Morningstar DBRS expects a stable credit rating environment for aircraft lessors in 2025. We expect continuing solid growth dynamics in global aviation along with supply and demand imbalances for commercial aircraft to underpin sound lessor financial and operating performance. Global travel is expected to remain strong in 2025 with sound growth in passenger volumes supported by solid global economic growth, improving corporate travel volumes, and a still strong desire amongst consumers to travel; especially internationally. Broadly, airline financial performance remains healthy, and our expectation is that airline earnings will remain steady in 2025 but with pockets of turbulence due to a few airline defaults. Ongoing OEM production and supply chain issues continue to constrain new aircraft deliveries while longer shop visits limit airline capacity driving strong demand for older aircraft from both airlines and lessors. These trends are expected to continue through 2025 supporting both narrowbody and widebody values.

Downside risks to the outlook that are not in our baseline scenario but warrant monitoring are the health of the global consumer and the potential for a reversal in the desire to travel should economic activity slow while travel costs remain elevated impacting affordability. Geopolitical risks remain at the forefront for lessors with the ongoing conflict in Ukraine and the Middle East, as well as the potential for intensifying trade disputes to disrupt travel and/or lead to slowing economic growth.

For those lessors we follow, we anticipate continued good earnings generation in 2025. While funding costs have improved and are expected to improve further in 2025, current financings are at levels above the cost of maturing debt. That said, improving lease yields due to better lease pricing at extension and renewal is partially mitigating the impact of higher funding costs on earnings. With the favorable aircraft supply/demand imbalance to continue in 2025, we expect lease yields to improve and gain on margins from secondary market sales to remain strong. Further, with aircraft values remaining firm, we see any impairments to aircraft likely to be modest and to be easily absorbed through earnings for the lessors we follow.

Lessors have noteworthy financing requirements in 2025, including the financing of new aircraft deliveries as well as the refinancing of maturing debt. With asset-backed securities (ABS) markets reopening during 2024, we expect that lessors will return to the ABS markets to diversify funding, obtain lower cost financing as well as manage airline exposures. Nevertheless, we anticipate that the large lessors will sustain their unsecured debt-oriented funding structures and be active issuers in the capital markets while maintaining similar leverage levels.

Lessors’ 2025 Earnings to Remain Solid Supported by Industry Tailwinds

We expect aircraft lessors’ earnings performance in 2025 to remain solid benefiting from the continuing imbalance in the supply and demand of commercial aircraft, high utilization rates, improving all-in funding costs, and low leasing expenses due to reduced transition of aircraft between airlines. Through 9M24 aircraft lessor financial performance was sound with lessors benefiting from strong airline demand for aircraft leading to an above average rate of lease extensions at improved lease rates, as well as solid gains on the sale of aircraft sold. Further, strengthening aircraft values across most aircraft types resulted in low levels of impairments hitting lessor income statements (See Exhibit 1

Aircraft lessors reported improving lease rates across most aircraft types given the strong demand for aircraft to meet passenger volume growth and continued new aircraft delivery issues at the OEMs constraining supply. Overall, lease rental revenue improved 2% year-on-year (YoY), reflecting declining lease deferral balances, declining power-by-the-hour contracts, as well as strengthening lease rates and modest aircraft portfolio growth. Results also benefited from a 29% increase in the gains on aircraft sales supported by improving aircraft values resulting in gain on sale margins of 15%, steady from 2023, but elevated to historical levels. For the large lessors, funding costs improved moderately in 2024 as base rates began to decline and spreads tightened. We expect that continued favorable industry dynamics will support improving lease yields which should afford lessors the ability to navigate a potential higher for longer interest rate environment.

Impairments have remained at below normalized levels through 9M24 reflecting the improving credit profile of the global airline industry and strengthening aircraft values. Impairments for 9M24 across the Morningstar DBRS universe of lessors totaled just $60 million, in line with 9M23 levels. Meanwhile, pre- tax and pre-impairment income (IBPT) generation continues to be sound totaling more than $2.9 billion through 9M24, more than sufficient to absorb the modest level of impairments. With lease yields remaining healthy, sound gains on asset disposals, and operating costs well controlled, we expect IBPT generation to remain healthy in 2025.

Lessors’ Growth Constrained by OEM Production Issues

Over the last few years, several aircraft lessors have placed large orders with OEMs to capitalize on future growth opportunities. Orderbooks can be a key source of growth for lessors. However, supply chain issues as well as production-related issues are leading to a record backlog of new aircraft orders at Airbus and Boeing. Depending on the aircraft type, these backlogs have resulted in very limited new aircraft delivery slot availability before the end of the decade. While supportive of aircraft values and lease rates of existing aircraft, these delays constrain a lessor’s ability to grow and can be a potential headwind to earnings expansion. Entering 2024, the aircraft lessors we follow expected the delivery of 249 new aircraft from Airbus and Boeing. As of their most recent reporting, the lessors had taken delivery of just 139 of these aircraft, or 56% of the total.

With the delays of new aircraft being delivered, lessors are seeing elevated lease extension activity as airlines lock-in current capacity. While these lease extensions can be lucrative for lessors, increasing utilization rates are leading to lower costs given the absence of having to ready an aircraft for transition from one airline to another, it can lead to age creep in the lessor’s portfolio. As seen in Exhibit 2, for the lessors we follow, the average age of the portfolio was steady from 2015 – 2019, but the shortage of deliveries that began in 2019 with the grounding of the Boeing 737MAX, which was then exacerbated by the pandemic and subsequent supply chain and production issues, has led to a more than one year average age increase to 6.5 years as of the most recent reporting date.

