=20 ---------------------------------------------------------------------- This article was sent to you by someone who found it on SF Gate. The original article can be found on SFGate.com here: http://www.sfgate.com/cgi-bin/article.cgi?file=3D/news/archive/2003/01/14/f= inancial1005EST0053.DTL ---------------------------------------------------------------------- Tuesday, January 14, 2003 (AP) Airline woes to hurt financing J. LYNN LUNSFORD, and (01-14) 07:05 PST (AP) -- SUSAN CAREY The Wall Street Journal The hardball tactics of troubled airlines may turn a popular form of jet financing into trouble for some of the nation's biggest companies. And that could make it tougher for the airline industry itself to get the cash it badly needs. During the 1990s, banks, insurers and cash-rich companies flocked to get= a piece of the action financing expensive new jetliners because it offered both potentially lucrative returns and tax advantages. Now, under terms being offered by UAL Corp.'s United Airlines and those won by US Airways Group Inc. -- both operating under bankruptcy-court protection -- many of these investors are finding the downside risk to these deals can be huge. In some cases, United has offered its creditors deals that value aircraft at 30 cents to 50 cents on the dollar. Their only recourse if they choose not to accept the terms: repossess the planes and take their chances in a market that already has forced more than 2,000 unneeded jets into storage lots in the desert. The activity in the wake of the bankruptcy-court filings is yet another rude awakening for investors who have lost billions in the imploding "dot-com," telecommunications and energy markets. For some companies, like Boeing Co. and General Electric Co., both of which have substantial aircraft-financing units, losses on airplane investments during what has become the deepest aviation slump since World War II is no surprise. The twist this time is that it is hitting some investors whose main business has nothing to do with airplanes. Walt Disney Co. surprised some of its stockholders late last year when it announced, after United sought bankruptcy-court protection, that it was taking a noncash charge of $114 million to write down losses on 11 planes that it has on lease with three airlines, including United, Delta Air Lines and freight carrier FedEx Corp. A number of other companies, including Bank of New York Co., Morgan Stanley, Pitney Bowes Inc. and John Hancock Financial Services Inc. made similar announcements, with dollar amounts ranging from $35 million to $240 million. And those are just a few of the dozens of companies with aircraft holdings. Last week, energy holding company Edison International said that its financial-services unit, Edison Capital, would take a write-down of $35 million against fourth-quarter earnings related to two aircraft it leases to United. The parent of Southern California Edison said United has proposed restructuring the leases on both planes that would result in Edison Capital "receiving no further rent payments." A spokesman for Edison International couldn't comment beyond the information made in a regulatory filing. The setbacks could just be beginning for other creditors, depending on what happens with United. "If United can pull off all of what it wants to do with its aircraft leases, it could be Armageddon out there for anybody who has an airplane under lease to one of United's competitors," predicts one airline executive. According to industry figures, more than 1,300 airplanes sold by both Boeing and Europe's Airbus since 1995 have been financed through so-called leveraged leases. These leases are in many cases held by companies seeking to reduce their taxes by taking advantage of the accelerated depreciation allowed on aircraft. Because of declining demand during the past two years, aircraft values have declined 20 percent to 40 percent, depending on the model. Some people in the industry fear that those values could plummet even further as airlines in and out of bankruptcy court continue to pound on creditors to lower their payments. "A number of people who entered this business in the 1990s, thinking that these structured financial instruments eliminated the risks, are finding that that was an ill-considered conclusion," says Richard Bittenbender, an analyst at Moody's Investors Service who follows airline financing. Part of the pain among the noncore players in the aviation industry is self-inflicted, say those who have weathered previous aviation downturns. Steven Udvar-Hazy, chairman of Los Angeles-based International Lease Finance Corp., a unit of American International Group Inc., compared the situation in the aviation industry with the "cleansing process in the jungle," in which faint-hearted investors will be washed out of the market for several years. ILFC, which has $27 billion in aircraft leases, has taken no charges so far, largely because the bulk of its airplanes are on more-lucrative operating leases to airlines outside the U.S. None are on lease to United or US Airways. Henry Hubschman, head of GE's aircraft-financing unit, says his company was losing financing deals in the two years prior to Sept. 11, 2001, when the bottom dropped out of airline travel, to new players throwing cash into the market "as if the trees grew to the sky." The fallout could make it tougher in the future for some airlines to finance their planes, says longtime airline analyst Julius Maldutis, now an independent consultant. Investors, he reckons, will pay closer attention to the credit ratings of the airlines instead of focusing simply on the relative value of the airplanes. Leveraged leases became popular in the '90s as both investment banks and airlines saw an opportunity to draw in new investors and to lower financing costs. In a leveraged lease, an equity provider puts up 20 percent of the cost of the airplane, enabling it to have ownership of the airplane. As owner, the equity provider can get the tax benefits of depreciating the aircraft over a seven-year period. The remaining 80 percent of the loan -- the debt portion -- is borne by the airline, which finances all or part of it by borrowing from investors. Since the mid-1990s, one of the most popular forms of this financing has been so-called enhanced equipment trust certificates. EETCs are usually issued on a pool of airplanes, normally 20 or so. The notes are issued in groups called tranches. The B, C and sometimes D tranches typically carry higher interest rates than the A tranche because they stand below it in the debt-repayment pecking order. When most of these certificates were initially sold, they were priced at 1.25 percentage points to five percentage points above comparable Treasurys, for periods ranging from five to 20 years. In leveraged leases involving EETCs, the 20 percent equity holders are t= he last to get paid -- and the first to get wiped out -- when the market turns bad, hence the string of write-offs from the likes of Disney and others. Some airlines such as Continental Airlines have 75 percent or more of their new airplanes financed with such instruments; at America West Holdings Corp., virtually every airplane. US Airways used EETCs to finance most airplanes it has taken since 1995. One of the last big aircraft financings, a $749 million EETC transaction completed last August by Northwest Airlines, would be much more difficult to do today, many in the industry agree. Stephen Kane, a portfolio manager for Metropolitan West Asset Management LLC, a closely held debt-securities firm that owns some UAL EETCs, says aircraft values would have to fall by about 60 percent before the A tranches would be impaired. So far, those values have tumbled by only about 20 percent since the September 2001 terrorist attacks. "Almost no matter what United does, (those holders) will be made whole," he says. "The real damage will be" to the B,C and D holders. According to people familiar with the deals, in recent airline bankruptcy-court filings (Midway Airlines and America West) the majority of EETCs were unimpaired. At US Airways so far, six out of seven EETCs are performing, and the junior investors on the seventh appear likely to come out almost whole. Mr. Kane said United "is doing what you'd expect in this situation." But investors are fretting because the company hasn't clarified its fleet strategy and is being "very coy and somewhat coercive," he said. A consultant to United responded: "We are simply trying to do deals based on the market conditions, consistent with our fiduciary duties to the bankruptcy estate." Until Feb. 7, the carrier needn't make payments on its planes; after that it must decide which planes to reject and become current on lease payments on the remainder or risk having them seized by owners. =20 ---------------------------------------------------------------------- Copyright 2003 AP