Overview
• U.S.-based Aircraft lessor Aviation Capital Group Corp. (ACG) has reduced the amount of secured debt in its capital structure by issuing unsecured debt and repaying secured debt.
• We are raising our issue rating on ACG’s unsecured debt to ‘BBB-’ from ‘BB+’.
• We are also affirming our ‘BBB-’ corporate credit rating on ACG.
• The stable outlook reflects our expectations that ACG’s debt levels will
remain relatively consistent through 2015 due to capital spending for new
aircraft deliveries.

Rating Action
On July 17, 2014, Standard & Poor’s Ratings Services raised its issue rating
on Newport Beach, Calif.-based aircraft lessor Aviation Capital Group Corp.‘s
(ACG’s) unsecured debt to ‘BBB-’ from ‘BB+’. At the same time, we affirmed our
‘BBB-’ corporate credit rating on the company. The outlook is stable.

Rationale
The upgrade reflects the reduced secured debt level in ACG’s capital
structure, with secured debt now equaling less than 30% of the company’s
assets. This is below our threshold for notching down unsecured debt of an
investment-grade (rated ‘BBB-’ and higher) aircraft leasing company. Over the
last five years, ACG has been issuing unsecured debt and repaying secured
debt. We expect these trends to continue and that secured debt as a percentage
of assets will continue to decline.

We view ACG as a major provider of aircraft operating leases and owner of new
technology aircraft with relatively stable asset values. The company’s fleet
comprises more than 250 owned and managed aircraft leased to 90 airlines in 40
countries. In terms of fleet size, this places ACG in the second tier of
aircraft lessors, which includes Babcock & Brown Air Ltd. (including Fly
Leasing Ltd.), AWAS Aviation Capital Ltd., CIT Aerospace International, SMBC
Aviation Capital Ltd., Aircastle Ltd., BOC (Bank of China) Aviation Ltd., and
Air Lease Corp. However, in terms of both the number and value of aircraft,
each of these companies’ aircraft fleet is much smaller than those of GE
Capital Aviation Services (GECAS) and AerCap Holdings N.V. (which acquired
risks of cyclical demand and lease rates for aircraft. We assess the company’s
business risk profile as “satisfactory.”

ACG’s fleet comprises primarily popular narrow-body Airbus A320 family
aircraft and Boeing B737s, with a relatively young average fleet age of about
six years. The company’s portfolio is well diversified both geographically and
in terms of its customer base. ACG’s committed orders total more than 120
aircraft to be delivered through 2021.

We expect continued revenue growth related to the incremental aircraft to be
added to the fleet, modestly improving lease rates, and relatively stable
margins through 2015.

ACG’s credit metrics are weaker than many of its peers’, and its ongoing
funding needs related to its capital spending commitments for new aircraft
deliveries will result in continued high debt leverage. However, the company’s
pool of unencumbered assets is substantial and increasing due primarily to the
addition of unsecured debt to its capital structure while it has repaid
secured debt. ACG does not disclose its financial results publicly. We assess
the company’s financial risk profile as “significant.”

In 2013, ACG’s funds from operations (FFO) to debt was about 8% and debt to
capital was about 80%. We expect that the debt levels will remain relatively
consistent through 2015 due to capital spending for new aircraft deliveries.
We also expect ACG’s credit metrics to remain relatively consistent, with FFO
to debt at about 8% and debt to capital at about 80%.

In March 2014, Pacific Life contributed $150 million of equity to ACG. ACG’s
credit metrics are weaker than most of its rated peers, where FFO to debt
averages 10%-12% and debt to capital averages 70%-75%. Aircraft lessors’
credit ratios, similar to other lessors of transportation equipment, are
typically weaker than those of comparably rated industrial companies. However,
these companies typically generate relatively strong and stable cash flow to
service high levels of debt.

ACG is a wholly owned subsidiary of Pacific Life Insurance Co. We consider ACG
to be “moderately strategic” under our group rating methodology.

Our base case assumes the following:
• Continued capital spending for new aircraft deliveries in 2014 and 2015,
• Increased earnings and cash flow over that period due to the additional
aircraft and modest lease rate increases, and
• Pacific Life’s $150 million equity contribution in March 2014.

Based on these assumptions, we arrive at the following credit measures for
2014 and 2015:
• Relatively stable FFO to debt of about 8%, consistent with the level
achieved in 2013; and
• Relatively stable debt to capital of about 80%, consistent with the level
achieved in 2013.

Liquidity
ACG has adequate sources of liquidity to cover its needs over the next year,
in our view. We believe the sources of cash will likely exceed the uses by
1.2x or more, the minimum threshold for an “adequate” assessment under our
criteria, and that the company will also meet our other criteria for such
assessment.

The principal liquidity sources comprise the following:
• Cash,
• Internally generated funds,
• Access to various bank and export credit agency financings to fund new
aircraft purchases,
• Proceeds from aircraft sales, and
• Potential further unsecured capital markets financings.
The principal liquidity uses consist of the following: • Debt maturities, and
• Capital expenditures for new aircraft.

Outlook
The stable outlook reflects our expectation that ACG’s debt levels will remain
relatively consistent through 2015 due to capital spending for new aircraft
deliveries. We expect ACG’s FFO to debt to remain at about 8% and debt to
capital of about 80%.

Downside scenario
While not considered likely, we could lower rating if ACG’s FFO to debt
declined to below 6% on a sustained basis. This could result from global
economic weakness causing weaker demand for aircraft, which would likely
pressure lease rates and cash flow.

Upside scenario
We do not consider an upgrade likely until the company’s FFO to debt
approaches 10% on a sustained basis or if Pacific Life chooses to operate ACG
at a lower leverage level.