The Weaponising of
Operating Leases Mar/Apr 2022

In the economic war between Russia and the West leased aircraft have been weaponised. The fall-out is widespread and complex. Sanctions imposed on Russia effectively terminated the leases of about 500 Western aircraft operated by the Aeroflot Group or independent Russian airlines (S7, Utair, Ural Airways and Nordwind). It is estimated that about 80 of these have been repossessed or were stored outside Russia at the time of the invasion.

The value of the Russian-leased fleet is estimated to be in the region of $11.5bn. The cost of this particular sanction is estimated to be between $5bn and $15bn, the lower figure assuming recovery of more aircraft from Russia and rapid resolution of legal issues, the higher figure including loss of rentals by the lessors while they continue to make finance payments on their lost aircraft (which might explain why AerCap is putting its Russian losses at $3.5bn while the value of the relevant aircraft would be around $2.5bn). The question is: who bears the cost?

Firstly, the market value of the aircraft remaining in Russia is depreciating precipitously. The Russian authorities have refused to return the leased aircraft to their owners, though it is difficult to see how this massive fleet transfer could have been made, and have placed them on the Russian registry. Previously the aircraft were on Irish or Bermudan registries, a legal process that dates back to the introduction of operating leases to Russia in the mid-2000s when lessors were concerned about the repossession rights the Russian legal system (ironically, the Russian airlines had, up to the Ukraine war, been reliable customers with very few defaults). With the Russian registered-aircraft no longer having internationally recognised AOCs, they cannot be flown legally outside Russia (plus Belarus and former Soviet states in the east).

The value of aircraft depends on their maintenance manuals being correct and up to date. This cannot happen in Russia as the Western OEMs and lessors have withdrawn both the supply of parts and support from licensed engineers. Even if the war were to unexpectedly end and sanctions were removed, restoring the manuals and hence the fleet’s airworthiness would be a lengthy and very expensive process.

To maintain domestic service Aeroflot and the other Russian airlines will have to cannibalise aircraft for parts. There are longer any viable Ilyushin or Tupolev or Antonov alternatives to the Boeings and Airbuses, though the Aeroflot group operates 76 Sukhoi SuperJets manufactured in Russia. The maximum current production rate for the SSJ is about 14 units a year.

The lessors have hull and liability insurance, as well as specific aviation war cover, and expect these policies to pay out on the expropriated aircraft. As independent leasing consultant Dick Forsberg put it in a recent HSBC webcast the lessors regard the case as simply “property stolen in Russia”.

Most of these insurance policies are underwritten through the Lloyd’s of London market, with 30%–40% of the premiums then reinsured. There are reports that the insurers are “pushing back”, questioning for example whether the coverage would be still fully in place after the lessors in effect defaulted on their lease agreements (having being ordered to do so by the EU, the UK and the US). There are lots of convoluted issues here for the lawyers to get into (see following article for an independent legal view on the Russian situation).

The stockmarket reaction to the Ukraine war’s impact on the quoted lessors has been quite modest, at least in comparison with the first phase of the pandemic. There seems to be an assumption that the insurers will absorb most of the pain in the same way as state aid to airlines protected the lessors from widespread defaults.

The Russian jets only account for about 4% of the global operating leased fleet but the ramifications are broader for the sector. Increased insurance premiums are expected to push up lease rates at a time when dollar interest rates are also rising. On the other hand, lessors may try to rebalance their portfolios away from riskier markets to mainstream carriers, which might result in surplus capacity and downward pressure on rates.

Chinese speculation

More generally, the Ukraine war has highlighted the global leasing industry’s interconnections with geo-politics, and Putin’s malign influence on President Xi of the PRC. Democracy has already been suppressed in Hong Kong and the nightmare scenario is an attempt by the PRC to annex the ROC (Taiwan), a threat that is now being taken seriously by the West.

China is a major player in the aircraft leasing industry, with about 20% of the global operating fleet. Chinese state banks own leasing companies that own about 1,400 Western jets while Chinese majority-owned lessors have over 1,000 more aircraft. Of the total, 2,455 units as at the end of last year, about 31% were leased to Chinese airlines but 28% were leased to North American and European airlines. Could these 700 aircraft be weaponised like the 500 Western aircraft in Russia in the event of a China conflict?

Such speculation would have been dismissed as alarmist nonsense two months ago but since then we have learnt that governments can intervene to instruct lessors to terminate leases and take back owned aircraft. With the Chinese leased fleets, it could conceivably work in two ways — the Chinese could demand the return of their owned aircraft from Western airlines or Western airlines could be required to stop dealing with the Chinese owned lessors.