Fitch Ratings has revised the Outlook on China Aircraft Leasing Group Holdings Limited's (CALC) Long-Term Issuer Default Rating (IDR) to Negative, from Stable, and affirmed its Long-Term IDR at 'BB+' and Short-Term IDR at 'B'.

Fitch has also affirmed the long-term rating on the senior unsecured notes and the medium-term note (MTN) programme issued by CALC Bonds Limited at 'BB+'.

The Negative Outlook on the IDR reflects CALC's weakened capital profile and raised leverage as well as the increased execution risk associated with its deleveraging objectives. This raises the pressure on the company's standalone credit profile (SCP) and could lead to a downgrade of its IDR if the elevated leverage persists.

State-owned China Everbright Group (CEG) owns about 19% of CALC's effective equity interest through China Everbright Limited (CEL, BBB/Stable). CALC Bonds Limited is registered in the British Virgin Islands, and serves as the wholly owned debt-issuing subsidiary of CALC.

Key Rating Drivers

Heightened Leverage Pressure: CALC's leverage, measured by debt to tangible equity ratio, increased to 11.9x by end-2023, from 10.0x at end-2022. The leverage increase is attributable to weakened profitability and slower deleveraging than we expected while US dollar interest rates remain elevated. Management has delayed its aircraft disposal plan over the past two years in anticipation of higher post-pandemic aircraft prices. CALC plans to resume trading activities in 2024, which could bolster its liquidity and capital profile.

The company's leverage, which is significantly higher than its global peers' 2x-4x, weighs on its overall credit profile and leaves limited headroom to navigate potential asset-quality deterioration from its small and concentrated portfolio.

Increased Execution Risk: We have lowered CALC's management and strategy score to 'bb-' with a stable outlook, and concurrently revised the Outlook on its risk profile to negative while maintaining the 'bb' score. These revisions reflect the company's increased leverage tolerance and the elevated operational risk associated with its deleveraging objectives amid the possibility of sustained high US dollar interest rates.

Notching-Up Approach: CALC's IDR benefits from two notches of uplift from its 'bb-' SCP. The uplift reflects Fitch's expectation for modest potential support from state-owned CEG and affiliated entities in the group, including China Everbright Bank Company Limited (BBB+/Stable). The application of the notching-up approach, instead of top-down, is driven by CEG's limited shareholding control, the lack of common branding, and complexities in legal commitments to CALC from CEG and CEL.

The uplift also reflects CALC's meaningful alignment with CEG's strategic objective of cultivating a world-leading aircraft lessor, CEG's strong operational and managerial control over CALC, and CEG's record of providing ordinary funding and liquidity support to CALC. CEG's development strategy was approved by China's Ministry of Finance and China Huijin Investment Ltd, an investment company wholly owned by the Chinese government. Fitch expects any support required by CALC would be immaterial relative to CEG's ability to provide it.

Modest SCP: Our assessment of CALC's SCP reflects its small scale, high leverage, and high lessee and geographic concentration relative to higher-rated peers, as well as significant financing and refinancing needs for a large order book and substantial debt maturities in the next two to three years. However, these risks are mitigated by the company's moderate asset-quality risk, characterised by a liquid fleet portfolio and limited exposure to troubled airline companies, as well as its adequate funding access and liquidity profile.

Weakened Profitability: CALC's net spread - defined as lease yields less funding costs - contracted to 5.9% in 2023 from 6.7% in 2022, due to rising funding costs, despite improving lease yields on new leases. The contraction, along with higher depreciation expenses from its portfolio expansion, kept its reported pre-tax return on average assets subdued at 0.9% in 2023. The financial gain realised from an insurance settlement for an aircraft previously leased to a Russian airline was offset by mark-to-market losses on its loans to CAG Bermuda 1 Limited, an aircraft management platform CALC manages.

Moderate Asset-Quality Risk: CALC's portfolio is small and concentrated relative to other higher-rated global peers. Nevertheless, it has maintained an in-demand, fuel-efficient fleet with an average age of 8.5 years and average remaining lease term of 5.7 years at end-2023. We estimate that 84% of CALC's portfolio consists of Tier 1 assets, helping to mitigate asset-quality risk during economic downturns.

Concentrated Portfolio in China: The company's exposure to lessees domiciled in China, at 55% of its portfolio (based on Fitch estimates of aircraft values), is still significant compared with global peers, despite a decrease from 62%. However, its exposure is mainly to the three largest domestic airlines and their affiliates, which have strong government backing.

Adequate Funding Access: CALC had a large order book of 141 aircraft and total aircraft purchase commitments of HKD52.8 billion (around USD6.8 billion) at end-2023, with deliveries through 2028. However, its funding profile benefits from large undrawn uncommitted credit lines, continued access to secured and unsecured markets, and ordinary support from CEG and its affiliates.

Weak Liquidity Coverage: We estimate CALC's financing needs and aircraft purchase commitments will be over USD3 billion in 2024, and we expect its liquidity coverage for the next 12 months to remain weaker than that of peers. Unsecured debt formed 47% of CALC's total debt at end-2023, and this was adequately covered at 1.4x by unencumbered assets.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Fitch may consider downgrading CALC's SCP if the company's leverage is sustained at above 10x over the 12-18 month rating horizon.

A material deterioration in asset performance, heightened risk appetite for growth beyond our expectations, unsecured funding level consistently below 50%, and/or reduced liquidity relative to debt maturities and order book commitments could lead to a reduction in Fitch's assessment of SCP, and thus the IDRs.

A weakening in the linkage between CEG and CALC, such as a dilution in ownership or control; or a reduction in CALC's strategic role to CEG; or reduced liquidity support from CEG and its affiliates would also lead to a downgrade.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Fitch may revise the Outlook to Stable if leverage decreases to below 10x over the 12-18 month rating horizon, provided that other credit considerations remain largely unchanged.

A sustained decrease in leverage to below 5.5x without deterioration in its asset quality and profitability, coupled with strengthened funding and liquidity relative to its financing needs, could lead to an improvement in Fitch's assessment of CALC's SCP, and hence the IDRs.

Stronger linkages between CALC and CEG could be positive for the rating, which could arise from more explicit legal ties between CALC and CEG. A meaningful increase in CEG's shareholding and control through board representation in CALC could also lead to an upgrade.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The rating on the MTN programme under CALC Bonds Limited and the senior unsecured notes issued under the MTN programme are equalised with CALC's 'BB+' Long Term IDR, as the MTN programme and the notes are unconditionally and irrevocably guaranteed by CALC, and will at all times rank at least equally with all other present and future unsecured and unsubordinated obligations of CALC and CALC Bonds Limited.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The rating on the notes and the MTN programme will move in tandem with any changes to CALC's Long-Term IDR.

ADJUSTMENTS

The asset-quality score has been assigned below the implied score due to the following reason: concentrations.

The funding and liquidity score has been assigned above the implied score due to the following reason: business model/funding market convention.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

CALC has an ESG Relevance Score of '4' for Management Strategy due to the increasing execution risk in achieving its deleveraging target amid possibly sustained high US dollar interest rates, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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