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Fitch Ratings: Airline and Lessor Risks Raise the Stakes for Aircraft ABS

January 15, 2020, 07:15 AM
Filed Under: Aircraft

Airline credit risk and heated competition in the leasing industry will test aircraft lessors' ability to adequately service asset-backed securities (ABS) in 2020, including repossessing and remarketing aircraft and placing them back on lease while managing ABS cash flows and containing expenses, says Fitch Ratings. Fitch-rated ABS transactions are expected to perform within expectations this year, despite these concerns, as cash flows are forecast to be sufficient to repay notes. Our Ratings Outlook is stable and our asset performance outlook is stable to negative.

Airline credit peaked in 2017 and gradually deteriorated since, specifically for smaller, regional airlines. Major airline bankruptcy filings continued in the past three years, and a select few aircraft ABS pools have seen higher airline defaults and aircraft on the ground, testing performance and placing heightened importance on lessor servicing abilities.

Over the past two to three years, lessors have been able to repossess and redeploy aircraft with new lessees fairly easily, given the robust demand for aircraft partially driven by ongoing aircraft and engine production delays and the Boeing 737 MAX grounding and subsequent production shutdown.

Robust competition, growing passenger volumes, strong demand for aircraft and increased adoption of leasing has driven asset values to peak levels in the past few years. Further, competition from new entrants in the lessor space has driven lease yields to unsustainable levels, particularly in the sale leaseback market.

In response, Fitch is taking a cautious approach to airline credit in ABS pools, assuming more stressful lessee default assumptions where appropriate, mostly for smaller, less established airlines. When assessing asset values, we cut values by up to 10 percent compared with appraisals provided and are conservative when it comes to residual assumptions.

Fitch is very selective regarding which lessor ABS platforms we rate, rating only 46 percent of the market since 2013, the large majority issued by large, established investment-grade-rated lessors. We have rated only two new lessor platforms issuing ABS in 2017-2019, both serviced by large investment-grade lessors. We believe these lessors can weather the highly cyclical aviation industry given their solid servicing capabilities to manage aircraft.

The 13 large aircraft ABS lessor platforms rated by Fitch possess fully built-out servicing platforms in each leasing function, from aircraft acquisition to fleet management/servicing. These issuers typically have investment-grade credit profiles supported by their scale and franchise strengths, robust risk controls, consistent operating performance and cash flow generation through cycles, appropriate leverage and strong, experienced management teams.

These issuers mostly have strong liquidity profiles and solid funding flexibility, with access to the capital markets across secured and unsecured financing. ABS is typically used to diversify funding, and finance aircraft purchases or manage fleet concentrations. These issuers do not rely on ABS servicing fees, while mostly holding equity in transactions aligning interests with investors.

Riskier newly established, smaller lessors with less than five years of operating history have entered an already crowded global aircraft lessor market in the last several years, including alternative investment managers. They have grown their portfolios, rapidly acquiring aircraft at inflated prices.

Less established lessors are untested and could face operational challenges, including pressure to place defaulted aircraft back on lease in a downturn. These lessors have limited operating scale and fleet size and mostly rely on ABS for funding, leaving them overly exposed to market volatility.

Additionally, the typically fixed-life nature of private equity ownership can increase long-term strategic and financial uncertainty for owned lessors, while the cyclicality and sensitivity to exogenous shocks exposes sponsors to heightened execution risk surrounding investment realization. Ultimately, this could impair servicing abilities and practices and negatively affect ABS performance.

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