Doric Asset Finance founder Mark Lapidus talks A380s

2009/2010 saw the increased participation of export credit agencies (ECAs) in financing aircraft. What is your take on the current state of the aircraft financing market, the players in it, and the impact of the OECD's Aviation Sector Understanding (ASU)?

We lost business to the ECAs last year that we could have done commercially, so we are happy to see their pricing go up towards market rates. The ECAs should be the source of last resort, not first choice. For that, they ought to further improve and shorten the time someone can come to them for a deal without complaints so that commercial possibilities are fully explored. A 6 month lead time to come to ECAs for a deal is way too long and that will again cause an interference with what can be done commercially.

Doric Asset Finance currently has 10 A380s in service which is very interesting considering most lessors tend to be steering clear of the aircraft, especially after ILFC's recent order cancellation. What value do you see in your A380 fleet?

We like the A380 as an investment, but many people still do not get it and we are happy if it remains that way. The current value of our fleet must be increasing every time the oil price ticks up and airports get more congested.

ILFC have not shied away from big aircraft in the past, but their funding is a different challenge now and they are readjusting their business to fit the new world and probably when they deferred in mid 2009 their 2013-2015 early A380 slots to the back of the queue, the original order lost value and lustre for them. Delays cost money and at some point, if the delays are long enough, the original logic can get lost.

In any case, our business model is different as we are not a traditional leasing company that wants to be able to have "liquid" aircraft assets and trade often and achieve 20% equity returns. We fund our deals with more equity, usually repay most or all of the debt in the initial lease period, and see these aircraft as high-yielding, long-term, stable investments with a good upside chance and a limited downside residual risk.

What is the lease duration of these aircraft?

10 to 12 years.

Doric is currently ranked as the 38th largest lessor by fleet size, but the 15th largest by fleet value, which is an impressive gap. Is it part of Doric's strategy to pursue such high value aircraft? Why?

We are also ranked 6th largest for widebodies, and indeed that is our main focus. We see lots of people chasing sale and leaseback opportunities for narrowbody aircraft with rents going down to below 80 bps in some cases. That does not work for us. Such deals are more likely to generate a 5% return on equity, not 20%.

What instruments are you using to finance the A380s?

To date we have been able to source senior debt from traditional, asset lending banks, but as we grow and our funding needs grow, we are looking at capital markets debt, both EETC in the US and private debt placement to European institutions.

76% of Doric's in service fleet are widebodies while many of Doric's competitors opt for a higher proportion of narrowbodies. What is the reason behind this strategy?

Growth in air travel, resulting airport congestion, concerns about carbon emissions, aircraft manufacturing challenges, program delays, duopoly of large aircraft manufacturers (which perhaps is no longer the case with narrowbodies) and high oil prices have been and will continue to generate a shortage of modern widebody lift.

Look, 737s and A320s will remain a more liquid asset than a 777 and certainly an A380. They are smaller ticket items, easier to absorb into a new fleet, there are a lot more people who use them, but they will be impacted within this decade by credible competition from new manufacturers, from the A320NEO, from whatever Boeing decides to do to the 737 in response - probably its own NEO. But with larger planes, the Boeing and Airbus duopoly will remain for at least a few decades, but then even they struggle to make new widebodies.

Industrialisation of the A380 production remains a challenge, and that is after the initial delay of almost three years, the 787 is not yet in service - nearly 4 years late and not on spec, even stretching and updating the 747 has proven a lot more difficult than anyone anticipated, and everyone agrees it will be a minor miracle if Airbus manages the A350 without significant adventures.

Meanwhile, air travel growth races ahead. Yes, it can take a short pause from regular, "Black Swan", external shocks, but only to resume and catch up almost immediately. Looking back at both Airbus' and Boeing's global forecasts made in 2000 for 2009, they both were short by 10% to 15%. Neither did Goldman Sachs predict, when it coined the BRIC term in 2006, that China will overtake Japan as the second largest economy by 2011 in dollar terms. I think the growth will be greater than anticipated in the future - we underestimate the propensity and the need to travel for those who could not do it before, either for social, political or economic reasons. So we are happy to be contrarian and favour widebodies.

Can you comment on Doric's future orders? What is the composition of your backlog?

Our business model is not about speculative aircraft orders and current sale-and-leaseback opportunities with airlines provide sufficient business for us. Having said that, we told Airbus that we are interested in ILFC's A380 positions and would be pleased to hear back, even if at the back of the queue in 2016 or 2017 because I am certain it is not long before new A380 orders will start piling up.

Look at BA. 12 A380s ordered with options for 7 more - 19 aircraft. I am based in London and going to NY next week, obviously with my favourite airline. I had a choice of 12 daily departures on BA. Take away two A318s out of London City, the remaining 10 flights, of which 6 are 747-400s, can be beautifully rationalised with A380s. One does not need 9 departures between 18:00 and 23:00 out of New York as BA has now; less will do. And if BA's valuable premium customers tell it now that they want these frequencies, they also tell it when they want to be in the quiet upper deck on the 747. Once these same customers experience the upper deck of the A380 with BA service, they will tell BA that they only want to fly on the A380 - and I know what I am talking about here, I am one of these customers for BA.

