Insight Monday 13 July 2020: Is Boeing Capital the Key to the 737 MAX future?

News:

Several carriers are seeking financing for their Boeing 737 MAX orders, but in the midst of the current global pandemic are finding that lenders with terms that were available pre-crisis are virtually impossible to find. That, of course, changes the economics of a new aircraft, and airlines like American are reportedly asking Boeing for help in arranging appropriate financing.

Traditionally, the leasing companies would be the market maker for new aircraft, with sale and leaseback transactions when airlines can’t obtain financing. But in the case of the MAX, leasing companies are worried about future demand, with many reducing their order books for the type in the wake of two crashes and an extended grounding. Confidence in the MAX was weaker than for its competition prior to the global pandemic, which has resulted in a decimated airline industry and little confidence in the market overall in the near term.

As a result, finding financing is difficult, even for aircraft that have already been built and were scheduled for delivery a year and a half ago. Airlines find themselves at a decision point. Can they afford to take on debt for new aircraft at higher rates than they have been planning given the impact of the pandemic on their balance sheets, or are they better off canceling orders and sticking with older aircraft?

Analysis:

Fuel prices have remained low throughout the global pandemic, and used aircraft are becoming available that could fill the need for capacity at a lower cost than new aircraft. The trade-off between capital cost and operating costs is different for an airline that was highly profitable than for one that has aircraft grounded and is bleeding cash flow.

Given the length of the grounding and the nature of aircraft contracts, airlines now have the right to walk away from their 737 MAX commitments with no penalty. That places Boeing’s skyline at considerable risk, especially since 615 orders have already been canceled for the MAX this year.  Boeing can’t afford more.

Since banks and leasing companies are looking at the residual value and service life of the MAX more skeptically than before, rates are rising and virtually no airline has the cash on hand to purchase new aircraft without financing given the pandemic induced losses. So airlines have a decision to make — do I continue to take new and more efficient aircraft, or do the higher financing rates make deliveries prohibitive.

Insight:

The backstop for Boeing is Boeing Capital, the company’s financing arm. Boeing can obtain financing at better rates than airlines, although it too is bleeding cash. But if Boeing doesn’t move airplanes into customer’s hands, it will end up in a situation with too much inventory for too few customers, and need to curtail production. That would decimate the supply chain and company profitability.

Boeing will likely need to step up and finance new aircraft for key customers, or it will lose additional commitments for the MAX, a trend that it cannot currently afford to have continued. With more than 450 new 737 MAX aircraft awaiting delivery to customers, some of which are no longer wanted by those customers, Boeing has a major problem. If those aircraft can’t be competitively financed, airlines won’t take them.

Boeing capital is the backstop. Boeing will likely need to either provide support to financial institutions in the form of residual value guarantees or even finance the aircraft for airlines directly if the MAX program is to flourish. It looks like the backstop will be needed in today’s environment if the MAX is to have a successful return to the market.

Financing the grounded fleet of 450 aircraft would likely take an additional $12 billion in capital for Boeing beyond its current operating needs. That might require them to do the unthinkable – accept a bailout that would negatively impact shareholders. The alternative of residual value guarantees is also risky – just ask Bombardier.

The Bottom Line: The current financial conditions for airlines have made traditional financing at favorable rates impossible. Without a favorable rate, the trade-off between new and now lower-priced used aircraft moves in the opposite direction. Boeing is caught between a rock and a hard place – and will need to backstop financing of aircraft to move its inventory. The questions now are how much will this require, and where will Boeing find the cash?