Fitch Maintains Rating Watch Negative on Avation PLC and Subsidiaries

(The following statement was released by the rating agency) Fitch Ratings-Taipei/Chicago-09 July 2020: Fitch Ratings has maintained the Rating Watch Negative (RWN) on the Long-Term Issuer Default Ratings (IDRs) of 'B' of Avation PLC and its subsidiaries, Avation Capital S.A. and Avation Group (S) Pte. Ltd. A full list of the rating actions is at the end of this commentary. These actions have been taken in conjunction with a broader aircraft leasing industry peer review conducted by Fitch, which includes ten publicly rated companies ("Fitch Completes Aircraft Lessor Peer Review, Maintains Negative Outlooks and Watches", available at www.fitchratings.com). Key Rating Drivers The maintenance of the RWN reflects heightened refinancing risk associated with its unsecured debt due in May 2021 and potential earnings and impairment pressures associated with its exposure to distressed airlines. Nonetheless, Avation's IDR is supported by its relatively young average fleet age of 4.1 years (excluding finance leases) as of end-May 2020 and the long-term demand dynamics for the majority of the fleet, as well as the company's position as one of the largest lessors of ATR turboprops in the Asia-Pacific region. However, Avation's elevated leverage, weakening profitability, increased asset quality risk and rising refinancing risk constrain the rating. In addition, the rating reflects the company's limited economies of scale and operating record with high lessee concentration and larger exposure to lower credit-quality lessees compared with larger lessors. The top five lessees accounted for around 69% of Avation's portfolio at end-May 2020. Avation's impairment loss increased to $10.2 million in the first nine months of the financial year ending June 2020 (FY20) due to the declining value for its two old-technology widebody aircraft and two jet aircraft, which were repossessed from Thomas Cook and reclassified as held for sale. The asset quality risk associated with its exposure to Virgin Australia Holdings Limited (VAH, D) and Braathens Regional Airways AB (Braathens) has also increased after the airlines entered administration in April 2020, which accounted for around 19% and 2%, respectively, of Avation's run-rate revenue. The company granted total lease rent deferrals of $12.2 million (around 10% of its lease revenue in FY19) to 12 of its lessees at end-June 2020, which could increase loss severity in the event of further lessee defaults. Impairment charges and/or lower lease yields for restructured leases would in turn weigh on Avation's profitability and further increase leverage. Avation's refinancing risk has increased because of its weakening credit profile and the wider challenges faced by the aviation sector due to the coronavirus pandemic. The company's ability to refinance its USD349 million unsecured debt maturing in May 2021 will increasingly depend on the recovery of the airline industry and market confidence in the aviation sector. Avation could seek to refinance by securing its unencumbered aircraft, but this would reduce the company's financial flexibility. That said, Fitch does not expect immediate liquidity or refinance risk for Avation in light of its USD57.3 million of unrestricted cash at end-March 2020, which provides a cushion from the abrupt downturn. The company has deferred its scheduled ATR deliveries to 2021 and has no large refinance needs until its senior unsecured debt comes due in May 2021. Some lenders have allowed Avation to defer some of its secured debt repayments (USD9.2 million) to ease the liquidity pressure while it grants lease rent deferral to its lessees. Fitch believes Avation can maintain a positive cash position for the next 12 months, but liquidity coverage of debt maturities and purchase commitments over the next 12 months will remain below 1x, weaker than that of higher-rated peers. Avation's profitability has been volatile in recent years due to rising impairment costs and volatile gains on aircraft sales. Its pretax return on average assets, after adjusting for non-recurring unrealised gains on aircraft purchase rights, declined significantly to 0.5% in 9MFY20, compared with 2% in FY19. Its lease yield has also weakened since FY19 as the company expands into narrowbody and widebody aircraft with more competition, partially offset by its lower funding costs relative to prior years. Avation's leverage - measured by gross debt/tangible equity - rose further to around 5.2x by end-March 2020 from 4.9x at end-December 2019 and its capitalisation headroom to withstand impairments was meaningfully weaker compared with other Fitch-rated peers. We expect leverage