- We estimate aircraft make up some 20%-50% of portfolios for the bank-owned financial leasing companies we rate in China.
- Valuation impairments of aircraft could dilute capital adequacy ratios for leasing firms that are regulated as financial institutions.
- Ratings are supported by strong backing from the parents; however, if the pandemic is prolonged and losses pile up, then group support could weaken.
China's bank-owned financial leasing companies have sizable exposures to the slump in global airline travel. However, most of these firms are subsidiaries of large banking groups that should support them in times of stress according to regulatory guidance. S&P Global Ratings believes this will cushion the ratings for those leasing companies.
Risks are tilted to the downside, given uncertainty on the duration of the COVID-19 pandemic. Travel is among the industries most disrupted by the pandemic. About half of the global aircraft fleet was still grounded as of June 15, 2020, and activity is only gradually picking back up. While China's economy is normalizing faster than others, the number of flights recovered to only about 60% of pre-pandemic levels by mid-May 2020. And airlines in China collectively lost Chinese renminbi 34 billion (US$4.8 billion) in first quarter 2020, according to the Civil Aviation Administration of China. This and other factors are an overhang on aircraft rental collections in the country.
Bank-owned financial leasing companies are regulated as financial institutions. The capital adequacy ratios of the six bank-owned leasing firms we rate in China could weaken if aircraft valuations drop substantially, lease activity dries up, or is signed at much lower rates. Other leasing segments, such as equipment and shipping, have been holding up better than aircraft leasing, providing some revenue diversification. The ultimate backstop for financial leasing companies is the high level of group support from their parents. If their profitability reached an unsustainably low level, the parent banks could distance themselves from the leasing companies, though we see the scenario as rather remote for now.
A Growth Driver Stalls
Air travel is the focal driver of growth for China's bank-owned financial-leasing companies. Aircraft lease assets for our rated companies more than doubled over the past five to six years on average. As at Dec. 31, 2019, the aircraft book ranged from 20% to 50% of lease assets. The aircraft are largely narrow-body passenger planes leased to airline operators, with the exception of Minsheng Financial Leasing Co. Ltd., which focuses on the corporate jet business.
We rate seven financial leasing subsidiaries supervised by China Banking And Insurance Regulatory Commission, or CBIRC (excluding offshore companies). Six of these are subsidiaries of large Chinese banks with ratings aligned or closely aligned with the group (see table). The other, China Huarong Financial Leasing Co. Ltd., is majority owned by China Huarong Asset Management, but this one does not have an aircraft leasing book.
|Our Rated China Financial Leasing Companies Directly Regulated By The CBIRC*|
|Entity||Domicile||Ratings||Total assets (bil. RMB, 2019)|
ICBC Financial Leasing Co. Ltd.
China Development Bank Financial Leasing Co. Ltd.
Bank of Communications Financial Leasing Co. Ltd.
CMB Financial Leasing Co. Ltd.
Minsheng Financial Leasing Co. Ltd.
China Huarong Financial Leasing Co. Ltd.
CCB Financial Leasing Corp. Ltd.
|*ICBCIL Finance Co. Ltd., BoCom Leasing Management Hong Kong Co. Ltd., CMB International Leasing Management Ltd., CCB Leasing (International) Corp. DAC are 100% owned or managed by those leasing companies. CBIRC--China Banking and Insurance Regulatory Commission. RMB--Chinese renminbi. bil.--billion.|
While travel restrictions are generally easing in China, uncertainty clouds the industry prospects, given the risk of new outbreaks as lockdowns ease and people flows increase. An example is a localized outbreak in Beijing, leading to targeted quarantines and travel restriction for residents of neighborhoods identified as higher risk. A major part of the onshore exposure is attributed to the top-three Chinese national airline operators together with their subsidiaries and associates. Good domestic capital market access offsets some of their liquidity risks and supports rent collection from those aircraft operators. Global conditions also weigh on our rated lessors, which have sizable global aircraft lease exposure through their offshore subsidiaries. The offshore book represented, on average, around half of the collective aircraft portfolio as at December 2019.
