Fitch Upgrades AerCap Holdings N. V. to 'BBB-'; Outlook Stable
These actions are being taken in conjunction with a broader aircraft leasing industry peer review conducted today by Fitch, which includes five publicly rated firms. For more commentary on the broader sector review, please see 'Fitch Completes Aircraft Lessor Peer Review', available at 'www. fitchratings. com'.
KEY RATING DRIVERS - IDRs
The upgrade reflects AerCap's meaningful deleveraging since the International Lease Finance Corp. (ILFC) acquisition in May 2014, continued fleet management execution and notably improved unencumbered asset coverage.
The ratings continue to be supported by the company's scale and franchise strength as the world's largest pure play aircraft lessor, access to multiple sources of capital, good liquidity and cash flow generation, and a strong management team. Although leverage remains somewhat elevated on a Fitch-adjusted debt-to-tangible equity basis (estimated to be 3.8x as of June 30, 2016), this ratio is expected to continue declining to the 3.0x - 3.5x range over the outlook horizon as a result of excess capital generation, despite two share repurchase programs that were authorized this year totalling $650 million. The company remains committed to its 2.7x - 3.0x self-defined debt-to-equity target.
Rating constraints specific to AerCap include an older average fleet age relative to rated peers, potential financing risk associated with its large order book, and above-average exposure to China. Rating constraints applicable to the aircraft leasing industry more broadly include the monoline and cyclical nature of the business, potential exposure to residual value risk, sensitivity to sustained low oil prices, reliance on wholesale funding sources and increased competition.
Significant Franchise, Fleet Management Execution
AerCap has one of the largest aviation portfolios among aircraft lessors, with 1,637 owned, managed and on order aircraft as of June 30, 2016. In addition to the diversification benefits that come with size, Fitch believes that scale provides certain strategic benefits, such as increased purchasing/negotiating power, an ability to transact with larger and more highly-rated airlines, and more available channels to re-lease planes when needed. Conversely, with broad reach comes increased likelihood of exposure to challenged airlines and/or geographies during periods of stress.
Since the ILFC transaction, AerCap has sold 109 aircraft including 44 widebody aircraft, which underscores the current liquidity for AerCap's older fleet, supported by the low interest rate, low fuel price environment. Most recently, in 1Q2016, the company disposed of 19 owned aircraft with an average age of 14 years and purchased 6 aircraft in its order book, including 5 Boeing 787-9s and 1 Boeing 737NG.
Despite the aircraft sales completed over the last several years, AerCap's average fleet age effectively remained flat year-over-year at 7.7 years as of March 31, 2016 from 7.6 years as of March 31, 2015 given the continued aging of its remaining fleet. The average age should improve to between 6.4 - 6.7 years next year following order book deliveries and $2 billion in asset sales this year (including the sale of 35 mid-life aircraft in 2Q2016). In addition, Fitch considers the current fleet to be tier 1/2 aircraft on average. Fitch believes that by 2020 approximately 50% of AerCap's portfolio on a net book value basis will consist of next generation aircraft as Airbus A320neo family, Airbus A350, Boeing 737MAX, Boeing 787, and Embraer E190/195-E2 are delivered.
Meaningful Deleveraging
As a result of asset sales and capital retention (no dividends have been paid since the ILFC transaction), Fitch-calculated adjusted debt to tangible common equity is estimated to be 3.8x as of June 30, 2016, down from 4.7x as of June 30, 2014. This ratio is expected to be further reduced to the 3.0x - 3.5x range over the outlook horizon, driven by excess capital generation and order book deliveries that should reduce the intangible assets associated with the legacy ILFC order book, provided the value of AerCap's existing fleet and order book are not materially impaired.
