Avialeasing” Company Annual Report of Closed Joint-Stock Company (zao)

for passengers – maximum safety and worthy comfort of the service

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for passengers – maximum safety and worthy comfort of the service;

  • for airlines – an opportunity to effectively (in view of resource planning) employ owned and leased aircrafts that are completely airworthy, to expand passenger traffic bearing no heavy lump-sum costs, and at the same time to ensure properly flight safety.

    We suppose that, as a result of our dedicated activities in 2006 and the following years, the Company will ensure a constant increase of completely airworthy domestic aircrafts promotion to the Russian airlines to meet the air carriers’ demands for safe, comfortable and cost-effective planes. Fruitful cooperation of the Company and its partners in 2005 made it possible to raise profitability and capital yield.

    7. Position of ZAO “Avialeasing” Company in the Industry
    There are dozens of leasing companies in Russia that deal with aircraft and aircraft engines. Currently the biggest Russian companies engaged in aircrafts lease, sales, consulting, and maintenance usually rely upon governmental support. For instance, “Ilyshin Finance Co.” (IFC) and “Finance Leasing Company” (FLC) are leasing companies of joint state and private ownership (the governmental shares of the authorized capitals are 46% and 77.52%, respectively). They were chosen by the Ministry of Economic Development and Commerce in 2001 upon the results of a tender. These companies are state-funded. From the 6 bln rouble budget of 2005 provisioned for authorized capital raise IFC received 2.75 bln, FLC- 3.25 bln. In the budget of 2006 the same sum was provisioned but the distribution proportion was unknown at the date of Company’s Annual Report preparation.1

    Ilyshin Finance Co.” (founded in 1999) specializes in funding of manufacturing and financial/operating lease of new domestic passenger aircrafts. These are IL-96 and

    An-148 produced by Voronezh city Joint-Stock Aircraft Construction Company (VASO) and Tu-204 produced by Ulyanovsk city “Aviastar”. The business partners are Atlant-Soyuz, KrasAir Airlines, Vladivostok Avia, Domodedovskie Avialinii. A 6 IL-96-300 delivery contract wasn’t signed with Aeroflot-RA due to an airline refusal. As a compromise solution 6 A/C of IL-96-400T type built by VASO will be delivered to Aeroflot-Cargo, a company’s subsidiary. According to 2006 annual results IFC carried out the following projects to the amount of over $ 300 mln: 4 A/C of Tu-204-300 type leased to Vladivostok Avia; 2 A/C of IL-96-300 – to Cubana de Aviacion (Cuba).

    Moreover, during the reporting year IFC has signed a number of contracts with Russian and foreign air companies, including Vladivostok Avia, Air Zimbabve (Zimbabve) and Cubana de Aviacion (Cuba). A 5 Tu-204 delivery contract with Iran AirTour (Iran) is being settled. In 2006 IFC started to execute the contracts to the amount of $1.4 bln (23 A/C): 2 IL-96-400T A/C delivery to Atlant-Soyuz airline, 2 Tu-204-300 A/C delivery to Vladivostok Avia, IL-96-300 (VIP) delivery to “GTK Rossiya” Federal State Unitary Enterprise, 2 IL-96-300 and 3 Tu-204 A/C delivery to Cubana de Aviacion (Cuba), 5 IL-96-400T and IL -96-400M A/C delivery to Air Zimbabve. Thus an IFC backlog of orders accounts for more than 100 A/C to the amount of $3.5 bln. As per forward estimate in 2006 IFC assets has grown from $576 mln to $800 mln. The equity capital makes $520 mln. In 2006 an income reached a $5 mln mark.1

    allocated for lease of civil aircrafts. There were two basic objections. First, the auditors pointed out that the former Ministry of Property Management (reorganized to Russian Property Agency (Rosimushchestvo)) purchased shares of IFC for 2.52 bln rubles, while the company received for its authorized capital only 212 thousand rubles. Second, private founders of FLC illegally placed the equity interests, they owned in the company, into the commercial entities that had liabilities to the company the amounts of which were often almost same as the cost of the placed equity stakes. As a result, the amount of budget funds used inefficiently was 749 mln rubles. Moreover, equity holding of the OAO “Ilyshin Finance Co.” was arrested under a criminal case initiated against the company management upon the abuse of authorities. About 36% of ordinary shares of the NRC subsidiaries, 15% of the shares of Vnesheconombank and other minority shareholders were arrested. The equities owned by the government were not arrested. At present the criminal case is terminated and the shares are released from arrest.

