Fitch Ratings - Chicago - 31 Mar 2020: Fitch Ratings has placed 35 outstanding tranches of Aviation ABS (aircraft and engine) notes on Rating Watch Negative (RWN). In addition, the Rating Outlooks on 51 classes of notes were revised to Negative from Stable. These actions encompass all 27 aircraft and four engine ABS transactions totaling $13.8 billion in notes issued by 13 lessor ABS platforms rated by Fitch, as listed below.
These rating actions are driven principally by the massive negative impact of the coronavirus pandemic, specifically the ongoing declining credit quality of over 200 airline lessees backing the 31 securitized pools. This has increased pressure on ratings, particularly for tranches with RWN. Fitch is now conducting a more in-depth review of the rated portfolio that could result in further negative rating actions in the weeks ahead.
These actions follow on from March 23, when Fitch placed the sector asset performance rating outlook to negative from stable-to-negative. This reflected material downside risks from this global pandemic driving unknown and unique risks for aviation ABS that is hitting global airlines head-on (see link https://www.fitchratings.com/research/structured-finance/aviation-abs-outlooks-revised-to-negative-on-coronavirus-impact-23-03-2020).
KEY RATING DRIVERS
To determine the immediate impact from the severe hit to airline lessee credits backing ABS pools, Fitch updated ABS pool airline ratings issued recently by our global airline corporates team. Non-rated airline assumptions were also reviewed with many airline ratings assumed to move lower, specifically for smaller, weaker regional airlines with poor financials or operating metrics. This updated view on underlying airline credit assumptions is a key driver of these actions.
Transactions placed on RWN were driven principally by greater near term risk from the immediate impact of deteriorating airline pool lessee credit. This is due to the overall global impact of the coronavirus to the travel sector, and heightened probability for airline defaults and/or lease deferrals, and thus potential declines in ABS cash flows. This was coupled with reviewing risks related to implied cash flow coverage sensitivity levels; asset risks such as potential value declines on widebody aircraft; ongoing deal performance metrics and cash flows paying down the waterfall; and structural features such as implications to debt service coverage ratio (DSCR) triggers, and other features.
Any immediate material airline lessee lease deferrals hitting transaction cash flows and/or airline defaults/bankruptcies resulting in aircraft groundings or storage, can result in negative rating actions. Fitch will take into account lease deferral terms as information filters through, and apply to individual transaction analyses accordingly.
Fitch is currently reviewing and addressing tranches placed on RWN. This will involve running bespoke asset and liability cash flow modeling, including updating revised airline rating and default assumptions; revisiting asset specific assumptions/stresses specifically on widebody aircraft value/appraisal assumptions; and potentially applying additional stresses where deemed appropriate, given the ongoing pandemic and hit to the sector.
To reiterate, updated airline credit assumptions and modeled cash flow results will be the key factors in resolving RWN actions during this review. This will be most applicable for subordinate notes on RWN, and specifically be more impactful on class B and C notes currently rated 'BBBsf' and 'BBsf'.
Although vulnerable to increasing industry risks, tranches assigned a Negative Outlook are viewed as more resilient in the short term due to the following factors, or a combination thereof, including less exposure to risky airline credits; a more attractive aircraft mix comprised solely/mostly of more in-demand narrowbody aircraft; stronger initial modeled cash flow coverage and thus a level of cushion built in; or are performing within initial expectations and paying down as scheduled all the way down to equity.
Fitch expects a significant global economic impact to the travel and aviation/airline sectors from the pandemic, due to the recent and sudden global airline groundings and revenue/financial body-blow to airlines backing ABS pools. Additionally, there is a lack of clarity on the potential length of the impact at this time. Such ongoing stress and uncertainty driving the rapid decline of many airline ABS credits globally, will be a key when assessing rating actions.
While Fitch acknowledges that government support and/or consolidation initiatives may provide support to some airlines, the form of support and details are unclear at this point and the agency will consider implications as more information becomes available.
RATING SENSITIVITIES
Down Sensitivity
Fitch expects to resolve the Negative Watch within the next six months, and actions will consider both forecasted ABS cash flows and structural protections/mitigants. Downgrades are possible if there are airline defaults/bankruptcies or lease deferrals resulting in immediate material decline in cash flows, or impacts to structural features such a DSCR triggers tripping. This includes notable increases in transaction loan-to-values (LTVs) that impair credit enhancement, and will take into account pool transaction performance metrics, as well as forward looking scenarios that stress transaction liquidity and cash flows.
Should overall cash flows or transaction performance across individual tranches return to expected or initial levels, then classes may be removed from RWN or the Negative Outlook revised and affirmed. This includes stabilization of and/or government support for ABS pool airline credits; and aircraft/engine demand and values holding steady and not declining materially specifically for widebody aircraft in coming months; and no material impact to performance metrics, cash flow or structural features.
Up Sensitivity
Rating upgrades are limited as Fitch caps the aircraft ABS sector at 'Asf' ratings. This is due to heavy servicer reliance, historical asset and performance risks and volatility, and its pronounced exposure to exogenous risks. This was evidenced by the effects of the events of Sept. 11, 2001, the 2008-2010 credit crisis and pandemic disease scares like coronavirus, all impacting demand for air travel. Finally, the risks that aviation market cyclicality presents to these transactions are compounded because when lessee default probability is highest, aircraft values and lease rates are typically depressed. Fitch also considers jurisdictional concentrations per the "Structured Finance and Covered Bonds Country Risk Rating Criteria," which could result in lower rating caps. Hence, senior class 'Asf' rated notes are capped and there is no potential for upgrades at this time.
As it relates to subordinate class B and C notes rated 'BBBsf' and 'BBsf', rating upgrades across our rated portfolio are not possible at this time given the ongoing pandemic and impact on aircraft ABS. However, a key driver of potential upgrades for the subordinate notes would be corporate airline rating upgrades and resulting positive impact to ABS assumptions, and cash flow coverage levels. This is followed by aircraft values/appraisals increasing and a resulting decline in LTVs sustained over a period of time.
BEST/WORST CASE RATING SCENARIO
Ratings of Structured Finance transactions have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of seven notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of seven notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings https://www.fitchratings.com/site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com