The current conflict in Ukraine has sent shock waves through the commercial Aviation industry. Anyone with financial exposure to aircraft, controlled by Russian entities or otherwise connected to Russia is, unsurprisingly, concerned.
Western sanctions, and Russia’s response to them, have raised important questions as to the validity of the assumptions underpinning appraised Market Values of affected aircraft. In this article, we will outline our thoughts on a topic that will undoubtedly be front and centre in the minds of the Aviation investment community.
Restrictions on aircraft connected to Russian entities and person, or for use inside Russia
The restrictions imposed by the US, UK, EU, and Canada have swiftly blocked the transfer of aircraft and parts, curtailed provision of maintenance services, enforced cancellation of leases and insurance, and restricted the movement of hard currency in and out of Russia.
Most Western built aircraft operating in Russia are registered outside the country, in jurisdictions such as Bermuda, Ireland and the Isle of Man. Bermuda and Ireland have revoked the airworthiness certificates for Russian operated aircraft under their jurisdiction whilst retaining them on their registries; the Isle of Man has deregistered them and will not support transfer onto another register.
In response to these measures, the Russian authorities have legislated for the effective seizure of ‘unfriendly’ aircraft within their territory and begun the process of entering these aircraft onto their registry, in apparent violation of the Chicago Convention, which expressly prohibits simultaneous registration of aircraft in more than one state.
Impact of restrictions on underlying Market Value assumptions
At VesselsValue, our calculated Market Values represent the aircraft’s trading price under the market conditions prevailing at the date of the transaction. These Market Values rest on three key assumptions regarding the nature of the transaction:
Open and unrestricted market: the transaction is negotiated at arm’s length between two willing, able, knowledgeable, and prudent parties in an open and unrestricted market.
Airworthy: the aircraft is airworthy.
Sale without hindrance: the aircraft is intact, in a configuration and condition (including its records) for its relevant age that would facilitate sale without hindrance.
The conflict in Ukraine has called into question all three of these assumptions’ applicability to aircraft that are subject to sanction.
Figure 1: Market Value assumptions of aircraft, both subject to and not subject to sanctions.
The impact on Market Values of those Western built aircraft currently under Russian control flows from the reality that, for the foreseeable future, their trading market is decidedly Russian.
The nature of the restrictions, particularly the licence requirements issued by the United States that apply to any aircraft with more than 25% US originated content, effectively render sanctioned aircraft off limits to anyone anywhere seeking a trade. It is important to note that the restrictions also apply to trades within Russia: enforcing them is obviously impractical within Russian territory, but may still give potential traders, with an eye towards future relationships with the West, reason to pause.
Trading in a restricted market: impact on Market Value
We recognise that there are different ways to treat values in restricted markets, and the resulting numbers can vary widely between zero and full value depending on the perspective of the buyer.
To legitimate Western traders, the current obstacles affecting a sale of an aircraft out of Russia at any price, in exchange for hard currency into Russia, appear all but insurmountable.
On the other hand, within Russia these aircraft have a clear trading value: knowledgeable buyers, with means, exist in country; the aircraft are operable domestically according to recently passed Russian legislation, and they certainly have domestic part out value, should sanctions continue to restrict the import of Western components. Indeed, as sanctions increase the scarcity of serviceable components, an aircraft may become more valuable as a source of parts than as an operable entity.
Furthermore, as the experience with aircraft in other sanctioned countries attest, parts have a way of circumventing restrictions. Therefore, we believe it is more realistic to view the market for these aircraft as restricted rather than to say there is no market for them. In our view, it is most likely that if aircraft are traded, it will be for parts to enable other aircraft in the Russian ecosystem to continue to fly, or clandestinely into countries where component traceability is less rigorously controlled. Everything has a price.
Therefore, we have chosen to use a proxy that accounts for this specific restricted market, rather than returning a null value or refusing to have an opinion at all. The proxy for these sanctioned, so called “Russified” aircraft is their equivalent part out value at the end of their economic useful life. This is effectively a discount of up to 90% of the ‘normal’ Market Value depending on aircraft type.
The rationale is that, while sanctions are in place these aircraft are untradeable outside Russia, it is difficult to fly the aircraft internationally undetected, and its operation by whoever bought it would quickly become evident. Given the potential penalties for breaking the sanctions, we think trading as an intact aircraft is next to impossible. Cannibalising the aircraft for parts is much more likely, but even for young aircraft, the complications of getting them to a wider market outside of Russia would result in a low realisable value, even for relatively fresh components. Looking ahead, should sanctions eventually be lifted, any questions around component traceability would continue to render these aircraft untradeable as intact vessels in the global market, and only that portion of their components with proof of sanction free history would have any value.
These kinds of considerations lead us to view an end of life part out value to be a reasonably consistent proxy for the hypothetical market value of the intact aircraft while under sanction. We will monitor the situation and adjust accordingly.