Fitch Ratings-New York-07 November 2017: The announcement by SMBC Aviation Capital Limited (SMBC AC) that its shareholders, Sumitomo Mitsui Financial Group, Inc. (SMFG) and Sumitomo Corporation (Sumitomo), have agreed to change its ownership structure does not affect SMBC AC's 'A-' Long-Term Issuer Default Rating (IDR) or unsecured debt rating, according to Fitch Ratings.
SMFG and Sumitomo agreed that the primary leasing vehicle between both companies, Sumitomo Mitsui Finance and Leasing Company, Ltd. (SMFL), will become a 50% - 50% joint venture as opposed to the current 60% - 40% ownership structure. The change will result in the de-consolidation of SMFL and accounting for the investment as an equity method affiliate under Japanese GAAP. SMFL will remain the primary entity through which SMFG's transportation financing and leasing activities (e.g., SMBC AC) are conducted, and SMFG's beneficial ownership of SMBC AC will remain unchanged at 66%. SMBC AC will continue to receive the majority of its funding from its shareholders, retain its branding, maintain parent company representation on its Board of Directors, and maintain a consistent strategy.
Fitch considers SMBC AC to be a strategically important subsidiary of SMFG as defined under the agency's "Global Non-Bank Financial Institutions Rating Criteria". This consideration results in a rating one notch lower than SMFG's Long-term IDR, since SMBC AC has a proven track record of profitability under SMFG's ownership over the last five years, and receives internal funding that comprised 57.1% of its total debt as of June 30, 2017.
Yesterday's announcement also detailed expectations for a capital injection of up to $1 billion into SMBC AC by its shareholders by March 31, 2019. Fitch believes this investment will support SMBC AC's growth aspirations and further strengthens the notion that the company is a strategically important subsidiary of SMFG.
In terms of its standalone credit profile, SMBC AC (and its predecessor organization prior to acquisition by SMFG) has built a well-established aircraft leasing franchise over the last 16 years, has been profitable in every year of operation (excluding the effect of one-off breakage costs in relation to acquisition refinancing in the year ended March 31, 2013), has experienced limited asset impairment charges and has maintained stable lease rates. The company has an experienced management team, an institutional structure capable of supporting a large aircraft fleet, and a customer base well-diversified by both operator type and geography.
Rating constraints for SMBC AC on a standalone basis include its concentrated funding profile and elevated balance sheet leverage. Rating constraints applicable to the aircraft leasing industry more broadly include the monoline nature of the business, vulnerability to exogenous shocks, potential exposure to residual value risk, sensitivity to oil prices, reliance on wholesale funding sources and increased competition.
Fitch considers the quality of the aircraft fleet a significant strength, as it is largely unencumbered and predominantly comprised of young, in demand and fuel-efficient narrowbody Boeing and Airbus aircraft. As of June 30, 2017, the weighted average age of the fleet was 4.6 years, which is low when compared to the rated aircraft lessor peer group. The company has demonstrated the ability and discipline to execute aircraft sales successfully through various market environments, which Fitch views positively. Moreover, it has committed deliveries of 216 aircraft including 114 A320neo and 90 B737-MAX, which should allow the company to migrate more heavily toward a fleet comprising next generation aircraft over the next five years, although placement risk remains.
SMBC AC's funding profile exhibits concentration with parent funding sources as third-party funding represented just 42.9% of total debt funding as of June 30, 2017. Leverage (debt to tangible equity) was 4.0x at June 30, 2017, which has trended down but remains high compared to the peer average. The expected capital injection of up to $1 billion will further reduce SMBC AC's leverage.
The IDR and Outlook for SMBC AC's unsecured debt issuing subsidiary, SMBC Aviation Capital Finance DAC, are equalized with SMBC AC's IDR and Outlook and reflect the full and unconditional guarantee of SMBC Aviation Capital Finance DAC's obligations by SMBC AC. The senior unsecured note rating is equalized with SMBC AC's Long-Term IDR, reflecting Fitch's expectation for average recovery prospects given that the majority of SMBC AC's consolidated debt-funding is unsecured. As of June 30, 2017, secured debt represented just 3.4% of total debt and 2.4% of total assets, which is well-below the peer average.
Fitch currently rates SMBC AC as follows:
SMBC Aviation Capital Limited
--Long-Term IDR 'A-'.
SMBC Aviation Capital Finance DAC
--Long-Term IDR 'A-';
--Senior unsecured debt 'A-'.
The Rating Outlook is Stable.