NEW YORK—(BUSINESS WIRE)—Fitch Ratings has completed a peer review of five publicly-rated aircraft leasing firms, resulting in the upgrade of two aircraft lessors and the affirmation of the three others. Specifically, AerCap Holdings N.V.‘s (AerCap) Long-Term Issuer Default Rating (IDR) was upgraded to ’BBB-’ from ‘BB+’ and the Rating Outlook was revised to Stable from Positive; Avation PLC’s (Avation) Long-Term IDR was affirmed at ‘B+’ with a Stable Outlook; Aviation Capital Group Corp.‘s (ACG) Long-Term IDR was upgraded to ’BBB’ from ‘BBB-’ and the Outlook revised to Stable from Positive; BOC Aviation Limited’s (BOCA) Long-Term IDR was affirmed at ‘A-’ with a Stable Outlook; and SMBC Aviation Capital Limited’s (SMBC AC) IDR was affirmed at ‘BBB+’ with a Negative Outlook. Please refer to company-specific rating action commentaries published today, available at www.fitchratings.com, for further information on rating rationales.

Supportive Market Dynamics

The actions are supported by rated aircraft lessors’ generally strong franchise positions, capable management teams, improving funding positions and aircraft fleet characteristics, and acceptable leverage levels relative to assigned ratings. Fitch also notes that aircraft lessors are currently benefiting from a number of supportive market dynamics including increased air travel, improved financial condition of airlines, growing adoption of aircraft leasing, low interest rates, generally accessible funding markets and the absence of exogenous shocks. While these dynamics have enhanced aircraft lessors’ recent financial performance, Fitch notes that many are pro-cyclical in nature, and therefore, their impacts on ratings are somewhat moderated.

Aircraft lessors’ credit profiles remain constrained by the monoline nature of the business model, reliance on wholesale funding, the cyclicality of the business, potential residual value risk, sensitivity to sustained low oil prices and increased competition.

Favorable Passenger Traffic Trends

Global air passenger traffic, measured in revenue passenger kilometers, grew 7.4% in 2015 according to IATA, the strongest rate since 2010, and IATA projects this rate to increase to 6.2% in 2016. In 2015, growth was 5.3% in North America (4.0% projected for 2016), 6.0% in Europe (4.9% projected for 2016), and 10.1% in Asia-Pacific (8.5% projected for 2016).

The expected economic growth deceleration in China through 2017 should not significantly hurt aircraft lessors’ credit profiles. While the Asia-Pacific region is a meaningful area of current exposure for most aircraft lessors, Fitch expects that resilient consumer spending in China over the next few years and the Chinese government’s support for top airlines that are among the lessors’ top customers should suppress the fallout from a broader China slowdown. At March 31, 2016, China averaged 10.3% of Fitch-rated pure play aircraft lessors’ exposure on a market value basis, with a maximum of 12.6%.

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 U.K. is among the top sovereign exposures for only a few aircraft lessors, notably AerCap Holdings N.V. and Avolon Holdings Limited, although even in these cases exposure represents less than 5% of aggregate lease revenue.

Further Consolidation Possible, Competitive Environment

On Jan. 8, 2016, Bohai Leasing Co., Ltd., a container and aircraft leasing company based in China, acquired Avolon Holdings Limited (Avolon) for $7.6 billion (a 31% premium to Avolon’s unaffected share price. Fitch believes further consolidation is possible in the sector, particularly following CIT Group Inc.’s announcement in October 2015 that it is exploring strategic alternatives for its $10 billion commercial air business.

The commercial aviation market continues to be highly competitive, with demand for higher yielding U.S. dollar assets remaining elevated as interest rates remain low or negative in many parts of the world. Certain established lessors have been adding to their backlogs with the aircraft manufacturers, while institutional investors such as insurance companies, business development companies, hedge funds and pension funds continue to participate alongside lessors for mid-life aircraft. The sale-leaseback market in particular has been highly competitive. Competition is not strong in all areas of the market, however, as Ascend has recently noted weakness for certain widebody aircraft such as the Airbus A330. Overall, however, lease yields have remained consistent year-over-year in first quarter 2016 (1Q16), remaining in the low-to-mid-teens.

Debt Markets Remain Accommodative, Slight Decline in Leverage

AerCap, Air Lease Corporation (Air Lease), Aircastle Limited (Aircastle), BOCA, and SMBC AC have issued unsecured notes thus far in 2016, capitalizing on accommodative markets. Year-to-date through July 22 2016, aircraft lessor corporate bond spreads have tightened 44 basis points on a weighted average basis. The aircraft finance market has remained healthy overall, following the volatility experienced in early 2016, and Fitch expects accommodative market trends to continue during the remainder of the year as growing air travel and the improved financial condition of airlines persist despite pockets of weakness.

In addition to the unsecured bond market, aircraft lessors have been able to access the securitization markets or obtain funding from commercial banks, insurance companies and government-sponsored export credit agencies. While the Export-Import Bank of the U.S.‘s (Ex-Im) charter was re-authorized in November 2015, the U.S. Senate has not yet approved a nominee to Ex-Im’s Board to enable Ex-Im to provide credit guarantees, suggesting that the capital markets and bank and insurance markets will remain the primary sources of debt capital for the lessors over the near term.

Average leverage for the five publicly rated lessors was 3.8x as of March 31, 2016, down from 3.9x as of Dec. 31, 2015 and 4.0x as of Dec. 31, 2014. This trend is attributable to equity growth via retained cash flow and the absence of material asset impairments. However, there continues to be a divergence between leverage of stand-alone lessors, which tend to employ lower leverage, and institutionally supported lessors, which employ higher leverage but benefit from potential equity support from their parent companies.

Share Prices Remain Depressed but Partial IPOs Still Being Pursued

Price-to-book ratios are currently below 1.0x for the pure-play publicly traded lessors, AerCap, Air Lease, Aircastle, and FLY Leasing Limited. Price-to-book ratios were 0.91x as of March 31, 2016, down from 0.95x at year-end 2015 and 1.01x at year-end 2014. Fitch believes reduced market expectations regarding lessors’ growth over the next few years have driven prices below book values.

Despite share price trends, Pacific LifeCorp is considering a partial public listing of ACG and Bank of China Limited completed a partial IPO of BOCA in May of this year. Strategic rationales behind partial IPOs have been to diversify the shareholder base and/or pursue growth strategies.

Low Oil Prices Can Cut Both Ways

Low oil prices have generally benefitted aircraft lessors thus far, boosting airlines’ profitability, thereby keeping utilization rates high and repossession activity low. In addition, older and less fuel-efficient aircraft which might have otherwise been parted out have instead been profitably kept in use.

Even so, if oil prices were to remain low for a sustained period of time, this could have adverse effects on aircraft lessors. For example, if airlines were to experience sustained increases in profitability and financial flexibility, this could reduce their appetite for aircraft leasing and instead lead airlines to increase their direct purchase of aircraft. In addition, sustained low oil prices would reduce the expected benefits of more fuel efficient, next generation aircraft, for which many lessors have accumulated large orders. Fitch views current oil prices as sufficiently favorable for aircraft lessors in the sense that they are low enough to support airlines’ profitability but not so low as to invalidate the fuel efficiency benefits of next generation aircraft.

Additional information is available at ‘www.fitchratings.com’.