Fitch Ratings Completes Aircraft Lessor Peer Review

Fitch Ratings has completed its periodic peer review of aircraft lessors, which is comprised of nine publicly rated firms.

Fitch affirmed the following ratings as a result of this review:

AerCap Holdings N.V. (AerCap)
–Long-term Issuer Default Rating (IDR) at ‘BBB-‘; Outlook Stable.

Air Lease Corporation (Air Lease)
–Long-term IDR at ‘BBB’; Outlook Stable.

Aircastle Limited (Aircastle)
–Long-term IDR at ‘BBB-‘; Outlook Stable.

Avation PLC (Avation)
–Long-term IDR at ‘BB-‘; Outlook Stable.

Aviation Capital Group LLC (ACG)
–Long-term IDR at ‘BBB+’; Outlook Evolving.

Avolon Holdings Limited (Avolon)
–Long-term IDR at ‘BBB-‘; Outlook Stable.

BOC Aviation Limited (BOCA)
–Long-term IDR at ‘A-‘; Outlook Stable.

SMBC Aviation Capital Limited (SMBC AC)
–Long-term IDR at ‘A-‘; Outlook Stable.

Voyager Aviation Holdings, LLC
–Long-term IDR at ‘BB-‘; Outlook Stable.

Individual rating action commentaries for each of the aircraft lessors are available at www.fitchratings.com. For further information on the rationale for each rating action, please refer to these commentaries.

Aircraft lessors continue to benefit from largely 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 demonstrated limited impairment risk in recent years; and accessible funding markets.

However, competition has placed pressure on lease yields and net interest margins over the past several years, with further modest declines anticipated given an expectation of relatively stable to lower interest rates in the near term. The financial condition of airlines remains generally sound, but Fitch expects it to deteriorate over the medium
term due to rising fuel costs and the strong US dollar. While some of these market 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.

The global grounding of Boeing’s (Long-Term IDR ‘A’/Stable) B737 MAX does not represent an immediate credit risk for aircraft lessors, reflecting manageable exposure and the likely temporary nature of the grounding. On average, MAX 8 and 9 variants represented 2.6% of aggregate owned and managed portfolios, by count, as of 31 March  2019.

GE Capital Aviation Services (GECAS, a subsidiary of GE Capital Global Holdings, LLC [Long-term IDR ‘BBB+’/Negative]), Air Lease and SMBC AC had the most exposure given their size, order book and focus on younger fleets but represented less than 5% of the total fleet by book value. With the delays, aircraft lessors may experience the offsetting benefit of increased demand for existing aircraft models to replace the MAX while it is grounded.

A long-term grounding or sustained adverse market sentiment about the MAX could increase aircraft lessors’ impairment risk, with respect to owned MAX aircraft, while calling into question the value and strategic benefit of order book commitments. Under this scenario, we would consider profitability effects on underlying airline lessees more dependent on the MAX and the potential to cancel orders and replace the aircraft with viable alternatives.

According to Fitch’s June 2019 ‘Global Economic Outlook’, global growth prospects remain robust even though trade protectionism has become more significant in recent months. Fitch’s global growth forecast is 2.8% in 2019 and 2.7% in 2020. Revenue passenger kilometres (RPK) grew 5.0% year-to-date through June 2019 according to The International Air Transport Association (IATA); this was below the 7.4% growth rate achieved in 2018, but remains consistent with the long-run average of 5.5%.

Air travel continues to grow at a solid pace, despite the trade tariffs imposed by
the US on some of its trading partners. Given continued growth of air travel in the emerging markets such as in Asia and Latin America, IATA projects RPKs to grow at a rate modestly above the global economy, with downside risk of approximately 0.5% to its 2019 growth forecast of 5.0%.

Consistent with recent years, RPK growth in 2018 was strongest in the Asia-Pacific region (6.3%) and Latin America (6.2%) and lowest in the Middle East (2.0%). 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 43% of Fitch-rated aircraft lessors’ aircraft, as measured by value, were
domiciled in the Asia Pacific region as of March 31, 2019, 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 escalates, this could have a more direct impact on aircraft purchased directly by airlines and/ or economic activity and passenger travel.

Most of the rated lessors have sufficient scale, which Fitch generally views favorably. 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 broad reach comes increased likelihood of exposure to challenged airlines and/or geographies during periods of stress.

The recent bankruptcies of Oceanair Linhas Aereas S/A (Avianca Brasil), Jet Airways Ltd., WOW air and Germania Fluggesellschaft mbH (Germania) have tested lessors’ ability to repossess and remarket aircraft, but these bankruptcies had a muted impact on utilization rates and operating results given the minimal downtime, cash coverage of reserves, and manageable exposures given relative portfolio diversity.

Lease yields across the sector are expected to decline, since the sale-leaseback market remains competitive and interest rates are expected to remain steady or decline in the near term. Average lease yields, calculated as lease revenue to total aircraft assets, for aircraft lessors monitored by Fitch declined modestly to 11.0% in 1Q19 compared to 11.2% in 2018, 11.6% in 2017 and 11.7% in 2016.

At the same time, larger lessors like 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 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 $13.7bn in unsecured note offerings in 2018 and $8.9bn during 1H19, driven by the need to fund their order books and refinance debt maturities.

Issuance in 2019 was led by Avolon’s $3.6bn note offering, which was a primary driver of its upgrade to investment-grade ratings in April 2019. Aircraft lessor corporate bond spreads have tightened 75bps on a weighted average basis during 1H19, to trade at 140 bps over benchmark rates.

Average leverage for the nine publicly rated lessors was 2.8x as of March 31, 2019, unchanged from year-end 2018 and 2017. While debt issuance remained active in 1Q19 and 2018, this was offset by debt repayment and modest equity growth, via retained earnings and the absence of material asset impairments.

AerCap and Aircastle continue to repurchase shares, funded largely by their asset sales programs, while Air Lease and Aircastle also pay modest dividends. There continues to be a divergence between the leverage of standalone 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 as a result of support-driven lessors at least temporarily deleveraging.

While publicly traded lessors’ equity valuations continue to trade below book value, the discount contracted in 1H19. Price-to-book ratios were 0.74x, on average, for AerCap, Air Lease, and Aircastle Limited as of 31 March 2019 up from an average of 0.67x during 2018.

Fitch believes aircraft lessor fundamentals remain sound, but slowing global GDP growth, uncertainty around US trade, airline bankruptcies, the MAX groundings and Boeing and Airbus delays continue to weigh on aircraft lessor equity valuations.