Profitability And Capital Pressure Piling Up
The profit impact to date is small, largely because lessors can still book revenue on rents deferred amid moratoriums. Falling fund costs in China's version of lower-for-longer rates also provide some cushion. However, prolonged travel restrictions would not only enlarge and extend moratoriums but also fuel greater collection uncertainty when repeated concessions are granted. The systemic nature of this pandemic also weakens the bargaining power of lessors if lease receivables become problematic, because finding a new lessee during this demand slump would be more difficult. Lower renegotiated lease rates and long idle periods after repossessing aircraft would accelerate opportunity costs and weigh on profitability. As lessors have fewer option to realize the value of aircraft, they will likely hang on, hoping the lessees and the industry will recover over time.
While we have not seen lessors booking large impairments in plane values, a material decline would add capital adequacy pressure for these prudentially regulated financial lessors. Currently, these lessors are generally able to withstand about 5% decline in net book value (some more) before breaching capital adequacy requirements. We see some buffer in book valuations due to steep accumulated depreciation that creates a cushion between the net book value and market valuations. Also, these fleets are generally young, which should impart value resilience.
Planned capital injections and issuance of capital instruments will bolster the buffers of leasing companies with moderate capital ratios. These injections have been in the pipeline for some time, before COVID-19, and demonstrate parental support. We also expect more flexibility from the parent on key performance indicators such as growth rate, profitability, and nonperforming assets.
Group Support And Diversified Leasing Portfolio Cushion The Risk
So far equipment and shipping have been holding up better in the face of the pandemic. Shipping and equipment leasing that is mostly domestic focused should provide a backbone for overall leasing revenue even if aircraft leases could be cancelled. The client base for these business arms has a high degree of overlap with their parent bank and specifically focus on state-owned enterprises (SOEs) in sectors such as transportation, utilities, power generation, and water supply. Despite some temporary operational pressure from the lockdown measures, these clients have better financial resources to survive the economic strike from COVID 19. Minsheng Financial Leasing, in line with its parent bank, has more small and midsize clients and relatively higher proportion to manufacturing sectors that could be more vulnerable than peers. In contrast with other major bank groups, its aircraft portfolio is smaller at about 20% of overall lease assets, largely comprising private jets and a lesser portfolio of commercial jets.
We note that under CBIRC regulations the bank parents are required to provide capital and liquidity support for their financial lease subsidiaries when needed. Group support, including planned capital injections, ward off potential capital shortfalls in mild to medium stress scenarios for aircraft devaluation. There are also direct and indirect mechanisms of support for offshore subsidiaries of the leasing firms, such as asset purchase plans by the onshore entity and parent bank providing direct committed U.S.-dollar bank line to enhance subsidiary's foreign funding position. The lease subsidiary can fund up to 40% of total liabilities using borrowing from the parent, according to CBIRC's requirement.
At the same time, liquidity can also be aided by reduced capital spending due to aircraft deferrals, delays, and cancellations.
We expect Chinese bank groups to remain committed to their leasing arms and respective aircraft business lines and continue to formulate this support into our rating construction. However, in our view, poor operating performance and earnings contribution could weaken the groups' commitment to the subsidiaries. We would review our assessment of strength of the group support if the impact of the pandemic led to an unsustainable business model.
A Note On Our Coronavirus Assumptions
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
- Credit Conditions Asia-Pacific: COVID-19: Flatter Growth, Tougher Recovery, April 22, 2020
- Aircraft Lessors, Hit By Coronavirus Fallout, Should Fare Better Than Their Airline Customers, March 25, 2020
- China's New Financial Leasing Rules Strengthen The Overhaul, Jan. 9, 2020
- Financial Leasing Firms Are Next In Line As China Reform Gets Granular, Nov. 15, 2019
This report does not constitute a rating action.
|Primary Credit Analysts:||Xi Cheng, Hong Kong (852) 2533-3582;|
|Harry Hu, CFA, Hong Kong (852) 2533-3571;|
|Secondary Contacts:||Amos Liu, Hong Kong + 852 2533 3519;|
|Phyllis Liu, Hong Kong (852) 2532-8036;|
|Robert Xu, Hong Kong (852) 2532-8093;|
|Ryan Tsang, CFA, Hong Kong (852) 2533-3532;|
|Research Assistant:||Winnie Wang, Taipei|
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