Fitch Ratings has assigned expected ratings to Lunar Aircraft 2020-1 Limited.
Fitch expects to rate the aircraft operating lease ABS secured notes issued by LUNAR Aircraft 2020-1 Limited (LUNAR Ireland) and LUNAR Aircraft 2020-1 LLC (LUNAR USA), collectively LUNAR, as listed above. LUNAR expects to use proceeds of the initial notes to acquire a pool of 18 midlife aircraft from LUNAR Aircraft HoldCo Limited (LAHL) and certain of its subsidiaries or affiliates and LUNAR Ireland.
The pool will be serviced by DVB Bank SE, London Branch Aviation Asset Management (DVB), with the notes secured by each aircraft's future lease payments and residual cash flows. Additionally, an affiliate of Sculptor Asset Management will act as the asset manager for the investor and will acquire the E notes.
This is the first Fitch-rated aircraft ABS serviced by DVB and third ABS transaction serviced by DVB. In 2019, DVB was acquired by MUFG Bank Ltd. (MUFG; A/Negative), a subsidiary of Mitsubishi UFJ Financial Group, Inc. and BOT Lease, Co., Ltd (BOT Lease), an affiliate of MUFG. The acquisition is expected to be completed in 1H20.
KEY RATING DRIVERS
Asset Quality — Mostly Liquid Narrowbody — Positive: The pool is largely composed of liquid B737 and A320 family current generation aircraft including 17 in-demand narrowbodies and one widebody ranging from mid to end-of-life, with a weighted average (WA) age of 9.2 years. The single widebody aircraft is a 10.7 year old A330-300 totaling 12.75% of the pool, on lease to Finnair with a remaining term of 6.1 years. Widebodies are prone to higher transition costs, and this variant is considered a Tier 1 asset given current demand and production dynamics.
Lease Term and Maturity Schedule — Concentrated: The weighted average remaining lease term is 3.9 years, lower than recently Fitch-rated transactions. Two leases comes due in 2020 totaling 11.5% of the pool, four (17.6%) in 2021, and three (15.3%) in 2022. The Finnair-leased A330-300 lease expires in 2026, and has the largest contracted cash flow of 23.3% for the pool.
Operational and Servicing Risk — Adequate Servicing Capability: Fitch believes DVB, supported by their related DVB aviation finance groups, will be able to collect lease payments, remarket and repossess aircraft in an event of lessee default, and procure maintenance to retain values and ensure stable performance. Fitch considers DVB to be a capable servicer as evidenced by their servicing experience and performance of two serviced ABS transactions and other managed aviation assets. MUFG, the parent of DVB, is currently rated 'A'/Outlook Negative by Fitch.
Lessee Credit Risk — Weak Credits: The pool includes 16 lessees with two airlines rated by Fitch (WestJet, rated BB-/Positive, and TigerAir Australia [Parent Virgin Australia, rated B+/Stable]) with three aircraft totaling 19.0%, and two flag carriers (Finnair and Kenya Airlines). The majority of airlines are either unrated or speculative-grade credits, typical of aircraft ABS. Fitch assumed a 'B' or 'CCC' Issuer Default Rating (IDR) for unrated lessees and stressed IDRs downward in recessions, to reflect default risk in the pool. Ratings were further stressed during future assumed recessions and once aircraft reach Tier 3 classification. The assumed 'CCC' concentration in the pool is 31.9%, in line with recently rated aircraft ABS.
Country Credit Risk — Neutral: The largest country concentration is Russia (13.4%), (Long-Term IDR BBB-/ Stable) comprised of two aircraft leased to Nordwind Airlines (9.2%) and S7 Airlines (4.2%). The second largest is the Finland (12.6%) with one aircraft, followed by India (12.1%), Turkey (10.0%) and Chile (7.9%). The top five countries total 55.9% with 74.7% of lessees concentrated in emerging markets, with 28.6% in Emerging Asia Pacific (APAC) and 25.4% in Emerging Europe and CIS.
Transaction Structure — Consistent: Credit enhancement comprises overcollateralization, a liquidity facility and a cash reserve. The initial loan to value ratios for series A, B and C notes are 66.9%, 77.9% and 84.0%, respectively, based on the average of the maintenance-adjusted base values.