Fitch-calculated leverage is defined as gross debt adjusted for 50% equity treatment on the company's subordinated notes and fair value debt adjustments, divided by equity adjusted for the 50% equity treatment on the company's subordinated notes, fair value debt adjustments, the legacy ILFC order book that was valued as an intangible asset pursuant to purchase accounting, goodwill, other intangibles and non-controlling interest. If the fair value of the portion of the order book that has already been placed was included in the denominator of Fitch's leverage ratio, adjusted debt to tangible common equity would be 3.1x as of June 30, 2016.
Company-reported debt/equity declined to 2.8x as of March 31, 2016 from 3.7x as of June 30, 2014. Company-reported leverage is defined as net debt adjusted for 50% equity treatment on the company's subordinated notes, divided by reported common equity adjusted for the 50% equity treatment on the company's subordinated notes. The company expects to generate excess capital in 2016 and therefore implemented a $400 million share repurchase program on Feb. 23, 2016 and a $250 million share repurchase program on May 31, 2016 to maintain its 2.7x - 3.0x self-defined leverage target. Fitch views debt funded share repurchases as a rating constraint at the 'BBB-' level until such time as Fitch-calculated leverage is below 3.0x.
Consistent Performance
AerCap executed 276 lease agreements during 2015 and 100 lease agreements including widebody and narrowbody aircraft in 1Q2016. As a result, the average remaining lease term was extended slightly to 6.1 years as of March 31, 2016 from 5.9 years as of March 31, 2015. Utilization remains strong at 99.3% as of March 31, 2016. Fitch believes that a substantial portion of lease revenues from current fleet and order book is contracted through 2018. This should improve cash flow predictability over the Outlook horizon.
Favorable commercial aviation traffic trends and the company's large platform have driven Fitch-defined yield on assets in the 15% - 16% range over the past several quarters. AerCap's annualized net spread was 9.8% in 1Q2016, 2015 and 2014, driven by high utilization rates and long-term leases. Net spreads are defined by Fitch as net interest margin (basic lease rents less interest expense, excluding the non-cash charges relating to the mark-to-market of interest rate caps and swaps) divided by flight equipment held for operating lease, net investment in finance and sales-type leases and maintenance rights intangible assets. Strong underlying fundamentals in the aircraft leasing industry including rising passenger growth and still moderate jet fuel costs could continue to support strong asset yields, at least in the near term, absent exogenous shocks.
Consistent performance comes despite some pressure in certain emerging markets. AerCap's largest market is China (13.2% of lease revenues in 2015). However, the slowdown in China's economic growth has not yet had a material impact on portfolio yields as the secular drivers of Chinese air travel persist, namely a growing middle class and airlines' increased use of leasing. While South America remains under pressure, this has yet to adversely impact AerCap's portfolio and this region represented less than 5% of AerCap's lease revenue in 2015. Separately, the recent vote by the United Kingdom to exit the European Union creates uncertainties regarding future travel rights in the U. K. and potential pressure on air traffic from the U. K. to other jurisdictions due to the weakening of the British Pound. The United Kingdom is one of AerCap's largest markets, albeit still less than 5% of total lease revenue.
Strong Access to Capital and Improved Liquidity
The company completed $7.3 billion in financing transactions in 2015, including unsecured notes and secured debt with commercial banks and insurance companies, and also upsized its corporate revolver. In May 2016, AerCap Ireland Capital Limited and AerCap Global Aviation Trust issued $1 billion of 3.95% Senior Notes due 2022 at five year U. S. treasuries plus 270 basis points (bps). This was a material improvement from the previous notes offering of 4.625% senior notes due 2020 at five year U. S. treasuries plus 327 bps. Overall access to capital continues to remain strong, supported at least in part by supportive financing markets in the current low interest rate environment.
The company's liquidity coverage ratio, defined as availability from the unsecured revolver and other committed borrowing facilities, unrestricted cash and estimated operating cash flow, divided by debt maturities and expected cash payments for aircraft purchases over the next 12 months, was 1.3x at March 31, 2016 pro forma for the 2022 notes offering and $250 million share repurchase.
