News Column

Fitch Affirms Aircraft Lessors Following Peer Review

August 11, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has completed a peer review of three rated aircraft lessors, resulting in the affirmation of the long-term Issuer Default Ratings (IDRs) of AerCap Holdings N.V. (AER, 'BB+'), Aviation Capital Group Corp. (ACG, 'BBB-') and BOC Aviation Pte Ltd (BOC Aviation, 'A-'). The Outlooks remain Stable. Company-specific rating rationales are described below, and a full list of rating actions is provided at the end of this release.

The aircraft leasing sector has experienced another year of strong performance, which has been characterized by strong airline industry fundamentals, favorable credit markets, improving lease rates and consolidation among lessors. Profitability in the airline industry has continued to improve this year, which has resulted in a lack of significant credit issues among the lessors. Aircraft financing has become more plentiful with increasing investor appetite and the securitization market re-emerging. This favorable environment has attracted new competition from a variety of sources, both global and regional in nature. As the industry has grown, the market has become more segmented with numerous strategies and value propositions. Among the challenges aircraft lessors will need to navigate over the coming years are industry cyclicality, competitive pressures on underwriting standards, large aircraft order books, residual value risk associated with older model planes, and rising interest rates.

The aviation cycle has the tendency to change direction rapidly and remains highly sensitive to exogenous shocks. While lessors have proven to be more resilient than airlines due to their ability to redeploy aircraft, Fitch's ratings on the sector are constrained by its singular focus on aircraft assets and reliance on wholesale funding markets. The lack of price transparency for aircraft makes it more difficult to analyze the residual values of lessors' fleets. Therefore, shareholders' equity is susceptible to impairments, particularly for lessors with older and less frequently traded portfolios.

Supply of new aircraft has become more constrained, as manufacturers have seen strong new order activity from both lessors and airlines and accumulated record backlogs. Orders being placed at the upper point in the cycle naturally tend to be more expensive, which increases the risk that these aircraft will not meet their long-term return hurdles and increase residual risk. For the most popular narrow-body models, order books of eight to nine years today compare with six to eight years in the mid-2000s and just three to five years in the early 2000s.

The secondary market for aircraft has also heated up, with a number of new entrants, including Business Development Companies, insurance companies and private equity firms. Operating lessors should stand to benefit from this development, particularly those that strive to maintain young fleets by selling older aircraft as they take delivery of new equipment. However, it is important to note that secondary market liquidity is also driven by narrow funding spreads and could dry up relatively quickly.

AerCap's acquisition of International Lease Finance Corp (ILFC), which closed in May 2014, was an important and positive industry development for several reasons. The transaction represented what is expected to be the last transfer of a large fleet of leased aircraft, following RBS's sale of its aircraft leasing business to Sumitomo in 2012 and CIT's re-emergence from bankruptcy in 2009. In Fitch's view, material consolidation in the industry is now complete, with two large players (AerCap and GECAS) controlling close to half of all lessor-owned aircraft globally. Additionally, the increase in the sector's market capitalization has increased investor visibility and should lead to improved access to capital markets for other aircraft lessors. There have been several IPO filings in recent months, including Avolon and China Aircraft Leasing Co.

AerCap Holdings N.V.

KEY RATING DRIVERS -- IDRs

Today's affirmation of AerCap's Long-term IDR of 'BB+' is supported by the recently expanded scale of the company's franchise, robust funding and liquidity profile, and strong management team. The ratings are constrained by increased balance sheet leverage, execution and integration risk associated with the ILFC acquisition, recent change in strategic direction and the increased fleet age. AerCap's recent acquisition of ILFC was transformative and fundamentally changed the company's risk profile and strategic direction.

AerCap's balance sheet leverage has increased materially, primarily as a result of the assumption of ILFC's existing debt and acquisition-related purchase accounting. Therefore, AerCap's credit profile has initially become riskier, but Fitch expects it to improve over time as the acquisition is integrated and equity is built up through retained earnings. The 'BB+' rating is supported by the company's plans to maintain a conservative capital policy with a targeted debt-to-equity ratio (as reported) of approximately 3.0x. Fitch believes the combined business offers fairly good visibility into future earnings and operating cash flows, which underpins the company's de-leveraging plan.

