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Fitch Completes Aircraft Lessor Peer Review

Fitch Ratings has completed its periodic peer review of aircraft lessors, which is comprised of ten publicly rated firms. The following actions were taken as a result of this review:

• AerCap Holdings N.V. (AerCap) – Long-Term Issuer Default Rating (IDR) affirmed at ‘BBB-’; Outlook Stable.
• Air Lease Corporation (Air Lease) – Long-Term IDR affirmed at ‘BBB’; Outlook Stable.
• Aircastle Limited (Aircastle) – Long-Term IDR affirmed at ‘BBB-’; Outlook Stable.
• Avation PLC (Avation) – Long-Term IDR affirmed at ‘BB-’; Outlook Stable.
• Aviation Capital Group (ACG) – Long-Term IDR upgraded to ‘BBB+’ from ‘BBB’; – Outlook revised to Positive from Stable.
• Avolon Holdings (Avolon) – Long-Term IDR affirmed at ‘BB’; Outlook Stable.
• BOC Aviation (BOCA) – Long-Term IDR affirmed at ‘A-’; Outlook Stable.
• Intrepid Aviation Group Holdings (Intrepid) – Long-Term IDR affirmed at ‘BB-’; Outlook Stable.
• SMBC Aviation Capital (SMBC AC) – Long-Term IDR affirmed at ‘A-’; Outlook Stable.
• Transportation Partners (TP) – Long-Term IDR affirmed at ‘B-’ and withdrawn; Outlook Stable.

Individual rating action commentaries for each of the aircraft lessors are available on our website. For further information on the rationale for each rating action, please refer to these commentaries.

The rating actions are supported by multiple factors, including generally strong franchise positions among those that have achieved scale, various ownership dynamics (standalone or corporate / insurance / bank-owned), capable management teams, differing levels of funding flexibility, largely attractive aircraft fleet characteristics, and appropriate leverage levels relative to the assigned ratings.

Aircraft lessors continue to benefit from supportive market dynamics including above-average air traffic growth; the increasing adoption of aircraft leasing; demand for various aircraft types across the age spectrum, which has limited impairment risk; and accessible funding markets. Competition has placed pressure on lease yields and net interest margins over the past several years. While yields should benefit from rising US interest rates over the medium term, more costly funding may be an offset. The financial conditions of airlines are generally sound, though expected to deteriorate over the medium-term due to rising fuel costs, as evidenced by recent fare/route adjustments made by certain large-scale airlines. While some of these dynamics have enhanced aircraft lessors’ recent financial performance, many are cyclical in nature, and therefore, their impacts on the ratings are somewhat muted.

Rating constraints applicable to the aircraft leasing industry include the monoline nature of the business; vulnerability to exogenous shocks; potential exposure to residual value risk; sensitivity to oil prices; reliance on wholesale funding sources; and increased competition from new entrants, particularly in Asia.

According to Fitch’s June 2018 Global Economic Outlook, global growth prospects remain robust despite rising trade tensions and political risks. Fitch’s global growth forecast is 3.3% in 2018 and 2.9% in 2019. Revenue passenger kilometres (RPK) grew 7% year-to-date through April 2018 according to The International Air Transport Association; this was below the 8.1% growth rate achieved in 2017 but above the long-run average of 5.5%. Falling travel costs have attracted new passengers, load factors remain high, and the introduction of unique city-pair networks have all served to expand RPKs.

Consistent with recent years, RPK growth has been strongest in the Asia-Pacific region (9.5%) and lower in North America and the Middle East (both 4.9%). China (sovereign Long-Term IDR A+/Stable), continues to be a meaningful driver of growth in the Asia-Pacific region for most aircraft lessors. The Chinese airline sector is likely to continue to grow over the long term, supported by rising household incomes, infrastructure investment and market-oriented reforms that are driving improvements in airline efficiency, and aircraft lessors continue to support this growth. Approximately 50% of aircraft lessors’ airline customers were domiciled in the Asia Pacific region as of 31 March 2018, essentially unchanged from the previous year.

Fitch believes that the prospect of a broader trade war between the U.S. and China is likely to have a limited impact on aircraft lessors, based on currently-proposed Chinese tariffs, which target specific Boeing aircraft that constitute a limited percentage of aircraft lessors’ portfolios. In addition, taxes and tariffs are typically borne by airline customers, not lessors. That said, if a trade war further escalates, this could have a more direct impact on leased aircraft and/or economic activity and passenger travel.

