Until
just a few weeks ago, Russian airlines were reliable business partners
for the global aircraft leasing industry. The Russian sector was one of
the least affected by the COVID-19 pandemic
because its large domestic market recovered faster than elsewhere. But
since President Vladimir Putin started a war in Ukraine, lessors have
been facing an unheard-of scenario: a total loss of more than 500 of
their aircraft.
- Hundreds of leased aircraft are likely to be kept in Russia
- Lessors prepare for total-loss scenario
- Contingency insurance coverage might apply
European
Union sanctions imposed in response to Russia’s invasion of Ukraine
require lessors to cut ties with Russian operators by March 28. But
stopping sales of parts or new aircraft—which
the sanctions also require—is far easier than trying to repossess
assets in customers’ hands. The Russian government has indicated that it
is willing to go to extremes to protect the fleets of its airlines,
including confiscating or “nationalizing” aircraft
that are owned by lessors. A draft law published March 10 establishes a
government commission to determine whether aircraft can be returned to
lessors and decrees that lease payments be made in rubles rather than
U.S.-dollars for the rest of 2022, shielding
operators from a further plunge of the Russian currency.
The
unfolding drama is likely to redefine the commercial aircraft leasing
market, which could exclude Russian customers for a very long time.
“If
we have continued risk of nationalization, nobody in their right mind
would take that risk,” says the CEO of one large lessor with a
substantial fleet operating in Russia, speaking on the
condition of anonymity. He says it is hard to see an inflection point,
even far into the future, that would allow the industry to return. “What
is the definition of: ‘It is over’?” he asks.
What
the Russian transport ministry calls “nationalization” amounts to
illegally taking possession of leased aircraft against the will of their
owners and very likely without making purchase
payments. Should the government proceed with the plans, “Russia will be
an uninvestable country for a long time,” says Agency Partners analyst
Sash Tusa.
The
country, having opened up to Western suppliers and lessors just about 30
years ago, had turned into a good aviation market, buoyed by growth in
both domestic and international flying and
demand for replacements for aging Soviet-era aircraft. While some
lessors took a relatively cautious approach to Russia, others were
comfortable doing business there. Russian airlines depended on leasing
to a large degree, given their precarious financial
state after the breakup of the Soviet Union. At the end of 2021,
domestic traffic was 20% above 2019 levels—partly because many Russians
still could not fly abroad due to COVID-19-related travel
restrictions—whereas globally domestic traffic was down 20%.
The Aviation Week Network Fleet
Discovery database shows
that Russian airlines lease more than 600 large transport
aircraft—those certified for 19 or more seats—from lessors based outside
Russia. At least 100 more aircraft belong to lessors with Russian roots
and subsidiaries based outside the country. Many aircraft
are leased through Irish affiliates, as is standard industry practice,
and so are subject to EU sanctions. In some cases, determining the
status of a leased aircraft is impossible without knowledge of
contractual details.
By
absolute numbers, AerCap, based in Dublin, Ireland, is the most exposed,
with close to 150 of its aircraft operating in Russia (see chart). SMBC
Aviation Capital has 36, Air Lease Corp. 32, BOC Aviation 24 and DAE Capital 22.
For the largest international
lessors to Russian airlines, the exposure is around 7% of their
portfolio, which the CEOs of two of those lessors independently
described as “manageable.”
How
painful would the consequences be if repossessions cannot be made,
access to the assets is permanently lost, or their value declines so
much over time that they become complete write-offs?
These are more than theoretical questions; they are likely scenarios
for which the industry has to prepare as Russia tries to keep its air
domestic transport industry going amid Western sanctions.
“There
will be no repossessions,” says one leasing company CEO. “The
state-owned companies are not cooperating. The private ones pretend to
but do nothing.” Why? “There are implications for
airlines that don’t hold the [official] line,” another executive says.
In other words: Even if an airline wanted to adhere to international
law, it has no choice but to break it because of government orders.
“A
couple dozen [aircraft] have come out [of Russia],” Bloomberg
Intelligence analyst George Ferguson says he has heard. “I think if you
don’t have your airplane out now, you’re not going to
get it, because the Russians are hiding them.” And even if ultimately
some aircraft are returned, they likely will be complete write-offs.