    Finance Leasing Company was founded in 1997 by “Tatneft” oil company, “Zenith” bank and “Solid” investment & finance company. The government is among FLC shareholders since 2002, it holds 77.52% of the company equity. The main FLC activity is implementation of the governmental programme of manufacturing and leasing of modern mid-distance Tu-214 aircraft produced by FSUE “S.P. Gorbunov Kazanskoye Aviation Production Association” (“KAPO”). Among FLC partners are Dalavia, a federal state unitary enterprise, KrasAir airline, Yakutia airlines, Transaero airline. As a result of the first lease transaction in 2001, “Dalavia” airlines obtained two Tu-214 planes. In 2006 the 6th long-haul Tu-214 built at KAPO. The aircraft has been delivered to Dalavia that currently operates 5 modern Russian-built Tu-214. Another Tu-214 owned by FLC has been operated by KrasAir since 2005. In 2006 An-140 aircraft was delivered to Yakutia airlines and IL-76TD – to Aerostars air company. Moreover in 2004 Transaero ordered 10 Tu-214. The A/C are to be delivered on the finance leasing basis for a term of 15 years. As per official data the value of the contract amounted to $600 mln. Initially the first aircraft was planned to be delivered to Transaero in December 2005, the next four A/C – in 2006 and the rest five A/C – till the end of 2007. However the construction of the first A/C at the time of the Company’s annual report has not been finished and delivery term was once again put off till the spring of 2007. The FLC management admits that it can’t finance a contract due to a money receipt delay. Besides, the Tu-214 net cost of assembly at KAPO exceeds the price laid down in the contract with Transaero.2

    In the reporting year IFC and FLC took part in OAO OAK setup. Under the President’s Decree of Russian Federation 38% of IFC shares and 58% of FLC shares that are state-owned will be consigned to the OAO OAK authorized capital. According to Protocol of Government Committee session on Russian aircraft building companies’ integration IFC is granted a right to lease aviation equipment as a business priority and FLC is only assigned to lease production machinery. Hence only IFC dealing with A/C lease will stay within OAK. Experts believe that IFC has won because it managed to prove its efficiency. At the moment it is not clear how the company will fulfil its commitments yet the IFC management is ready to buy out A/C manufactured by the competitor.

    Both IFC and FLC compete for the budget funds allocated to support leasing projects and implement mutually competitive financing programmes of manufacturing and leasing of new regional aircrafts. By estimates, in the next 20 years only in Russia the volume of the potential market of new regional planes will be around 400 planes; their sale can raise 1.5-2 bln USD of tax income for the national budget.

    However, most of the Russian airlines do not have enough working capital to operate modern aircraft. Targeted financing of new aircraft purchase, even by way of operating lease, is unavailable either. The private leasing companies also do not have enough working capital. That is why currently most of the companies in aircraft lease market deal with used aircrafts. Major lessors of passenger aircraft similar to Tu-154 (Yak-42, Tu-134, Il-86, Il-96, Tu-204, Tu-214) performance characteristics operating on the Russian market are presented below.

    ZAO Aviatekhnologhia (Moskovskaya oblast’, Bykovo) has been operating on civil aircraft market since 1991. Overhaul works, modernization and leasing of domestic A/C is company’s business priority. Equity capital amounts to $100 mln. ZAO Aviatekhnologhia owns ZAO “Maintenance and Repair Station “Bykovskaya Aviaservisnaya Company” a certified repair plant specialising in Yak-42 and IL-76 maintenance and overhaul. In its business activity the company focuses on Yak-42D1 leasing. According to official data the company has 10 A/C of the said type operated by Elbrus-Avia, KrasAir, Center-Avia, Volga-aviaexpress, Samara, Vim-Avia.

    OOO “Dalmasheasing” (Khabarovsk city) is a subsidiary of OAO “Machine-Building Leasing Company” (Mashleasing”). The idea of the company foundation emerged in 1996 along with the search for new ways to stabilize financial situation needed by the majority of industrial enterprises. OAO “Mashleasing” was founded in 1996 in pursue of the Russian Government Resolution on support and stabilization of machine-building and tool-making enterprises. For several years OAO “Mashleasing” has been successfully operating in the leasing market. The company has subsidiaries in different regions of Russia, Ukraine, and Belarus. The most important activity of OAO “Machine-Building Leasing Company” is participation in the programme of technical renovation of domestic machine-building enterprises the scope and significance for the national economy of which makes it possible to minimize financial risks of leasing schemes implementation. The company also offers for lease airplanes, aviation engines, vehicles, and construction and road machinery. According to the official data of 2006, OAO “Mashleasing” owns five A/C: 4 Tu-154М owned by OAO Dalmashleasing and leased to “Dalavia” airlines, 1 AN-24PB owned by OAO Mashleasing and operated by Tomsk Avia airline.