Unencumbered asset coverage of unsecured debt has also improved meaningfully over the past year as a result of secured debt repayment and overall leverage reduction. Unencumbered asset coverage is now viewed as adequate for the 'BBB-' rating.
AER's unsecured debt levels have continued to outpace secured debt levels, further expanding financial flexibility. Unsecured debt to total debt was 53.7% (37.2% of total assets) as of March 31, 2016 pro forma for the May unsecured bond offering and $250 million share repurchase while secured debt to total debt was 41.7% (28.9% of total assets). The company has articulated a target of secured debt to total assets not more than 30%.
AeroTurbine Downsizing Neutral
During 4Q2015, AerCap decided to downsize its AeroTurbine business, as the engine leasing, airframe and engine trading services provided by this segment are no longer viewed by AerCap as core to its aircraft leasing platform. After completion of the downsizing, AeroTurbine may be absorbed into AerCap. This fee generating business was not a core part of AerCap's credit profile and the downsizing should have a neutral impact on ratings.
KEY RATING DRIVERS - Senior Unsecured Debt
The equalization of the unsecured debt with AerCap and ILFC's IDRs reflects material unsecured debt as a portion of total debt, as well as the availability of sufficient unencumbered assets, which provide support to unsecured creditors and suggest average recovery prospects.
KEY RATING DRIVERS - Senior Secured Debt
AerCap's senior secured bank debt and ILFC's senior secured notes ratings of 'BBB' are one-notch above the Long-Term IDR, and reflect the aircraft collateral backing these obligations which suggest very strong recovery prospects.
The 'BBB-' ratings of the senior secured term loans of Flying Fortress, Inc., Delos Finance SARL, and Temescal Aircraft Inc., which are wholly owned subsidiaries of ILFC, are equalized with the IDR of ILFC. These secured term loans are secured via a pledge of stock of the subsidiaries and related affiliates and are guaranteed by ILFC on a senior unsecured basis. The ratings on these secured term loans are not notched above ILFC's IDR due to the lack of a perfected first priority claim on aircraft provided to support repayment of the term loans. Furthermore, there is a risk of substantive consolidation of Flying Fortress, Inc., Delos Finance SARL and related affiliates in the event of an ILFC bankruptcy.
KEY RATING DRIVERS - Hybrid Debt
The ILFC preferred stock ratings of 'BB-' incorporate a three-notch differential between the long-term IDR and preferred stock ratings reflecting the going-concern loss absorption nature of the instruments. This is consistent with Fitch's 'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' criteria published on Feb. 29, 2016.
RATING SENSITIVITIES - IDRs, Senior Unsecured Debt, Senior Secured Debt and Hybrid Debt
Fitch views further positive rating action as limited until such time as AerCap is able to achieve a further and sustained reduction in balance sheet leverage below 3.0x on a Fitch-calculated basis. Thereafter, positive rating momentum could be driven by reduced average fleet age towards the long-term targeted level of five to six years, further improvements in unencumbered asset coverage of unsecured debt, and maintenance of robust liquidity particularly with respect to near-term funding obligations.
Negative rating pressure could arise from increased leverage (company defined leverage of above 3.0x or Fitch-calculated adjusted debt-to-tangible common equity above 4.0x) as a result of more aggressive capital returns, aircraft impairments or increased use of debt, a sustained deterioration in financial performance and/or operating cash flows, higher than expected repossession activity, difficulty re-leasing aircraft at economical rates, a reduction in available liquidity or unencumbered assets, and/or inability to maintain or improve the fleet profile.
To the extent that oil prices remain low for a sufficiently long time that it permanently impairs the value of newer, more fuel efficient planes or provides airlines with sufficiently financial flexibility that they have materially lower demand for aircraft leasing (versus outright purchases), these dynamics could have negative rating implications for the aircraft leasing industry as a whole.
The ratings of the senior secured debt, senior unsecured debt and hybrid debt are primarily sensitive to changes in AerCap and ILFC's IDRs and secondarily to the relative recovery prospects of the instruments.
