In February, ratings agency S&P Global put Element's 2015 asset-backed securities deal (ECAF 2015-1) on "CreditWatch negative", usually the precursor to downgrading a deal. Since then, there has been a lot of buzz about what this means for the securitisation market.
But the answer is probably: not much.
Firstly, several deals are waiting in the wings, including one possibly launching later this month, which would suggest that a slowdown is not imminent.
But also it's important to consider S&P's rationale for putting the deal on watch. As the 3 February report states: "The CreditWatch negative placements reflect the aircraft portfolio's higher-than-expected value decline and resulting increased loan-to-value ratio (LTV) and reduced credit enhancement."
When the deal was reappraised this year, the portfolio values came in significantly lower than predicted. This is in partly a function of a recalibration in base values by one of the appraisers, Flight Ascend Consultancy, which changed its long-term view on aircraft values since appraising the Element portfolio in 2014.
"Our base values went through some fundamental review and recalibration in 2014 and 2015, which were pivotal years. Base values represent a long-term view, and as such we try not to have knee-jerk reactions to market movements, such as the economic downturn of 2008," says George Dimitroff, head of valuations at Flight Ascend Consultancy.
"In 2014, the industry had clearly emerged from the downturn on most metrics, so it was a good year to begin this recalibration."
Dimitroff explains that for some aircraft types with market values still significantly below base values, the base values still needed a fundamental correction downwards even though the market had recovered.
S&P's action is in line with the original read from Fitch Ratings, which rated ECAF 2015-1 one notch lower than S&P at "A-".
Issuers and bankers confirm to FlightGlobal that the ECAF 2015-1 potential downgrade has come up in discussions, but investors do not appear to be dissuaded.
Putting the deal on credit watch because of the shift in values is arguably somewhat misleading. Ratings agencies rate the debt not the equity. According to S&P, the deal is performing, with leases still generating cash flows and therefore repayments to the debtholders.
Bondholders in ABS deals invest for the reliable cash flows. The risk in these deals is the time to getting paid back. It could take longer than initially predicted, but only an apocalyptic scenario would leave the debtors unpaid at the end of a deal.
In fact, they could be paid off early like Castlelake just did with its first securitisation, CLAST 2014-1, repaying the debt in full nearly three years earlier than expected.
And while residual values do matter, because they determine the lease rental that the servicer can seek or demand if and when the aircraft comes of lease, the cash flows for the most part will continue once the aircraft is leased to the next customer, even if the lease is agreed at a lower rate. The deal will simply pay off slower than initially expected. But total repayment is virtually certain for the debt – whether senior or junior.
If the aircraft is not re-leased, eventually it will be sold at a discount or for parts, the profit of the deal being distributed down the capital stack from the senior to equity investors.
Deals can underperform, however. But for a deal to default, the issuer would have to fail to pay interest on the Class A notes, which is near-impossible according to one ratings agency which says it vigorously stress-tests all the deals to ensure that the senior debt gets paid back in every deal.
Yes, if the deals materially underperform compared with expectations it could be an issue for the market and eventually limit access for consumers of this type of funding, but there doesn't seem to be any evidence of the tide abating for now.
And while selling the E-note might slow down execution as equity investors may consider residual value risk more rigorously following the ECAF move, there are indications that, in addition to the two deals that came to market earlier this year, three more could close during the first half of the year. If so, more than two-thirds of the number of deals that closed in 2016 would have closed in 2017's first half, leaving six months for additional deals.
Despite some jitters in the market as a result of S&P's action, 2017 could end up being a record year for post-financial-crisis ABS issuance.
Source: Cirium Dashboard
