International Lease Finance Corporation (ILFC) recorded a $1.3 billion operating loss for the third quarter, according to parent American International Group's (AIG) quarterly filing released yesterday. AIG attributes the loss to impairment charges of $1.5 billion as a result of ILFC's annual review of its aircraft fleet.
The announcement comes as a shock, given that management predicted about $300 million worth of annual impairments earlier this year.
While the company had lease revenues of $1.1 billion for the third quarter - almost flat over last year's results - the impact of volatile fuel prices, high production rates and a lack of market appetite for older equipment has force ILFC to reconsider the viability of certain aircraft types in its fleet.
Taking impairments now
Before last year, when it announced about $1.5 billion of impairments, ILFC had not taken any writedowns on its fleet, nor had the company sold that many aircraft over the years.
With airlines preferring younger equipment, and increasing production rates from the manufacturers, older aircraft are becoming less competitive.
Typically, depreciation curves are based on a 25-year life of the asset. Given that the useful economic life of certain aircraft types has fallen short of expectations, ILFC has been forced to review the values of certain assets in its portfolio given the market conditions.
Additionally, the fact that Airbus and Boeing both announced this year that they will introduce re-engined options of their narrowbody families - the A320neo and 737 Max - by the middle of the decade will push certain aircraft types into early retirement.
Gary Liebowitz, senior analyst, Wells Fargo wrote in a research note, published today that ILFC "was at high risk of future impairments". He notes that the values of "out-of-favor planes" have declined significantly.
About 10% of the company's 934 aircraft portfolio falls into the category of jets - made up of mostly older three and four engine widebodies and 737Classics.
Liebowitz further notes that ILFC has had "aggressive accounting policies" in both its depreciation policy and with respect to maintenance reserves that has led to overstating net aircraft values.
In a measure to address its older fleet, in order to maximise the residual values of aging aircraft, ILFC purchased AeroTurbine from Dutch aircraft lessor AerCap earlier this year. The part-out company will give ILFC the option sell jet parts if no demand for certain out-of-production models exists in the secondary market.
A profitable business
The impairments are a reflection of ILFC's revaluation of certain aircraft types or the lease rentals that can be achieved as it assesses the market conditions. They are not, however, a reflection of the business's success as a whole.
AIG has announced publicly that ILFC is a non-core business. In September ILFC filed with the SEC to do an initial public offering. Read the story here.
Liebowitz says that the impairments could be related to ILFC's IPO registration in September. "The Q3 impairment would bring ILFC's book value closer to NAV [net asset valuation] and reduce the risk of future similar charges," he writes in his report.
Despite the impairments leading to an overall loss for the company, the fundamentals of aircraft leasing continue to be healthy, and the company had rentals in excess of $1.1 billion for the quarter.
The company is upgrading its fleet, and has signed orders with Airbus for 100 A320neos that start to deliver in 2015 and 737-800s that will begin delivery in 2012.
ILFC management have expressed their desire to be investment grade. Last year, the aircraft lessor raised over $14 billion in secured and unsecured funding, including a $3.9 billion senior secured bond that paid back a government loan in total, for which it won Airfinance Journal's Overall Deal of the Year.
ILFC had no comment. The company is expected to file its 10Q either today or Monday.
Sophie Segal
ssegal@euromoneyplc.com
+44 (0) 207 779 8853