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Fitch: Aircraft Lessors Supported by Demand, Access to Capital

July 13, 2012, 06:48 AM
Filed Under: Aircraft

According to Fitch Ratings, long-term credit fundamentals in the aircraft leasing industry are being supported by a number of factors, including growth in global air travel demand, capital constraints among the world's airlines, and the aircraft technology replacement cycle. Despite near-term risks in the airline operating environment (particularly in Europe) and threats to the global economy, Fitch expects lessors to benefit from longer term growth opportunities and improved access to capital as the structure of the industry evolves.

Largely as a result of turmoil in the global airline industry over the past decade, the share of the world's commercial aircraft fleet financed through operating leases has increased sharply over the past decade, to 35% from approximately 25% in 2000. As airlines have struggled in the face of ongoing operating pressure, driven by air travel demand shocks and extreme fuel price volatility, aircraft lessors have filled important financing gaps that grew as debt capital markets tightened and airline credit quality weakened.

In response to these opportunities and the post-2009 recovery in world air travel demand, a number of new entrants have emerged in aircraft leasing over the past three years, primarily backed by private equity funding. Most new players are focused on sale-leaseback transactions to drive growth, with the notable exception of Air Lease Corp. (ALC), which is focused on building its direct aircraft order book. This influx of capital may unduly influence competitive dynamics, drive down price/lease terms, and focus certain lessors on the near-term goals of their private-equity backers.

While long-term trends are favorable, aircraft lessors have some near-term issues to deal with. Market values and lease rates on some popular aircraft models remain soft, which has affected profitability. Furthermore, low interest rates continue to put pressure on lease rate factors, which tend to be fixed for a number of years. When interest rates rise, there could be a potential mismatch with funding costs at some companies. We do not see either of these trends changing in the near future.

Aircraft lessors primarily employ one of two strategies to grow and shape their fleets. The first is to build an order book directly with the manufacturers and take deliveries of new aircraft over a number of years. The second is to provide sale-leaseback financing, where an airline purchases the aircraft from the manufacturer and resells it to the lessor, which provides an operating lease.

Among large lessors focused on building order books, both ALC and General Electric Capital Aviation Services (GECAS) announced large new orders for Boeing narrowbody aircraft at this week's Farnborough Air Show. ALC ordered 75 of Boeing's upgraded B737 MAX aircraft, which will offer significant fuel efficiency gains when delivered. GECAS also ordered 75 B737 MAX aircraft, along with 25 current generation B737-800s from Boeing.

Improved access to capital, including unsecured debt, is supporting the growth plans of both incumbents and new entrants in the global aircraft leasing market. Many stand-alone aircraft lessors have improved their leverage profile over the last several years in an effort to diversify funding sources.

Aircraft lessors raised approximately $3.6 billion in unsecured debt during the first five months of 2012, a strong start to the year. The pricing and structure of recent deals have been relatively favorable for lessors. General market
conditions are likely to influence lessors' future ability to tap capital markets for additional funding.

The earnings and cash flow outlook for large airline lessees remains highly uncertain, particularly in light of weakening global macro fundamentals and the ever-present risk of rapid increases in jet fuel costs. As a result, global capacity may grow more slowly in the near term, exposing lessors to greater operating risks if aircraft valuations and lease rates come under pressure.

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