Rating action

Scope Ratings has today downgraded the notes issued by PR Aircraft Finance S.A. – Compartment 1 (PR Aircraft) to BBB+ from A-. The rating’s review status is maintained at ‘under review for downgrade’. Scope reviewed the rating on the notes issued by PR Aircraft in relation to the new loans added to the portfolio, in the context of the Covid-19 crisis. The impact of Covid-19 crisis on airline traffic and aircraft values is still developing and could further affect our assessment of expected losses for the investor.

Rating rationale

The new loans have increased the expected loss for investors as the loans’ credit quality are below the average of those already in the portfolio. The new loans have also increased the exposure to airlines already in the portfolio and therefore reduced some of the positive diversification effect.

Scope keeps the BBB+ rating under review for downgrade. Aircraft values have dropped in the wake of the current Covid-19 crisis and it remains uncertain how much further they will drop. Also uncertain is the level of recovery in aircraft values once fleets are no longer grounded and airlines are again operational. The review status would be lifted if both the industry and aircraft values recovered quickly from the crisis.

The notes’ credit quality also depends on the ramp-up strategy for the portfolio and the new loans’ effect on expected loss for investors.

The rating considers the long-term portfolio’s credit quality to accommodate the risk of a long-term investor, as well as potential minor shifts expected in the portfolio’s quality as the ramp-up phase continues. The transaction has sufficient liquidity to remain current should the Covid-19 crisis take longer to be resolved.

All loans in the portfolio are directly or indirectly secured by one or more aircraft and, in certain instances, direct recourse to a lessor.

Scope continuously monitors PR Aircraft Finance S.A. – Compartment 1.

Key rating drivers

Alignment of incentives (positive). The portfolio’s performance is closely aligned with the incentives of Investec (the adviser), which retains sufficient interest in the transaction.

Excess spread (positive). The portfolio will generate excess spread above the coupon promised on the notes, which can buffer losses from loan defaults and, when trapped, will build hard credit enhancement.

Asset quality (positive). The loans benefit from a solid security package with high-quality collateral. The underlying aircraft are generally recent models, characterised by strong demand and short remarketing times. In addition, the relevance of higher-quality aircraft for fleets of certain obligors (fleet relevance) reduces the contracts’ probability of default (i.e. the affirmation of those contracts, rather than their rejection, benefits lenders upon restructuring in certain jurisdictions).

Single-industry exposure (negative). The portfolio is solely exposed 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 portfolio do not feature the active involvement of a lessor or a bankruptcy-remote vehicle. An experienced lessor generally supports the efficient remarketing of aircraft upon a lessee’s default. A bankruptcy-remote vehicle could reduce repossession times in the event of default. This risk is partly mitigated by Investec’s solid ability and good track record in aviation finance.

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

Rating-change drivers

The rating could be positively affected if newly purchased assets have a better credit quality than the current average in the pool, or if the market recovered and aircraft values increased.

The rating could be negatively affected as a result of the aircraft value risk from Covid-19. Aircraft market values would decrease if several airlines defaulted, as this would increase the supply of aircraft in the open market. This would create the risk of lower recoveries. The risk is partially mitigated through PR Aircraft’s well-diversified portfolio of aircraft from several different manufacturers.

The rating could be negatively affected if the airlines’ probability of default increased, an aspect to which the portfolio is particularly sensitive. An increased credit risk of airline counterparties would also increase PR Aircraft’s credit risk. The risk is partially mitigated through the well-diversified portfolio of a large number of airlines from several regions.

The rating could be negatively affected if newly purchased assets have a lower credit quality than the current average in the pool.

Quantitative analysis and assumptions

Scope analysed the contributions to total expected loss from each of the underlying assets and factored in the loss-mitigating impact of excess spread available to investors and trapped in the reserve mechanism.

Scope’s loan-by-loan analysis is based on information from April 2019 and suggests that the portfolio’s assets are low investment grade quality on average. However, the structure of the vehicle enhances the credit quality of the notes to a BBB+ (under review for downgrade) thanks to excess spread and a sufficiently large liquidity reserve.

Scope assessed the portfolio’s credit quality by producing private ratings or credit estimates on loans with a significant concentration (i.e. more than 10% or 5% of the total exposure, respectively). Scope calculated the total expected loss on each loan by adding the probability-weighted loss-given-default for every period in the life of the loan. Total expected loss was benchmarked against Scope’s idealised expected loss curves, at a risk horizon equal to the expected weighted average life of the loan portfolio.

A loan’s probability of default relates to the credit quality of the underlying airline, the pool of airlines or guarantors. Scope also accounts for the underlying aircraft’s relevance in the airline fleet. If an aircraft is relevant and operating under certain jurisdictions, Scope expects a lower probability of default for a contract than the one implied by the airline’s credit quality. These contracts are likely to survive if an obligor can file for obligor protection.

A loan benefits from full recovery on any given period if the underlying aircraft’s stressed value can cover the outstanding loan exposure on that period. The recovery rate is driven by the leverage or loan-to-value at the time of the aircraft’s remarketing. This analysis considers the seniority of the defaulted loan and the corresponding market value of the aircraft at remarketing, net of costs.

Scope estimated the half-life value of the aircraft under market-value-decline assumptions specific to each aircraft type. Scope’s assumptions reflect worse-than-agreed return conditions for aircraft upon an obligor’s bankruptcy unless maintenance reserves are payable and pledged to the lender. Scope assumes that recoveries can reach half-life base values after incorporating maintenance reserve payments (when available and sufficient). Scope also considered shorter remarketing times for lessors with above-average quality.

Sensitivity analysis

Scope tested the sensitivity of the rating against deviations from main modelling assumptions, including the credit quality of obligors and 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 (airline, lessee or guarantor) decreased by one notch to B from B+.
   
• The rating would decrease by one notch if downside volatility increased by 10 percentage points.

Stress testing
Stress testing was performed by applying rating-adjusted recovery rate assumptions.

Methodology
The methodologies used for this rating(s) and/or rating outlook(s) Aviation Finance Rating Methodology as of 1 July 2019; General Structured Finance Rating Methodology as of 18 December 2019 and Methodology for Counterparty Risk in Structured Finance as of 24 July 2019 are available on https://www.scoperatings.com/#!methodology/list.
The model used for this rating(s) AF EL v1.0 is available in Scope’s list of models, published under: https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.

Solicitation, key sources and quality of information 
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entities’ agents, third parties and Scope internal sources. 
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Scope has performed its own analysis of the data quality, based on information received from the rated entity or related third parties, which is not and should be not deemed equivalent to the performance of due diligence or an audit. The external due diligence assessment/asset audit/internal analysis was considered when preparing the rating and it has no impact on the credit rating.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures 
This credit rating and/or rating outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Helene Spro, Director 
Person responsible for approval of the rating: Carlos Terré, Managing Director
The ratings/outlooks were first released by Scope on 27 January 2017. The ratings/outlooks were last updated on 19 March 2020. 

Potential conflicts 
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.
Scope provided the following ancillary services to the rated entity and/or its agents within two years preceding this credit rating action: Rating Assessment Service

Conditions of use / exclusion of liability
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