“[The
airlines] are probably taking parts off some of the airplanes to keep
the others flying,” Ferguson says. “You are going to have parts mixed
and mingled, which makes it difficult to keep
the record straight. It’s a really bad situation for the lessors.”
“In
our view, it is unrealistic for lessors to repossess aircraft within a
month because more than 80% of the planes are narrowbody and regional
jets that are unlikely to leave Russia for a
neutral jurisdiction,” Scope Ratings analyst Dierk Brandenburg writes.
“Russia’s aviation legislator has banned international flights with
foreign--leased planes from this week. Even under normal circumstances,
we would have expected repossessions in Russia
to take up to six months.”
“[Given] current airspace and border closures, we question whether any aircraft will exit” Russia, J.P.
Morgan Chase analysts write in a March 3 research note issued after an
investor conference it hosted. “We don’t believe Russia will simply
allow Aeroflot or
S7, for example, to fly aircraft out of the country to Western jurisdictions simply because leases have been canceled.”
Avolon was one of very few lessors able to repossess aircraft from
Russian carriers: It took possession of a Boeing 737-800 on lease to Aeroflot subsidiary
Podeba when the aircraft was in Istanbul on Feb. 27.
On
March 5, Russia’s Federal Air Transport Agency (Rosaviatsiya)
recommended that local carriers with aircraft leased from foreign
companies and registered in foreign registers suspend all international
passenger and cargo services. The ban for outbound flights took effect
on March 6; return flights were stopped starting March 8.
The largest Russian airlines—including Aeroflot and
its low-cost subsidiary Pobeda, Ural
Airlines, charter carriers Azur Air and Nordwind—responded on March 5 by saying they would cut international operations
beginning March 8. S7 and Smartavia announced similar measures ahead of Rosaviatsiya’s recommendation.
Aeroflot is
still operating flights beyond Russia’s borders only
to Belarus, Moscow’s ally in the war in Ukraine. Red Wings announced it
would still fly to Armenia and Uzbekistan using Russian-made Superjet
100 regional jets leased from Russian lessors. All-Superjet operator Azimuth flies to Armenia, Azerbaijan and Turkey. Azur
Air planned to use only Russian-registered Boeing 767s and 757s for
international flights after March 8. Utair is continuing international
services for the time being, too, as it owns about 40% of its fleet,
including 18 Boeing
737-500s and six Boeing 737-400s, and has moved three of them into the Russian register.
With
repossessions feasible only when leased aircraft are outside Russia,
maintenance shops are moving into the spotlight as well. One lessor told
J.P.
Morgan chase analysts that it had four Russian customer airframes in heavy checks outside the country.
Lessors
not subject to sanctions still face significant hurdles. Broad
sanctions are limiting Russia’s access to the global financial system,
making routine payments difficult, if not impossible.However,
one of the main lessors active in Russia said its monthly lease rates
had been paid in U.S. dollars the week of Feb. 28.
The
payments are unlikely to continue. “[The] suspension of certain Russian
banks’ access to SWIFT, the universally used international bank
messaging system that facilitates interbank transfers,
could disrupt rent and loan payments owed lessors by their Russia-based
airline customers,” Moody’s writes in a March 4 research note.
“[While]
some Russian airlines may be able to remit lease payments through
China, the ability to move U.S. dollars directly from Russia appears [to
be] next to impossible,” J.P.
Morgan Chase states.
“The
initial financial impact to aircraft lessors will be disruptions to
their revenues and operating cash flows as near-term payments from
Russian airline customers due in March are not likely
to be received,” write DRBS Morningstar analysts. “Longer-term, the
absence of rental revenue from these aircraft creates an additional
headwind to the lessors’ ability to restore their revenue generation to
pre-pandemic levels, as revenues remain constrained
by rent deferrals granted to airlines looking to navigate the impact of
the pandemic.”