Age creep within a lessor’s portfolio may become a concern especially for those lessors whose business models are designed to recycle out of older aircraft. Lessors’ financial performance may incur some headwinds as older aircraft require greater technical expertise and may incur higher maintenance expense.

Lessor Refinancing Requirements Manageable in 2025

Aircraft lessors continue to access the unsecured markets to fund portfolio growth and refinance maturing debt. Lessors followed by Morningstar DBRS issued $19.7 billion of senior unsecured debt year-to-date, a 38% year-on-year increase from 2023. Interestingly despite rate cuts by the U.S. Federal Reserve in September, 69% of lessor senior debt issuance occurred in H1 2024.

We expect that lessors will enjoy continuing access to the capital markets in 2025 with bank financing widely available, albeit at higher costs, and the unsecured corporate debt markets open to those larger lessors with diverse aircraft fleets by type and customer and sound asset management capabilities. Importantly, the second half of 2024 brought with it signs that the asset-backed securitization market was reopening for aircraft transactions, which we expect ABS issuance to continue to be active in 1H25. This market has largely been shut since the onset of the COVID-19 pandemic.

Maintaining such access is important not only to fund potential future growth, but also to refinance existing debt. As of September 30, 2024, lessors we follow have $11.1 billion of senior corporate debt requiring refinancing in 2025 (see Exhibit 3), notably lower than the $18.1 billion of senior unsecured debt scheduled to mature entering 2024.

Leverage Provides Cushion for Unexpected Turbulence

Aircraft lessors continue to manage balance sheet leverage appropriately. We see the current levels of balance sheet leverage as providing a reasonable cushion for unexpected turbulence in the operating environment and continue to be an important consideration for the investment grade credit profiles of the large lessors. Balance sheet leverage at the lessors we follow improved during 2024 despite higher debt financing activity in 2024. Specifically, leverage (debt-to-equity), as of the lessors’ most recent reporting date, was 3.2x, a 6% improvement from year-end 2023, and the lowest level for the group over the last 10 years (See Exhibit 4). We expect leverage will remain consistent through 2025 with debt issuance activity balanced by good financial performance and continuing solid earnings retention

Heightened Geopolitical Tensions Continue to be a Risk to the Global Aviation Industry

Geopolitical tensions continue to be a risk to the global aviation industry, including aircraft lessors. Ongoing military conflicts in Ukraine and the Middle East, as well as the potential for intensifying trade disputes that negatively impact global economic growth if the Trump administration follows through with its tariff threats. We see aircraft lessors’ proactive actions to lower their exposure to potentially high growth and profitable markets such as China, as evidence of good risk management supportive of investment grade credit profiles.

Indeed, having experienced the adverse impacts from the Ukraine conflict, aircraft lessors have been reassessing their exposures to other potential regional conflicts that could result in financial losses from airlines’ inability to meet their obligations or an increased risk to the lessor’s ability to repossess aircraft, which can impair its value. Indeed, with tensions between China and the West intensifying, several aircraft lessors have been gradually reducing their exposure to China. As an example, AerCap has reduced the net book value of its aircraft portfolio on lease to Chinese airlines to 15.7% as of December 31, 2023 (the last date data was reported) compared to 20.5% at year-end 2018. Similarly, Air Lease Corporation has reduced the percentage of its fleet on lease to Chinese airlines to 6.8% at December 31, 2023, down notably from 17.0% at year-end 2018.

While specific details on the Trump Administration’s tariff plans are not known, we expect that higher tariffs will not have a material direct impact on aircraft lessors. However, if higher tariffs become a meaningful headwind to passenger volume growth reflecting weaker economic growth, profitability would likely be pressured at aircraft lessors.

Airline Profitability is Generally Strengthening but Pockets of Turbulence Still Can Appear With the positive dynamics of continuing strong demand for leisure travel and strengthening corporate travel, the global airline industry financial performance is improving with airlines generally reporting solid financial results (see Exhibit 5). Reflecting this strong operating environment, IATA forecasts 2024 airline net profit to be approximately $30.5 billion, compared to an estimated net profit of $23.3 billion in 2023. Except for Africa, all regions are expected to generate net profits. However, industry profitability is still driven by North America followed by Europe. Despite the relatively favorable operating environment, there were a handful of airline bankruptcies in 2024 demonstrating that airlines without proper scale or management missteps can succumb to pressures from rising costs or an inability to respond to shifts in competitive dynamics.

Rising bankruptcies among smaller airlines reflect their struggle to generate sustainable earnings. According to various industry sources, there were eight airline failures during 2024, a relatively modest level compared to historical levels. Most of these airlines were small with only a few aircraft and limited route networks. The most notable bankruptcies were Gol Linhas Aereas Inteligentes in January 2024 and Spirit Airlines, Inc. (Spirit) in the United States late in 2024. For aircraft lessors, the bankruptcies were manageable with a limited impact on earnings from modest impairments (LINK to Morningstar DBRS: No Impact to Aircraft Lessors’ Credit Profile or Publicly Rated Structured Aircraft Transactions from Spirit Airlines Bankruptcy, 20 November 2024). Importantly, the relatively modest size of most of the fleets involved were easily absorbed by the industry. While not a bankruptcy filing, Azul, a large Brazilian based carrier that is the second largest in Latin America, completed a restructuring to improve its financial standing. As part of the restructuring, aircraft lessors converted $550 million of future lease obligations into a 20% equity stake in the airline.

While aggregate airline industry profitability is forecasted to improve in 2025, Morningstar DBRS expects an uptick in troubled credits for lessors, as start-up and smaller regional airlines in emerging markets with unproven operating track records are challenged in 2025 from elevated interest rates and a strengthening dollar. Nevertheless, we expect these issues to be manageable for the lessors.

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