The great Russian plane theft is a blow, not a calamity

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 owned or managed. In the world of aerospace, if not in politics, AerCap is truly a powerhouse with financial reserves to match. However, international treaties that guaranteed repossession rights to lessors and allowed the industry to grow significantly over the past decades have proven to be a poor match against the hard power of a reckless state actor. . AerCap has terminated its Russian leases – as required by US, European Union and other government sanctions – but Russian airlines continue to fly some of its planes regardless.

The size and scope of the AerCap fleet that Russia essentially stole is large on the face of it, but marginal in relation to the overall scale of the company. While the net book value of AerCap’s Russian-operated aircraft fleet is $3.1 billion, the company should be able to recoup a decent amount. It has already repatriated 22 of the 135 planes it rented in Russia before the invasion of Ukraine, which is quite a good result under the circumstances. Including some $175 million in compensation received to date from banks that issued letters of credit in conjunction with leases on the Russian assets, AerCap has already reduced potential liability by nearly $600 million, and this is before insurance payments. Insurers are likely to push back on AerCap’s $3.5 billion in claims, and the matter won’t be resolved soon, but those should also bring in more money eventually.

AerCap expects the timing lag between accounting rules and any potential insurance recoveries to force an impairment charge yet to be quantified in the first quarter. Still, it has a substantial enough capital cushion to withstand a temporary bruise. Even if AerCap must ultimately write off all of the remaining $2.5 billion exposure to Russia, such a charge would increase its leverage ratio to about three times. This is where AerCap initially told investors it would end up anyway after the GECAS deal closed. Earnings last year beat corporate expectations when the transaction was announced in March 2021, putting AerCap ahead of its leverage target. So a delisting linked to Russia is a setback but far from a disaster.

A more pressing challenge for AerCap is convincing shareholders that the blockbuster takeover of GECAS will be a success. Wednesday’s AerCap stock selloff – which peaked around 12% – was likely more related to relatively mundane GECAS accounting and tax factors that led to a bigger decline in fourth-quarter earnings than analysts had expected. . (By the way, that’s not uncommon for GE assets that are untangled from the enormous complexity of the parent company; Wabtec Corp. took earnings adjustments related to “accounting policy harmonization” after the purchase. of GE’s 2019 locomotive business, for example.) is mostly short-term noise. But given investor anxiety over Russia, it’s unfortunate that AerCap’s first quarter incorporating GECAS earnings was so difficult to unpack.

The outlook for this year is more encouraging. The rebound in passenger traffic is helping airlines pay AerCap what they owe after the lessor cut cash-strapped customers at the start of the pandemic. As rising fuel prices and labor inflation threaten to put pressure on airline profits, lessors are less exposed to such volatility. Demand should actually be buoyant as airlines try to avoid big capital outlays and lease planes instead. Meanwhile, helicopter rental activity is rebounding as the resurgence of the oil market boosts demand from the exploration and production sector, and cargo planes remain a sought-after commodity. A new risk is that rising interest rates will put pressure on lessor margins, at least until these additional charges can be passed on through higher rental rates. Wider ripple effects for the aircraft finance market from Russia’s drive to fly aircraft efficiently also cannot be ruled out.

The Cape Town Convention treaty established an international aircraft registry to help companies enforce their rights over aircraft that can, by definition, fly away. The effect has been to open up markets that were previously considered too risky for aircraft lessors and to bring air travel to wider segments of the world’s population. But if Russia can thumb its nose at those standards and keep the jets out of reach of their rightful owners, other countries could eventually follow suit, raising the prospect of higher risk premiums in rental rates and therefore weaker demand in the geopolitically more volatile regions of the world. . Although AerCap’s aircraft portfolio and geographic footprint are very diverse, some 17% of its long-term assets are in China, and it certainly cannot afford to lose them. AerCap management called the seizure of the Russian plane a “black swan event” and a “temporary aberration”. Other countries may find warning, not license, in the rapid collapse of Russia’s aerospace industry and the impact of sanctions on its access to aircraft parts. But the long-term impact on investors’ future risk assessment of the sector could be greater than AerCap would like.

Still, the fairly limited immediate impact on AerCap of Russia’s de facto seizure of its jets is encouraging for the rest of the industry as the lessor had by far the largest exposure in the country. Avolon Holdings Ltd. only had 14 chartered jets in Russia before the invasion of Ukraine, and four have been recovered, chief executive Domhnal Slattery said in an interview this week. “It doesn’t seem like a good set of circumstances to pick up these planes,” he said. Still, “we never really researched Russia as a market compared to some of our competitors,” he said. Slattery likened the company’s potential liabilities to a headache, rather than cancer or even a migraine. Like AerCap, Avolon’s jets are insured, and indemnification of these claims will offset any potential depreciation. Air Lease Corp. CEO John Plueger also suggested governments could step in to support lessors in the event of losses on seized Russian planes, such as what happened following the September 11 terrorist attacks. .

The pandemic has been far more damaging to aircraft lessor businesses than Russia’s actual theft of jets will be, Air Lease Chairman Steven Udvar-Hazy told a conference JPMorgan Chase & Co. earlier this month. Covid “overshadows these recent events by a huge margin,” Udvar-Hazy said. “It was an 8.0 earthquake. It’s like an aftershock of 2.5. More other writers at Bloomberg Opinion:

• Russia is not a pandemic for the aerospace sector: Brooke Sutherland

• Crisis Survival Tips from Alaska Air CEO: Timothy O’Brien

• Observers remind us of how far aviation has come: Tim Culpan

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering transactions and industrial companies. She previously wrote a column on mergers and acquisitions for Bloomberg News.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.

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