Air France reported some EUR15 million per year savings replacing an A340-300 and a 777-200 on the NY route with one A380. By this rough measure, BA is leaving on the table perhaps USD50 to USD100 million extra profit on the NY route along by not having the A380s now. From what I know from my personal flying experience, all of BA's mega routes like Jo-burgh, San Francisco, LA, Beijing, etc. are splitting the 747s at the seams.

Today they have about 50 747-400s. With the industry's growth in mind, they will need at least 50 A380s, 19 is a joke, especially as the third runway at Heathrow is a known myth. And if you take into 3 account the planned savings from the economies of scale with Iberia and the amazing growth Brazil is leading in South America, IAG should be probably looking at 70 A380s.

Can you comment on how successful you think the B747-8 will be as a freighter or passenger aircraft? Is Doric interested in this aircraft?

We are very interested in the -8 Freighter for similar reasons we are bullish on the A380 as a passenger aircraft. This aircraft will also perhaps not have a competitor for a long time to come. Although, given the challenges with making it, it would be good to find out exactly what its capabilities are once it enters service.

Do you agree with ILFC's comments that the A321neo could potentially replace the B757? Why or why not?

Well, 757s are getting on, so something will need to replace them and with sharklets and improved fuel burn the A321neo will have a nice range. But I also think that A321s (and B737-900s) will take a larger share of the mainline narrowbody fleet going forward as growth will dictate a need for larger planes. I do not know though if for mainline operations, the heavier A321neo with greater range will always be the choice vs lighter existing A321. If you do not need the range, perhaps not.

Would you be less or more inclined to finance an A320 in the face of a neo? How will the neo affect Boeing and Airbus narrowbodies?

The debate about the neo and its impact on the A320 will rage on for some time yet. However, we are very happy indeed with our existing A320 investments. We are keen to do more A320s (or 737s), but it is the intense competition from various new lessors that makes it difficult, not the prospect of the neo. We have recently bid for an A320 and lost by a big margin. However, again our model is different; we are looking for long-term, 12 year leases, which are less common on narrowbodies. Over such longer tenor, the residual risk position is mitigated by greater recovery of capital over the longer lease and by the time value of money. So for our deals the main impact is not the neo but the surplus of new money and many lessors who are all chasing the same deals.

Do you see the C Series and the COMAC 919 becoming serious contenders in the narrow-body market? Would Doric be interested?

It is not for us at this point in time but, if the C Series overcomes the various technological challenges and delivers what it promises, it will have an impact, and so will the second generation COMAC. The first generation now built will also have some impact in terms of competitors selling fewer aircraft into China. But surely when they reload for the second generation aircraft, one that will be designed for global competition, the determined Chinese will be give everyone a run for their money.

Can you comment on the idea of the B787-10 being a candidate to replace the A340-300 or 777-200?

It is better to replace an A340-300 and 777-200 with one A380, like Air France did on the New York route.

It is hard to tell about 787-10 - we are still some years away from seeing it. I think 787 will be a great aircraft, once Boeing irons out all the issues - and I do not know if that starts with MSN 50 or MSN 100, but the 787-8 is a great replacement for 767. It feels that one should be replacing A340-300 or 777-200 with A350 or 777-300ER, otherwise one is downsizing his business - after all aviation is growing by 5% every year.

Do you see consolidation as a big part of the aircraft leasing industry's future?

If it did not happen already, maybe not for a while. We may even see more fragmentation if, for example, further pieces of ILFC break away.

How do you see the fuel environment being played out in 2011? Do you think this will be a boon or bust to the leasing industry?

I am not sure I can see a direct link between fuel costs and lease or buy decisions going forward. Obviously, high fuel prices have put some weaker airlines out of business and those leasing to them had problems. But generally, leasing portfolios held up very well in the recent downturns and in fact, attracted new private equity capital into the reasonably stable business of owning aircraft; as opposed to the more volatile business of running an airline - although some airlines have shown remarkable ability to make profits - Singapore, Cathay, and especially Emirates come to mind. Leasing companies' problem has been in refinancing debt, not in high fuel costs, and the revenue-generating, leasing side of the business has done ok. However, if the fuel price keeps on rising, more fuel efficient aircraft will become significantly more valuable, and the A380 leads the way here.

What markets are you hoping to target? Is targeting emerging markets, such as Asia and Africa, important to Doric?

Almost all of our current lessees are based in some of the world's fastest growing markets - Asia and the Middle East. We are interested in expanding our lessee base to South America in the next couple of years. However, besides the airlines' growth prospects, we have always been analysing the sustainability of their business models over time, which is an important part of our decision making process based on our long-term view of the market.