Fitch has upgraded the following ratings:
AerCap Holdings N. V.
--Long-Term IDR to 'BBB-' from 'BB+'; Outlook revised to Stable from Positive.
AerCap Ireland Capital Limited
AerCap Global Aviation Trust
AerCap Aviation Solutions B. V.
--Senior unsecured notes to 'BBB-' from 'BB+'.
International Lease Finance Corp.
--Long-Term IDR to 'BBB-' from 'BB+'; Outlook revised to Stable from Positive;
--Senior secured notes to 'BBB' from 'BBB-';
--Senior unsecured notes to 'BBB-' from 'BB+';
--Preferred stock to 'BB-' from 'B+'.
Flying Fortress Inc.
Delos Finance SARL
Temescal Aircraft Inc.
--Senior secured term loans to 'BBB-' from 'BB+'.
ILFC E-Capital Trust I
ILFC E-Capital Trust II
--Preferred stock to 'BB-' from 'B+'.
AerCap B. V.
AerCap Dutch Aircraft Leasing I B. V.
AerCap Dutch Aircraft Leasing IV B. V.
AerCap Dutch Aircraft Leasing VII B. V.
AerCap Engine Leasing Limited
AerCap Ireland Limited
AerCap Partners 767 Limited
AerCap Partners I Limited
AerFunding 1 Limited
AerVenture Leasing 1 Limited
Bluesky Aircraft Leasing Limited
CelestialFunding Limited
Cielo Funding Limited
Cielo Funding II Limited
Excalibur One 77B LLC
Flotlease MSN 973 Limited
Harmonic Aircraft Leasing Limited
Harmony Funding BV
Limelight Funding Limited
Melodic Aircraft Leasing Limited
Monophonic Aircraft Leasing Limited
NimbusFunding BV
Parilease / Jasmine Aircraft Leasing Limited
Philharmonic Aircraft Leasing Limited
Polyphonic Aircraft Leasing Limited
Quadrant MSN 5869 Limited
Renaissance Aircraft Leasing Limited
Rouge Aircraft Leasing Limited
Sapa Aircraft Leasing 2 BV
Sapa Aircraft Leasing BV
SkyFunding Limited
Skyfunding II Limited
SoraFunding Limited
StratocumulusFunding BV
StratusFunding Limited
Symphonic Aircraft Leasing Limited
Triple Eight Aircraft Leasing Limited
Wahaflot Leasing 3699 (Bermuda) Limited
Westpark 1 Aircraft Leasing Limited
Worldwide Aircraft Leasing Limited
--Senior secured bank debt to 'BBB' from 'BBB-'.
Fitch has assigned the following ratings:
AerCap Leasing XXX BV
ALS3 Ltd.
Annamite Aircraft Leasing Limited
BlowFish Funding Limited
Burgundy Aircraft Leasing Limited
Camden Aircraft Leasing Trust
Celtago Funding Limited
Constellation Aircraft Leasing Limited
Electra Funding Ireland Limited
FlyFunding Limited
FodiatorFunding B. V.
GlideFunding Limited
Gunung Leasing Limited
ILFC Aircraft 73B-41789 Limited
Jetstream Aircraft Leasing Limited
Moonlight Aircraft Leasing Limited
Northstream Aircraft Leasing Limited
Southstream Aircraft Leasing Limited
Sunflower Aircraft Leasing Limited
Tucana Aircraft Leasing Limited
Whitney Leasing Limited
--Senior secured bank debt 'BBB'.
Fitch has withdrawn the following ratings as the obligations have been repaid or the aircraft have been sold (i. e., a reorganization of the rated entity for reasons other than financial distress):
AerLift Leasing Jet Limited
Genesis Portfolio Funding 1 Limited
Sunflower Leasing Co., Ltd.
Tulip Leasing Co., Ltd.
--Senior secured bank debt 'BBB-'.
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