Merger and acquisition activity has continued in 2018 on the heels of two large-scale transactions in 2017 — Avolon’s acquisition of CIT Group Inc.’s commercial aircraft leasing platform and Dubai Aerospace Enterprise’s acquisition of AWAS. In June 2018, Goshawk Aviation announced that it would acquire Sky Aviation Leasing International, bringing its combined fleet to $9.1bn.

Aircraft lessors have also continued to establish partnerships to achieve growth objectives. Avolon recently established an asset management platform with China Cinda Asset Management, known as Jade Aviation and Air Lease is growing its second joint venture vehicle with Napier Park Global Capital (US), Blackbird Capital II. In June 2018, Intrepid announced that its shareholders, which include funds managed by Centerbridge Partners and Reservoir Capital Group had entered a partnership with Amedeo Capital Management whereby the combined platform will manage approximately $8bn in aircraft assets.

Most of the rated lessors have sufficient scale, which Fitch generally views favourably. In addition to the diversification benefits that come with size, Fitch believes that scale provides certain strategic benefits, such as increased purchasing/negotiating power with the aircraft manufacturers, an ability to transact with larger and more highly rated airlines, and more available channels to re-lease planes when needed. Conversely, with a broad reach comes increased likelihood of exposure to challenged airlines and/or geographies during periods of stress. The airline bankruptcies that occurred in 2017, Air Berlin and Monarch Airlines, were manageable for the rated lessors.

The outlook for lease yields across the sector is mixed. Established lessors’ direct orders with the aircraft manufacturers are particularly appealing in the current environment since the sale-leaseback market remains highly competitive. Average lease yields, calculated as lease revenue to total aircraft assets, for aircraft lessors monitored by Fitch declined to 8.3% in 1Q18 from 8.5% in 2017, 8.9% in 2016 and 9.2% in 2015. At the same time, larger lessors like GE Capital Aviation Solutions (GECAS), AerCap, and Avolon, have all selectively sold higher yielding aircraft to take advantage of the strong secondary market for older planes, thereby lowering lease yields.

The recent increase in jet fuel prices could lead airlines to increase their appetite for more fuel-efficient next-generation aircraft and/or reduce their appetite for older planes, which should benefit players with long-dated order books and potentially lead to more impairments for lessors focused on the midlife or older segments.

The unsecured bond, commercial bank and private placement markets continue to be the primary sources of debt funding for aircraft lessors, although the ABS market has been readily accessible as well. The aircraft leasing sector completed 514.4 billion in unsecured note offerings in 2017 and $6.6bn during 1 H18, driven by the need to fund capital expenditures and refinance debt maturities. AerCap, Air Lease, Avation, ACG, Avolon, BOCA, and Nordic Aviation Capital DAC have all been in the unsecured funding markets in 2018. Still, aircraft lessor corporate bond spreads have widened 23bps on a weighted average basis during 1 H18, to trade at 171bps over benchmark rates.

Average leverage for the ten publicly rated lessors was 2.8x as of 31 March 2018, flat compared with year-end 2017 but down from 3.1x at year-end 2016. While debt issuance was active in 1Q 2018 and 2017, this was offset by debt repayment and moderate equity growth, via retained cash flow and the absence of material asset impairments. AerCap continues to repurchase shares as a by-product of its asset sales program, while Air Lease and Aircastle have instituted modest dividends.

There continues to be a divergence between leverage of stand-alone lessors, which tend to employ lower leverage, and institutionally supported lessors, which employ higher leverage but benefit from potential credit and/or liquidity support from their parent companies, though the gap is tightening. In March 2018, SMBC AC received confirmation that its shareholders, Sumitomo Mitsui Financial Group and Sumitomo Corporation, agreed to provide up to $1bn in capital to support its growth objectives. This should further reduce SMBC AC’s leverage, which already declined to 3.5x at 31 March 2018 from 4.1x the previous year, at least until the additional capital can be deployed.

As interest rates have increased, publicly-traded lessors’ equity valuations have been negatively impacted. Price-to-book ratios were 0.85x on average for the four publicly traded lessors (AerCap, Air Lease, Aircastle, and Fly Leasing) as of 31 March 2018, down from an average of 0.93x during 2017. Air Lease has been the one firm that has generally traded at a premium, which Fitch believes reflects equity investors’ favourable view of Air Lease’s larger order book than peers and younger fleet, the latter of which may reduce impairment risk.

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