Fitch Ratings-New York-22 February 2018: Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) for Avolon Holdings Limited (Avolon) at 'BB'. Fitch has also affirmed the IDR and senior unsecured debt rating of Park Aerospace Holdings Limited, an Avolon subsidiary, at 'BB'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
Avolon announced today that it will pay a dividend of $250 million to its direct owner, Bohai Capital Holding Co., Ltd. (Bohai Capital), amend its guarantee structure to eliminate potential structural subordination amongst the debt issuing entities, and introduce a mandatory redemption covenant, limiting payments to Bohai Capital within certain thresholds. Fitch views these collective announcements as credit neutral.
KEY RATING DRIVERS - IDRs, SECURED DEBT, UNSECURED DEBT
The rating affirmation reflects Avolon's high quality commercial aircraft portfolio; scale and franchise strength as one of the world's largest aircraft leasing companies; strong profitability; robust risk controls; and strong management track record. The ratings are constrained by Avolon's predominantly secured, wholesale funded debt profile; elevated leverage, defined as gross debt to tangible common equity; aggressive growth via its order book and stated acquisition appetite; and qualitative considerations surrounding Avolon's ownership structure.
Avolon's gross debt to tangible common equity ratio was 3.6x as of Dec. 31, 2017 and will increase modestly following the dividend payment. Fitch believes Avolon will look to manage gross debt to tangible common equity within a range of 3.0x-3.5x over the intermediate term, driven primarily by the amortization of intangible assets (maintenance right assets and lease premium), and within its target range of 2.5x-3.0x over the long term.
The amendment to the existing guarantee structure seeks to ensure that Avolon's full operations explicitly support unsecured debt repayment. Fitch views this favorably as it reduces organizational complexity.
The mandatory redemption covenant further formalizes the segregation of Avolon's financial resources from Bohai Capital and HNA Group Co. Ltd. (HNA), Bohai Capital's majority owner. Fitch views this development favorably because it places explicit limitations on Bohai's ability to extract capital from Avolon in addition to the pre-existing insulation framework.
Fitch does not publicly rate HNA or Bohai Capital but views the entities as having highly speculative risk profiles. The funding and liquidity needs of HNA and Bohai Capital have indicated the potential for capital extraction from Avolon during periods of stress, but the introduction of the mandatory redemption covenant is expected to limit payments from Avolon to Bohai Capital. The covenant will include a general basket of $800 million and a net income builder basket representing 50% of consolidate net income. As of Dec. 31, 2017, Avolon had loan facilities of $237.5 million outstanding to Bohai Capital. Avolon itself did not originate this loan but assumed it when Avolon integrated Hong Kong Aviation Capital Limited into Avolon in 2016.
As of Dec. 31, 2017, Avolon was the third largest aircraft lessor in the world, with 908 owned, managed and committed aircraft leased to 153 customers. In addition to the diversification benefits that come with size, Fitch believes that increased scale provides certain strategic benefits to Avolon, such as a larger presence in the growing Asia-Pacific market, increased purchasing/negotiating power, a platform through which it can grow managed aircraft with institutional partners, and more available channels to re-lease planes when needed. For example, Avolon placed 10 of 13 aircraft previously leased to Air Berlin and Monarch, which filed for bankruptcy during 2017, by year-end 2017.
Fitch expects that Avolon's lease revenue yields will be approximately 12% over the next several years, indicating strong profitability prospects from contractual leases. Avolon has placed approximately 75% of its committed aircraft through 2019, with 27 committed aircraft available for lease. The company also has eight aircraft available for lease roll-off in 2018. Overall, the company's average remaining lease term was 6.6 years as of Dec. 31, 2017, supporting cash flow predictability absent material lessee bankruptcies.
Fitch considers Avolon's asset quality to be strong. The average fleet age was 5.3 years as of Dec. 31, 2017, which is young relative to the aircraft lessor peer group and supports demand in the current market environment. Avolon continues to sell older aircraft at gains ranging from 8%-9%.