Fitch believes that the best measure of financial leverage for the combined company is tangible debt-to-tangible equity. This measure adjusts for certain accounting assets and liabilities that will be created as a result of purchase accounting, and is more reflective of the economic value of the balance sheet than the reported debt-to-equity ratio. Some of the adjustments include the fair value (FV) adjustment to ILFC's debt, the FV of the order book, and the lease premium. According to Fitch's estimates, the tangible debt-to-tangible equity ratio was 5.1x as of March 31, 2014, higher than the reported pro forma leverage figure of 4.5x. However, the two measures are expected to converge as the purchase accounting adjustments get accreted over time.

The acquisition requires significant integration efforts, which will continue to consume meaningful time and effort of AerCap's senior management team. In Fitch's view, the acquisition brings a significant amount of integration and execution risk as AerCap transfers ILFC's fleet and ILFC's staff onto AerCap's platform. These risks are mitigated to some extent by AerCap's scalable operating platform (including its interest in AerData), the relatively small number of employees at ILFC, overlapping locations of regional offices, and prior ownership of the AeroTurbine platform which has been reacquired as part of the transaction.

Fitch believes that the acquisition has resulted in a significant shift to AerCap's current business strategy. The size of the fleet has increased dramatically to approximately 1,200 aircraft from 238 as of March 31, 2014; and its average age has increased by roughly two years, to over seven years from 5.6 years as of March 31, 2014. Historically, AerCap's strategy focused on newer aircraft, a modest fleet size and a moderate order book supported by a predominantly secured funding profile.

With the acquisition of ILFC, AerCap has become the owner of one of the largest order books in the industry. Fitch recognizes that ILFC's orders represent some of the most in-demand aircraft in the market and were placed at attractive prices and delivery slots. However, the long-term nature of the commitments creates a liability that may need to be funded at a time when capital is not readily available. Furthermore, given the cyclical nature of the aviation market and continual technological advances, the contracted purchase price of the aircraft could potentially exceed the market value on the delivery date.

Despite the concerns cited above, Fitch believes that the acquisition offers potential long-term strategic benefits for both AerCap's and ILFC's creditors. The economics of the combined business have remained intact, with no immediate impact to lease cash flows and a relatively modest increase in the debt balance to fund the cash portion of the purchase price. AerCap expects to reap significant tax benefits by re-domiciling the vast majority of ILFC's assets to Ireland and transferring ILFC's large deferred tax liability to AIG.

AerCap's post-acquisition liquidity position stands at approximately $6 billion, composed of $2 billion in unrestricted cash and $4 billion of undrawn revolver availability, as of March 31, 2014. The company plans to maintain a liquidity buffer (including cash flow from operations, unrestricted cash and undrawn revolvers) at 120% of debt maturities and capital expenditures over the next 12 months. Fitch views this as an appropriate liquidity framework given AerCap's significant purchase commitments and debt maturities.

KEY RATING DRIVERS - AerCap & ILFC Senior Unsecured Debt

The equalization of the unsecured debt with the IDR reflects material unsecured debt, as a portion of total debt, as well as strong unencumbered asset coverage of unencumbered debt. The acquisition of ILFC has significantly expanded AerCap's access to unsecured funding, which now represents approximately 60% of total debt. Furthermore, AerCap has acquired a large pool of unencumbered aircraft, which will provide support to unsecured creditors going forward.

KEY RATING DRIVERS - AerCap & ILFC Senior Secured Debt

AerCap's and ILFC's senior secured debt ratings of 'BBB-' are one-notch above the long-term IDR, and reflect the aircraft collateral backing these obligations.

The ratings assigned to the senior secured debt issued by Flying Fortress, Inc. and Delos Finance SARL, both wholly owned subsidiaries of ILFC, are equalized with the IDR of ILFC. This debt is secured via a pledge of stock of the subsidiaries and related affiliates and is guaranteed by ILFC on a senior unsecured basis. The ratings on these secured term loans are not notched above ILFC's IDR due to the lack of a perfected first priority claim on aircraft provided to support repayment of the term loan. Furthermore, there is a risk of substantive consolidation of Flying Fortress, Inc., Delos Finance SARL and related affiliates in the event of an ILFC bankruptcy.

KEY RATING DRIVERS - ILFC Hybrid Debt

The rating of 'B+' reflects a three-notch differential between the long-term IDR and preferred stock rating. This is consistent with Fitch's 'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' criteria published on Dec. 23, 2013.

