A Conversation with Peter Juhas, Chief Financial Officer of AerCap

Thanks Andrew.

Well, so we had been looking at GECAS for quite some time. It was our largest competitor and we had a lot of respect for the business, thought it was well run, very competitive. We ran into them across a lot of campaigns and knew that they had a very good aircraft fleet. The question was at what price would we buy it. And we had had discussions with Larry Culp, CEO of GE for a while. We had been building those really introductory ones prior to the pandemic, where our CEO, Gus Kelly had reached out to him and basically tried to set the stage. We had done a previous acquisition of AIG's business, ILFC, which was also a very large acquisition. And in that deal, it allowed AIG to basically have a path to exit. So we thought that was a good template for this. And we had raised that idea with Larry prior to the pandemic. Then COVID hit, put everything on hold and it was pretty clear, GE had been public that they were planning to dispose of GECAS or almost public about it. And so it was obvious that they wanted to sell it. Then COVID hit. And obviously that threw all those plans, GE’s plans askew, and people, we, GECAS, others GE obviously at first were spending all of our time dealing with the repercussions of COVID. But as things progressed, it became I think from GE's perspective, they thought, look here is an opportunity to exit. It would allow them to do some other things like wind down GE capital. So Larry Culp reached out to us, to Gus and said, look, let's talk about that idea that you had before. And from our perspective, I think that fundamentally aircraft leasing is a good business. It's very long dated contracts. It's predictable. Your depreciation is predictable, your interest, you match it. That's all pretty predictable. But there aren't many opportunities to outperform. Like you can get good returns. Right? But it's hard to get exceptional returns other than when you have times of stress. And what you really need to do is be positioned for those times so that when they come because they don't come around very often. But when they do come around, that you can really act on them in a sizable way. And so we had seen that with ILFC, as I mentioned back in 2014, where AIG needed to sell that business and we were able to get it at a very good price and we thought this was another similar opportunity. And so in order to do that, we had to make sure that we had the banking relationships that would enable us to finance such a huge transaction, that we had the support of the board, that they were well informed about what the strategy was and why this would make sense. And then from an investor, just from an investor side to make sure that they would understand why we were doing it. And I think fundamentally, we needed to make sure that we had the balance sheet to do it. And so having all of those things, even despite such extreme event such as COVID, on the aviation industry in particular, we were positioned to be able to do it.

When we were negotiating the deal with GE, this was really in December of 2020, it was a very small group of people involved in that on the GE side and on the AerCap side initially. And because Larry Culp wanted to keep it very tight, didn't want to have any leak out there. And there were a couple of banks that GE had been using in order to try and sell GECAS. And it was very specific that we only go to those banks. We couldn't go to a wider group and it was critical that we have the financing in place, committed financing in order to even contemplate the transaction, frankly. So we went to those banks and talked to them and said, look, here's what we're thinking about. Here's what we would project for the business to look like. And we were able to, they came back and said, yes, we think we can do that with the bridge financing. Obviously it's going to be syndicated to a large group of banks. That was a critical element because, if that syndication was not successful, well, if these banks didn't think it would be successful, then we wouldn't have gotten it in the first place. And so I'd say in order to do that, we've spent a lot of time over the years with our banking partners, including Mizuho, which is one of our most important banking partners, in order to build relationships. Because I think it's a steady thing where you need to build it over time and not having people jump in and say, okay, we want to join. And we'll start at a very high level, which you might not feel good about later because you're not getting the fees that you were looking for initially. So we've tried to build that step by step with people over time. We have over 130 banks that we work with globally. And I think that was critical to being able to do it because the banks knew us. Right? They trusted us. They had seen us do it in the past. And this was on a larger scale. I think the interesting thing about this transaction, one very interesting thing and an opportunity to create value, was that GE had financed this business on their own balance sheet. Which is a massive amount to be financing, $30 billion worth on their own balance sheet. So GECAS had no public debt itself and only a very small amount of private debt. And so essentially you had a situation where the entire debt stack of the balance sheet would be done in one fell swoop, really. And so once we were able to get the bridge financing done, then there was a lot of consideration for our management team about when do we do that, take out financing, because we had to get regulatory approvals from countries all over the world. And obviously some of those take more time than others. So we were able to get the US and EU pretty quickly and a lot of other countries, but we were waiting for China ultimately. And it was a question because you say, okay, you don't want to wait till the last possible minute to finance this right, until right before closing. But on the other hand, if you do the financing and then you're waiting for the Chinese government to approve it, you could be waiting a long time for that. And you're paying double on the debt, basically. And so that was a big consideration. And I'd say we had a lot of vigorous debate internally about that, but ultimately, it was a good time to do it. I mean, we did it in October of 2021. And at the time, if I think of the value that that created, AerCap’s average cost of debt was about 4%. Right? Just on our whole balance sheet. And GECAS, if they had been doing financings at the same time all along, when they bought those assets, it probably would have been equivalent. We were able to get it done at 2.6%. So that's just a huge benefit, but it wasn't without some nervous times, particularly when we saw interest rates starting to rise.

