Greg McKenzie: RMB’s connection to new supercraft – Virgin’s Airbus A350

I was surprised to learn during research for this interview that Sandton-based RMB has been financing aircraft for more than two decades. So it makes sense that the bank would take the next step as it has done through the involvement with two of Airbus’s replacement for the iconic A380 planes. In this insightful interview with Greg McKenzie, head of RMB’s Aviation division, we get the back story to the bank’s breakthrough into the global aviation’s big league through its co-funding for Virgin Atlantic of two A350-1000s, whose ticket price comes in at almost $200m each. – Alec Hogg

This special podcast is brought to you by RMB and it’s a warm welcome to Greg McKenzie who is the Head of Aviation Finance at RMB. It surprised me – while doing my research – to see that RMB has been in the aviation financing business for more than 20 years.

Yes, Alec we have. We initially started financing some aircraft for our flag carrier SAA in 1996 and from there the business has progressed substantially. We initially funded what we term senior debt – which is just long-term financing for those aircraft. We’ve moved along the capital spectrum and we now also participate in junior loans and equity positions. We currently own some aircraft which we lease out on an operating basis to commercial airlines.

So RMB is actually an aircraft owner. Please give us some more insight into that.

Our portfolio is small at the moment: we have nine turbo props which are on lease to a regional airline in South Africa, but we have had some Boeing classics too that were on lease to Air Namibia. They’ve since come off lease and we’ve disposed of those aircraft. We took a decision as a Group in about 2010-2012, that to sustain the earning levels of the Group, we had to look at other opportunities to meet the exponential growth and equity positions in assets. We identified aircraft as one of those types of assets and saw the ability to ramp up our earnings. Today we’ve been pretty successful with that. Aircraft is an asset type that not everybody is comfortable with and we have some rigorous debates internally around the transactions that we participate in, but to date, we have had a good track record.

Today we’re going to talk about your latest transaction which is an A350. This is a new plane that is going to replace the A380. It’s not as big as the A380, but it can go further and it’s much lighter on fuel. It’s kind of the next generation to the Airbus that many people have flown in. Please tell us a little bit about the background. Why did Airbus decide to get rid of the A380s and bring in the new A350?

There’s been a lot of speculation in the industry and a lot of strategy around aircraft sizes and the route networks that these aircraft fly. If you go back 10 or 15 years, you’ll remember many aircraft that flew long distances (12-14-hours) had four engines. Engines have since become a lot more technical and a lot more modern to the point where twin engine aircraft are now able to fly the same routes. So, the A380 is a four-engine aircraft and the A350 a two engine aircraft. 

Many listeners have probably flown on the A380. It’s a fantastic aircraft to fly in, but when you get to an airport and you have to disembark, you suddenly go from 250 to 500 people in the arrivals hall and it’s a bit of a nightmare. The A350 is smaller in terms of capacity. Virgin’s current aircraft has 335 seats that are divided up into three classes: 44 business seats, quite a large premium economy of 56 seats and the remainder are economy seats. I was fortunate enough to visit Virgin’s headquarters in London in the UK to look at the mock-up of this new aircraft – and it really is something special. They’ve done a lot of work internally on the design: the features, the fabrics used on the seats etc. It really is a special product.

It’s quite special for an African bank – because that’s what RMB is, to be involved in the financing of one of the first of these Virgin planes.

Yes. It wasn’t a targeted airline of ours. Our new strategy is focusing on airlines in Europe – typically aimed at second tier airlines and regional aircraft operators. The aircraft industry is very hot at the moment in terms of appetite for financing aircraft. There is a lot of money chasing the debt requirements of the growing fleet. So Virgin wasn’t an airline that was on our radar. We thought that you’d have to be very competitive to get in there, but through a couple of relationships and networks that we’ve established, we suddenly got the opportunity to co-fund an aircraft alongside a senior lender with whom we have since built a good relationship with, but who at the outset we didn’t know about.

We were fortunate to win the first aircraft and now we are busy closing on a second. That one is going to close on the 27th of this month. That came about, not through a failed financing, but a different financing structure that unfortunately couldn’t be put in place in time. We were asked if we would like to participate alongside another senior lender on that transaction. We’ve been very fortunate to do the second and the fourth aircraft for Virgin which is a fantastic win for a South African aircraft financing business.

Have you done work with the Virgin Group as a whole before?

Everybody knows the brand and South Africans will probably know Virgin Active the gym company for which RMB had done some substantial fundraising for in previous years. 

We had our first engagement with the executives at Virgin Atlantic which are a distinctly separate business in the Virgin Group. They certainly were aware of who Rand Merchant Bank was and what we had previously done for the Group. We have broadened that relationship which is a big win for us because we focused traditionally on the South African and African markets, with limited exposure to clients outside of those markets. But when you get the opportunity to fund somebody in Europe or the UK with ties to a South African business, it’s really great to see that relationship work and grow.

Is this the biggest aircraft – the A350 – that you’ve been associated with?

Yes. I think it would be the biggest aircraft that we’ve funded. It’s not the biggest transaction in terms of size though because we are participating as a junior lender and our exposure is much smaller than the senior lender. We have however funded individual transactions on our own, both as a senior and junior lender which were substantially bigger than what we have at risk with this particular transaction.

So, what are the numbers of this transaction? What does an A350 cost?

