” said UBS.

By the time of the UBS survey Airbus hadn’t changed its position that it would produce a “similar” number of airplanes in 2009 compared with the 483 it delivered last year, although CEO Tom Enders conceded that he would not exclude further cuts “if the need arises.” The company has announced plans to cut production of its A320 family by two airplanes per month starting in October, however, and it suspended a planned increase in A330/A340 production.

Whatever they eventually build by the end of the year, both Airbus and Boeing will no doubt need to rely more on their own financing capacity and help from export credit agencies to pick up slack left by an anemic level of straight commercial bank financing.

Boeing Capital has placed a $1 billion target on the amount of financing it will have to supply this year, while the U.S. ExIm Bank has pledged to support delivery of 150 to 175 Boeing aircraft. Estimates of the level of support expected from European export credit agencies for Airbus airplanes range from 200 to 300, or roughly half of all deliveries from the consortium. 

It is interesting to note that the financing community has awakened to the fact that the OEMs finance only about 10 percent of their deliveries,” said Merrill Lynch. “We are confident that OEM financial support of aircraft deliveries will go up, thus Boeing Capital’s goal of $1 billion in 2009 appears a bit optimistic at this point. It seems likely that it will be [double to triple] Boeing’s guidance.”

Notwithstanding the difference in credit agency support for Boeing and Airbus airplanes, neither company can credibly say that they won’t build any white tails if they don’t cut production rates this year, according to Merrill Lynch. “White tails are bad for everyone: they put pressure on aircraft values, suck up working capital and just add to the growing oversupply of aircraft,” said the Merrill report. “Given the unrealistic view at OEMs, it appears white tails are inevitable.”

During the March ISTAT conference, one of the OEMs estimated a funding gap of $5 billion or $6 billion, while the U.S. ExIm Bank representative suggested it stood closer to $4 billion or $5 billion. By contrast, a panel consisting of some key members of the aircraft leasing community came to a consensus that the gap would fall between $10 billion and $15 billion, according to the Merrill report.

All told, the market will require $65 billion to $70 billion in funding to support the 2009 Boeing and Airbus delivery targets, which total between 950 and 1,000 airplanes. That money simply will not materialize, according to UBS. The firm cited contraction in western European commercial bank funding–from between 30 and 40 active players to just 10 to 15–as the biggest obstacle to funding deliveries.

According to UBS, U.S. airlines face a particular disadvantage due to their lack of access to export credit agency (ECA) support and “significant upcoming financing needs.” It also said lessors have seen increased interest in sale-leaseback transactions from “high-quality” airlines due to funding difficulties and a desire to protect cash flow. Outside of the Chinese banks, which will fund local deliveries, regional bank funding has not increased meaningfully, added UBS, and while the ECAs have noted that liquidity has improved since the fourth quarter, banks have already run through a significant portion of their available capacity for 2009. Meanwhile, ExIm has had to directly fund a few deals because the parties in question could not obtain outside financing even with ExIm guarantees.

Nevertheless, during the first quarter of this year, Carson’s confidence did not appear misplaced, as Boeing Commercial Airplanes’ delivery rate rose 5.2 percent from a year earlier, to 121. Although at the same time the company registered four more cancellations than new orders and last year’s fourth-quarter strike forced a shift of several deliveries to the first quarter, the period proved more lucrative than analysts predicted. Aircraft manufacturers get paid the majority of the purchase price of each airplane at the point of delivery.

The bulk of the deliveries came from the 737 line, which produced 91 airplanes during the quarter. Boeing also delivered 23 B777s, four 747s and three 767s.
All told, Boeing projects it will deliver between 480 and 485 airplanes this year. Carson has said the company likely would not need to consider cutting production until next year and by 10 percent at the most.