Fitch: North America Aerospace & Defense Supported By Strong Global Demand, Spending Trends in 2008

Business Wire, Dec 5, 2007

NEW YORK -- Fitch Ratings has a positive outlook for credit quality in the North American commercial aerospace industry in 2008, and a stable outlook for credit quality in the North American defense sector. The favorable outlook for commercial aerospace is based on demand outside of North America, which has resulted in large order books and strength in all commercial product segments. Concerns about economic weakness have increased in recent months, but Fitch estimates that only a global recession would change the positive outlook for commercial aerospace. The defense credit outlook continues to be supported by high Department of Defense (DoD) spending levels, although spending growth in the core budget should slow. Supplemental defense spending to support operations in Iraq and Afghanistan will likely continue through 2008, and any impact from lower supplemental spending would not be significant for several years due to the need to reset and modernize equipment. The outcome of the U.S. presidential elections is not likely to affect core defense spending until FY2011.

Global Exposure Limits Impact of U.S. Economic Slowdown

U.S. economic weakness could test the strength of the current commercial aerospace upturn, but Fitch believes the industry would pass that test because of the global diversity of commercial aerospace demand. For example, at least 75% of the current large commercial aircraft (LCA, Airbus and Boeing) backlog is from customers outside North America. In Fitch's view, there would need to be a substantial amount of contagion leading to a global economic downturn for the commercial aerospace outlook to become negative. The sector is not exhibiting signs of weakness at this time, as illustrated by the strong orders for LCA and business jets in the past two-three months. The most significant concern would be that high fuel prices and higher interest rates combine to compress already thin airline profit margins.

Fitch will continue to monitor several key items for signs of a change in commercial aerospace trends. The business jet market would likely be the first segment to show weakness, in Fitch's opinion, because of substitute forms of travel and higher exposure to North America demand. Other data that will be watched include global passenger traffic, global cargo traffic, global airline profitability, delivery deferrals, and order cancellations. Fitch does not believe lower orders in 2008 would be a warning sign of commercial aerospace weakness because of the high orders in the past three years and the large backlogs in the industry.

There has been no noticeable impact on the aircraft finance market from the 'credit crunch' at this point, but it is an area to watch in 2008. Given the large backlog in the commercial aerospace industry (more than 6,000 LCA), there will be several hundred billion dollars of new aircraft to be financed and insured over the next several years. Commercial aircraft have been a strong asset class over the past few years, attracting a significant amount of capital. There were several capital market aircraft transactions in 2007, but the market still mainly consists of leasing companies and banks. Fitch expects this to continue in 2008. The healthy aircraft finance market has benefited some manufacturers with finance subsidiaries (Boeing and Bombardier are examples) which have been able to reduce financing assets, raising free cash flow.

Commercial Aerospace

Fitch expects all segments of the commercial aerospace industry to deliver solid growth in 2008, and this growth should continue into 2009. Orders have exceeded expectations again in 2007, and Fitch now projects that most parts of the commercial aerospace industry will not reach a delivery peak until 2009 or 2010. Substantial order backlogs provide a cushion to delivery estimates, particularly in the LCA segment. Markets outside of North America continue to drive the strong demand for commercial aerospace products, and the current demand is a mix of both a cyclical upturn in some markets and secular growth in other markets. Risks to the outlook include exogenous shocks (terrorism, disease pandemic, etc.), changes in global economic activity, supply chain pressures, execution on new programs, production increases, and labor negotiations.

The following expectations for some key commercial segments are incorporated into Fitch's credit ratings:

--Large Commercial Aircraft (LCA): Fitch expects LCA deliveries from Boeing and Airbus to rise to approximately 980-1000 aircraft (up 11%) in 2008 from approximately 890 aircraft in 2007, which is up about 7% from 2006 deliveries. Fitch expects deliveries to rise to more than 1100 aircraft in 2009, with further increases in 2010. Deliveries in 2008 should be split nearly equally between the two manufacturers (with a slight edge possible to Airbus), and the mix between wide-body and narrow-body aircraft should be about the same in 2008 as in 2007, before shifting in favor of wide-body deliveries in 2009 as 787 production increases. Orders have exceeded expectations for the third consecutive year, totaling more than 2,100 aircraft year-to-date. Fitch expects orders to decline in 2008, but the book-to-bill ratio could still approach 1:1 in 2008 given some pending aircraft campaigns.