The
DRBS analysts further note: “More importantly, we see the lessors as
facing an elevated risk of noteworthy impairments to the value of the
aircraft on lease in Russia. Should the aircraft
become stranded in Russia with the lessors having no ability to regain
possession of the aircraft, then the lessors will likely have to write
down the value of the aircraft to a low recovery value that reflects
collateral such as letters of credit and maintenance
reserves that serve as security as well as any potential insurance
proceeds.”
If
Russian airlines refuse to return leased aircraft after March 28, a
portfolio of more than 500 aircraft worth well in excess of $10 billion
would be in limbo, according to Scope Ratings estimates.
As a consequence, one industry CEO forecasts that lessors will file
claims with their insurers for a total loss of affected aircraft. “It is
complicated, and there will be years of litigation over this, as some
insurers will reject the claims,” the leasing
industry executive says. “I’m concerned about how the insurance market
will absorb this.”
Aircraft
insurance arrangements usually are complex, but lessors typically
require airlines to “carry those types of insurance that are customary
in the air transportation industry, including
comprehensive liability insurance, aircraft all-risk hull insurance,
and war-risk insurance covering risks such as hijacking, terrorism (but
excluding coverage for weapons of mass destruction and nuclear events),
confiscation, expropriation, seizure, and nationalization,”
Air Lease Corp. writes in its most recent annual report.
In
Russia, airlines are obliged to insure aircraft locally, and most
lessors also have contingency coverage for individual aircraft or parts
of their fleets where the risk of relying only on
airline-managed policies is considered too high. That is the case for
most of the Russia-based fleet, according to one insurance industry
expert. The contingency policies cover everything or only certain
aspects, including war risk or confiscation.
Whether
lessors can expect to recover damages through the contingency
arrangements is not yet clear. No claims have been filed so far. Plus,
the policies are typically handled on the London
insurance market, and the UK, unlike the EU, has not yet published the
details of its Russia sanctions, which will determine whether the
financial impact is covered or not. “A lot of people are very nervous,”
an insurance official says. He also expects premiums
to rise substantially in the future as insurance companies reassess
risk profiles.
“Due
to sanctions, many insurance companies have canceled coverage or may
contest future claims, but certain lessors moved aircraft to their
contingent/possession insurance policies,” Fitch
Ratings writes. “Russian aircraft are insured in Russia, but the value
of these policies is uncertain, if [of] any value at all. Individual
insurance and umbrella policies with contingency clauses intend to cover
‘act of war’ events, and these policies could
potentially cover the current aircraft market value under certain
terms. . . . Any policy payouts may take time.”
Another
concern is that the West’s major aircraft and engine manufacturers have
ceased aftermarket support for Russian operators, either voluntarily or
due to sanctions. Without access to around-the-clock
technical support, spare parts sales and foreign airframe and engine
maintenance services, Russian airlines planning to operate Airbus, ATR, Boeing, Bombardier (MHI RJ
Aviation) or Embraer aircraft for any length of time seemingly face an uphill struggle.
Two-thirds of the 1,259 aircraft in Russian scheduled and nonscheduled services were built by Airbus, ATR, Boeing, Bombardier (MHI RJ
Aviation) or Embraer.
Lost access to international markets and a drop in booming domestic
demand will create excess capacity—and
open the door for parts cannibalization within subfleets. But long-term
operations without support probably will require securing parts on the
black market, similar to the way airlines in targeted countries such as
Iran evade Western sanctions to keep their Airbus and Boeing aircraft
flying. Iran, of course, is a much smaller market by comparison, and far fewer aircraft have had to be sustained.
Russia
is already preparing for an environment without OEM support. The
transport ministry published a draft government decree on March 5 that
automatically extends until Sept. 1 expired airworthiness
certificates for foreign-made aircraft registered in Russia. The same
measure is suggested for aircraft on foreign registers that are operated
in Russia under the Chicago Convention Article 83 bis. Crews can
operate these aircraft based on a document issued
by the Russian authorities without approval by the country of
registration, according to the provision.
The
ministry also will allow Russian airlines to use operating and
maintenance manuals for foreign-made aircraft without support and
updates from the OEMs. The draft decree is open for public
consideration until March 28.
