Rating action

Scope Ratings has today downgraded the notes issued by PR Aircraft Finance S.A. – Compartment 1 (PR Aircraft) to BB from BBB+. The rating’s review status is a result of the developing nature of the current crisis and how this will continue to impact the aviation industry in the short to medium term.

Scope has reviewed the rating on the notes issued by PR Aircraft in the context of the Covid-19 crisis. The impact of the crisis on airline traffic and aircraft values is still developing and could further affect Scope’s assessment of expected losses for the investor, in either direction. The full impact of the crisis on aircraft values is still uncertain. A recovery of aircraft values would be a credit-positive for investors. The full extent of the value impact will not be visible until aircraft trading picks up and potential value losses can be assessed.

Rating rationale

The Covid-19 crisis has resulted in a substantially higher expected loss for investors due to the decrease in airlines’ credit quality and the reduction in aircraft values. The financial stability of all airlines across the world has deteriorated. This increases the probability of default of the facilities in the transaction’s portfolio. The decreased aircraft values increase the loss-given-default of the facilities.

Further, the transaction is currently marginally undercollateralised due to the aforementioned circumstances and reduced excess spread (i.e. total transaction assets are USD 200,000 less than the total balance of the notes). Scope believes this undercollateralisation is temporary as it only represents 11bp of the notes’ balance. This is a credit-negative that could result in a loss to investors if the notes were to be redeemed today.

Scope has considered qualitative credit risk factors that support the rating of this transaction and lift it from the credit quality level of the underlying portfolio. The most relevant qualitative factors are the potential support of sovereigns to certain national champions (e.g. Korean Air Lines) as well as the active role of lessors in preventing airline defaults that would result in a flooding of the market with aircraft. The credit quality of the underlying portfolio is now five notches lower than what it was before the Covid-19 crisis, a result of airline credit quality problems and reduced aircraft values. Excess spread and overcollateralisation currently do not represent material elements of support to uplift the credit profile of the underlying portfolio of loans. Scope has weighed the support provided by excess spread with the probability of airline performance over the life of the transaction.

The downgrade to BB signals to investors that the distance to default is now less than what it was before the crisis started. Scope avoids procyclicality in ratings by trying to maintain a constant protection level to support the ratings at the highest end of the scale (i.e. AAA ratings) and a constant distance to default for ratings at the lower end of the scale (i.e. B ratings). Under this approach and under severe crises like the Covid-19 crisis, this downgrade reflects the drastic reduction in distance to default, while Scope still expects the transaction to perform. This is to be expected when a global systemic crisis occurs.

Investec’s strong alignment of interest, capabilities and experience as a manager continues to support the rating. The high diversification within the portfolio is credit-positive and will support the portfolio if the effect of the crisis on the aviation industry differs across jurisdictions and regions. The notes’ credit quality also depends on the ramp-up strategy for the portfolio and the new loans’ effect on expected loss for investors, particularly if value is added to the portfolio via some opportunistic investments.

Scope has kept the BB rating under review developing. The review status signals that continued market developments could lead to either a further downgrade, an affirmation, or an upgrade of the rating on the notes. Aircraft values have dropped in the wake of the current Covid-19 crisis and it remains uncertain how much further they will drop, or whether restructuring transactions will bring new funding opportunities that would apply a floor to any value declines in the industry. Also uncertain is the level of recovery in airlines’ credit quality once restrictions are lifted and passenger numbers increase. The financial position of the airlines could improve if airlines receive more state aid or if passenger traffic increases.

The transaction has sufficient liquidity to remain current should the Covid-19 crisis take longer to be resolved (i.e. up to 18 months). The rating considers the long-term portfolio’s credit quality in the way a long-term investor would, as well as potential minor shifts expected in the portfolio’s quality as the ramp-up phase continues.

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.

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, they represented a net asset value addition to the portfolio, or if the market recovered and aircraft values increased.

The rating could be negatively affected as a result of the aircraft value risk prompted by the Covid-19 crisis. 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 many 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 October 2020 and suggests that the portfolio’s assets are below investment grade quality on average.

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.

Cash flow analysis
No cash flow analysis was performed. 

Methodology
The methodologies used for this rating(s) and/or rating outlook(s) Aviation Finance Rating Methodology as of 30 June 2020; General Structured Finance Rating Methodology as of 18 December 2019 and Methodology for Counterparty Risk in Structured Finance as of 8 July 2020 iare 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 28 April 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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