SMBC flying high in dynamic aircraft leasing market

Just weeks ago, aircraft leasing specialist SMBC Aviation Capital agreed to buy 80 of Boeing's newest model, the 737 Max, from the US giant in a deal valued at €7 billion. It was the largest single order for the aircraft from a lessor anywhere in the world. Boeing must think there is something in the water over here, because its biggest airline customer for the same aircraft is Ryanair, which plans to buy up to 200 of them.

SMBC's deal followed a larger order from Airbus for 115 A320s, which was the biggest placed to date by an Irish company for a single-aisle craft.

The two orders are valued at an eye-watering €16 billion or, as the company's chief executive Peter Barrett notes, come to "future commitments of close to $20 billion". The contracts, which will be delivered between now and 2022, marked a final break with a period of uncertainty that began when the financial crisis struck in 2008. Shortly after that, SMBC's then owner, Royal Bank of Scotland (RBS), decided it would have to sell the Irish business.

The British lender was in a bad way, it could not afford to own the aircraft financier as it was an operation that required a lot of funding at a time when funding was difficult to raise. Also, the Dublin-heaquartered company was focused on a global industry, while RBS was having to switch its attention to its home market.

“It’s a pretty traumatic time when your shareholder tells you ‘much and all as we like you, good and all as you are, we can’t own you any more’,” Barrett says. “A lot of your customers are wondering, a lot of your suppliers are wondering, ‘are you going to be able to deliver on your commitments, are you going to be there?’ Your staff are wondering, ‘what’s going to happen to the business, are we going to be sold, not going to be sold, are we going to be wound down’?”

He acknowledges that RBS Aerospace, as it was then known, was not by any means unique; many Irish businesses were going through the same thing. In any event, while the Scottish bank decided to sell, it also stuck with the company until it found a buyer. RBS formally began the sale process in late 2011 and a deal was done in the opening weeks of January 2012.

"It was a very sharp process," Barrett says. "There were three bidders vying for the business, RBS chose the current owners, effectively a consortium of the Sumitomo Financial Group and the Sumitomo Corporation, which are two of the biggest companies in Japan, " he says. "Both of our shareholders were involved in aircraft leasing and finance in various ways. They saw this as a great opportunity to go into it in a big way at the very top tier. We're rated number four in the world."

It offered high-growth opportunities, its fleet is young, which makes the craft themselves very tradable, and that fleet is made up of single-aisle Boeing and Airbus models, the “workhorses of the air travel industry”. In addition, many of the 90-plus airlines it counts as customers are in emerging markets. “It made a lot of sense at the time, it makes a lot of sense today,” Barrett says.

The last two years have exceeded his expectations. “We have placed two large orders in the last 12 months, so that’s really a significant vote of confidence in our business. We’ve expanded our team here, we’ve gone from 75 people to over 120 today, we’ve been investing in our offices, we’ve been investing in our IT platform, so it’s been good.”

The new owners let the Irish-based company get on with things. As Barrett points out, they bought it for its experience and expertise, so it does not make sense to second guess it. When it came to doing the Airbus and Boeing deals, the shareholder and the leasing company sat down and weighed up what ambitions they had for growing the business.

“Then we looked at supply and demand. We do a lot of deep analysis about what planes people are going to want, where they will want them and when they will want them,” he says.

He and his colleagues then went back to the shareholder and said they believed there was the potential to do a deal with the big manufacturers, to whom they then began talking. “These negotiations take time,” he says. “It’s like any sales process, there’s different positions that you want to take and that the supplier wants to take and we keep our shareholder informed.

“We would have set ourselves a very clear benchmark in order to make the deal viable for us. Obviously if we had not hit that benchmark, then we wouldn’t have done the trade. We got to that point and we told our shareholder that we thought we were in a position to bring a deal to fruition. It’s very much a partnership. We didn’t just turn up in Tokyo one day and say ‘good news, lads, we’ve just bought 100 airplanes’.”

In fact, the two sides communicate in a very deliberate and planned way, simply because of the differences in time, language and culture. “Communication is critical,” Barrett stresses. “You have to work on it rather than fall into it.” At the same time, it’s not completely alien. Companies in SMBC’s business have to deal with customers in all corners of the world.

Barrett has been going to Japan since 1990 and speaks a little of the language, although he admits that he recently discovered it was not as much as he thought when a Tokyo taxi driver delivered him to the wrong destination.

The aircraft now on order will have to be paid for as they are delivered. SMBC recently got a triple B plus rating from Standard & Poors, meaning the agency regards its debts as investment grade. That opens the door to tapping capital markets for at least some of the funds needed to foot the bill.