Sure. So for us, we thought it was very important that we integrate the business quickly and we were constrained because of all those antitrust approvals that we had to get. The antitrust lawyers, particularly on the GE side, were very clear that we couldn't do anything that suggested that we were working together, managing the businesses together prior to closing. So we had some discussions, but we really couldn't do much until we took it over on November 1st, which was the closing date. We really wanted to hit the ground running with that. And so we basically had a plan that within a month we would try and give certainty to as many employees as possible about the future. Because, fundamentally, we don't have a lot of people, so it's not a huge amount of employees, even though, as you said, $70 billion of aircraft assets, but only AerCap had fewer than 400 employees. GECAS had maybe 600 or so. And the combined business is about 700 employees now. So we move very quickly to do those things. I mean, obviously that involves some hard decisions, but our thought was better to do those sooner. Particularly around things like, headcount or around people issues. And so we did those quickly, we made decisions about which offices we would, how we would consolidate those. I mean, as it happens, our business, our Shannon office, which is our second largest and GECAS’s Shannon office, which was their largest office, are right next door to each other in the west of Ireland. And so that actually made it easier because they were right next door, to be able to consolidate. But, so I'd say that was a key thing initially, to do that. And then, it was very important to get the commercial teams working together as soon as possible get those accounts reassigned. All of those things happened very quickly and that was a big part of it. I mean, even though, as I said, even though the business has gotten much bigger, operationally, most of that we could do very quickly. There were some systems things that we continue to do. And now going forward, I think the challenges are really that you are just that much bigger. Right? So things that you were doing before, it's almost like a mindset change where you say, okay, we used to sell $2 billion of assets in a year and think that was a lot of assets to sell. And now the portfolio is almost twice as big. So you say, well, 2 billion isn't 2 billion anymore. Or raising debt we used to raise, I don't know, in a big year, we would raise $4 billion of debt. And that's going to be a normal year now. So, not this year, this year, because the financing was sort of pushed out in terms of the tenors, we don't have much to do there. But in future years, that will be the case. And so I think that it does require some sort of mindset change to say, everything is that much bigger and you have to think about it that way.

Well, we've seen these supply chain issues happen for a while. Supply chain and also regulatory things. We had the MAX that was grounded right prior to COVID and at the time that was a huge thing for the industry. Right. And then everyone was wondering, how are we going to deal with that? And then COVID happens and nobody's talking about the MAX anymore, right? Or very little. So you had that, Airbus had their own issues on the A321 in particular. And there have been a number of teething issues on the engine side, too, in terms of ramping up and then Boeing on the 787. So all of that has led to a lot of supply constraints. And from our perspective as the largest owner of aircraft in the world, yes, obviously we have a big order book and we want to see those deliveries come through, but it's not the worst thing for us, if we do see, if some of that gets pushed back, right, we can manage that. We have other sources, we have other ways to deploy our capital, rather than just on new aircraft coming in. So obviously, you want to satisfy the customers. Obviously, we want to get our planes on time, but if not, we can do things with our capital to deal with that. And fundamentally, I do think that that leads to, we do think that there will be kind of supply pressures affecting the industry as the recovery continues to take hold. I mean, we've seen it, obviously. It's very strong in the US, very strong in Europe, starting to strengthen in Southeast Asia, which was kind of the laggard. China, obviously, there are continued lockdowns there and that's probably going to be the last place that comes back, internationally. Domestically, it has been very strong there for most of the pandemic. And so I think as all of those countries come online we are going to see a supply crunch for aircraft. And we're already seeing that today where these rates are going up, particularly for deliveries kind of out 2024 and beyond where airlines are just anticipating that they're going to have a hard time getting their hands on equipment.

