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Fitch Ratings: Aviation ABS Outlooks Revised to Negative on Coronavirus Impact

March 24, 2020, 07:04 AM
Filed Under: Aircraft

Fitch Ratings has revised its sector Asset Performance and Ratings Outlooks for aircraft and engine asset-backed securities (ABS) to “Negative” from “Stable-to-Negative.” This change reflects material downside risks from the global spread of the coronavirus driving unknown and unique risks for the aviation industry versus prior pandemics and exogenous shocks, the degree of negative impact on airline lessee credit and aircraft value impairments that may occur, ramping up pressure on ratings.

Fitch is actively assessing its rated portfolio totaling $13.8 billion of outstanding notes, composed of 27 aircraft and 4 engine transactions issued from 13 lessor ABS platforms. While we rate 'through the cycle' and transaction structures offer protections, the ongoing spread/scale of the virus, its global impact, and policy measures instituted are unprecedented and beyond prior industry and business cycle downturns.

This action considers the weakening airline credit profiles stemming from the virus impact, as passenger travel collapsed and restrictions came into place with airlines cutting capacity on a massive scale in response. This is more acute for financially weak and/or smaller regional airlines across the globe comprising ABS lessee pools, but clearly all airlines globally are being impacted.

Fitch is reviewing the ABS portfolio to consider the escalating risks facing the industry, implications to lessees and collateral in underlying transactions, and the sharp weakening of the global macro landscape. As we assess the impact on ABS transactions, deteriorating airline lessee credit in securitized pools is the key credit factor driving our portfolio review.

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.

Key Credit Factors in Focus

The key credit factors we are monitoring/reviewing that could impact transaction cash flows and/or ratings include:

  • Deteriorating airline lessee corporate credit profiles, including rating downgrades and/or potential bankruptcy filings;
  • Declines in ABS cash flows resulting from such lessee defaults, lease deferments and/or restructurings;
  • Significant aircraft value impairments, specifically for widebody aircraft given current market supply and demand dynamics thereof; and
  • Sharp erosion in transaction loan-to-values that lower available credit enhancement levels and modeled loss coverage.

Fitch is also monitoring the virus-related impact on aircraft lessor credit profiles and their roles as servicers on ABS transactions. On March 16, 2020, Fitch revised the global aircraft lessor sector outlook to negative from stable, as reported by Equipment Finance Advisor.

Fitch rates ABS issued from mostly the large, more established lessors with a stronger financial wherewithal to be able to manage through downturns. However, lessors' ability to manage through the current stress and service ABS pools adequately will be tested, including their ability to manage multiple lessee defaults/bankruptcies simultaneously, repossessing and releasing aircraft, and containing costs. While lessors have historically benefited from the ability to move aircraft from regions or countries with weak demand to others with stronger demand, the global scale of the current stress can significantly impair this traditional risk mitigation strategy.

Biggest Risk to ABS is the Rapid Deterioration of Airline Lessee Credit

The massive decline in global travel demand is hitting airline revenues and financials on a scale never seen before, and lessors are fielding and assessing lease deferral or restructuring requests across rated ABS transactions. The combination of growing airline solvency risks and lease deferrals/restructurings is expected to weigh on aviation ABS cash flows and has elevated performance downside risks to existing transactions.

An important element of our initial ABS transaction rating analysis includes elevated airline default assumptions, particularly for those unrated airlines such as smaller, weaker regional airlines with poor financials or operating metrics across APAC/China, Europe (including Eastern Europe and Russia), and South America. While this approach builds in a level of cushion to withstand deterioration in individual airline credits, the scale of the current pandemic is having a profound impact on airlines, industry supply and demand dynamics that will challenge initial airline credit and collateral value assumptions; hence the revision to negative for the sector outlook.

We are working closely with our corporate airline team to understand the potential impact of coronavirus-related risks on airline credits in securitized pools. As airline credit profiles evolve, we will update airline rating assumptions in ABS pools, and these will be a driver of our analysis and potentially ratings in the weeks and months ahead. Further, we are pushing forward our recession timing in transactions to start now (from six-month following close initially applied). This change, combined with updated airline ratings, will drive modeled coverage levels and ratings.

Fitch believes that lessors have been selectively granting rent deferral and lease restructuring requests for a limited number of customers in instances where they believe they can protect the collateral and economic values of their aircraft and leases. However, a prolonged stress on the airline industry could increase the frequency of deferrals and restructurings, impairing ABS cash flows. We acknowledge that such deferrals or restructurings may require airlines to pay back these amounts within a short-term window and to the extent that this information is available, Fitch will take this into account when reviewing individual transactions and existing ratings.

A global jump in aircraft repossessions, including across ABS pools, could increase supply in the market and pressure residual values, particularly for widebody aircraft. This could drive material impairments and hit ABS cash flows when aircraft are sold or released at much lower lease rates. While Fitch has taken conservative residual value assumptions initially, which cover such stressed scenarios, we will continue to monitor market conditions and amend our assumptions if required.

ABS Structures Provide Support

Structural features in ABS transactions provide a degree of support against stressed scenarios that could occur in pools driven by airline defaults across our rated portfolio. These include debt service coverage ratios that can trip and sweep cash to pay down debt and nine-month liquidity facilities in place to cover interest payments. We will track transaction cash flow impacts in the months ahead as servicer reports become available.

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