The emerging trend of aircraft lessors switching a portion of their lease exposure to cash accounting from accrual accounting underscores the credit and liquidity risks facing the sector, Fitch Ratings says.
Cash accounting, in and of itself, is not a credit concern, but is an indicator of increasing pressure on underlying airline lessees and the reduced likelihood of collecting on lease payments. Overall cash collections from lessees on cash accounting tend to be significantly lower than those utilizing accrual accounting.
As of 3Q20, the percentages of fleet net book value that had been switched to cash from accrual accounting were 15% for AerCap (‘BBB-’/Outlook Negative), 10% for Avolon (‘BBB-’/Outlook Negative) and 6.6% for Air Lease Corp. (‘BBB’/Outlook Negative).
Fitch believes rated lessors have sufficient headroom to withstand the non-payment of the portion of fleets on cash accounting, as the agency’s base and downside cases for default of 17% and 34%, respectively, already build in conservative assumptions around airline performance in a stressed scenario. However, a sizable increase of cash-based accounting may indicate a meaningful decline in future cash flow generation.
The switch to cash-based accounting is usually preceded by a drawdown of security deposits, with lessors switching accounting methodologies when lease receivables exceed security packages. Fitch anticipates higher impairment risk for aircraft underlying leases subject to cash accounting, as lessors have typically depleted cash deposits from the lessees prior to switching the accounting standard, thereby lowering possible recoveries on aircraft if leases are rejected during a lessee’s restructuring.
Most of the leases that transitioned to cash accounting relate to airlines which were granted lease deferrals earlier in 2020 amid the fallout from the pandemic, and subsequently became uncollectable due to insolvency or restructuring of the airlines. The switch to cash accounting is generally triggered when the lessor has determined that the collectability of lease payments can no longer be reasonably assured or when lease receivables exceed lessors’ security packages.
In addition, lessors typically switch to cash accounting for lease contracts under which the airline pays the lessor for actual hours used at a specific rate (also known as “power by the hour”) instead of the monthly lease payment due to the unpredictability of the associated cash flows. Power by the hour arrangements are concessions typically granted by aircraft lessors to stressed airlines.