Scope Ratings (Scope) has assigned a final rating to the registered securities issued by PR Aircraft Finance S.A. – Compartment 1:

Profit Contingent Subordinated Securities: new rating of BBB

Scope’s rating reflects the expected loss on the instrument for the current committed amount until the instrument’s maturity in December 2030.

The transaction is a debt fund secured by a pool of aircraft-financing loans actively managed by Investec Bank plc (Investec). The issuer, PR Aircraft Finance, is a limited-liability company (société anonyme) incorporated under Luxembourg’s securitisation law, enacted in 22 March 2004. The rated securities bear a quarterly fixed coupon and a profit-contingent interest component. The fund is under ramp-up; and the issuer can draw down further on the outstanding subscription amount from investors and issue securities, at up to USD 500m in volume, to purchase additional loans. As of October 2016, the portfolio consists of loans granted to finance one or more aircraft; most of which are secured.

Rating rationale

The BBB rating reflects the fund’s investment criteria; the credit quality of existing loans; the investment strategy to ramp up the portfolio as indicated by Investec; the legal and financial structure of the transaction; and credit and operational risks related to key transactional parties.

The rating factors in Investec’s ability, experience and incentives as portfolio advisor, sourcing agent and portfolio servicer. Investec is an experienced provider of aviation-financing solutions, with a large operational network and well-established processes over asset management and technical support. Investec’s retained stake in the deal results in the effective alignment of interest with that of investors. In addition, the performance fee of the manager is partially time-subordinated to enable the provisioning of portfolio losses.

The fund’s investment criteria provides substantial flexibility over asset management, but limits the share of riskier assets like subordinated loans, or loans backed by older or wide-body aircraft. In addition, maximum loan-to-value ratios (LTV) at the loans’ inception and maturity reduces the exposure to residual-value risk.

The rating takes into account the portfolio’s credit quality as of October 2016, with characteristics significantly above the fund’s minimum investment criteria. Also, Scope has concluded that the credit profile of the assets acquired after October 2016 are immaterial to the rating. The fund’s assets exhibit an average credit quality commensurate with a BBB- (enhanced by one notch to BBB thanks to expected excess spread available in the fund). Based on Investec’s investment strategy and incentives, Scope also expects that the pool’s current quality will be maintained when assets are replenished.

All loans in the fund benefit from a security on one or more aircraft, from aircraft leases, and, in certain instances, a direct recourse to a guarantor. The portfolio also benefits from securities over relatively new aircraft. Based on the latest aircraft appraisals, the portfolio averages an LTV barely above 70%, which is expected to decline to conservative levels at respective loan maturity. The aircraft securing the loans are in-production models, which Scope views positively due to their young age, broad user base, and strong marketability for re-leasing to other operators or for selling.

The rating accounts for the transaction’s counterparty exposures to Investec as account bank and Deutsche Bank AG, London branch (rated A-/S1 by Scope) as principal paying agent. Scope’s assessment of Investec is based on public ratings.

Rating drivers

Alignment of incentives (positive). The fund’s performance is aligned strongly with the incentives of Investec.

Excess spread (positive). The portfolio will generate excess spread above the coupon promised on the securities, which could buffer losses from portfolio-loan defaults, if any.

Asset quality (positive). The loans benefit from a solid security package on high-quality collateral. The underlying aircraft are generally recent models, characterised by strong demand and are quick to re-market. Further, the relevance of better-quality aircraft for fleets of certain obligors (core fleet aircraft) reduces the contracts’ probability of default in some jurisdictions because the affirmation of those contracts, rather than their rejection, benefits lenders upon restructuring.

Single-industry exposure (negative). The fund is exposed solely to the airline industry, which is inherently cyclical and highly sensitive to macroeconomic shocks. Scope reflects this in its analysis.

Airline direct lending (negative). Certain facilities in the fund do not feature the active involvement of a lessor. An experienced lessor generally supports the efficient re-marketing of aircraft upon a lessee’s default. This risk is partly mitigated by Investec’s ability and track record in aviation finance.

Asset replenishment (negative). The revolving nature of the fund exposes investors to a long risk horizon, increasing the risk that the fund’s credit characteristics change over time. This is partly mitigated by Investec’s experience and incentives in sourcing adequate investments.

Rating-change drivers

The rating might be positively affected if newly purchased assets have better credit quality than the current average in the pool.