If you Google the A350, you’re going to probably come up with a list price close to US$300-m. These list prices are a bit of a misnomer. It’s a legacy thing in the industry dating back to the 1970s, where the aircraft manufacturers created a list price that they kept escalating. To find an airline paying anywhere close to that list price would be out of the norm. Typically, you’d be looking in the region of around 60% because they obviously negotiate substantial discounts. The airlines have their specific requirements within those aircraft.  Virgin paid between US$160-m and US$170-m for these aircraft. It’s quite a lot lower than the list price you would find on Google or any of the networks, but it’s a competitive price within the industry.

How much of that is RMB putting up?

Our junior loan is around US$20-m per aircraft and the majority of the balance of that is funded by the senior lender. Virgin Atlantic themselves will put in a strip of equity or a pre-payment in the transaction. So it’s not as though the transactions are 100% debt funded. Virgin actually put in some of their own money as well.

It’s a little more than 10% of the total cost of the airline. How do you get paid? What is the return?

The deal is structured through a Special Purpose Company (SPC). This company is actually domiciled in Delaware in the US for which there are various reasons. It’s a common jurisdiction for American lenders and I think there are some tax advantages in doing that. It’s a low tax jurisdiction for American lenders and we make use of a double taxation agreement between South Africa and Delaware, so that there is no withholding of tax on interest.

Our second transaction is going to be done through the Cayman Island, it’s probably the most common jurisdiction for these aircraft SPVs. The lenders want an insolvency remote ring-fenced SPV to protect them against any other claims against the security. So each SPV company will own one aircraft. Typically your only creditors against those SPV’s are the senior debt and the junior debt funders. That SPV will then enter into a lease arrangement with the airline. In this instance, Virgin is leasing the aircraft for twelve years. Our funding is in that SPV for 12 years alongside the senior lender.

It is a relatively long-term transaction posing a few challenges for us as a South African bank, because we are a Rand denominated bank and we have to raise US dollars to fund these types of opportunities. It’s common knowledge that sovereign downgrades etc. all impact the rate at which we can borrow dollars. So it is a challenge to be competitive in this market. But I think because of our flexibility and our ability to innovate around structures, we’re having quite a good success rate.

Where exactly are these aircraft going to be flying to? Any of them coming here to South Africa?

One of the major things that Virgin Atlantic have done is to form a joint venture with American operating airline, Delta Airlines. Delta purchased 49% of Virgin Atlantic. More recently, Air France and KLM also bought another 31% of Virgin. So Virgin investments which is the holding company (ultimately controlled by Richard Branson), actually only owns 20% of this airline. Those three airlines together, have created a Transatlantic Partnership which is rated number one in the world in terms of the number of flights and routes that they fly across the Atlantic.

Typically they fly from the UK as a base into the West Coast San Francisco, as well as the East Coast (Washington, Miami) and then to the top of South America. The KLM aspect of the JV provides access to a lot of routes in the east, so you’re looking at Hong Kong, Shanghai, Delhi, Mumbai in India and as far as Melbourne and Sydney in Australia. It’s a really strong partnership with revenues of over $11-bn which clearly provides many benefits for the Virgin Group.

But might we see the RMB funded or partly funded aircraft coming to OR Tambo?

Hopefully we will see that. The executives love the route to South Africa as it’s a very profitable route for them. In fact, they have mentioned that they might be increasing the number of flights they put through to Johannesburg, possibly even Cape Town. So it might not be long before we see our aircraft flying on this route which would be great.

Greg what about more business with Virgin Atlantic? You’ve broken into what must have been a very difficult relationship to establish in the first place, but you’re in there now and you’ve now funded or partly funded two aircraft. Is it likely that you’ll get more business from them in the future?

The intention certainly is that we want to grow our relationship with the Virgin airline business. My colleagues obviously did a sterling job on Virgin Active – growing the brand and the funding, so we will certainly look to grow that relationship. We have to however be cautious in terms of too much exposure to one counterpart especially because we have limited access to dollars. So, from a prudential point of view, we may be cautious about trying to source further aircraft transactions from Virgin, but we can always source these transactions and possibly syndicate them at a later stage to manage our exposure. 

From a general banking point of view, we’ve already started talking to Virgin (through our London branch) about other general funding requirements that they may have. They have a panel of six main international banks, but they’ve said that they were certainly willing to accommodate us as a seventh lender. It’s really exciting for us to grow that relationship.

And your London base, I’ve visited them a few times. Have they played much of a role in landing this transaction?

The relationship originated from my colleagues and myself out of South Africa on our visits to Europe, but we certainly work closely with the guys in the London office. They back us 100%. They join us on meetings and they certainly played an integral role in ensuring that all the legalities for this transaction were done correctly. We use the London branch because this is where the loan transaction onto the balance sheet is done. They are very integral to the transaction.

Just to close off with, how many other South African banks are involved in aviation funding? Has any of them to your knowledge also funded an international airline like this?

The biggest competitor in the aviation space is Investec. They have a significantly larger team in the UK and they’ve done exceptionally well. They’ve done a lot of large transactions for international airlines, they have portfolios and have created funds. The other two banks are Nedbank and ABSA. They also have small teams like us and I think they face the same sort of challenges that we do.

What differentiates us from those two is that we’ve move right along the capital spectrum to invest equity into aircraft by actually owning our own aircraft. I’d like to believe that we are one step ahead of them, but on another basis, we work together on certain transactions and we also compete on similar transactions. So it’s a love/hate relationship but we know all the guys in South Africa and we get on exceptionally well. We congratulate each other on transactions and the responses from the press releases so far have been really good, both in South Africa and Europe.

Greg McKenzie is the Head of Aviation Finance at RMB. This special podcast is brought to you by Rand Merchant Bank.

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