Fitch Ratings-Chicago-08 April 2019: Fitch Ratings expects to assign the following ratings and Outlooks to the notes concurrently issued by Castlelake Aircraft Structured Trust 2019-1 (CLAS 2019-1):
--$679,420,000 class A asset-backed notes 'Asf'; Outlook Stable;
--$114,979,000 class B asset-backed notes 'BBBsf'; Outlook Stable;
--$73,168,000 class C asset-backed notes 'BBsf'; Outlook Stable.
CLAS 2019-1 expects to use the note proceeds to acquire the aircraft-owning entity (AOE) series A, B and C notes issued by CLSec Holdings 18S DAC and CLSec Holdings 19S LLC (collectively, the AOE issuers). Each AOE issuer will use the note proceeds to acquire 28 midlife aircraft and four promissory notes secured by one aircraft each from funds affiliated with and managed by Castlelake, L.P. (Castlelake) and certain third-party sellers.
The pool will be serviced by Castlelake Aviation Holdings (Ireland) Limited, which will enter into a sub-servicing agreement with Castlelake, with the notes secured by each aircraft's future lease and residual cash flows and principal and interest owed on the promissory notes. This is the second Fitch-rated aircraft ABS serviced by Castlelake (NR) and Fitch last rated the CLAS 2018-1 transaction which closed in June 2018. Castlelake has sponsored and serviced five prior aircraft ABS since 2014.
Funds managed by Castlelake, the sellers of the aircraft to CLAS 2019-1, will initially retain the class C notes and will also provide a portion of the equity to the transaction, consistent with similar investments made by the funds in prior CLAS transactions. Therefore, Castlelake will have a vested interest in performance outside of merely collecting servicing fees. Fitch views this positively since Castlelake will have a significant interest in servicing the transaction adequately and generating positive cash flows through management of the assets over the life of the transaction.
As of the cutoff date, Castlelake funds own 14 of the pool's 28 aircraft and all four promissory notes, with the remaining 14 aircraft owned and/or managed by four other lessors/airlines. The 14 aircraft are currently subject to executed purchase agreements or letters of intent (LOIs) for sale to Castlelake funds. Castlelake funds will acquire these remaining assets and transfer to the AOE issuers and their subsidiaries during the contribution period. Fitch views this negatively, since the pool will be exposed to counterparty risks, particularly if any agreements or LOIs are not finalized during the contribution period.
The contribution period will end 360 days from closing, longer than periods in most prior aircraft ABS that have typically lasted 270 days. Fitch views this negatively, since initial cash flows may be lower in the first year if certain aircraft are not novated in a timely fashion. Additionally, the longer the contribution period is, the longer the pool will be exposed to risks associated with a bankruptcy of Castlelake and the counterparties that own aircraft in the proposed pool. However, if any aircraft or replacements are not transferred, the applicable debt amount will be prepaid to noteholders from the acquisition account, offsetting this risk.
The senior amortization schedule is faster than in CLAS 2018-1, with 12.5 year schedules for the majority of the assets, plus 10 year schedules for the two 777 aircraft and 6.5 year schedules for the four promissory loans. This compares to, in the prior transaction, 14 years for all assets for years one to three and then 12 years thereafter. Additionally, unlike CLAS 2018-1, partial cash sweeps are included in the waterfall, which are positive additions to the structure and are consistently included in many recent mid- to end-of-life aircraft ABS transactions.
KEY RATING DRIVERS
Strong Collateral Quality - Mostly Liquid Narrowbody (NB) Aircraft: The pool is largely liquid, mid-life A320s and B737s with a nine-year WA age. Two widebody B777-300ERs and one A330 total 28.4%, which are prone to higher transition costs. Notably, 13.8% of the initial contracted cash flow is from one of the B777-300ER aircraft. No aircraft will come off-lease until 2020, and 48.1% of the pool comes off lease in 2024-2025.
Asset Value and Lease Rate Volatility: Fitch derives assumed initial aircraft values from various appraisal sources and employs future aircraft value and disposition stresses in its analysis. These take into account aircraft age and marketability to simulate the decline in values and lease rates expected to occur over the course of multiple aviation market downturns.
Operational and Servicing Risk - Adequate Servicing Capability: The transaction will be heavily reliant on the Castelake to remarket and repossess aircraft, adequately manage and monitor the technical upkeep of the aircraft, and legally protect trust assets in multiple foreign jurisdictions. Fitch considers Castlelake a strong servicer of mid- to end-of-life aircraft, evidenced by performance of their total fleet and prior ABS, which have all performed within expectations to date.
Lessee Credit Risk - Weak Credits: Most of the pool's 14 obligors (13 lessees and the obligor under the promissory notes) are either unrated or speculative-grade credits, typical of aircraft ABS. However, Fitch does publically rate one lessee, GOL, at 'B', with WestJet (BBB-/Negative) rated by another NRSRO. Fitch assumed a 'B' or 'CCC' Issuer Default Rating (IDR) for unrated lessees and stressed IDRs downward in recessions, consistent with prior analyses.
