Fitch Ratings: Aircraft Lessor Sector Outlook to Negative on Coronavirus Impact

Fitch Ratings has revised its sector outlook for global aircraft lessors to negative from stable, reflecting elevated downside risks from the global spread of the coronavirus. The dramatic reduction in global travel demand is already increasing financial pressure on airlines, which Fitch expects will result in increased lease deferrals or restructurings, airline bankruptcies, and ultimately, aircraft repossessions. While lessors have historically benefited from the ability to move aircraft from regions or countries with weak demand to others with stronger demand, the global scale of the current stress significantly impairs this traditional risk mitigation strategy. These dynamics are expected to pressure aircraft lessors' cash flow and earnings in the near term, and aircraft utilization rates, residual values and capitalization levels in the medium term. The negative sector outlook also reflects Fitch's expectation that aircraft lessors will face far less accommodative funding markets in the near term, due both to aviation sector-specific concerns as well as broader market volatility and risk aversion.

ISSUER-SPECIFIC RATINGS

These dynamics have not yet translated into issuer-specific changes to Rating Outlooks or ratings, as Fitch believes rated lessors have sufficient liquidity availability, in the form of unrestricted cash, borrowing capacity on credit facilities, and next 12 months operating cash flows to meet funding obligations in 2020. For example, Fitch estimates that standalone investment-grade-rated lessors can withstand a 75% decline in 2020 lease payments and still maintain sufficient liquidity to meet funding obligations over the same time period. That said, the aircraft leasing industry was already grappling with challenges associated with the on-going Boeing 737 MAX (MAX) grounding and, pre-coronavirus, intense industry competition was contributing to loosened underwriting terms, implying an increasingly limited margin of safety for the industry.

Issuer-specific rating actions will be a function of the duration of the decline in air travel; the magnitude of cash flow and earnings impacts; the effect of aircraft repossessions on utilization rates, aircraft valuations and leverage levels; and funding accessibility. Fitch will also focus on issuer-specific rating sensitivities as outlined in most recent rating action commentaries, taking into account any credible near-term mitigation strategies issuers are pursuing. Lastly, for support-driven aircraft lessors, Fitch will consider the rating profile of the support provider as well as the on-going strategic importance of the aircraft lessor to the support provider.

Fitch reviews its aircraft lessor ratings on a least an annual basis, which would imply a formal rating review of the global rated portfolio no later than July 2020. That said, if market stress continues to escalate, formal rating reviews would likely take place much sooner.

LESSEE CREDIT RISK

Fitch believes COVID-19's impact on worldwide economies and markets presents unknown and unique risks for the aviation industry compared with previously observed pandemics and exogenous shocks. Fitch expects an increase in airline bankruptcies, in particular, in smaller and financially weaker airlines that are more sensitive to exogenous shocks and market impacts such as oil price and currency volatility (see 'Coronavirus Is Likely to Pressure Global Airline Credit Quality' dated March 12, 2020). Given the correlation between oil prices and economic activity, Fitch believes that airlines may not reap the full benefit from the recent fall in oil prices, due to depressed demand and the offsetting devaluation of foreign currencies compared with the U.S. dollar.

Thus far, Fitch believes that aircraft lessors have been selectively granting rent deferral and lease restructuring requests for a limited number of customers in instances where lessors believe they can protect the collateral and economic values of their aircraft and leases. However, a prolonged stress on the airline industry could increase the frequency of deferrals and restructurings, impairing lessor operating cash flow generation and eroding utilization rates and net spreads.

AIRCRAFT RESIDUAL VALUES

An increase in aircraft repossessions could dampen residual values, particularly for widebody aircraft and certain mid-life and end-of-life narrowbody aircraft, resulting in impairment charges, increased leverage, losses from aircraft trading and lower lease rates for new leases for aircraft lessors. If a ban on air traffic to a specific country creates challenges for aircraft lessors to repossess and redeploy aircraft to other regions, or if airlines start refusing aircraft deliveries, that could represent additional rating pressures for lessors.

Fitch regularly tests aircraft lessors' sensitivity to impairments and the resultant impact on gross debt to tangible equity. For the current analysis, Fitch held debt constant at year-end 2019 levels, and divided that amount by year-end 2019 tangible equity, net of hypothetical impairments. On average, standalone investment-grade rated lessors have capacity to withstand impairments of 5% of fleet net book value before exceeding Fitch's issuer-specific leverage-related downgrade triggers. Headroom ranges from 7% for Air Lease Corporation (BBB/Stable) and Avolon Holdings Limited (BBB-/Stable) versus 3% for Dubai Aerospace Enterprise (DAE) Ltd. (BBB-/Stable). In comparison with the stressed ranges, the highest four-year average impairments reported in 2015-2018 was 1.4% across Fitch-rated lessors.

Fitch acknowledges that this sensitivity analysis does not take into account internal capital generation and the discretionary nature of share repurchase activity, both of which are expected to further support capital positions. For example, on March 11, 2020, AerCap's CEO noted that the company had suspended share repurchases, which over 2018-2019 totalled $1.3 billion.

FUNDING AND LIQUIDITY

Aircraft lessors are exposed to the risk of an extended disruption in the unsecured debt market, as rated aircraft lessors needed to fund a total of $10.4 billion in term debt maturities, $704 million of commercial paper maturities (backstopped by a credit facilities from appropriately rated counterparties), and $23.5 billion in aircraft purchase commitments in 2020, as of Dec. 31, 2019. Fitch expects overall funding needs may be lower, depending on the timing of the MAX return to service and deliveries from The Boeing Company; however, overall funding needs will remain sizable and new issue market disruptions could have a significant impact on aircraft lessors who have largely relied on the unsecured market for funding needs in recent years. Fitch notes about $3 billion of industry debt has been refinanced with unsecured issuances in early 2020.

While unsecured debt market access could become less economical, aircraft lessors have meaningful unencumbered assets available to pledge as collateral to secured facilities, partially mitigating their need to issue unsecured debt. At Dec. 31, 2019, the majority of aircraft lessors had strong funding profiles with unsecured debt comprising 73.6% of total debt which provided solid financial flexibility due to a sizable pool of unencumbered assets.

Aircraft lessors' liquidity resources could also support upcoming debt maturities and funding requirements in case of an extended disruption in the unsecured debt market. As of Dec. 31, 2019, aggregate liquidity sources of rated aircraft lessors (unsecured revolver capacity, unrestricted cash and next 12 months of operating cash flow) covered uses (next 12 months of debt maturities and capex) by approximately 1.4x, on average. In addition, unutilized credit facilities of approximately $32.6 billion, in aggregate, represented 67% of total liquidity sources and provided 94% coverage of the rated group's total funding needs of $34.7 billion in 2020. Certain lessors have already drawn on bank revolvers in an effort to proactively shore up liquidity, which Fitch views positively, provided borrowings are held in cash or cash equivalents.