    RB Leasing (Moscow) is a subsidiary of JSCB Rosbank and has been a member of Rosleasing, Russian leasing association of companies since 2003.
    RB Leasing positions itself as a multipurpose leasing company that acquires and leases complex production machinery that as a rule requires long-period production time and significant building and assembly work scope. Machinery leasing for electric–power industry is a business priority of a company. RB Leasing mainly specializes on economic transactions with large enterprises of metallurgy and metal-working industries, the power and power engineering industry, oil production, the mining industry, telecommunications, transport and communications. As of 1 of January 2007 an active contract portfolio evaluates at $400 mln. In 2006 contract portfolio amounted to $210 mln. According to reporting year results the company ranked 11th among major leasing companies (Expert-RA rating agency).2 According to state sources RB-Leasing OOO (LLC) owns 5 A/C: 4 Tu-154M operated by S7 Airlines and 1 AN-26-100 operated by Khabarovskye Avialinii airlines.
    Severleasing OAO (OJSC) (Arkhangelsk) operates at financial market since 2000 and is a multipurpose leasing company that let on lease any asset that is authorized to be used for commercial purposes. Since September 2005 it is a member of the North-West Leasing Association. Among its business priorities are transaction volume increase with air companies, participation in ZAO Aeroflot-Nord fleet renewal. According to state sources in 2006 OAO Severleasing owns 8 A/C: 1AN-2PB, 1 AN-26BRL, 3 A/C Tu-134A and 3 A/C Tu-154B2. All aircraft are operated by Aeroflot-Nord.
    In 2006 together with Russian leasing companies a number of new major companies appeared offering A/C for lease. Their setup was determined by an aggravated situation on the global transport market in view of restrictions that were imposed on outdated A/C impelling to buy 67 western A/C in 2006 in spite of high customs fees on import.
    According to state sources of 2006, a share of passenger A/C owned by foreign companies composes 11.26% of gross passenger A/C volume registered in Russia (an increase by 75.27% or 70 units compared with 2005). A share of passenger A/C owned by Russian companies is 88.74% (a reducing by 2.28% or 30 units compared with 2005). Thus a tendency of a growing number of foreign lessors is observed.

    In 2006 40 foreign lessors that lease western long-range and regional passenger A/C were registered (an increase of 11 A/C compared with 2005). Their market shares are shown on the chart, p.34.

