Putting a 'cap' on risk

New modeling software helps mitigate exposure

Lending can be risky business. But lending—and leasing—is exactly Boeing Capital Corporation's business. That's why managing risk is a major objective. The market values any company's earning less when there's greater uncertainty. Greater stability, though, leads to greater confidence, better bond ratings, more financial strength—you get the picture.

Where does risk come from? Consider these hypothetical scenarios.

• An airline's passenger traffic and revenues are up, and it needs more airplanes. How does the lender value the aircraft to ensure its value stays above the amount of the loan over the full term of the loan?

• A carrier in the North Pacific has been gradually shifting its operations to point-to-point frequencies and would like to purchase 777s. As part of its financing package, the carrier would like to return its leased 747s to Boeing Capital. How will that affect the risk in Boeing Capital's portfolio, if it's already concentrated in 747s?

In prior years, Boeing Capital would consider each new business venture independently. It would consider factors such as a customer's credit rating, input from independent analysts and appraisers, and values of the assets in question to determine the potential exposure to the individual customer. The decisions generally provided good results—but, in recent years, yielded some unpleasant surprises too.

In mid-2004, BCC rolled out a new software modeling tool that it calls the Cap model, which looks at all these factors and all of BCC's customers in aggregate, along with historical market data. The software provides a clearer picture of how each decision affects BCC's total exposure to risk.

"Before the Cap model we'd look at every new loan or lease by itself, making no assumptions about how different investments might move together in value," said John Rosenthal, director of Risk Management for BCC. "By looking at the historical record of how customers' credit quality can change, how values of different airplane models have changed together, and how customer strength and airplane values have moved together, we can predict how our current portfolio will behave. We can also get a better view of what effect each new transaction has on the total portfolio risk."

Examining all risk factors simultaneously can help decision makers understand how to mitigate the swings, or volatility, in the financing business and make better predictions. Changes that negatively affect the overall health of Boeing Capital's portfolio can impact the confidence of Boeing investors and reduce BCC's ability to help Boeing customers finance airplanes.

Because the Cap model allows Boeing Capital to understand how individual additions or deletions will affect the entire portfolio and to predict fluctuations in income over time, it also helps the organization decide whether—and how—to grow the portfolio, with greater certainty.

"We've found that understanding history can give us a lot more confidence in predicting the future," Rosenthal said. "Using the Cap model, we now have a high degree of certainty that fluctuations in equipment value or in our customers' ability to pay will not jeopardize our mission or disappoint our investors. It's helping us make better, more confident decisions."

As Boeing Capital representatives continue to refine the tool (as they have since its inception) and act on the insights the model gives them, they have high hopes for fewer "surprises" and smaller effects on Boeing Capital's health as markets fluctuate.

No model could have predicted a surprise such as 9/11, which produced a significant amount of volatility for Boeing. Rosenthal said. However, while the Cap model doesn't give absolute certainty, it can be very useful in helping BCC predict the effects of more normal market downturns, plan accordingly, and mitigate what might otherwise be large income effects. Using the model will lower exposure and produce more predictable results over time, ensuring BCC's portfolio is safer and stronger than ever before.

"As we make better decisions—one by one—using the Cap model for evaluating overall portfolio risk," Rosenthal said, "we have an increasingly greater ability to tell the Boeing Board of Directors that we are effectively and optimally managing risk for them and for the Boeing shareholder."

debra.j.arkell@boeing.com