Yeah, well, I had been hoping that after COVID, and after the GECAS deal, that this would be a little bit more of a normal year. And then Russia hit and we had 135 planes and 22 engines there. Because of the sanctions that ensued, we had to terminate all of our leasing activity with Russian Airlines, which we did and notify the airlines that they needed to return the planes. Most of them didn't do that. We were able to seize and get back 22 of our aircraft and three of our engines. So that left 113 in Russia, aircraft. And for the most part, those planes continue to be flown around by the Russian airlines. And so, as we looked at that and obviously we continue to try and get them back, but most of the recoveries happened really in the first few weeks after sanctions. And it was when they were flying to jurisdictions abroad that would help us to recover them, Turkey and Egypt in particular, we got a lot of planes there. So we had to take stock of this and say, okay, what does this mean? What are the prospects for a recovery? We filed a large insurance claim, $3.5 billion insurance claim, which is probably the biggest in aviation history, I would guess. We know that that's going to take some time to work out, right? I mean, to work through those claims and others will have them as well. I mean, in total, you're looking at $15 billion worth of aircraft that have been detained in Russia, right, indefinitely. And so we, in talking with our auditors, for instance, said, look, here's the situation. We don't know when we're going to get those aircraft back. And I had heard of others in the industry saying, oh, well, maybe you can do some probabilistic assessment about maybe there is some 30% chance to get them back, 40%, whatever. For us, we don't control those aircraft now. We don't have them. They're being flown around and we can't get at them. And so, from my perspective, I thought the best course of action was just to write it off entirely, all of those aircraft and engines that are there. Which was a big, that was a big move. Right? And it's a lot of value. Ultimately, we ended up taking about a $2.3 billion write down after tax on that in the first quarter. But I think fundamentally that was the right thing to do. And we went out immediately after that, I went out and saw, well, we actually announced it in the fourth quarter, our exposures there. So when we reported fourth quarter results on March 30th, we announced what our exposure was and made it pretty clear that we expected to take a write down the first quarter. And so after that, we went out and saw investors for two and a half weeks. And it was very important obviously after COVID where you've been looking at them on video calls for two years to see them in person. It wasn't always the easiest right time to be doing that. It wasn't a victory lap for sure. But I thought that it was important to get out there and tell them in person, because a lot of them had questions. Like why are you doing this? There are some others out there who are saying, they're not going to take any impairments and I said, “ Look, I can't speak for them, but I can tell you what our situation is. And yes, we are confident that we'll get insurance recoveries. Yes, we feel good about that. And maybe we'll be able to get more planes back, but all of that is unknown.” How do you know, there's no way to estimate what the time frame is for that or really ultimately what the values are there that you’ll get. And so I think that that was the right case and frankly, the feedback from equity investors was very interesting, because a lot of them, a number of them said, look, we think that you should really look at this as a discontinued operation in the sense that it's gone, don't spend half of your earnings calls talking about Russia or insurance or that type of thing. We want you to talk about how your business is doing. And so that's what we plan to do and we'll see how it all shakes out and basically said to them, look, we're going to run the business as though we don't get any of that back. Like obviously we're going to work hard, vigorously to try and get those insurance proceeds and any other claims that we can get. But we're not counting on them in terms of how we run the business.