Transaction Structure: The performance triggers and amortization profiles have improved relative to CLAS 2018-1, as the senior notes' schedules are faster and partial cash sweeps have been added to the waterfall. The loan-to-value ratios (LTVs), utilizing the maintenance-adjusted book values (MABVs), are 65.0%, 76.0%, and 83.0% for the class A, B, and C notes, respectively, all down from 2018-1. Fitch stresses initial LTVs to 69.1%, 80.8%, and 88.3% in cash flow modeling scenarios by using lower initial aircraft values. All series pay in full prior to their legal final maturity dates when applying cash flows commensurate with the ratings.
Aviation Market Cyclicality: The commercial aviation industry has exhibited significant cyclicality tied to the health of the overall global economy. This cyclicality can produce increased lessee defaults, lower demand for off-lease aircraft, and deterioration in lease rates and asset values. Fitch stresses asset values, utilization levels, lease rates and default probability during assumed market down cycles to account for this risk.
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 detail, refer to Fitch's "Aircraft Operating Lease ABS Rating Criteria" (March 2019) and "Global Structured Finance Rating Criteria" (May 2018), available at www.fitchratings.com.
The performance of aircraft ABS 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. These sensitivity scenarios were also considered in determining Fitch's recommended ratings.
Increased competition, largely from newly established APAC lessors, has contributed to declining lease rates in the aircraft leasing market over the past few years. Additionally, certain variants have been more prone to value declines and lease rates due to oversupply issues. Fitch performed a sensitivity analysis assuming lease rate factors (LRFs) would not increase after an aircraft reached 11 years of age, providing a material haircut to future lease cash flow generation. Per Fitch's criteria LRF curve, no subsequent leases were executed at a LRF greater than 1.13%.
Cash flow generated in this scenario declined from the primary scenario by 6%-7%. All three series pass their respective rating scenarios, and should not experience rating downgrades.
All aircraft in the pool face replacement programs over the next decade, particularly the A320ceo and B737 NG aircraft in the form of A320neo and B737 MAX aircraft, which have already started delivering. Airbus plans to deliver the A330neo later this year, which if received well, could affect the existing A330 fleet. Certain appraisers have started to adjust market values in response to this replacement risk; the majority of the pool's market value appraisals are slightly lower than half-life base values. Fitch believes current generation aircraft are well insulated due to large operator bases and the long lead time for full replacement, particularly when considering conservative retirement ages and aggressive production schedules for Airbus and Boeing new technology.
However, Fitch believes a sensitivity scenario is warranted to address these risks. Therefore, Fitch utilized a scenario in which the lower-of-mean-and-median (LMM) of market values from each appraiser was utilized to determine each aircraft's value. 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 fairly significantly under this scenario, and aircraft are essentially sold for scrap at the end of their useful lives. In addition, the first recession was assumed to start two years following transaction close.
This scenario is the most stressful compared with the other two scenarios, as 'Asf' cash flow drops to $1.01 billion, compared with $1.12 billion in the primary scenario. The class A notes barely fail the 'Asf' scenario, while the class B notes only pass the 'BBsf' and 'Bsf' scenarios. The class C notes would likely fall to 'Bsf' due to the severe drop in cash flows.
Although a relevant scenario to consider, Fitch believes the stresses are very conservative, particularly when considering observed market values for current generation A320s and B737s. Fitch does not expect a significant effect from the neo or MAX variants until well into the next decade.
As the tenure of the leases is materially shorter than that of the transaction, new leases will continue to be executed over time. As such, the future pool mix is unknown. Airlines are generally speculative-grade credits and are sensitive to global economic downturns. As aircraft are leased across the globe, some may be placed in jurisdictions where repossession of aircraft may prove to be more difficult than in others. As such, Fitch considered a scenario in which the lessees in the pool performed notably worse than Castelake's historical experience.
Fitch assumed that all unrated airlines had a default probability in line with a 'CCC' credit. This rating was assumed to decline to 'CC' during recessionary periods. Furthermore, Fitch's assumed repossession time was increased by one month under all scenarios. Such assumptions are materially conservative, as the default rate and aircraft downtime significantly increases over the primary scenarios.
This scenario is more taxing on the structure than the LRF sensitivity as additional stress is immediately felt as a result of defaulting lessees. Under the rating scenarios, gross cash flow declines approximately $120 million-$152 million while expenses increased approximately $31million -$41 million as a result of the increased repossession and remarketing activity. Class A is unable to pass the 'Asf' scenario, but passes 'BBBsf' and below. Class B is able to pass under the 'BBsf' scenario, while class C is locked out from receiving any principal payments. Class C is unable to pass the 'Bsf' scenario. Such a stress is likely to result in the class A and B notes experiencing downgrades of up to one category, while the class C notes could fall to distressed categories.
The pool includes three widebody aircraft that make up a significant portion of the initial contracted cash flow from the pool. Fitch ran a sensitivity scenario where all three of these lessees were assumed to default on day one. Although cash flows drop slightly in these runs due to the increased downtime and expenses related to the assumed defaults, there was no impact on the 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
Fitch's analysis of the Representation and Warranties (R&W) of these transactions can be found in "Castlelake Aircraft Structured Finance 2019-1 - Appendix." These R&W are compared with those of typical R&W for the asset class as detailed in Fitch's May 2016 special report, "Representations, Warranties, and Enforcement Mechanisms in Global Structured Finance Transactions."