The rating might be negatively affected if the aviation industry undergoes a cycle of unexpected downturn volatility that is abnormal for the sector. Such volatility could be attributed to a global economic depression linked to unusually high oil prices, a change in state trade rules and regulations, or higher interest rates.

Quantitative analysis, loan-by-loan analysis and key assumptions

Scope’s loan-by-loan analysis is based on information from October 2016 and suggests an average portfolio credit quality commensurate with a BBB-, which is enhanced by one notch to BBB thanks to expected excess spread available in the fund. Scope also concluded that the credit profile of the assets acquired after October 2016 will not materially affect the rating.

Scope has assessed the portfolio’s credit quality by producing private ratings or credit estimates on the loans. Scope has calculated expected loss on the loans by combining the expected recovery on a default with the default probability of the contract through its entire life. Scope then derived a weighted average expected loss and a weighted average life for the pool of assets currently in the fund.

Scope performed a scenario analysis on the portfolio to estimate the impact of excess spread in the transaction (i.e. expected return available above costs and the coupon promised on the securities) to provision for losses on the portfolio. Scope tested combinations of loan defaults and concluded the pool can sustain expected losses from at least one loan without a material effect on the rating.

A loan’s probability of default relates to the credit quality of the underlying airline, the pool of airlines or guarantor. Scope also accounts for the underlying aircraft’s relevance in the airline fleet. If relevant, Scope expects a lower probability of default than the one implied by the airline’s credit quality. These contracts are likely to survive if an obligor files for protection.

The loan benefits from a recovery if the underlying aircraft’s stressed value can cover the outstanding loan exposure. After a loan defaults, the recovery rate is driven by the LTV at the time of aircraft’s re-marketing. This analysis takes into account the seniority of the defaulted loan and the corresponding market value of the aircraft at re-marketing, net of costs. Scope has estimated the half-life value of the aircraft under market-value-decline assumptions specific to each aircraft type. This assumption reflects worse-than-agreed return conditions of the aircraft upon the obligor’s bankruptcy. Scope assumes that, after incorporating maintenance reserve payments, recoveries can reach half-life base values. Scope has considered shorter re-marketing times for lessors with above-average quality.

Scope has modelled downturns in the aviation market to stress the value of aircraft in the pool. Scope’s assumptions range from a 20% downside volatility for the most liquid types, i.e. narrow-body, or new-technology wide-body aircraft; to 35% for ‘last of the line’ wide-body aircraft. Scope has assumed that downturns will occur in years 1-5 and 10-15. In a downturn, Scope reduces the value of aircraft over the first 24 months, and allows this to recover over the last 24 months. The good quality of aircraft underlying the portfolio allows Scope to assume a gradual reduction of 50% in downside volatility stresses. 

Sensitivity

Scope has tested the sensitivity of the rating against deviations from main modelling assumptions, including the credit quality of obligors and the market-value-decline assumptions on aircraft. This analysis has the sole purpose of illustrating the sensitivity of the rating and is not indicative of expected or likely scenarios.

The rating would decrease by one notch if the average obligor quality (lessee or their guarantor) decreased by one notch to B from B+.

The rating would decrease by one notch if downside volatility increased by 10 percentage points.
 
Regulatory and legal disclosures

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr Stefan Bund, Dr Sven Janssen.
The rating analysis has been prepared by Martin Hartmann, Lead Analyst. Guillaume Jolivet, Committee Chair, is the analyst responsible for approving the rating.

Rating history
The rating concerns newly issued financial instruments, which were evaluated for the first time by Scope Ratings AG.

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the issuer of the investment, represented by the management company.
As of the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG nor any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
Transaction-related contracts; management presentation provided by the asset manager; fundamental portfolio information provided by the asset manager including the fund´s reporting as of October 2016. Individual underlying asset information, legal opinions, third party valuation reports and expert opinions available as of the respective asset’s closing date.
Scope Ratings considers the quality of the available information on the evaluated entity to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.
The rating was disclosed to the rated entity prior to publication, and was amended following that disclosure.

Methodology
The methodology applicable for the ratings is ‘General Structured Finance Rating Methodology', dated August 2016 and the 'Rating Methodology for Counterparty Risk in Structured Finance Transactions', dated August 2016. Both files are available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

Conditions of use / exclusion of liability
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Rating issued by
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