Lessors: Things
Couldn’t Be Better Mar/Apr 2024

Commenting on their 2023 performances, the lessors oozed optimism:

• AerCap, having completed the purchase and integration of GECAS by the fourth quarter, saw its 2023 revenues increase by 12% to $7.8bn and it reported a record net profit of $3.1bn in contrast to a net loss of ($0.72bn) in the previous year. The profit figure for 2023 included a $1.3bn recovery in insurance settlement. Following a major share buy-back, its stockmarket value has doubled since the low point in early 2022.

• Avolon increased its revenues by 6% to $2.5bn 2023, and produced net profits of $0.34bn compared to break-even in 2022. Operating cash flow was stated to be at a record level.

• Air Lease Corporation reported record revenues of $2.7bn for 2023 up from $2.3bn and a near record net income of $0.75bn compared to a net loss for 2022 of ($0.14bn). Its share price is up about 50% since 2022.

• BOC Aviation reported a 7% increase in revenue to $2.5bn and net profit of $0.76bn, another record. Reflecting uncertainty over the Chinese aviation market, the share price has not changed much over the past two years.

The Russian crisis that dominated 2022 seems to have been partly solved. The lessors have managed to negotiate settlements for over 100 aircraft with a subsidiary of the Russian state insurance company NSK, whereby the insurer has compensated the lessors for the loss of their assets and taken official possession of them for transfer them to Russian carriers.

Because this is an insurance settlement rather than a sales agreement, it appears that this arrangement does not fall under the sanctions imposed by Western countries following the invasion of Ukraine.

NSK is believed to have a budget of $3.3bn to settle the lessors’ claims.

Meanwhile, the lessors are continuing their lawsuits in the Irish and US courts mostly against Lloyd’s of London insurers and re-insurers. The total amount of claims is estimated at $8-10bn. It is still not legally clear-cut as to whether the insurance policies do fully cover all the lessors’ costs as the leasing companies technically terminated the lease agreements, in line with the sanctions.

Interest rate impact

As the graph shows, interest rates have risen sharply to levels not seen since the just before the Global Financial Crisis. The benchmark one-year SOFR (Secured Overnight Financing Rate which has replaced LIBOR) stood at 5.24%pa in April in contrast to about 0.2%pa at the beginning of 2022.

For the lessors, their actual cost of capital depends on the proportion of floating or fixed rate debt, the maturity schedule of the debt and the lessor’s credit rating. The major lessors have predominantly fixed into historic low rates; ALC, for example had 85% of its debt at fixed rates, 15% on floating rates, at the end of 2023, giving it a composite cost of funding of 3.77%pa.

But raising new funds has become more expensive. SMBC Aviation Capital recently sold $1.5bn of five and ten-year bonds at 5.30-5.55%, representing 1.08-1.35% above the US Treasuries price. ALC has also recently extended its revolving credit facility to $7.8bn from $7.4bn at SOFR plus a margin of 1.05%pa.

Interest rates have been sticky in following inflation down, and are not now expected to revert to pre-2022 levels. This does not appear to concern the credit rating agencies which maintained their investment grade ratings for the leading lessors — for example, Fitch rates AerCap and ALC at BBB, BBB- for Avolon, BBB+ for SMBC and A- for BOC.

Recent trends in lease rate and aircraft values have been remarkably strong. According to an analysis by IBA, operating lease rates for all new narrowbodies are now significantly above pre-pandemic levels — for example, over $400,000/month in early 2024 for a 737MAX 8 compared to $320,000/month in mid-2019; $470,000/month for A321neo compared to $380,000 in 2019.

Supply/demand

This is partly due to higher interest rates, but there is also a very tight supply/demand balance for new aircraft caused by the well-publicised production problems at the OEMs, affecting MAXes, 787s and the A320neo family, combined with a recovery in traffic to pre-pandemic levels, Because of the constraint on deliveries, airlines are tending to extend leases on older types rather than returning them to the lessors on lease expiry, which is pushing up rentals and values for these types as well. These new disruptions come up top of the various supply constraints that during the period 2019-2022 meant that 1,800 fewer narrowbodies and 720 fewer widebodies (respectively 11% and 15% of the 2019 fleets) were delivered than was planned.

The lessors, in short, are in a very powerful position. Airlines seeking new equipment are facing long waits from the OEMs while the leading lessors, with their formidable orderbooks, are in a much better position to fulfil early delivery slots. Moreover, the balance sheets of many airlines have been weakened by the debt taken on during the pandemic, which has a positive implication for the lessors, in that airlines will prioritise paying down debt from their improving cashflow rather using it for capex, which means more demand for operating leases.