Avolon's order book as of Dec. 31, 2017 totaled 339 planes, including new technology aircraft such as the A320neo, A321neo, A330neo, B737 MAX 8/9, and B787-8/9. The order book represented 37.3% of the owned, managed and committed fleet (59.6% of the owned and managed fleet) at Dec. 31, 2017, and Avolon has signaled that further growth is possible. The order book and other funding requirements will create a need for consistent access to the debt markets in Fitch's opinion.
Nevertheless, near-term liquidity is viewed as solid as pro forma liquidity sources (cash and liquid investments, next 12 months funds from operations, available undrawn debt facilities, and expected proceeds from aircraft disposals) adequately cover uses (capital expenditures, debt principal repayments, pre-delivery payments, and other corporate uses) by 1.4x over the next 12 months. The solid liquidity profile is a result of Avolon's capital markets activities, most recently an upsizing of the revolving warehouse facility.
Avolon's ratings remain constrained by a funding profile comprised primarily of secured debt. Approximately 24% of Avolon's debt was unsecured as of Dec. 31, 2017, which was within Fitch's 'bb' quantitative benchmark range for balance sheet-intensive finance and leasing companies. Still, the company had approximately $2 billion of unencumbered aircraft assets, which Fitch believes provides some financial and operational flexibility.
The Stable Outlook reflects expectations that Avolon will continue to maintain scale and strong fleet characteristics, operating consistency, economic access to the capital markets to fund its order book, gross debt to tangible common equity at 3.5x or below, and a stable liquidity profile.
The secured debt ratings of Avolon subsidiaries are one notch above Avolon's Long-Term IDR and reflect the aircraft collateral backing these obligations, which suggest good recovery prospects.
The equalization of the unsecured debt rating with Avolon's IDR reflects modest unsecured debt as a portion of total debt, as well as an available pool of unencumbered assets, which suggest average recovery prospects for unsecured debtholders.
RATING SENSITIVITIES - IDRs, SECURED DEBT, UNSECURED DEBT
Avolon's ratings could benefit from execution on planned deleveraging, resulting in debt/tangible common equity approaching the company's long-term gross debt to tangible common equity target of 2.5x-3.0x, and execution on planned deleveraging at Bohai Capital, resulting in reduced double leverage. The maintenance of a strong separation framework, including adherence to limitations on capital extraction and/or intercompany loans and the mandatory redemption covenant, would also be viewed favorably.
A sustained increase in gross debt to tangible common equity above 4.0x, as a result of an increased risk appetite or asset underperformance by Avolon's owners, may result in negative rating momentum.
Additionally, a perceived weakening of the credit risk profiles of Avolon's direct or indirect owners; higher-than-expected aircraft repossession activity; sustained deterioration in financial performance or operating cash flows; and/or material weakening of liquidity relative to financing needs may result in negative pressure on the ratings.
Fitch has affirmed the following ratings:
Avolon Holdings Limited
--Long-Term IDR at 'BB'; Outlook Stable;
--Senior secured debt at 'BB+'.
Avolon TLB Borrower 1 (Luxembourg) S.a.r.l.
--Long-Term IDR at 'BB'; Outlook Stable;
--Senior secured debt at 'BB+'.
Avolon TLB Borrower 1 (US) LLC
--Long-Term IDR at 'BB'; Outlook Stable;
--Senior secured debt at 'BB+'.
CIT Aerospace International
--Senior secured debt at 'BB+'.
CIT Aerospace LLC
--Senior secured debt at 'BB+'.
CIT Aviation Finance III Limited
--Senior secured debt at 'BB+'.
CIT Group Finance (Ireland)
--Senior secured debt at 'BB+'.
Park Aerospace Holdings Limited
--Long-Term Issuer Default Rating at 'BB'; Outlook Stable;
--Senior unsecured notes at 'BB'.