The AIG Trifecta Part II – ILFC

As promised, the rest of the AIG trifecta. Part II is ILFC or International Lease Finance Corporation, an AIG subsidiary.

This part of AIG has been quietly “discovered’ by the mainstream press over the past year. So many of you may have read about it. LINK. LINK. (Very alarmist, not particularly insightful).

ILFC leases airplanes. Over 1,000 of them. They are the leaders in the business, which is dominated by themselves and GE Capital Aviation Services (a division of GE Capital).
Before you sigh and say “Oh no, the airlines are such terrible businesses, o dear me”, try to remember when they WEREN’T such terrible businesses. You can’t, can you? (unless you are really old, of course).

That’s why leasing exists and is so big for ILFC and GE. If the airline goes broke (as they periodically seem to do), the lessee takes its airplane back home and goes to play with someone else.

This has historically been good business. ILFC has been doing it since 1973, so they’ve been through ups and downs. This isn’t their first recession. The business is profitable: the company booked profits of $440 mm in the first half of 2009 and hasn’t registered a losing quarter as far as I looked back. LINK to 10-Q (if can you read these things).

So what’s the problem? Funding is the problem. ILFC would basically fund its operations two ways: commercial paper and notes (mostly medium term). It made sense, a typical airplane lease is three to five years, and so funding the purchases the same term is what would seem to be logical.
ILFC mid-term notes were even distributed on a retail basis as ideal investments for income-seekers looking for a bit more than the local bank offered (nothing strange with this, Ford, GMAC, GE, Dow and others do the same thing).

But when both the commercial paper and bond markets dried up, ILFC found itself in a bind. Notes were maturing at a quick pace and to boot they were a “part’ of AIG which was and to a point continues to be, financial caca (no touch!). The company was prepared (with credit lines) for temporary disruptions in the market, but this was and is and ongoing business. There were/are airplane orders in the pipeline, with which ILFC had to comply. These planes have airlines wanting them, but there is a cash imbalance in the process.

Mama AIG, now in government hands (kind of) has been both helpful and hurtful. On one hand AIG Funding lent ILFC $1.7 billion so it could keep up with maturing debt obligations and the purchase orders for new aircraft. (Taxpayer money? Not really, but the talking heads complain).

And AIG hasn’t been requiring dividend payments. But on the other hand AIG has been trying (unsuccessfully so far) to sell or otherwise dispose of this unit and that has undermined ILFC’s possibilities of obtaining stable (and inexpensive) sources of funding. Who is going to lend ILFC money (i.e. buy bonds), if they’re not sure what is going to happen to the company?

So there’s a kind of catch-22 going on with this. The press is focusing on the upcoming maturities as some kind of “impending doom”. Which I guess it could be. The notes are coming due constantly, as will the credit line (in 2010 and 2011).

However, if there is any rationality left in the market, this company should be able to come up with a solution, even if it is more stand-by financing by Mama AIG or even the government. AIG has committed to fund ILFC through August 2010.

A restructuring “a la CIT”, in which debt is capitalized wouldn’t seem necessary, since ILFC is far better capitalized than CIT. Not that it couldn’t happen, though. The ideal would be a return to the credit markets, which are thirsty for new paper. That return, however has been running into the concerns raised above about ILFC’s ownership.

The investment opportunity here is, of course, in ILFC notes and bonds, of which there many different options. The maturities are from now through 2013 and the yields currently around 11-13%. There are some large liquid issues, plus those retail “notes” that can sometimes be snapped up on the cheap, but which probably don’t have a good secondary market (so, you’ll have to hold them to maturity).

I’ve been a buyer, because frankly I can’t see a scenario where a Chap. 11 or a forced restructuring of this company makes sense. More likely they’ll come back to the credit markets sooner or later (as did Ford Credit) and get back to business.

It would be a shame that those shiny new 787 Dreamliners that Boeing is making should gather dust in the showroom.