    Thus among major foreign leasing companies are:
    GE Commercial Aviation services (hereinafter referred to as - GECAS), GE Commercial Finance operation, an affiliate of General Electric, provides financing as well as leasing of civil A/C services. At present 1400 A/C owned by the company are leased to more than 225 airlines from 60 countries. Moreover the company offers a wide range of finance products such as operational leasing and security loans. GECAS also provides engine lease services through Engine Leasing division and flight training services through its Aviation Training division. The company has its branches in 21 cities worldwide. GECAS ordered directly 340 A/C from Boeing, in 2006 it made 15 Boeing 777 A/C order and 24 Boeing 737-800 A/C to the amount of $5.34 bln with a delivery schedule from 2008 through 2010. GECAS fleet consists of 600 Boeing A/C including 200 Boeing 737 New Generation A/C.1 GECAS foreign commercial A/C lease market share amounts to 28.83%. In Russian Federation 47 A/C owned by GECAS are on lease, among them: 11 Airbus A319-111,6 Airbus A320-214, 22 Boeing 737,7 Boeing 767,1 Airbus A-310. These A/C are operated by Aeroflot-RA (17 A/C), S7 Airlines (14 A/C), Aeroflot-Nord (3 A/C), Transaero (3 A/C),KrasAir (3 A/C), KD Avia (2 A/C), Aviaprad (2 A/C) and Sky Express (1 A/C).
    International Lease Finance Corporation (hereinafter referred to as - ILFC). ILFC is a subsidiary of AIG-American International Group, the US major finance insurance company. The company cooperates with more than 150 airlines, its fleet numbers around 850 jet aircraft. ILFC is a world’s No 1Boeing lessor: since 1997 the company has placed orders for 698 Boeing aircraft. ILFC leases Boeing-777, Boeing–737, Boeing-747, Boeing 757 and Boeing 767 to the airlines worldwide. Its fleet includes 3 Boeing-737 Next Generation A/C modifications (Boeing 737-600,Boeing 737-700 and Boeing 737-800) and also 3 Boeing-777 A/C modifications (Boeing 777-200ER, Boeing 777-300 and Boeing 777-300ER). Moreover it was ILFC who was the first to place orders for Boeing-787.2 The company operates 20 A/C in the Russian market: 5 Boeing 767, 9 Boeing 737, 6Boeing 757. The said A/C are leased to KrasAir (5 A/C), Rossiya (5 A/C), Transaero (4 A/C), Aeroflot-RA (2 A/C), VIM-Avia (2 A/C), Orenburg Airlines (1 A/C), KD Avia (1 A/C). The ILFC western-built passenger A/C lease market share is 12.27%.
    Cramington Services Limited (Ireland). Its share accounts for 3.07%. As per available data the said company was set up for the purposes of S7 Airlines. According to the Russian official sources Cramington Services Limited owns 19 A/C though as per production list3 14 of them are owned by GECAS and Hapag Lloyd. In the instant case Cramington Services Limited has leased 5 Boeing 737-500 A/C to S7 Airlines.
    MS2 Denmark Limited APS. It’s share compounds 6.79%. The company owns 11 A/C: 4 Airbus A-319-111 and 7 Airbus A-321-211. Aeroflot-RA is an operator of these A/C.4
    The major lease companies such as Airbus Leasing II and Boeing Capital Corporation that are directly related to a manufacturer have insignificant market share in total volume. Airbus Leasing II has 1 Airbus-310-324 (YOM 1987) that is leased to S7 Airlines. Boeing Capital Corporation owns 3 A/C: 2 Boeing 737-400 (YOM 1989) that are leased to Transaero and 1 Boeing 737-300 (YOM 1993) leased to KrasAir. There is a reason to such tendency: a majority of foreign lease market players consider the risks related to operations at the Russian market to be excessive. As a consequence the age of leased A/C is near 20 years and among lessee the leading airlines in terms of traffic volume dominate.
    As per research findings small leasing companies have 1 or 2 A/C which they lease to Aeroflot –RA, Transaero, Rossia, KrassAir, KD Avia, Vim-Avia, Volga-Dnepr, Sky Express, Orenburg Airlines, Sahalinskie Avatrassy, Atlant-Soyuz, Aviaprad, Polet (Voronezh), Utair, Aeroflot-Don, Aeroflot-Nord. The presence of a great number of foreign lessors is explained by a deficit of A/C satisfactory as to its price and technical status. It forces the lessees to work with different leasing companies to provide themselves with sufficient number of airlines and therefore loose discounts they might have if they would have cooperated with one lessor. Thus Transaero cooperates simultaneously with 11 foreign lessors: Boeing Capital Corporation, GECAS, ILFC, Pegasus Aviation, Carotene limited, Embarcadero AST, AerCo Limited, Jumbo Finance Limited, ACG Acquisition Ireland, BA Finance Ireland. KD Avia works with 6 foreign lessors: ILFC, GECAS, Pegasus Aviation, Babcock & Brown, CIT Capital Finance, Aergo Omega Leasing. Aeroflot –RA leases from 5 foreign lessors: GECAS, ILFC, MS2 Denmark Limited APS, OH Aircraft, RBS aerospace Limited. KrasAir leases from 6 foreign companies: ILFC, GECAS, Boeing Capital Corporation, GATX, Woodrow Leasing Limited, Arbour Finance Limited.
    A market development study showed that such a tendency will keep on. However it is practically impossible to find several A/C of the same type and technical status, as reported GECAS and ILFC representatives. Besides, different A/C types impose totally different requirements to the personnel, equipment, and whole airline infrastructure. It is especially true when we compare Russian A/C with Western-built ones. This is the reason why it is expedient for Russian airlines to replace its fleet totally by western-built A/C of one type (for example, KD-Avia airline has totally replaced its fleet by western A/C and then sold the replaced ones). Though the majority of Russian companies is not yet ready to reequip its fleet with western A/C.
    It should be noted that Russian airlines operating foreign A/C are facing another serious problem: according to engineers’ and lessors’ requirements out -of –service A/C parts can be replaced by specially ordered ones, and the process of delivery and customs clearance is time-consuming and unprofitable since A/C stand idle.
    Therefore rapid and one-time full replacement of Russian A/C with foreign ones appeared to be impossible.
    All mentioned companies are strong and perspective operators yet none of them operates at the TU-154 lease market.