RATING SENSITIVITIES - AerCap & ILFC IDRs, Senior Unsecured Debt, Senior Secured Debt and Hybrid Debt

Fitch believes positive rating momentum is possible over the longer term as AerCap continues to execute on the plan outlined at the time of the ILFC acquisition. More specifically, successful integration of ILFC's fleet and staff, a reduction of balance sheet leverage as outlined by the company, maintenance of robust liquidity, and improvement in the fleet profile are viewed as positive rating drivers. Fitch will also assess AerCap's ability to effectively manage the average age and composition of its fleet. Positive rating momentum could stall if AerCap runs into any meaningful integration issues, if dividends or share repurchase activity are reinstituted before deleveraging plans are completed, or if there is a material downturn in the aviation sector, which negatively impacts its business.

Downside risks to AerCap's ratings will be elevated until the acquisition is fully integrated and leverage is reduced. Negative rating actions could result from significant integration issues, loss of key airline relationships, deterioration in financial performance and/or operating cash flows, higher than expected repossession activity and/or difficulty re-leasing aircraft at economical rates. Longer term, aggressive capital management, a reduction in available liquidity or inability to maintain or improve the fleet profile could also lead to negative rating pressure.

Aviation Capital Group Corp.:

KEY RATING DRIVERS - IDR and Senior Debt

The affirmation of the IDR and unsecured debt ratings at 'BBB-' and the Stable Outlook reflect ACG's solid franchise, attractive aircraft portfolio, consistent operating cash flow generation, solid liquidity, diverse funding profile and Fitch's assessment of the ownership by and strategic relationship with Pacific Life Insurance Company (PLIC, IDR rated 'A') and its parent Pacific LifeCorp (PLC, IDR rated 'A-'). Fitch also views the recent improvement in ACG's unsecured funding profile and unencumbered asset coverage favorably, as they provide additional financial flexibility.

Lease revenues grew 11.5% in 2013 to $736 million compared to $660 million in 2012, reflecting ACG's continued portfolio growth offset by a modest decline in net margin, which fell to 7.2% in 2013 compared to 7.3% in 2012. Operating performance has remained relatively flat over the same period, as pre-tax earnings increased 3.3% to $62 million in 2013 compared to $60 million in 2012, reflecting increased maintenance and operating costs resulting from portfolio growth. Net income of $76 million, on an adjusted basis, was 22.6% higher in 2013 compared to $62 million in 2012. Net income in 2012 accounts for a one-time basis adjustment to ACG's deferred tax asset valuation allowance related to aircraft depreciation, which reduced the provisions for income taxes during the year. Including this adjustment, reported net income would have been $119 million in 2012. Fitch expects medium- to long-term profitability to improve along with net margins as the new aircraft portfolio seasons.

ACG's aircraft portfolio remains attractive and broadly used by airlines, which provides stable cash flow generation that minimizes the impact of market volatility throughout economic and market cycles. The portfolio is composed predominately of B737 and A320 families, with a weighted average age of around six years, as of March 31, 2014. Approximately 76% of the portfolio is younger than 10 years, by net book value. Currently, ACG has 133 aircraft on order with deliveries scheduled through 2021. Given ACG's fleet strategy of investing in young, primarily narrowbody aircraft with broad customer appeal, Fitch expects the portfolio will remain relatively consistent over the near- to medium-term.

Fitch views ACG's liquidity profile as solid, and the company is well positioned to support ongoing aircraft funding requirements. As of March 31, 2014, the company had over $1.1 billion of liquidity, which included $39.2 million of unrestricted cash balances and $1.1 billion of available borrowing capacity under its credit facilities provided by a syndicate of global banks. In addition, ACG generates between $300 million to $500 million of annual cash flows from operations, which is also used to support portfolio growth and to manage debt maturities. The debt profile is well laddered with the next maturity coming due in 2016.

In addition, ACG has made significant progress in diversifying its capital structure and broadening its capital markets access and other funding sources. In third quarter 2013, ACG completed a three-year, $600 million 144A bond transaction at attractive terms. With the recent issuance, ACG's unsecured debt has grown to nearly 56% of total debt, which is viewed favorably by Fitch. The ratings of the senior unsecured notes are equalized with the IDR of ACG, reflecting sufficient level of available collateral to support average recoveries in a stressed scenario.

