OEM finance risk on the rise
Regional-aircraft manufacturers face the prospect of increased financial risk in coming years, despite having been able to reduce sales costs since the mid-1990s, according to Moody’s Investor Service. As the economic recession continues, the New York-based credit research agency said such companies might not escape global requirements for more financial assistance to operators. They also face greater risk if customers take advantage of commitments made for future assistance to buyers of regional jets.
Ultimately, increased exposure could dilute original equipment manufacturers’ own credit quality, said a Moody’s report. While manufacturers of larger airliners with more than 100 seats face the greatest exposure, Moody’s senior vice president Tassos Philippakos predicts that the regional sector “may see their participations [in customer financing] rising during this airline downcycle.”
He conceded that manufacturers have been “steadily winding down” their exposure, but questions whether they can continue the trend. Moody’s worldwide survey of 22 OEMs (including engine and component manufacturers) shows that regional aircraft suppliers reached a peak net exposure of almost $7.5 billion in 1996, compared with about $4.7 billion at the end of this year. “Our impression is that manufacturers of regional aircraft have generally been working hard to contain their exposure to their customers,” said Philippakos. “[But] market realities will probably make it challenging to accomplish this.”
The research firm has noted a number of factors that it argues help to explain why regional OEMs have not been eager to lend money to customers. Constrained by the country’s low credit ceiling, Brazil’s Embraer has experienced difficulty becoming “an effective lender” because borrowing costs are high, which makes it expensive to tap global capital markets. In the U.S., Raytheon Aircraft “expended much effort to prune its exposure in its efforts to reduce on- and off-balance sheet liabilities,” said Philippakos. Both Raytheon and Europe’s ATR have been handicapped by “lackluster” interest in turboprops.
Also in Europe, Moody’s points out that BAe Systems’ risk likely will decline over time; it has taken strong measures twice. Having previously written off £1 billion ($1.57 billion) against its BAe 146/Avro RJ program, the company paid £38 million ($59.7 million) for £2.4 billion ($3.77 billion) of insurance coverage on lease income from regional aircraft. Late last year the manufacturer abandoned such production, its marketing of the Avro RJX development having been overtaken by recession.
Furthermore, the industry expects to face difficulty collecting due payments and will suffer from reduced used-aircraft prices. “The sector has been somewhat affected by provisions taken against the gross exposures because of anticipated collection problems or lower collateral valuations,” said Philippakos. “For example, Bombardier at the end of its fiscal year 2001 posted provisions related to aircraft financing [including business jets] of C$283.5 million [$180 million].” The report makes no mention of other current or planned regional-jet manufacturers (including Fairchild Dornier) that were not included in the global survey.
Moody’s has concluded that such developments have gradually reduced the regional aircraft sector’s exposure to aircraft finance risk. But the credit agency warns that there might be trouble ahead: “Down the road, exposure may be forced up, at least for some manufacturers of regional jets. Moody’s has anecdotal evidence suggesting that there are significant commitments of financing, which, if exercised by the airlines, could increase the exposure of certain manufacturers materially.”
The agency predicts that the total commercial aircraft sector’s exposure will be almost $14 billion by the end of this year.
“Manufacturers will have no choice in their efforts to secure deliveries but to become financiers of last resort, with possible detrimental effects on their credit quality,” argues Philippakos. He identified three forces driving market trends: “The first is [airlines’] poor cash-flow generation and [their] inability to fund a reasonable portion of capital-spending requirements. The second occurs when traditional lenders–banks, financial institutions and security investors–become reluctant to [finance industries with] very weak credits. [Third], a new factor working to broaden exposure to customer financing [is] Boeing’s strategy to rapidly expand its capital subsidiary, Boeing Capital, [which] may pressure all players to follow suit.”
The report points out that significant participation in financing can affect OEMs’ creditworthiness because leverage of their balance sheets or liquidity dilutes borrowing capacity, airline customers usually carry high credit risk and declining residual values (the basis for security of loans) reduce the collateral value of aircraft.