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Avolon Holdings Ltd. Rating Raised To 'BBB-' From 'BB+' On Reduced Encumbered Assets; Outlook Stable

  • Avolon Holdings Funding Ltd., a wholly owned subsidiary of aircraft operating lessor Avolon Holdings Ltd., has issued $2.5 billion of unsecured notes; most of the proceeds will be used to repay secured debt, which will result in its secured debt as a percentage of total assets declining to about 30%
  • This level is similar to 'BBB-' rated aircraft operating lessors.
  • We are therefore raising our ratings on Avolon, including the issuer credit rating, to 'BBB-' from 'BB+' and removing the ratings from CreditWatch, where we placed them with positive implications on April 10, 2019.
  • The outlook is stable, reflecting our expectation that Avolon's earnings and cash flow will continue to benefit from the growth of its aircraft fleet and the strong demand for aircraft, with EBIT interest coverage in the mid-1x area and funds from operations (FFO) to debt of 9%-10% through 2020.
NEW YORK (S&P Global Ratings) April 12, 2019—S&P Global Ratings today took the 
above listed rating actions. We view the reduction in encumbered assets 
favorably.Investment grade rated aircraft lessors typically have secured debt 
equal to less than 30% of their assets. In our opinion, having fewer 
encumbered assets aids financial flexibility--companies are able to use 
unencumbered assets as collateral for secured borrowings if access to 
unsecured borrowing becomes unavailable. Indeed, during the financial crisis, 
International Lease Finance Corp. (since acquired by AerCap Holdings N.V. in 
2014) had a substantial portion of its assets unencumbered and was therefore 
able to refinance a large portion of its short-term unsecured debt maturities 
using these assets as collateral for secured borrowings after its parent, 
American International Group Inc., faced financial difficulties. This does not 
mean we believe the entire capital structure should be unsecured debt, but 
rather that aircraft lessors benefit from access to diverse funding sources. 
Aircraft assets tend to be good collateral and therefore readily financeable 
for secured borrowings. While unsecured debt in the capital markets is 
currently plentiful, it is not guaranteed that this would continue if credit 
conditions tighten. 

We believe Avolon will maintain its position as the third-largest aircraft 
lessor, with an attractive fleet. Avolon is the world's third-largest aircraft 
operating lessor. As of Dec. 31, 2018, its fleet comprised 512 owned and 49 
managed aircraft. Based on net book value, narrowbodies comprised 63%, 
widebodies 36%, and regional aircraft 2%. The average fleet age is a 
relatively young five years, with an average lease term of 6.8 years and a 
well-diversified customer base, both in line with those of other investment 
grade aircraft lessors. It also has an order book for 410 aircraft, primarily 
comprising narrowbodies. In our view, Avolon, along with other aircraft 
lessors, should continue to benefit from airlines' need for incremental 
aircraft to meet the growth in air travel, projected at a rate of at least 5% 

We believe Avolon's credit metrics will remain relatively consistent through 
2020. In 2018, Avolon's EBIT interest coverage was 1.9x, its debt-to-capital 
ratio was 68%, and its funds from operations (FFO)-to-debt ratio was 10%. We 
expect these metrics to weaken somewhat in 2019 due to incremental debt 
associated with heavy capital spending on new aircraft deliveries, but to 
improve beginning in 2020 as capital spending moderates and the company 
continues to benefit from lower funding costs on unsecured debt.

We believe ORIX 30% stake in Avolon separates it sufficiently from its 
ultimate owner, HNA Group. Avolon is 70% owned by Bohai Capital Holding Co 
Ltd., a public Chinese company with aircraft, marine cargo container, and 
infrastructure leasing operations. Bohai is 51% owned or controlled through 
related parties by HNA Group. In November 2018, ORIX Aviation Systems Ltd., a 
wholly owned subsidiary of Japanese financial services group Orix Corp., 
acquired a 30% ownership stake in Avolon. We believe the revised governance 
structure that was put into place in connection with the acquisition provides 
significant protections to ORIX, with ORIX holding two board seats and an 
independent director holding one, out of a total of seven. In addition, ORIX 
has voting rights on certain matters that we believe help separate Avolon's 
credit from that of parent Bohai and, indirectly, HNA.

The stable rating outlook on Avolon reflects our expectation that the 
company's earnings and cash flow will continue to benefit from the growth of 
its aircraft fleet and strong demand for aircraft due to the rising volume of 
global passenger traffic. We expect the company's EBIT interest coverage to be 
in the mid-1x area and its FFO-to-debt ratio to be 9%-10% through 2020.

We could lower our rating on Avolon over the next two years if its EBIT 
interest coverage declined below 1.3x or its FFO-to-debt ratio declined below 
7% for a sustained period. This could be caused by reduced aircraft lease 
rates due to weaker-than-expected demand and overcapacity or if Avolon adopted 
a materially more aggressive financial policy.

Although unlikely, we could raise our rating on Avolon over the next two years 
if the company's EBIT interest coverage increased to above 1.7x and 
FFO-to-debt ratio increased to at least 13%. This could occur if the company 
maintained lower-than-expected debt or if its aircraft lease rates improved 
significantly from current levels due to stronger-than-expected airline 
passenger traffic. We would also need to believe that there would not be any 
adverse changes in the company's level of minority ownership or governance 

Avolon Holdings Ltd. is the third-largest aircraft operating lessor. As of 
Dec. 31, 2018, its fleet comprised 512 owned and 49 managed aircraft. It has 
an order book for 410 aircraft. It has a well-diversified customer base, with 
150 customers in 61 countries.

Our base-case scenario assumes the company continues to expand its fleet, 
funded partially through incremental debt, along with increased earnings and 
cash flow. We also assume:

  • Real global GDP growth of 3.4% in 2019 and 3.6% in 2020,
  • Global passenger traffic growth exceeding 5% annually,
  • Relatively stable lease yield (revenues as a percentage of average fleet size), and
  • Operating margins (after depreciation) remaining in the low 50% area over this period.
Based on these assumptions, we arrive at the following credit measures:
  • EBIT interest coverage in the mid-1x area;
  • Debt to capital in the high 60% area; and
  • FFO to debt of about 9%-10%.
We assess Avolon's liquidity as strong. We expect the company's sources of 
cash to be about 1.6x its uses in 2019 and about 1.5x its uses in 2020 and 
believe that it also meets other requirements for such a designation. Avolon 
has generally prudent financial risk management, sound banking relationships, 
and access to multiple credit facilities (which include various financial 
covenants). We expect the company to remain in compliance with these covenants 
over the next year.
Principal liquidity sources:
  • $737 million of unrestricted cash as of Dec. 31, 2018;
  • FFO of about $2.8 billion per year in 2019 and 2020;
  • Availability under its various credit facilities;
  • Proceeds from aircraft sales; and
  • Potential proceeds from capital-market transactions.
Principal liquidity uses:
  • As of Dec. 31, 2018, debt maturities of about $700 million a year in 2019 and 2020;
  • Committed capital spending (including pre delivery deposits on new aircraft) of about $5 billion in 2019 and about $4 billion in 2020; and
  • Dividends of $150 million-$200 million a year.
The company has the following financial maintenance covenants:
  • Minimum consolidated interest coverage ratio of 1.5x, and
  • Maximum debt to equity ratio of 4.5x.
The company was in compliance, based on its calculations, on Dec. 31, 2018, 
and we expect it to remain so over the next year.

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