Structural Protections — Adequate: Each series of notes makes full payment of interest and principal in the primary scenarios, commensurate with their expected ratings after applying Fitch's stressed asset and liability assumptions. Fitch has also created multiple alternative cash flows to evaluate the structure sensitivity to different scenarios, detailed later in the report.
Aviation Market Cyclicality: Commercial aviation has been subject to significant cyclicality due to macroeconomic and geopolitical events. Fitch's analysis assumes multiple periods of significant volatility over the life of the transaction. Downturns are typically marked by reduced aircraft utilization rates, values and lease rates, as well as deteriorating lessee credit quality. Fitch employs aircraft value stresses in its analysis, which takes into account age and marketability of aircraft in the portfolio to simulate the decline in lease rates expected over the course of an aviation market downturn and the corresponding decrease to potential residual sales proceeds.
Rating Cap of 'Asf': Fitch limits aircraft operating lease ratings to a maximum cap of 'Asf' due to the factors discussed above and the potential volatility they produce. For more details, refer to Fitch's "Global Structured Finance Rating Criteria" (May 2019) and "Aircraft Operating Lease ABS Rating Criteria" (March 2019), available at www.fitchratings.com.
The performance of aircraft operating lease securitizations can be affected by various factors, which, in turn, could have an impact on the assigned ratings. Fitch conducted multiple rating sensitivity analyses to evaluate the impact of changes to a number of the variables in the analysis. As stated, these sensitivity scenarios were also considered in determining Fitch's expected ratings.
Technological Cliff Stress Scenario
All aircraft in the pool face replacement programs over the next decade. Fitch believes the current generation aircraft in the pool remain well insulated due to large operator bases and long lead times for full replacement. This scenario simulates a drop in demand (and associated values). The first recession was assumed to occur two years following close and all recessionary value decline stresses were increased by 10% at each rating category. Fitch additionally utilized a 25% residual assumption rather than the base level of 50% to stress end-of-life proceeds for each asset in the pool. Lease rates drop under this scenario, and aircraft are sold for scrap at end of useful lives.
Under this scenario, all classes fail at their respective rating category. As a result, class A would result in multiple categories of downgrades while class B and C would result in one level below their rating category. This is the most stressful sensitivity to this transaction because of the heavier reliance of residual proceeds.
LRF Stress Scenarios
Fitch ran a sensitivity scenario that capped LRFs for all aircraft. Fitch capped all leases at a 1.00% LRF. This is the criteria-assumed LRF at age eight. After this point, leases in prior pools have fallen notably below Fitch's curve. While the curve normally increases and is then capped at 1.65% in runs under these scenarios, no lease will be executed at a LRF above 1.00%.
Under this scenario, all classes fail at their respective rating category. As a result, such a result could result in a one level category downgrade of each class below their rating category.
Coronavirus Stress Scenario
Health outbreaks, such as the Coronavirus, can deter and restrict travel to certain regions. To account for the most recent health outbreak, with the vast majority of cases in Asia, more specifically China, Fitch ran a sensitivity that stressed the assumed ratings of any APAC lessees to 'CCC' and any lessees in China to 'D'. This pool has over 16% exposure to the APAC region more closely associated with China.
Under this scenario, all classes are able to pass at their respective ratings.
USE OF THIRD PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G -10
Form ABS Due Diligence-15E was not provided to, or reviewed by, Fitch in relation to this rating action.
REPRESENTATIONS, WARRANTIES AND ENFORCEMENT MECHANISMS
A description of the transaction's representations, warranties and enforcement mechanisms (RW&Es) that are disclosed in the offering document and which relate to the underlying asset pool is available by clicking the link to the Appendix. The appendix also contains a comparison of these RW&Es to those Fitch considers typical for the asset class as detailed in the Special Report titled 'Representations, Warranties and Enforcement Mechanisms in Global Structured Finance Transactions'.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is typically a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on transaction, either due to their nature or the way in which they are being managed.
For more information on our ESG Relevance Scores, visit www.fitchratings.com/esg.