Balance sheet leverage, measured by total debt-to-equity, improved to 3.5x as of March 31, 2014 from a range of 4.0-4.5x over the last several years, as a result of retained earnings growth and a capital injection of $150 million by ACG's parent, PLIC, in March 2014. Fitch expects leverage will remain around 3.5x to 4.0x over the medium term, which is consistent with its current ratings, as modest retained earnings generation and amortization of ACG's securitization debt may offset increases in debt levels to fund new aircraft purchases.

Fitch considers ACG's standalone credit profile to be reflective of a 'BB+' rating without institutional support. Based on the 'Rating FI Subsidiaries and Holding Companies' criteria, Fitch views ACG's business as having limited importance to PLC's overall operations due to limited financial and operating synergies, as well as lack of common branding. This suggests that future support may be uncertain, particularly in a stress scenario. That said, Fitch believes PLC maintains a high level of commitment to ACG, as evidenced by PLIC's recent capital injection, as well as the continued ownership of 100% of ACG's equity, which amounted to $1.56 billion of invested capital to date. Consequently, ACG's long-term IDR receives a one-notch uplift from the standalone rating due to PLIC's direct ownership and demonstrated financial support.

RATING SENSITIVITIES - IDR and Senior Debt

Positive rating momentum for ACG could be driven by management's commitment to manage leverage below 3.5x in conjunction with improved profitability over the medium- to longer-term, while maintaining an attractive aircraft portfolio, consistent cash flow generation, sufficient liquidity, and diversity of funding. Positive rating actions could also be driven by more explicit forms of parent support from PLIC.

Conversely, negative rating actions could be driven by an unwillingness or inability of PLIC to provide timely support to ACG. Significant deterioration in operating performance, a material decline in operating cash flow generation resulting from a significant weakening of sector or economic conditions, or a material increase in balance sheet leverage over and above the historical range could also result in negative rating actions.

The ratings of the senior unsecured notes are sensitive to changes in ACG's IDR, as well as the level of unencumbered balance sheet assets in a stressed scenario, relative to outstanding debt.

BOC Aviation Pte Ltd:

KEY RATING DRIVERS

The affirmation of BOC Aviation's IDR and senior unsecured debt rating of 'A-' reflect Fitch's continued expectation of a very high probability of extraordinary support to BOC Aviation from its ultimate parent, Bank of China (BOC; 'A', Stable Outlook), if required. This view is based on BOC Aviation's strategic importance to and strong links with BOC, which is evident in the shared brand name, 100% ownership and close board oversight by BOC, cross-selling potential, forthcoming resources, and strong reporting links despite the issuer's small size relative to its parent and their different domiciles.

BOC has committed a standby liquidity line of $2 billion, which is considerable relative to BOC Aviation's assets of $10.2 billion at end-December 2013. This is on top of the $300 million of common equity injection by BOC since it took over BOC Aviation in 2006. At end-December 2013, BOC Aviation had $1 billion in drawn committed long-term loan facilities with BOC and BOC (Hong Kong) Limited.

The aircraft leasing company is one of the few wholly-owned subsidiaries within the BOC group that reports directly to BOC's management. Eight of BOC Aviation's 10 board members are BOC representatives, with a high-ranking officer of BOC appointed as chairman. These internal arrangements underscore the strategic importance of BOC Aviation to BOC, even though the former accounted for only about 0.4% of BOC's consolidated assets. Cross-selling initiatives center on BOC Aviation assisting BOC in originating relationships with airlines and aircraft manufacturers. This supports BOC's aim of diversifying its non-interest income base and to move into non-commercial banking businesses.

Fitch views BOC Aviation's standalone financial profile without any institutional support to be reflective of a 'BB+' rating. This reflects BOC Aviation's consistent track record, young fleet age, solid lessee quality and an experienced management team. BOC Aviation has consistently reported one of the highest ROAs among its rated peers. This is due to its active fleet quality management, aircraft collections and procurement, as well as low funding costs. Fitch views as positive BOC Aviation's demonstrated ability to trade aircraft through the cycle, as shown by its ability to continually keep the average age of its portfolio at around four years.

BOC Aviation has a moderately higher appetite for leverage and reliance on bank borrowings compared to its peers. Changes in Fitch's view of BOC Aviation's standalone financial profile would be likely to take into account BOC Aviation's future leverage appetite, funding diversity and/or risk appetite in terms of lessee quality and growth ambitions.

