Until recently, the capital markets for aircraft ABS leasing transactions were effectively closed due to the COVID-19 pandemic. Given the prolonged steep decline in global commercial air traffic, market participants have been seeking clarity about S&P Global Ratings' rating considerations for new aircraft ABS transactions. Below we answer some frequently asked questions.

Frequently Asked Questions

What factors will you focus on when rating new aircraft ABS transactions?

Our analysis of the assets generally focuses on the characteristics of the collateral pool, including the age and type of aircraft, the lessee credit quality and domicile, the length of contractual cash flows, and the strength of the servicer. Our structural analysis further focuses on the amortization profile of the notes, the adequacy of the reserves, and the existence of performance triggers to redirect cash flows if the assets are underperforming.

Given the lingering uncertainties in the market and the prolonged steep decline in global commercial air traffic, we would (for now) consider favorably a transaction that is backed by a pool of younger-generation, in-production aircraft that are on lease to strong obligors and/or flag carriers; has long contractual cash flow; and is managed by a servicer with significant experience operating through a downturn.

What are the rating assumptions for new transactions?

Our analysis of aircraft ABS transactions is generally based on our aircraft lease criteria, see "Revised Cash Flow Assumptions And Stresses For Global Aircraft And Aircraft Engine Lease Securitizations," published Aug. 26, 2010. Our methodology focuses on the factors outlined in table 1.

Table 1

However, in September 2020, we made certain adjustments to our rating assumptions when we resolved our pandemic-related CreditWatch negative placements (see "Various Actions Taken On Aircraft And Aircraft Engine ABS Transaction Ratings Previously Placed On Watch," published Sept. 15, 2020). Specifically, we front-loaded defaults in years one and two of the first recession, assumed a 22-year useful life for portfolios that have a weighted average age greater than eight years, extended the aircraft on the ground (AOG) time during the first recession, and differentiated the AOG time for widebody and narrowbody aircraft. We also made a criteria exception for the AOG assumptions during our September 2020 review. Tables 2 and 3 show a comparison of these assumptions.

Table 2

Table 3

We expect to continue applying the September 2020 rating run assumptions throughout the pandemic and the subsequent recovery period. Depending on the stage of recovery, we may consider adjustments to certain assumptions. For example, in our September review, we allocated lessee defaults over a two-year period during the first recession, with 55% of the projected default rate in year one and 45% in year two (a 55/45 default pattern), to reflect the sudden and immediate impact of the COVID-19 pandemic rather than running our typical 25/25/25/25 default pattern. Going forward, we may consider spreading out defaults over a three- or four-year period.

Will you continue to apply an additional stress to starting aircraft values?

The starting aircraft value we use in our cash flow modeling is generally the lesser of the mean and median (the LMM value) of the aircraft half-life base and market values from three recognized appraisers. We typically exclude from the LMM value, appraised values that are 25% higher or lower than the average of the other two appraised values provided for a particular aircraft. We will continue to review the comparability of appraisals and apply this adjustment.

We may also stress appraised values to the extent we believe they do not capture current market conditions. For example, in our September 2020 review of the transactions we rate, we applied 50% of our 'B' lease rate decline stress to haircut the initial portfolio values of the transactions for which we did not receive updated appraisals. The final haircut to initial values in our model, based on this approach, ranged from approximately 10% to 15%, which was within the value decline ranges estimated by most appraisers at that time. For each aircraft in a pool, the lease rate decline stress includes an evaluation of the liquidity of the resale market and the risk that the aircraft will become economically unattractive due to advances in technology or regulatory changes.

Will you change your assumptions on useful life considering the current market conditions?

We typically assume useful life of up to 25 years for new passenger aircraft. If we believe certain aircraft are more likely to be retired early because of the dramatic decline in commercial air travel, we may decrease our useful life assumptions. Under our methodology, we assume an aircraft is sold at the end of its useful life and at its depreciated value, including an additional stress on residual values if the aircraft is sold during a recession. We believe certain older widebody aircraft, such as the Boeing 777, could be more vulnerable to early retirement because they are costly to reconfigure and had experienced some softening in the secondary market prior to the pandemic.

