Scope Ratings publishes its final ‘Aviation Finance Rating Methodology’ after a call for comments. The methodology uses an expected loss approach and applies to aviation finance transactions backed by commercial aircraft and engines.
The feedback received did not lead to any changes being made to the methodology proposed in the call-for-comments paper. The methodology is now final.
Scope’s aviation finance rating methodology goes beyond the traditional emphasis on probability of default, by calculating the loss given default for each period of the transaction contributing to total expected loss.
The rating agency believes that the focus on expected loss adds value for investors, as it properly reflects the risk-mitigating function of security, which improves credit differentiation. Scope includes aviation industry considerations in the credit risk evaluation of aircraft-finance transactions.
Expected loss. Scope’s aviation finance ratings reflect the expected loss on a debt instrument secured by commercial aircraft. This methodology focuses especially on the analysis of the severity to the investor by estimating recovery rates after an event of default.
Supported by real data. Aircraft are analysed individually based on their specific characteristics. Scope derives value-stress assumptions from historical data, linking stress to aircraft characteristics. These historical trends are also applicable to future market values of new aircraft sharing the same characteristics. This allows the consideration of new aircraft models and transaction-specific ratings with no general, overarching rating caps.
Industry perspective. The methodology incorporates and accounts for the factors and transaction characteristics which the industry believes impact credit risk. The methodology also integrates aviation-specific features. Scope’s approach results in credit ratings that focus on the same risk areas relevant to aviation finance investors.
Credit differentiation. Scope’s analysis relies on input assumptions which are instrument-specific. This fundamental, bottom-up approach captures the risk of each aviation financing transaction without resorting to top-down generic assumptions. Scope’s approach allows for greater differentiation between both ratings and aircraft types, ensuring appropriate credit is given to the underlying security.
Lessor involvement. Scope reflects the involvement of lessors and technical asset managers in a transaction, examining the alignment of interests between the service provider and the investor. This is an important driver of a transaction’s expected performance.
No mechanistic link to sovereign credit quality. Scope does not mechanistically limit the maximum rating an aviation transaction can achieve based on the credit quality of the country in which the the aircraft’s operator or owner is located. Instead, the agency assesses the efficacy of insolvency laws, convertibility risk, and the risk of institutional breakdown in the context of the tenor of each rated instrument. Scope also takes the macroeconomic environment into account.
Scope’s aviation finance credit ratings constitute a forward-looking opinion on relative credit risk. A rating reflects the expected loss associated with payments contractually promised under a secured credit exposure to aviation finance by its legal maturity, accounting for the time value of money at the rate promised to the investor.
Scope’s Aviation Finance Rating Methodology is applied in conjunction with Scope’s General Structured Finance Rating Methodology when portfolios of credit exposures to aviaton finance are securitised in a special purpose vehicle (e.g. aviation asset backed securities). Subject to adjustments, a similar analytical framework can be applied to transactions secured by aircraft engines, such as engine leasing transactions.