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
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
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
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
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
AerCap's post-acquisition liquidity position stands at approximately
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
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
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.
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
Lease revenues grew 11.5% in 2013 to
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
Fitch views ACG's liquidity profile as solid, and the company is well positioned to support ongoing aircraft funding requirements. As of
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,
Balance sheet leverage, measured by total debt-to-equity, improved to 3.5x as of
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
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.
KEY RATING DRIVERS
The affirmation of
BOC has committed a standby liquidity line of
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
Any perceived changes in BOC's propensity and ability to provide support would affect
Fitch has affirmed the following ratings:
AerCap Holdings N.V.
--Long-term IDR at 'BB+'; Rating Outlook Stable.
--Senior unsecured debt rating 'BB+'.
--Long-term IDR at 'BB+', Outlook Stable;
--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 Dutch Aircraft leasing
AerFunding 1 Limited
Flotlease MSN 973 Limited
Genesis Portfolio Funding 1 Limited
--Senior secured bank debt at 'BBB-'.
--Long-term IDR at 'BBB-'; Rating Outlook Stable;
--Senior unsecured debt rating at 'BBB-'.
--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:
--Senior secured bank debt 'BBB-'.
Additional information is available at www.fitchratings.com.
--'Global Financial Institutions Rating Criteria' (
--'Finance and Leasing Companies Criteria' (
--'Rating FI Subsidiaries and Holding Companies' (
Rating FI Subsidiaries and Holding Companies
Finance and Leasing Companies Criteria
Global Financial Institutions Rating Criteria
Mikho Irawady (Primary Analyst for
Source: Fitch Ratings
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