Fitch Ratings has assigned an initial Long-Term Issuer Default Rating (IDR) of ‘B-’ to Transportation Partners (TP) and an expected rating of ‘B-(EXP)/RR4’ to the company’s proposed issuance of US dollar denominated senior unsecured notes. The Rating Outlook is Stable.

Key rating drivers

The ‘B-’ IDR is supported by TP’s relatively young and liquid commercial aircraft portfolio; cash flow generation supported by solid lease yields; adequate interest coverage of near-term debt obligations; and low leverage for the rating.

The IDR is constrained by elevated key-man risk linked to one of TP’s co-founders; weaker corporate governance relative to larger, listed peers; material customer concentrations related to Lion Air Group and its affiliates; funding and placement risks associated with TP’s outsized order book which can be placed with the Lion Air Group of airlines for their external financing; an untested credit risk management framework relative to peers; and lack of financial performance track record through credit and aviation cycles. 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.

Elevated key-man risk resides with one of TP’s co-founders, Rusdi Kirana, who is also the co-founder and co-owner of Jakarta-based airline, Lion Air. While key-man risk is not uncommon for aircraft lessors rated by Fitch, Kirana is actively involved in all aspects of TP’s business, including advising management on the strategic direction and providing oversight of the business, which includes TP and its largest customers (airlines affiliated with Lion Air Group).

Fitch believes TP has a weaker corporate governance framework, as evidenced by a lack of independent director membership and numerous related party transactions. The Chief Executive Officer and Chief Financial Officer roles are also currently being shared on an interim basis, but are expected to be filled during the course of 2017. Fitch would view a strengthened corporate governance framework favorably.

TP’s fleet totaled 65 aircraft, 10 engines and 1 helicopter, as of Dec. 31, 2016. The aircraft portfolio primarily comprised narrowbody and turboprop aircraft with an average age of 2.5 years, which is among the lowest when compared to aircraft lessors rated by Fitch. The ATR72-500/600 aircraft, which represented 63.5% of TP’s total net book value (NBV), have experienced a resurgence in orders over the past few years primarily driven by favorable operating economics. Though viewed by Fitch as niche, these planes have an established operator base, and, compared to regional jets, ATRs are more fuel efficient and less exposed to technological disruption.

TP’s near-term performance and growth is expected to be supported by modest additional ATR deliveries, but in the medium- to longer-term, Fitch expects the fleet to evolve as the lessor expands further into widely-utilized aircraft, as evidenced by TP’s impending deliveries of current and next-generation Boeing B737 and Airbus A320 family aircraft. Still, the order book is aggressive, in Fitch’s view, and as of Dec. 31, 2016 represented 475 aircraft with staggered deliveries through 2035, translating to 731% growth of the existing fleet. TP has the option to not take deliveries, electing to place its near-term deliveries with Lion Air Group’s airlines for their external financing.

As of Dec. 31, 2016, TP’s portfolio was highly concentrated in Lion Air Group and its affiliates. TP’s asset quality performance has been solid to date, as the firm has not taken an impairment charge on its portfolio. Nevertheless, the firm’s financial performance and credit risk management framework have not been tested through a credit cycle given its inception in 2011. TP’s lessee concentrations represent a constraint to the IDR, due to the non-investment grade credit profile of many of its airlines, though not uncommon among aircraft lessors. Management is seeking to diversify its customer base through the placement of its order book deliveries with third-party airlines in the medium term. However, Fitch believes there is execution risk with the ability of TP to successfully diversify away from affiliate airlines, as well as the competitiveness of the overall aircraft leasing environment, which could pressure lease pricing, and ultimately earnings in the medium term.

The company has been profitable since inception with growing lease revenue and stable lease yields. In 2016, TP reported favorable net income margins (NIMs) relative to peers, which are attributed to the combination of higher lease yields and relatively lower funding costs associated with its secured funding profile. Fitch believes TP’s favorable lease yields also correspond to asset and/or lessee risk associated with the company’s turboprop aircraft which are often leased to smaller, regional airlines. Nevertheless, Fitch expects current NIMs and interest coverage metrics will normalize to 15.8% and 3x, respectively in the medium term, as the firm shifts its funding profile toward unsecured funding, which is relatively more expensive compared to securitizations, and other forms of secured funding.

Given operating cash flow generation is supported by long-term contractual lease terms, TP has sufficient liquidity and cash balances to support near-term debt maturities. However, Fitch believes TP remains exposed to potential funding risk associated with its sizeable order book commitments, with deliveries through 2035 which total $28.1 billion.

Leverage, calculated as total debt to tangible equity, was 3.28x as of Dec. 31, 2016. This ratio is expected to remain relatively stable, as cash flow from underlying lease payments is used to repay outstanding secured borrowings to deleverage the balance sheet, but will be offset by additional borrowings as TP funds its order book over time. Fitch believes TP’s leverage is consistent with the assigned rating given the company’s monoline business model, as well as its current revenue and customer concentrations.

The proposed issuance of USD denominated unsecured debt is rated ‘B-(EXP)/RR4’, equalized with TP’s IDR of ‘B-’, reflecting the firm’s predominately secured funding profile and Fitch’s expectations for average (i.e. 31%-50%) recovery prospects for unsecured debtholders in a stressed scenario.

The Stable Outlook reflects Fitch’s expectations of stable operating cash flow generation supported by solid lease yields; maintenance of a portfolio of relatively young, liquid aircraft; and relatively low leverage for the rating.

Rating sensitivities

TP’s ratings could be positively influenced by an improved corporate governance framework; the ability to place the order book deliveries in a manner that provides additional geographic and/or lessee diversification, provided such actions do not adversely affect underwriting or pricing terms; demonstration of credit risk and residual value management; improved scale efficiencies; increased funding flexibility; and maintenance of leverage below 3.0×.

The IDR could be adversely affected by credit deterioration of underlying lessees, particularly those which represent a meaningful portion of TP’s portfolio; maintenance of leverage above 5.0x over the long term; inability to fund and place order book deliveries; rapid expansion that is not accompanied by consistent underwriting standards and commensurate growth in capital levels and staffing; deterioration in residual value realizations and/or an increase in impairments; or the inability to successfully navigate market downturns.

The ratings of the proposed unsecured debt are sensitive to changes to TP’s IDR and the level of unencumbered balance sheet assets relative to outstanding debt. The unsecured debt ratings could be notched from the IDR should secured debt increase and/or the level of unencumbered assets decrease to such an extent that expected recoveries on the senior unsecured debt were adversely affected.

TP is a specialized aircraft leasing company formed in 2011 and based in Singapore. The company has a narrowbody and turboprop portfolio totaling 65 aircraft on lease with total assets amounting to $2.3 billion, as of Dec. 31, 2016.