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Fitch Ratings: Global Aircraft Lessor Profitability Tested Amid Normalizing Market

January 20, 2020, 07:05 AM
Filed Under: Aircraft

Fitch Ratings remains cautious amid the longer term normalization of the aircraft lessor market, as future lessor profitability could be tested by competitive dynamics, the placement risks of large order books and the potential for further airline bankruptcies and/or financing market disruptions.

However, aircraft lessors continue to benefit from largely supportive market dynamics, including strong demand for young and midlife aircraft, the increasing adoption of aircraft leasing, supply side disruptions, and accessible funding markets. Lessors have generally taken advantage of these dynamics in recent years to improve their credit profiles via deleveraging, increased unsecured funding and active aircraft sales to improve fleet profiles.

Manageable aircraft lessor exposure to the Boeing B737 MAX, coupled with increased demand for current generation aircraft, should result in a limited near-term impact on lessor operating performance from the grounding and subsequent production suspension of the MAX. However, the issue could become more acute to the extent a prolonged grounding affects scheduled deliveries, passengers' willingness to fly on the aircraft once it is back in service and lease yields and residual values.

While aircraft lessors are benefiting from elevated demand for current generation Boeing B737 and Airbus A320 aircraft mostly due to the MAX grounding, lease rates and residual values of these aircraft could come under pressure when the MAX returns to commercial service and should Airbus successfully ramp its production to 63 aircraft per month by 2021.

Fitch expects global airline profits will remain healthy, driven primarily by ongoing fleet rationalization and optimization by airlines, the expectation for stabilization in jet kerosene prices, which are closely tied to crude oil prices, and meaningful growth in revenue passenger kilometers led by China (A+/Stable) and India (BBB-/Stable).

Ongoing tensions between the U.S. and its trading partners will likely have a limited impact on aircraft lessors given the global nature of travel and healthy air traffic growth trends. Nevertheless, an escalation of trade tensions and/or geopolitical risks could reduce economic activity globally, affecting passenger travel and dampening aircraft lessors' growth and profitability.

Despite healthy macro factors, Fitch expects continued deterioration in the credit quality of smaller airlines over the medium term due to increased competition and the strong U.S. dollar. However, airline defaults are expected to have a limited impact on lessors' utilization and operating results over the near term given strong re-lease demand for current generation aircraft, healthy reserve coverage and lessee diversity.

The majority of aircraft lessors continue to place new orders with aircraft manufacturers, as access to next-generation aircraft can provide a competitive advantage when meeting client demand and replacement needs. However, increasingly speculative order books introduce sizable future funding needs and placement risks, as lessors may be challenged to maintain disciplined underwriting in a distressed market and forced to lease aircraft to weaker credit airlines in order to maintain high utilization rates.

The commercial bank, unsecured bond and private placement markets continue to be the primary sources of debt funding for aircraft lessors. The aircraft leasing sector completed $14.4 billion in unsecured note offerings in 2019 and $13.7 billion in 2018, driven by the need to fund capital expenditures and refinance debt maturities. However, issuance in 2019 was negatively affected by the grounding of B737 MAX, with lessors growing more slowly than expected.

Ratings of stand-alone aircraft lessors are generally limited to the 'BBB' rating category, due in part to the cyclical nature of the commercial aviation industry that remains highly sensitive to exogenous shocks. While lessors have proven to be more resilient than airlines due to their ability to quickly repossess and redeploy aircraft, Fitch's ratings for lessors are constrained by their monoline business model and high reliance on wholesale funding markets.

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