to rise further as the asset quality risk and profitability pressure continue to weigh on the company's credit profile. Fitch's sector outlook for aircraft lessors remains negative, as further deterioration of airline credit metrics could lead to a second round of deferral requests, additional insolvencies, aircraft repossessions and impairments, which could impair lessor operating cash-flow generation and erode capitalisation levels over the Outlook horizon of 2020-2021. Fitch's updated "Global Economic Outlook: June 2020 - Coronavirus Disruption Easing" (www.fitchratings.com/site/re/10127783), dated 29 June 2020, maintained its global GDP forecast of a 4.6% contraction in 2020, with economic activity picking up and global growth forecasts stabilising. Still, the special report also said that downside risks from a resurgence in the virus and renewed lockdown restrictions remained high. The climb back to pre-virus levels of economic activity will be much slower than the descent, despite massive policy interventions. Fitch's base-case scenario assumes the US will not return to pre-virus GDP levels (4Q19) until 2022 while the eurozone will take longer. Country-by-country and regional variations will depend on the intensity of lockdown measures, relative exposure to heavily affected industries (such as tourism) and scale of policy responses playing a key role in the depth of the downturn and pace of expected economic recovery. That said, the lack of major financial or inflationary imbalances prior to the crisis - along with unprecedented policy largesse - means that the return to pre-crisis GDP will be more rapid than after the global financial crisis, when it took the US three-and-a-half years, the UK five years and the eurozone seven years. Fitch's rating review and sensitivity analysis for Avation incorporated our forecasts of quantitative credit metrics, with particular focus on liquidity coverage and leverage under base-case and downside-case assumptions, which were broadly derived from the agency's global economic outlook. Under the base-case scenario, Fitch assumes that the commercial aviation industry recovers slower than other corporate sectors, due to lower business and leisure travel, especially for long haul, international routes. As a result, Fitch expects a sizable portion of the global fleet will remain grounded in 3Q20, airlines will operate at approximately 45% capacity in 3Q20 and 50% capacity in 4Q20, and air traffic will return to 2019 levels only by 2022. Fitch's base-case assumptions for Avation include up to 66% cumulative lease deferrals for a three-month period; the default of up to 21% of lessees; and up to 30% impairment of the net book value of default fleet, among other assumptions. Under the downside scenario, Fitch assumes there will be a second global wave of the coronavirus, followed by a re-imposition of lockdown measures and travel bans in 2H20. Air traffic falls back to 2Q20 levels, after a brief recovery in demand during the summer 2020 travel season in the northern hemisphere. The global aircraft fleet is grounded in 4Q20 and airlines operate at 45% capacity in 3Q20, 10% in 4Q20, 45% in 1Q21 and 55% in 2Q21. Oil prices are not expected to rebound and remain at current levels through mid-2021; having a positive effect on airlines when they resume operations. Fitch's downside assumptions for Avation include up to 86% cumulative lease deferrals for a four-month period; the default of up to 72% of lessees; and up to 30% impairment of the net book value of default fleet among other assumptions. Fitch believes that Avation's ATR turboprops, which account for 36% of the fleet based on net book value, benefit from improved fuel efficiency and lower risk of technological changes than jet aircraft, due to the use of propeller engines. This may reduce residual value risk. Lease rates for turboprops have been relatively consistent through economic cycles, while residual values of ATR 72 models have been more resilient than the widely utilised aircraft types in the Boeing (NYSE:BA) 737 and Airbus A320 families in light of limited supply but broad demand for short-haul routes. The Recovery Rating of 'RR5' on senior unsecured debt reflects Fitch's expectation of below-average recovery prospects for the debtholders under a stress scenario under the Fitch criteria, which states that Fitch assigns Recovery Ratings to non-bank financial institutions which have a Long-Term IDR of 'B+' or below. RATING SENSITIVITIES Factors that could, individually or collectively, lead to negative rating action/downgrade: The RWN reflects sensitivity to negative developments arising from VAH's and Braathens' restructuring process, as well as the rising refinancing