Russia’s Great Plane Robbery Is a Blow, Not a Calamity
(Bloomberg Opinion) -- It’s not especially fun for a plane lessor to tell shareholders that more than 100 aircraft formerly on lease to Russian airlines may be gone for good, especially when the aerospace industry is only just recovering from a global pandemic. Still, AerCap Holdings NV did a decent job Wednesday explaining why its remaining $2.5 billion exposure to Russia shouldn’t cause investors to lose too much sleep.
AerCap’s $30 billion acquisition of General Electric Co.’s GECAS operations in November made it by far the world’s largest aircraft lessor with some 3,200 planes, engines and helicopters under ownership or management. In the aerospace world, if not the political realm, AerCap is very much a great power with financial reserves to match. However, the international treaties that guaranteed repossession rights for lessors and allowed the industry to grow significantly over the past few decades have turned out to be a poor match for the hard power of a reckless state actor. AerCap has terminated its Russian leases — as sanctions from the U.S., European Union and other governments demanded — but Russian airlines continue to fly some of its planes regardless.
The size and scope of the AerCap fleet that Russia has essentially stolen is big at first glance but marginal compared with the company’s overall scale. While the net carrying value of AerCap’s Russian-operated fleet of planes is $3.1 billion, the company should be able to claw back a decent amount. It has already repatriated 22 of the 135 planes it had on lease in Russia before the invasion of Ukraine, which is quite a good outcome under the circumstances. Including some $175 million in compensation received to date from banks that issued letters of credit in conjunction with lease agreements on the Russian assets, AerCap has already lopped almost $600 million off the potential liability, and that’s before insurance payments. Insurers are likely to push back on AerCap’s $3.5 billion in claims, and the matter won’t be resolved quickly, but these should also bring in more cash eventually.
AerCap expects the timing mismatch between accounting rules and any eventual insurance recovery to force a yet-to-be-quantified impairment charge in the first quarter. Still, it has a substantial enough equity cushion to withstand a temporary bruising. Even if AerCap ultimately has to write off the entire $2.5 billion remaining exposure to Russia, such a charge would boost its debt-to-equity ratio to about three times. That was where AerCap had initially told investors it would end up anyway after the close of the GECAS transaction. Last year’s earnings were better than the companies expected when the transaction was announced in March 2021, and that put AerCap ahead of schedule in reaching its leverage target. So a Russia-related write-off is a setback but hardly a catastrophe.
A more pressing challenge for AerCap is to convince shareholders that the blockbuster takeover of GECAS will be a success. The selloff in AerCap shares on Wednesday — which peaked at about 12% — likely had more to do with comparatively mundane GECAS accounting and tax factors that dragged fourth-quarter profit down more than analysts had anticipated. (As a side note, this isn’t uncommon for GE assets that are untangled from the parent company’s hulking complexity; Wabtec Corp. took earnings adjustments tied to “accounting policy harmonization” after purchasing GE’s locomotive business in 2019, for example.) This is mostly short-term noise. But given how anxious investors are about Russia, it’s unfortunate AerCap’s first quarter incorporating GECAS earnings was so difficult to unpack.
The outlook for this year is more encouraging. Rebounding passenger traffic is helping airlines pay AerCap what they owe after the lessor cut cash-strapped customers some slack at the start of the pandemic. While higher fuel prices and labor inflation threaten to pressure airline earnings, lessors are less exposed to such volatility. Demand actually should be buoyed as airlines try to avoid large capital outlays and lease planes instead. Meanwhile, the helicopter-leasing business is bouncing back as the resurgent oil market drives demand from the exploration and production sector, and cargo jets remain a hot commodity. One new risk is that rising interest rates pressure lessor margins, at least until those extra burdens can be passed on through higher leasing rates. Broader knock-on effects for the aircraft financing market from Russia’s willingness to effectively steal planes also can’t be ruled out.
The Cape Town Convention treaty established an international registry for aircraft as a means of helping companies assert their rights over planes that can, by definition, fly away. The effect was to open up markets that were previously considered too risky for aircraft lessors and to bring air travel to wider swaths of the world’s population. But if Russia can thumb its nose at those standards and keep jets out of reach of their rightful owners, other countries could conceivably follow suit, raising the prospect of higher risk premiums in leasing rates and thus lower demand in more geopolitically volatile areas of the world. While AerCap’s aircraft portfolio and geographic footprint are highly diverse, some 17% of its long-lived assets are in China, and it certainly can’t afford to lose those. AerCap management characterized Russia’s jet seizure “a black swan event” and a “temporary aberration.” It’s possible other countries would find a warning, not a license, in the rapid unraveling of Russia’s aerospace industry and the impact of sanctions on its access to aircraft parts. But the long-term impact to investors’ future evaluation of risk in the industry may be greater than AerCap would wish.
Still, the fairly limited immediate impact at AerCap from Russia’s de facto seizure of its jets is encouraging for the rest of the industry because the lessor had by far the largest exposure to the country. Avolon Holdings Ltd. had only 14 jets on lease in Russia before the invasion of Ukraine, and four have been recovered, Chief Executive Officer Domhnal Slattery said in an interview this week. “It doesn’t look like a good set of circumstances in terms of getting those aircraft back,” he said. Still, “we never really pursued Russia as a market relative to some of our competitors,” he said. Slattery compared the company’s potential liabilities to a headache, rather than a cancer or even a migraine. Like AerCap, Avolon’s jets are insured, and compensation on those claims will offset any potential writedowns. Air Lease Corp. CEO John Plueger has also suggested governments may step in to backstop lessors for any losses on seized Russian aircraft, akin to what happened in the wake of the Sept. 11 terrorist attacks.
The pandemic was much more damaging to aircraft lessors’ business than Russia’s effective theft of jets will be, Air Lease Chairman Steven Udvar-Hazy said at a JPMorgan Chase & Co. conference earlier this month. Covid “overshadows these recent events by a huge margin,” Udvar-Hazy said. “That was an 8.0 earthquake. This is like a 2.5 aftershock.”
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Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.
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