- The aircraft-leasing sector should fare better than airlines in this coronavirus-related economic downturn, but will still face pressure on their revenues and cash flow.
- Lessors will need to repossess some aircraft and re-lease them at lower rates in a weak market.
- Based on past experience, many lessors have mitigated potential risks by having diverse customer bases, collecting security deposits, and matching the terms of their leases and the debt funding them.
- Nevertheless, we expect to revise many outlooks to negative or put the ratings on CreditWatch, with some downgrades possible.
Aircraft leasing companies are facing mounting requests from their airline customers for deferral of lease rentals, and will very likely have to repossess planes from airlines that enter bankruptcy or shut down. Still, their revenues and cash flows aren't as directly affected from the travel slump created by the coronavirus pandemic as those of the airlines, and S&P Global Ratings sees their credit situation as somewhat less negative. We've been focused on reviewing airlines, hard hit by the coronavirus and government measures to combat it, but we will soon turn our attention to the aircraft leasing companies. Based on the current situation, which is clearly subject to change, we anticipate revising rating outlooks to negative from stable for most or all aircraft leasing companies, and are likely to downgrade some or place their ratings on CreditWatch. We hope to complete our reviews on the aircraft leasing companies in the coming weeks.
Lessors' Characteristics Provide Some Downside Cushion
Aircraft leasing companies (aircraft lessors) provide medium term (generally three- to 10-year) operating leases to a diverse portfolio of airline customers worldwide. Because leases don't extend through the entire lives of planes, aircraft lessors are prepared to take back aircraft and re-lease them to new customers as a normal part of business. When airlines are under pressure, as they are currently, the lessors will have to repossess more aircraft from airlines that are insolvent, and, under the current circumstances, it will take much longer to find new homes for them. New leases signed during an industry downturn, whether because of repossession or simply because an existing lease has ended, will typically be at lower rates, with the discount depending partly on how technologically up-to-date the plane is and how widely it's used by airlines globally.
The characteristics that provide added protection for aircraft lessors in a downturn, relative to airlines, include the following.
- The leases are absolute commitments, and airlines have no legal rights to discontinue payment based on the planes being grounded or for other reasons. However, they can be rejected (and aircraft returned) in bankruptcy, like other debt obligations.
- Lessors typically have globally diversified customer bases, so they can often shift aircraft from weaker countries or regions to relatively stronger ones. The global nature of the current downturn undermines this normal advantage, however.
- Lessors often, though not always, hold security deposits or letters of credit that they can draw on to partly offset costs of repossession and foregone rentals.
- The lessors' fleets of aircraft are relatively young (average three to seven years old for most lessors), incorporate the newest technology (e.g., A320 NEO) or previous generation (but still widely used) of technology (e.g., B737-800), and they are heavily concentrated in the popular, widely used models. This makes it more likely that an airline restructuring in bankruptcy will want to keep these planes and likely ground older, less-efficient planes.
- Aircraft lessors' revenues and cash flows have been remarkably stable through previous industry downturns, though we expect they will be under greater pressure in the current one.
- Managements of the aircraft leasing companies have learned from the missteps of some industry participants in previous industry downturns, and tend to be careful to match the terms of their leases and debt to finance them. They also have lined up large bank credit facilities to provide backup liquidity.
Still, There Are Risks
The lessors also have characteristics that increase risk somewhat, albeit not more so than those of airlines.
- Lease rates can fall significantly in an aviation downturn, and leases signed in a downturn will therefore depress revenues for years, even after the airline industry starts to recover. Lessors' revenues and cash flows tend to lag (i.e., don't fall as quickly) going into a downturn, but they also lag coming out of a downturn. Aircraft lessors seek to sign shorter-than-normal lease terms (e.g., three-year terms) during downturns to mitigate the effect of the weaker rates on future revenues.
- Some aircraft leasing companies have substantial orders for new planes from the manufacturers. These orders have airline customers signed up to receive the aircraft, though clearly some will seek to defer or renegotiate the leasing agreements. The lessors will likewise seek to defer some deliveries, and the large ones in particular may have some bargaining power as big customers of the manufacturers. Boeing's and Airbus' struggles to deliver planes on time and the recent temporary shutdown of most manufacturing in response to the virus may actually help airlines and lessors to defer deliveries.
- Aircraft leasing companies are more highly leveraged (typically between 70% and 80% debt to capital) than industrial companies, though less so than banks or diversified leasing companies.
- Large aircraft lessors have shifted increasingly to unsecured borrowing in the public capital markets. This market may not be available in a severe crisis, particularly for those companies with speculative grade ratings or ratings at the low end of investment grade. However, one of the objectives of shifting to unsecured debt was to free up collateral for potential future secured borrowing, which is easier to arrange in a downturn.
The revenue damage to lessors from the pandemic and associated economic downturn is likely to be mostly a function of the following variables:
- The proportion of airlines that request rental deferrals and that the lessors grant (which is less than the proportion of all airlines that are asking for relief). Some deferrals may be repaid in the same year, thereby not affecting full-year results.
- The proportion of airlines that enter bankruptcy and either liquidate or reorganize but turn back planes to the lessors. Government aid may limit insolvencies somewhat, particularly for larger airlines or "flag carriers" (the principal airline of a country providing international service).
- The amount of time that repossessed aircraft are idle before finding a new airline user. This period is likely to be much longer than the typical several months that lessors are able to achieve in more normal circumstances.
- The proportion of leases that mature in any given year, and the proportion of those that are renewed by the same airline or are placed with a new airline. Most rated aircraft lessors have leases that average more than five years in length, implying average lease maturities of 15%-20% annually.
- The discounted rate that lessors would need to accept in a weak aircraft market. The discount would be a function, in part, of the number of potential airline users (in most cases, those that already operate the aircraft model) and the age of each particular aircraft, as well as the current supply and demand for each model of aircraft.
Stay Tuned For Outlook Revisions And Possible Downgrades
Our ratings on aircraft leasing companies are mostly clustered in the 'BB' and 'BBB' categories, with several companies reaching 'A-' because of potential support from their higher-rated owners. The trend of the past few years has been for gradual upgrades, and most companies have targeted investment-grade ratings as important for their access to a wide array of capital sources. The coronavirus pandemic will pose a significant test for a sector that now accounts for about 40% of all commercial passenger aircraft worldwide.
This report does not constitute a rating action.
|Primary Credit Analyst:||Philip A Baggaley, CFA, New York (1) 212-438-7683;|
|Secondary Contact:||Betsy R Snyder, CFA, New York (1) 212-438-7811;|
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