I would say to start I mean, fundamentally I thought it was important to have kind of an honest assessment of what do you know right about COVID and what don't you know. And what we knew is, okay, this is a big shock that is hitting. Didn't know how long it was going to last. Right. Very hard to plan for that. And so we're a public company. We don't have a parent. Right. GE now is 45%, but we've never had a parent. And so since 2006, when we went public, we're just relying upon ourselves and I think obviously there are some negatives to that, but there are also some positives because it forces you to be self-reliant and to say, okay, we both control our own destiny, but also kind of make our own destiny. We're subject to the forces of the markets. Right? And so we initially said we don't know how long this is going to last. We need to be prepared. The first thing we need to do is to make sure that we have as much liquidity as possible in order to get through this. I don't think anyone actually thought that it would be as long as it has been. But that was our approach. So we initially said, we're going to ramp up our liquidity. So we immediately increased our liquidity target. We typically run at 1.2 times coverage of next 12 months of uses of cash. And we said, we're going to keep that at one and a half times. And in fact, we far exceeded that over the last couple of years, including now, but we also moved out a number of our aircraft deliveries. So it was pretty I would say it was fortuitous in the sense that with the MAX delays, we had some greater ability than we normally would have had to reschedule aircraft deliveries. And as you mentioned, it was hard anyway for the OEMs to deliver. And so we pushed those out for several years, generally speaking, without cost to us. And that was very positive and frankly, we thought that that would make sense anyway, even without COVID, it would make sense to do that with the MAX because, once the MAX was re-certified, who knows what the reception is going to be initially for it. We were confident that ultimately airlines would want to have it. People would want to fly on it. And but there would be some initial time period where there would probably be less demand and so it made sense on several fronts to do that. So we pushed out billions of dollars worth of deliveries. We created billions of dollars worth of liquidity to be able to get through it. And then our next step really was to say, okay, we need to show the capital markets that we can continue to fund this business because we fund through banks. Obviously, we have secured loans, we have various other things. But fundamentally, the bond market is the biggest funding source for us. And so that our spreads were very wide in May or April and May, early June of 2020 and our thesis was until we actually do a transaction, there's nothing else that's going to catalyze those to make them lower. And so we and again, this is a thing that we had a lot of debate about internally, what are the pros and cons of doing that. And we went out and did a deal in June of 2020, early June. And on that deal we went from initial price talk in the eights to well we priced a deal in the sixes. So a 150 basis points move just on that transaction and yeah, look it's painful to be going out at 8% but fundamentally, that did drive it down, it drove down even for that transaction. We ended up coming to the market at the end of June to do another one at several hundred basis points lower. So I think that that was the right thing to do to try and get ahead of it because otherwise if you wait around and hope that things are going to get better, yeah, maybe they will get better, but they may well not. And I'd say that has been our approach throughout this has been like to try and act as soon as we could to take steps to make it better. There was a lot of work, obviously, done with the airlines in terms of granting them deferrals and things like that. We granted deferrals probably to half of our customers. And these are rent deferrals, so initially saying, okay, you don't need to pay us for this three month period, don't pay rent then, and you'll make it up to us over a subsequent 12 months. And so most of our customers were looking for those. We didn't always give it, but when we thought the airline needed it, we worked with them to get through it. And I think from my perspective, I thought, okay, obviously you're seeing this deferral balance grow over time. But fundamentally, if we can, once things start to recover, if we can see that coming down on a reasonable trajectory, that's okay if it takes a while to come down. Right. I mean, that's essentially additional cash flow that you're getting during those periods. So the key was getting the airlines through that initial phase and off of the deferrals. And now very few are on deferrals. We still have a deferral balance that will come down over the course of a few years. And I'd say like if we hadn't done any of this we wouldn't have done the GECAS deal if we didn't think that fundamentally air travel was going to come back because, then it's just sort of doubling down right on something. But we did believe that that would be the case. We believed that people still wanted to fly, like reports of the death of aviation were greatly exaggerated, including on the business travel side. Right. And I think things are supporting that. Now, as you say, there are additional headwinds now to face. You've got inflation, you've got higher oil prices, you've got rising interest rates, which, we haven't really seen for a decade, you know. I mean, not to this level. So those are things to deal with. I do think, though, that they're more regular way in the sense that coming out of COVID, I mean, COVID was existential for the airline industry, right? You had 85% of the global fleet on the ground. And so all of this is more normal. Right? And it's still issues to deal with, but at least it's kind of against a backdrop where people want to travel. There is normal flying happening.

No, thanks very much for having me. And thank you again for all the support that Mizuho has given to us. I mean, it's been very important and you guys have been a great partner through the years. Likewise.