risk associated with its unsecured debt maturing in May 2021. The ratings could be downgraded if Avation's asset quality and profitability weaken further on the back of higher impairment charges from these exposures and rising lessee defaults from elsewhere in the portfolio, leading leverage to rise above 6.0x. A substantial deterioration of cash flow due to large and prolonged lease rent deferrals or heightened refinancing risk for its senior unsecured debt due in May 2021 could also trigger negative rating action. The ratings could remain on RWN beyond six months if there is limited visibility around Avation's ability to refinance its unsecured debt maturing in May 2021. The rating assigned to the unsecured debt is one notch below the company's Long-Term IDR, reflecting below-average recovery prospects, and is likely to move in tandem with the IDR. The unsecured debt rating could be notched down further from Avation's IDR should aircraft values deteriorate beyond our expectation in a stressed scenario or if secured debt increases as a percentage of total debt, such that the unencumbered pool shrinks and causes the expected recoveries on the senior unsecured debt to decline. Factors that could, individually or collectively, lead to positive rating action/upgrade: The RWN could be revised to a Negative Outlook if the near-term liquidity risk stays low and refinancing risk on the senior unsecured debt is addressed, while leverage is maintained at 5.0x-6.0x on a sustained basis and the impact of the administration process at VAH and Braathens proves to be in line with our expectation. The ratings could be put on Stable Outlook if the above-mentioned financial metrics are achieved with improved liquidity coverage, continued demonstration of residual-value risk management and an easing of the health crisis, with air travel and broader economic activity returning to pre-pandemic levels. Fitch does not expect a rating upgrade over the near term. However, Avation's ratings could be positively influenced by better scale efficiencies, leverage falling to below 5.0x on a sustainable basis and an improved funding and liquidity profile over the long term. Fitch would also regard as positive improved fleet, geographic or lessee diversification, provided such action is undertaken at a moderate pace and does not adversely affect underwriting or pricing terms. The notching between the unsecured debt rating and Avation's IDR could be narrowed if the expected recoveries on the senior unsecured debt increase on a sustainable basis, driven by improvement in the assumption of aircraft value or increase in the unencumbered asset pool. Best/Worst Case Rating Scenario International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579] Summary of Financial Adjustments Fitch has adjusted its core leverage calculation by including maintenance right assets and lease premiums in tangible equity. This reflects Fitch's assessment that the balance sheet items contain sufficient economic value to support creditors. Fitch regards aircraft purchase rights as intangible assets until they are exercised and reflected in the cost of the aircraft. As such, Fitch excludes these from its calculation of tangible equity. 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. Avation PLC; Long Term Issuer Default Rating; Rating Watch Maintained; B; RW: Neg Avation Group (S) Pte. Ltd.; Long Term Issuer Default Rating; Rating Watch Maintained; B; RW: Neg Avation Capital S.A.; Long Term Issuer Default Rating; Rating Watch Maintained; B; RW: Neg ----senior unsecured; Long Term Rating; Rating Watch Maintained; B-; RW: Neg Contacts: Primary Rating Analyst Katie Chen, Director +886 2 8175 7614 Fitch Australia Pty Ltd, Taiwan Branch Suite A2 23F., No. 68, Sec. 5, Zhongxiao E. Rd., Xinyi Dist Taipei 110 Secondary Rating Analyst Johann Juan, Senior Director +1 312 368 3339 Committee Chairperson Nathan Flanders, Managing Director +1 212 908 0827 Media Relations: Wai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com Alanis Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com Hannah James, New York, Tel: +1 646 582 4947, Email: hannah.james@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Criteria Non-Bank Financial Institutions Rating Criteria (pub. 28 Feb 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10110170) Additional Disclosures Solicitation Status (https://www.fitchratings.com/site/pr/10129280#solicitation) Endorsement Status (https://www.fitchratings.com/site/pr/10129280#endorsement_status) Endorsement Policy (https://www.fitchratings.com/site/pr/10129280#endorsement-policy) ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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