Nearly all of the commercial airliners in Russia are operated under lease agreements, with 65% of the aircraft leased from foreign companies. The current political situation, the Western sanctions against Russia, the loss of access to cheap long-term Western loans, and other factors are all making the future of the Russian aircraft lease market so uncertain that lessors decline to give official comments.
This uncertainty stems from both political and economic factors. Foreign lessors say that, prior to the downing of the Malaysia Airlines Boeing 777 over Ukraine in July this year, the situation remained relatively benign: even though virtually no contracts were being signed with new clients or for new aircraft, work continued with existing customers under lease contracts for pre-owned airplanes. The only exception was Aeroflot’s subsidiary Dobrolet, which found itself on the EU sanctions list in early August. The European lessors immediately repossessed Dobrolet’s two Boeing 737-800s.
In a sense, the Western lease companies tended to perceive the situation in Russia as an inevitability they would have to learn to live with. It all changed after Flight MH17 crashed outside Donetsk. The prevailing mood now is to gradually discontinue all business activity in Russia, for the exception of the on-going contracts with reliable clients. All foreign lessors present in Russia can be ascribed to one of three different categories. Major businesses, each having around 100 airplanes operated by Russian carriers, are more inclined to leave, i.e. they are not planning to extend the current lease agreements beyond their expiration date. Medium-sized lessors, each with 10 to 15 aircraft let to different Russian airlines, are playing a waiting game and might consider extending their current contracts on a case-by-case basis. It is only the smaller companies, particularly those from Asian countries that are optimistic about the potential opportunity to expand to the Russian market. This categorization is, of course, very much notional: the behavior of each lessor is more complex in real life. Whatever the case, early contract severances with airlines are unlikely, unless something extraordinary happens. According to one lessor, if a pre-owned airliner worth $30–40 million gets returned early, the leasing company will be left dealing with an overhead of up to $1 million, which may effectively cancel out the entire lifetime gain to be had from leasing that aircraft.
Foreign lessors are also beginning to run into problems when securing funding for Russian lease contracts. Quite a lot of banks tend to view aircraft lease agreements as a variety of long-term loans, whereas the Western sanctions only permit short-term borrowings for up to 90 days. This is why existing contracts sometimes need to be redrawn in the name of special-purpose ventures (SPV). This scenario is not always deemed expedient because of the additional expenses it implies. Contracts funded against the guarantees of export agencies like the US Ex-Im Bank are also in the risk zone. Should the guarantees get recalled, the cost of these projects will grow sharply, potentially affecting their profitability.
Lease agreements involving aircraft parts merit special attention. This segment is relatively small in Russia because engines are normally considered to be part and parcel of the aircraft. On the other hand, powerplants are much more expendable than airframes. Therefore, companies specializing in the leasing of aero engines are more motivated to wait for the end of their current contracts before turning to other, much more promising regions of the world.
This is exactly the problem of the Russian aviation market, which was only of interest for as long as its growth rate remained in double digits. Its other appealing trait was that passenger numbers grew with the growth of oil prices, as distinct from the Western air transport market. It is different now, though: according to attendees of the ISTAT conference held in Istanbul in September this year, which is the world’s premier forum of companies involved in the leasing and funding of civil aviation, everyone’s interest is currently focused on China, India and other Asian countries, and Russia is all but forgotten.
Outlook from Russia
One of the few official acknowledgments that the Western sanctions may indeed have a negative effect on the Russian leasing market came from Vladimir Dmitriev, chairman of Vnesheconombank (VEB). Lessors reveal little more than that off the record. According to them, all market players are bracing for more economic sanctions, the rouble’s depreciation, further growth in the cost of funding (Western banks used to extend loans at 3–6% interest per year, whereas Russian ones charge at least 8–10%), etc. The opportunities of working with a Russian bank will be considerably reduced if it ends up on the Western blacklist. The aviation financing market mostly uses the US dollar as its currency of choice, so the costs are understandably growing. For example, a 1% increase in the lease interest rate for a new narrowbody (an Airbus A320 or a Boeing 737-800) adds an extra $500,000 per year to the lessee’s payments. A 10% growth of the dollar-ruble exchange rate increases the ruble equivalent of the lease payments for narrowbodies by around 15 million rubles per year. This, in turn, affects the airline’s profitability and may force it to default on its lease obligations.
The sanctions against the Russian financial sector are also affecting the leasing companies’ ability to restructure their existing contracts, which used to be financed with money taken from the EU and US markets. In other words, the cost of money for lessors is growing, forcing them to revise their contracts with carriers rather than suffering losses.
The fact that Russian lessors have a huge share of pre-owned aircraft operated under finance lease agreements implies a high probability of losses, because such airliners will be difficult to impossible to sell. The fact that these companies have no aircraft re-marketing skills does not help the situation either.
Lessors are skeptical of the suggestion that they will be able to quickly reorient their business to Asia. The Asian market is booming, and so is in great need of capital. Besides, Asia itself seriously depends on borrowings, which makes it controllable by the more powerful creditors, i.e. the USA and the EU. According to different estimates, around 400 aircraft on the Russian market have been borrowed from foreign companies under operating lease contracts. The entire Chinese lease market will not be enough to digest this figure. For example, China’s largest lessor, ICBC Financial Leasing Co., has a portfolio of around 180 aircraft, while BOC Aviation has some 150. In addition, Chinese lessors are normally extra cautious of the risks associated with the Russian market; so far their presence in Russia has been quite limited.
The sanctions business is certainly a two-way street. A total ban on aircraft deliveries to Russia would lose Airbus and Boeing around 20–30 aircraft sales each annually, or some 8% of their respective backlogs. This figure is quite significant, meaning that neither the manufacturers nor the Western governments would be happy with such a development. This is why Russian lessors maintain some modest optimism, even though they do admit that the market is in for a recession and that no new major contracts are likely to materialize in the near future.