Lessors like the Irish company typically borrow about 75 per cent of the cost of their aircraft, although Barrett points out that the backing of a global financial institution allows it slightly higher leverage than this. Once they start arriving, they will have to be leased. SMBC did not have customers lined up for the Boeing and Airbus that it ordered last year, so its job now is to find them and then lease the craft.

“That’s a complex enough process, you have to spec the plane and make sure the legals are correct around it,” Barrett says. Once this is done, the company collects the rent and other charges .

Typically it trades a lot of craft by packaging the asset itself with the cash that the rent generates and selling it on to a financial investor. Since the company was originally founded in 2001, it has sold more than 240 aircraft valued at about $7.5 billion.

A lot of its lessee customers are in emerging markets. Shortly before Christmas it delivered craft to China and Mexico. It also supplies airlines in more developed economies that are replacing parts of their fleets.

“It’s mostly emerging markets – Latin America, Brazil, Mexico – those kind of places, where there’s a lot of demand and where economies are growing quickly,” he says. “There’s a direct relationship between GDP [gross domestic product] growth and air travel. If GDP is growing at 6 to 7 per cent in those economies, you are going to have growth in air travel of about 10 per cent.”

Is he concerned that growth in some of those markets is slowing down? Barrett says SMBC monitors countries where it is doing business, such as Brazil, Russia, India and China, very closely. “We have orders spread out over close to 10 years so this is not a short game, but clearly the challenges around emerging markets today are real.

“ I don’t expect that they are gong to last forever. If you look at the Asian crisis in 1998, emerging markets had a tough time but they bounced back and recovered. By the time we got to late 1999-2000, there were good strong growth rates back in those markets.”

What about the shift in China that is seeing it focus more on the domestic market and less on growing through exports to the developed world? “Air travel is a consumer product,” he argues. “If there is a focus in China to get more money spent in the economy, then it will flow through very positively for airlines.”

At the same time, he points out that other countries are now beginning to present opportunities. “Thailand is a great growth market,” he says. “Look at Indonesia, 4 to 5 per cent per-annum growth, 200 million people, and it’s an archipelago – so, how are you going to get around? There’s huge demand there, people are going on holidays, small to medium enterprises are beginning to travel between islands to generate demand, there’s more inward investment. That all drives air transport and, for that, you need airplanes.”

Barrett has been the company’s chief executive since 2004. He joined as chief operating officer in 2001, shortly after it was bought by RBS. Dómhnal Slattery, now boss of recently listed Avolon, originally set up the business as International Aviation Management.

The Scottish bank had only just taken over when the 9/11 attack on New York’s World Trade Center threw the world, and aviation in particular, into turmoil. Its new shareholder stuck with the company, which turned things around by aiding its parent in managing its exposure to airlines.

In 2004, it placed its first big direct order and now, excluding what it announced recently, it owns and manages more than 370 aircraft valued at more than $10.5 billion. Its operations generated profits of €265 million in 2013.

From Clonakilty in west Cork, Barrett originally qualified as a civil engineer and then joined Andersen Consulting – now Accenture – before applying for a job with GPA, where, along with many of his contemporaries, he cut his teeth in aviation leasing.

The company of which he is now chief executive is unlikely to follow its recent orders with further deals on the same scale, although he counsels that you should “never say never”. Given that they are open to it, it may go to the bond markets. “We are keen to develop our brand and our reputation in that market,” he says. “It certainly will be used to fund the pipeline that we know about.”

It will also be looking at other expansion opportunities. “Ordering airplanes is not the only way to grow your business,” he notes. “You can also do sale and leaseback. Airlines have large order books. They will need to finance those and we have been very active in helping them to do that over the last few years. And I think as their fleets grow, there will be opportunities for us to do big transactions with our airline customers.”

He is not ruling out acquisitions. "It's something that, as a big player, you have to be alive to," he says, but he warns that no one should bet on it either. CV Name: Peter Barrett Age: 48 Position: chief executive, SMBC Aviation Capital

Why is he in the news? The Irish aircraft leasing company recently placed record orders with Airbus and Boeing and also earned an investment grade rating from S&P, opening the door to the bond markets.

Career: Qualified as a civil engineer but joined Andersen Consulting – now Accenture – after leaving University College Cork before going on to GPA, the Tony Ryan- controlled aircraft leasing specialist that laid the foundations for the sector in the Republic and elsewhere. He joined SMBC – then part of RBS – in 2001 as chief operating officer.

Family: Married with three children.

Something that won’t surprise: He is yet another Irish aviation leasing chief executive to have served his time at GPA.

Something that might surprise: He’s interested in music, plays the trumpet and was once a member of a jazz band as well as a number of choirs.