    In the Russian Federation in 2006 the Tu-154 A/C total lease market volume made up (according to verified data) 61 units among them 48 Tu-154M and 13 Tu-154B (all types). As of the current year a lease payment volume is circa USD73 mln.
    It is worth stating that in the reporting year we took into account only those A/C that have been operated by Russian airlines in 2006 since there is a discrepancy between the number of officially registered and actually operated A/C. The sampled data allows evaluating A/C lease market share of each player more objectively in 2006. In this respect a present study doesn’t include the compared data of the previous years since Company’s annual reports of previous years contain the study based on the data on all A/C registered in Russia.
    Presently, a concerned market is rather heterogeneous since different players that deal with not only economic but also logistic and optimization issues operate on it. Among the players with market shares there are administrative-territorial units occupied with social matters and state-owned property management (Khanty-Mansiysk AO – 3,28%, administrative authorities of the city of Kogalym, Moscow Property Department – 1,64% each), active airlines with an operator certificate as well as airlines that turned bankrupt or quitted a Tu-154 passenger operations market (Tchelyabinskoe airline – 6.56%, Bashkyr airlines, Samara- 4.92%, Orenburg Airlines, KrasAir – 3.28% each, S7 Airlines, Omskavia – 1.64%). It worth noting that players for whom leasing was not a core business keep leaving the market. As a reference, in 2005 Yamalo-Nenetzky AO Tomsk Federal State Air Company withdrew from the market and in 2006 the Republic of Khakassia, Tatarstan and Aerokuzbass Airline joined them (the airworthiness directives havn’t been extended).
    Airlines shares accounts for: in the entire Tu-154 segment – 26.23%, Tu-154B segment – 15.38%, Tu-154M segment – 29.17%. An administrative-territorial unit share in tu-154 segment totaled 6.56%, inTu-154B segment – 0.00%, Tu-154M segment – 8.33%.
    The share of market –orientated companies with a market history accounts for, upon our estimation:

    • 84.62% of Tu-154B lease market share (11 A/C);

    • 62.50% of Tu-154M lease market share (30 A/C):

    • 67.21% of Tu-154 all types lease market share (41 A/C).

    We mention in passing that we don’t consider airlines that gone bankrupt or with poor financial standing that are compelled to lease their A/C as market-orientated companies.
    Tu-154B lease market analysis showed that that no any new operator had appeared with 2 or more A/C of said type. Some operators have increased whilst others have reduced their portfolios by one A/C. OOO Standart (LLC) is the only new operator with one A/C.
    In 2006 a number of new operators has entered the Tu-154M lease market, among them are OOO Energoprominvest (2 A/C), OAO Munitzipalnaya Investment company (2 A/C), OOO Frankleasing (1 A/C), OOO Utair –Leasing (1A/C), Moscow property department.
    Alongside with that the process of operators’ integration and competition aggravation starting from sourcing of the A/C for the airline is taking place at the market. The companies compete not only at the level of sources but at the level of potentials as well since leasing is a very complex and specific issue.
    On the whole all types Tu-154 market sharing is the following:

    1. ZAO PIFK Avialeasing is an absolute market leader (6A/C; 9,84%), it managed to increase market share from 3 to 6 A/C.

    2. Chelyabinsk airline (4 A/C; 6.56%) has gone bankrupt and is not market –orientated.

    3. A group of strong, market-orientated, leading companies that have 3-4 A/C and 4.92-6.56% market share each represented by OOO Dalmashleasing (LLC), OOO RB Leasing (LLC), OOO TK Leasing (LLC), OAO Severleasing (OJSC) – 22.96% of total market share.

    4. A strong base with a potential for a growth that have 2 A/C (3.28%): «ROSSAHAleasing», OOO Energoprominvest (LLC), OAO Munitzipalnaya IC (OJSC) – 9,84% of total market share.

    5. Market participants without market motivation in A/C leasing that have 2-3 A/C in theirs portfolios:S7 Airlines, Orenburg airlines, Samara airlines, KrasAir, Bashkir Airlines, Khanty-Mansiysk AO – 19,67% of the market.

    6. Outsiders that have 1 A/C in the indicated segment – 31,15%. Outsiders’ survival is probable provided that the fleet is expanded, including its diversification in other segments. Otherwise they would have to drop out.

    Accordingly, currently a group of leaders ha been formed at the all type Tu-154 market segment represented by:

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