RATING SENSITIVITIES

Any perceived changes in BOC's propensity and ability to provide support would affect BOC Aviation's IDR and senior unsecured debt rating. Any changes in BOC's IDR would also have a direct impact on BOC Aviation's IDR. However, a change in BOC Aviation's standalone risk profile is unlikely to directly impact its IDR, unless support factors that drive its IDR were to change.

Fitch has affirmed the following ratings:

AerCap Holdings N.V.

--Long-term IDR at 'BB+'; Rating Outlook Stable.

AerCap Ireland Capital Limited

AerCap Global Aviation Trust

AerCap Aviation Solutions B.V.

--Senior unsecured debt rating 'BB+'.

International Lease Finance Corp.

--Long-term IDR at 'BB+', Outlook Stable;

--$3.9 billion senior secured notes at 'BBB-';

--Senior unsecured debt at 'BB+';

--Preferred stock at 'B+'.

Flying Fortress Inc.

--Senior secured debt at 'BB+'.

Delos Finance SARL

--Senior secured debt at 'BB+'.

ILFC E-Capital Trust I

--Preferred stock at 'B+'.

ILFC E-Capital Trust II

--Preferred stock at 'B+'

AerCap B.V.

AerCap Dutch Aircraft Leasing I B.V.

AerCap Dutch Aircraft leasing IV B.V.

AerCap Dutch Aircraft Leasing VII B.V.

AerCap Engine Leasing Limited

AerCap Ireland Limited

AerCap Partners 767 Limited

AerCap Partners I Limited

AerFunding 1 Limited

AerVenture Leasing 1 Limited

Cielo Funding Limited

Flotlease MSN 973 Limited

Genesis Portfolio Funding 1 Limited

GLS Atlantic Alpha Limited

Harmonic Aircraft Leasing Limited

Harmony Funding BV

Melodic Aircraft Leasing Limited

Parilease / Jasmine Aircraft Leasing Limited

Philharmonic Aircraft Leasing Limited

Rouge Aircraft Leasing Limited

Sapa Aircraft Leasing 2 BV

Sapa Aircraft Leasing BV

Skyfunding II Limited

SkyFunding Limited

Symphonic Aircraft Leasing Limited

Triple Eight Aircraft Leasing Limited

Wahaflot Leasing 3699 (Bermuda) Limited

Westpark 1 Aircraft Leasing Limited

Worldwide Aircraft Leasing Limited

--Senior secured bank debt at 'BBB-'.

Aviation Capital Group Corp.:

--Long-term IDR at 'BBB-'; Rating Outlook Stable;

--Senior unsecured debt rating at 'BBB-'.

BOC Aviation Pte Ltd:

--Long-term IDR at 'A-', Outlook Stable;

--Senior unsecured debt rating at 'A-'.

Fitch has assigned ratings to senior secured debt obligations of the following AER subsidiaries:

AerLift Leasing Jet Limited

Bluesky Aircraft Leasing Limited

CelestialFunding Limited

Cielo Funding II Limited

Limelight Funding Limited

Monophonic Aircraft Leasing Limited

Quadrant MSN 5869 Limited

Renaissance Aircraft Leasing Limited

SoraFunding Limited

Sunflower Leasing Co., Ltd

Tulip Leasing Co., Ltd.

Polyphonic Aircraft Leasing Limited

--Senior secured bank debt 'BBB-'.

Additional information is available at www.fitchratings.com.

Applicable Criteria and Related Research:

--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);

--'Finance and Leasing Companies Criteria' (Dec. 11, 2012);

--'Rating FI Subsidiaries and Holding Companies' (Aug. 10, 2012).

Applicable Criteria and Related Research:

Rating FI Subsidiaries and Holding Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209

Finance and Leasing Companies Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696720

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=848914

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Ilya Ivashkov, CFA (Primary Analyst for AER, Secondary Analyst for BOC Aviation)

Senior Director

+1-212-908-0769

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Johann Juan (Primary Analyst for ACG)

Director

+1-312-368-3339

or

Mikho Irawady (Primary Analyst for BOC Aviation)

Associate Director

+65 6796-7220

or

Brendan Sheehy (Secondary Analyst for AER and ACG)

Director

+1-212-908-0138

or

Committee Chairperson

Nathan Flanders

Managing Director

+1-212-908-0827

or

Media Relations:

Brian Bertsch, New York, +1 212-908-0549

Email: brian.bertsch@fitchratings.com

Source: Fitch Ratings


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