NEW YORK--(BUSINESS WIRE)--Fitch Ratings has completed a peer review of five rated aircraft lessors, resulting in the affirmation of the long-term Issuer Default Ratings (IDRs) of AerCap Holdings N.V. (AER, 'BB+'), Avation PLC (AVAP, 'B+'), Aviation Capital Group (ACG, 'BBB-'), BOC Aviation Pte Ltd (BOC Aviation, 'A-') and SMBC Aviation Capital Limited (SMBC AC, 'BBB').
The Rating Outlooks for AER and ACG have been revised to Positive from Stable and the Outlooks for AVAP, ACG and BOC Aviation remain Stable.
The revision of AerCap's Outlook to Positive reflects deleveraging and fleet optimization undertaken by the company, combined with Fitch's expectation of further deleveraging over the outlook horizon. Fitch also believes execution/integration risk associated with the International Lease Finance Corp. (ILFC) acquisition has significantly abated given that the company has successfully combined the ILFC fleet into the portfolio and largely completed the staff integration.
The revision of ACG's Outlook to Positive reflects improvements in ACG's stand-alone credit profile, most notably including reduced balance sheet leverage (debt-to-tangible equity) appetite over the last several years, driven by a capital injection of $150 million in March 2014 by from ACG's parent, Pacific Life Insurance Company, and continued retained earnings growth. Balance sheet leverage on a consolidated debt to equity basis was 3.2x as of March 31, 2015, a material improvement from the historical average of between 4x and 4.5x over the last several years.
For further rating rationale, please refer to the company specific press releases published today and available at www.fitchratings.com.
Largely Accommodative Financial Markets
The aircraft finance market has remained healthy and is expected to continue this trend during the remainder of the year, with aircraft lessors benefitting from strong liquidity provided by a balanced group of funding sources including the capital markets (e.g. securitization financing, unsecured debt) and commercial banks. The Export-Import Bank of the U.S.'s (Ex-Im) cessation of new lending activities does not have an immediate impact on aircraft leasing companies given the broad market access they currently enjoy; however, a permanent loss of Ex-Im would eliminate a contingent funding source for these lessors. Ex-Im has historically been viewed by Fitch as an important back-up funding option for aircraft lessors, particularly those with material long-term contractual order books with Boeing.
Strong Secular Trends Leading to Increased Competition
Financial performance has remained steady for most aircraft lessors, underpinned by firm lease yields, improving aircraft values and strong airline industry operating fundamentals. In aggregate, lease rates have largely recovered from the dip experienced during 2013 and are expected to remain relatively stable over the near term, supported by strong global demand for air travel.
These strong underlying fundamentals, combined with historically low interest rates and the potential to generate acceptable risk-adjusted returns, have attracted new competition from a variety of sources, both global and regional in nature. New entrants have remained fairly rational to date. However, the influx of capital could lead to more competitive lease pricing and terms, and may tempt some lessors to expand outside their core strategy to grow and increase earnings.
Increased competition in the sale-leaseback market has driven many lessors to place orders directly with the manufacturers. Boeing and Airbus have seen strong new order activity from both lessors and airlines and accumulated record backlogs. Announced orders by Fitch-rated aircraft lessors over the last 12 months include AerCap's order of 100 Boeing 737MAX-8 aircraft with deliveries starting in 2019, SMBC's order of 90 737MAX-8 aircraft and BOCA's order of 80 737MAX-8 and New Generation 737-800s. Orders being placed now, towards the upper end of the cycle, are likely to be more expensive, which increases the risk that these aircraft do not meet their initial return expectations.
Tailwind from Sustained Low Fuel Prices
Oil prices remain well below their peak in 2011, reflecting, in part, slowing global oil demand combined with robust production from oil-exporting nations and U.S. oil producers. As of Aug. 5, 2015, the price of Brent crude was $49.70/per barrel. The price of jet fuel has followed a similar trend, which, if sustained, will continue to create a significant tailwind for the airline industry and support the benign credit environment for aircraft lessors. Fitch's projection for Brent crude is $65/per barrel for 2015 and $75/per barrel for 2016.
Rising Rates May Lead to Heightened Airline Reliance on Lessors
Fitch believes aircraft lessors would be net beneficiaries of a gradual rise in interest rates, as a rising interest rate environment would generally indicate that economic conditions were improving and asset inflation was present. Furthermore, rising interest rates would lead to higher funding costs for airlines which could make financing owned aircraft less attractive, provided lessor funding costs rise more slowly. In this scenario, airlines may choose to place greater reliance on aircraft lessors in financing their fleets. Fitch expects the Fed to start raising interest rates this year and to follow a gradual tightening path, leading to an average policy rate of 1.6% in 2016. Fitch also projects that U.S. 10-year bond yields will rise to 3% by year-end 2016.
Trade-Offs Between Leverage, Fleet Strategy & Parental Support
While there is a fair amount of homogeneity in the business models of aircraft lessors, distinctions can be made between their leverage appetites and fleet profiles, in part informed by the ownership structure of the lessor and the potential for strategic and/or financial support to be extended to the lessor from the parent company. In assessing the leverage appetites of aircraft lessors, Fitch considers the risk profile of the fleet (and the related airline/geographic exposure) as well as the extent to which parental support can offset the risks of elevated leverage on a stand-alone basis.
Exogenous Risks Remain
Among the challenges aircraft lessors will need to navigate over the coming years include industry cyclicality, geopolitical risk, oil price volatility, competitive pressures on underwriting standards, funding and placing the delivery of large aircraft order books, residual value risk associated with older model planes, and rising interest rates. Fitch remains cautious as downside risks to a global economic recovery remain elevated, particularly as it relates to the lackluster economic recovery in the European Union and Japan, slowing growth in China, and geopolitical and other events, including in Greece, Russia and the Middle East.
Additional information is available on www.fitchratings.com
Applicable Criteria
Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351
Related Research
Aircraft Leasing Sector Review (Consolidation and Competition Amid Continued Growth)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864762
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