For most of the transactions we rated in recent years, we ran multiple scenarios assuming useful life of 25 years and 22 years, and, for older portfolios, a management case based on the servicer's expectation of when the aircraft is likely to be sold or parted out. We considered whether these applicable runs passed the relevant rating-level stresses before assigning a rating.

Is there a minimum number of lessees required to rate a transaction?

Our criteria do not explicitly require a specified number of unique obligors, but it is intended to apply to a pool of obligors. We run CDO Evaluator to assess the credit risk of the pool. The CDO Evaluator performs Monte Carlo simulations of defaults and two additional supplemental tests: the largest obligor and geographical concentration tests. The geographical concentration test only applies to tranches rated 'AA-' and above.

Each tranche must have sufficient credit enhancement to pass the highest of the scenario default rates (SDRs) and the outcomes of the largest obligor and geographical concentration tests. For previously rated transactions with a typical diversified pool of obligors, the SDRs were the rating constraint. For pools with fewer than approximately 10 obligors, we expect that the supplemental tests' results would be the constraining factor. We may further stress the results of the supplemental tests to address the inherit risk associated with a concentrated pool of obligors that operate in one industry. Depending on how small the pool of obligors is, we may consider whether the transaction is better suited for our corporate methodology (see "Request for Comment: Methodology and Assumptions for Rating Aircraft-Backed Debt and Enhanced Equipment Trust Certificates," published Nov. 18, 2020, and "Criteria for Rating Aircraft-Backed Debt and Enhanced Equipment Trust Certificates," published Sept. 12, 2002).

What are your rating assumptions for business jet and aircraft loan transactions?

We generally apply the same framework we use for commercial aircraft securitizations to typical business jet ABS and aircraft loan transactions. We conduct stress tests that factor in aircraft depreciation, recessionary assumptions, loan and lessee defaults, lag time to sell the aircraft upon lease expiry or upon default, and stressed security deposit requirements.

One key difference in rating business jet and aircraft loan transactions is that they have no re-leasing component. We assume the aircraft loans and the business jet finance leases amortize according to a schedule, subject to our default assumptions. For an operating lease, we assume the aircraft will be sold at the end of its first lease after a recovery lag period. For defaulting assets, we assume a recovery lag period before the asset is sold. The recovery proceeds generated depends on the value of the aircraft at the time of sale compared to the par amount of the loan. (For information on related aircraft transactions, see "Presale: Business Jet Securities 2021-1 LLC," published Feb. 24, 2021, and "Presale: PK Air 1 L.P.," published Dec. 2, 2020)

What general themes you have been hearing from servicers?

Since the onset of the COVID-19 pandemic, we have proactively reached out to, and have had periodic conversations with, aircraft lessors and servicers for transactions we rate. Many servicers have indicated that the recovery is slower than they had initially expected, partly due to challenges in the vaccine roll out.

We've learned that aircraft lessors are attempting to manage their relationships with lessees and are generally trying to work with them rather than resorting to repossessions. Power-by-the-hour lease agreements, which in some cases include a minimum flight hour clause, offer a temporary solution for airlines focused on conserving cash. These leases may be structured to include a period where payments are based on power by the hour (or actual use), followed by a set lease rate.

We also understand that aircraft maintenance costs are now more competitive, given the decline in demand because aircraft maintenance has generally been deferred due to low utilization rates. Further, the engine market may pick up before the aircraft market as airlines choose to use available "green-time" (engines that still have some use) rather than performing maintenance, which can be more costly.

Overall, we expect domestic leisure travel will likely lead the aircraft industry's recovery, with business travel lagging.

How frequently do you review outstanding transactions?

We conduct quarterly, annual, and event-driven reviews of the aircraft asset transactions we rate. We complete quarterly reviews of each transaction's key performance metrics, and a transaction could be flagged for a full review committee if we believe its performance has deteriorated beyond our expectations at the requisite rating level. Our annual review comprises a full review of each transaction, including cash flow analysis, and may also result in a committee review. When a quarterly or annual review results in a committee referral, we conduct a full analysis of the ratings within six months of the referral date. Our event-driven reviews could include more frequent evaluation of a transaction's performance or ratings, based on a specific occurrence.

The COVID-19 pandemic's impact on the aircraft sector has prompted monthly reviews of key performance metrics, which include us requesting more frequent deferral and forbearance updates from lessors and having frequent discussions with issuers.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.