NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded SMBC Aviation Capital Limited's (SMBC AC) Long-term Issuer Default Rating (IDR) to 'BBB+' from 'BBB'. The Rating Outlook is Stable.
KEY RATING DRIVERS - IDR
The upgrade of SMBC AC's rating follows Fitch's upgrade of SMBC's majority parent, Sumitomo Mitsui Financial Group, Inc. (SMFG) to 'A' from 'A-' on Nov. 17, 2015, and maintains the two notch differential between SMBC AC and SMFG. The upgrade of SMFG's rating reflects the consistent outperformance (relative to the other major banks) in profitability and enhanced resilience against key market risks, specifically its reduction of Japanese government bond (JGBs) exposures and the shorter duration of its JGB holdings. SMFG's common equity tier 1 ratio reached 12.1% on a fully loaded basis and 9.8%, excluding unrealized gains from available-for-sale securities, as of Sept. 30, 2015. For more information, see Fitch's press release 'Fitch Upgrades SMFG; Affirms Other Major Japanese Banks' dated Nov. 17, 2015.
Strategically Important Subsidiary
Though presently representing only a small portion of SMFG's total assets, SMBC AC is viewed by Fitch as strategically important to SMFG and its core banking subsidiary Sumitomo Mitsui Banking Corporation (SMBC), given SMBC AC's fit with the broader company's strategic objective to diversify its business mix and invest outside Japan in activities with different risk/return profiles to the group's traditional corporate financing business. Since SMFG's acquisition of SMBC AC in 2012, this strategic importance has been supported by an integrated strategy, consistent branding, parent company representation on SMBC AC's Board of Directors and parent-supported funding to SMBC AC.
Two Notch Difference from SMFG's IDR
Fitch considers SMBC AC to be a strategically important subsidiary of SMFG as defined under its Global Non-Bank Financial Institutions Rating Criteria, which typically results in notching of one to two notches from the parent company's long-term IDR. In SMBC AC's case, the IDR is notched down twice from SMFG's long-term IDR, reflecting that SMBC AC has a limited operating history under SMFG, is small in size relative to the broader organization and operates in a different jurisdiction and is not fully-owned by SMFG.
Over the last 14 years, SMBC AC (and its predecessor organization prior to acquisition by SMFG) has built a well-established aircraft leasing franchise, profitable in every year of operation (excluding the effect of one-off breakage costs in relation to acquisition refinancing in fiscal year 2013) with limited asset impairment charges and stable lease rates. The company has an experienced management team, an institutional structure capable of supporting a large aircraft fleet, and a customer base well-diversified by both operator type and geography, with a number of relatively strong airline credits comprising the top exposures.
High Quality Fleet
In terms of SMBC AC's standalone credit profile, Fitch considers the quality of the aircraft fleet a significant strength, as it is largely unencumbered and predominantly comprised of young, sought after and fuel-efficient narrowbody models of the Airbus A320 and Boeing 737 families, with more on order. The company has demonstrated the ability and discipline to execute aircraft sales successfully through cyclical market environments, which Fitch views positively.
Concentrated Funding Profile, Elevated Leverage
These strengths are counterbalanced by SMBC AC's concentrated funding profile, which to date has had limited third-party funding, and its elevated balance sheet leverage. Leverage, defined as debt-to-tangible equity, on a consolidated basis was 4.9x at Sept. 30, 2015 and represented the highest leverage among Fitch-rated aircraft lessors. Fitch expects some reduction in SMBC AC's balance sheet leverage over the next three years, although it is likely to remain higher than most peers.
RATING SENSITIVITIES - IDR
SMBC AC's ratings are primarily sensitive to changes in SMFG's ratings, given that the ratings of SMBC AC are notched two notches below those of SMFG.
Further, although not expected by Fitch, SMBC AC's IDR could be adversely affected should SMFG seek to dispose of its investment in SMBC AC or should there be any other developments within SMFG that are perceived by Fitch to alter SMFG's willingness or ability to provide support to SMBC AC. Negative rating action could also be taken if SMBC AC's own operating performance deteriorated, thereby not delivering the return on investment envisaged by SMFG, to the extent that this affected Fitch's assessment of the propensity of SMFG to provide support to SMBC AC in case of need.
Absent upward movement of SMFG's IDR, positive rating action for SMBC AC would most likely be limited to an increase in Fitch's assessment of SMFG's propensity to support SMBC AC, in which case the notching between SMFG's rating and SMBC AC's rating could narrow. For example, consistent profitable growth within SMBC AC, such as to render it a more significant contributor to SMFG's overall business, could be beneficial to the ratings in the long term, especially if accompanied by a degree of earnings retention which served to reduce leverage.
Fitch has upgraded the following rating:
SMBC Aviation Capital Limited
--Long-term IDR to 'BBB+' from 'BBB'.
The Rating Outlook is Stable.
SMBC AC is a leading global aircraft lessor, established in 2001 and rebranded as SMBC AC in 2012 on its acquisition by a consortium of SMFG and Sumitomo Corporation companies. As of December 2015, the company owned and managed 420 aircraft valued at over $15 billion, on lease to airline customers in over 45 countries, with commitments to purchase a further 206 aircraft worth over $23 billion from Airbus and Boeing in the coming years.
Additional information is available at 'www.fitchratings.com'.
Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)
Dodd-Frank Rating Information Disclosure Form