S&P: Ratings Assigned To ABS Truck Lease Transaction FCT Eurotruck Lease III
ETL III is a new structured untranched issuer arising from the restructuring of the existing operating truck lease securitization--ETL II and the underlying euro - and British pound sterling-denominated RCF--which closed in 2004 and was subsequently restructured in 2008, 2012, and March 2016.
Economic Outlook In our view, changes in GDP growth and asset values largely determine the performance of truck lease portfolios. We have therefore considered the macroeconomic outlooks in France and Spain when determining our base-case credit assumptions. Moreover, we captured the risk linked to the state of the second-hand truck market through our residual value risk analysis.
Operational Risk The originator and servicer in this transaction is the Fraikin Groupe (Fraikin), the largest long-term truck hire provider in Europe, with leading positions in France and Spain. It manages a fleet of more than 57,000 vehicles, employs about 2,800 people across Europe, and has generated a turnover of €656 million in 2015. We visited Fraikin in October 2015 and believe that the company's origination, underwriting, servicing, and risk management policies and procedures are in line with market standards and are adequate to support the ratings assigned.
Our operational risk criteria focus on key transaction parties (KTPs), the potential effect of a disruption in the KTPs' services on the issuer's cash flows, and the ease with which a KTP could be replaced if needed (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014). In this transaction, where underlying assets are operating leases for vehicles that require maintenance, we have assessed under this framework the servicer, Fraikin, and the back-up servicer, Oliver Wyman. We classified the latter as warm under our operational risk criteria. Based on our view of the servicer's capabilities and the implemented back-up servicer setup, which aims to ensure the continuity of the lease contracts in a Fraikin insolvency scenario, our operational risk criteria do not constrain our ratings in this transaction.
Credit Risk We analyzed credit risk under our European consumer finance criteria using dynamic net loss data for France and Spain for the originator's book, and we determined annual net loss base cases for each country (see "European Consumer Finance Criteria," published March 10, 2000). We then derived gross loss cumulative base-case assumptions by combining our recovery assumption and a stressed portfolio weighted-average life of two years.
We set a high-range default stress multiple of 2 at the 'BBB (sf)' rating level for our base-case assumption, to account for the nature of the loss data received and the reprocessing they required.
As the transaction re-invests principal collections into new receivables during the five-year replenishment period, there is a risk of portfolio deterioration through substitution. To account for this risk, we considered at the start of the amortization a worst-case asset pool based on the implemented concentration limits, with notably the maximum allowed residual value exposure of 33% of the long-term lease value. Any other adverse distortion of the portfolio during the revolving period in terms of asset types or country exposure would be mitigated by the dynamic overcollateralization, which would adjust according to the actual composition of the asset pool. The transaction also benefits from the protection of certain performance triggers, which would stop the replenishment period if the transaction's performance were to deteriorate substantially.
As Fraikin provides fleet leasing to commercial and industrial clients, the lease portfolio exhibits significant obligor concentration. To account for this lack of granularity, we factored the risk of the simultaneous default of several large lessee groups (the top six obligors at the 'BBB (sf)' rating level) into our credit analysis by including a concentration floor in our stressed gross loss assumptions.
In the normal course of its business, Fraikin does not sell the trucks coming back from defaulted lessees; instead, these trucks are converted from long-term leases to short-term leases. As a result, standard cumulative recovery data were not available, and we derived our 65% base-case recovery assumption essentially on the basis of comparable truck lease transactions but also on the basis of proxy recovery metrics provided by Fraikin. To account for these data limitations, we considered conservative recovery rate haircut assumptions of 45% at the 'A (sf)' rating level, and 40% at the 'BBB (sf)' rating level.
Following our analysis and the application of our European consumer finance criteria, we have affirmed our 'A (sf)' and 'BBB (sf)' ratings on ETL II's outstanding senior and subordinated VFNs, respectively. We have also affirmed our 'BBB (sf)' ratings on the underlying RCFs.
Market Value Risk In the liquidation scenario we considered, the transaction is exposed to truck residual values through liquidation of vehicles either at contract maturity for long-term leases or during the year following the start of the early amortization period for short-term leases. We considered a base-case market value decline assumption of 22% at the 'BBB (sf)' rating level, which we then adjusted to account for the good truck manufacturer diversification and the historical sale performance per vehicle types in each country.
The transaction relies on the external appraiser, l'Argus, the market leader in France and Spain, which provides monthly vehicle valuations. As per the transaction documentation, these are factored into the asset base-case value against which FA can borrow, after adjustment for risk and senior costs.
Payment Structure And Cash Flow Analysis We have assessed the transaction's documented payment structure. During the five-year revolving period, the transaction benefits from the protection of an asset/liability test: If the loans granted under the credit facility--including both its term and revolving parts--exceed the borrowing base (the asset base value, adjusted for credit risk and senior costs), then the transaction would immediately enter into early amortization.
The transaction uses two successive pass-through combined priorities of payments, one at the level of the term loan facility and the other one at the level of the structured issuer, ETL III. The transaction also benefits from a liquidity mechanism, implemented at the levels of ETL II, through liquidity notes, and the credit facility, through liquidity tranches. It aims to cover six months of term notes' interest and certain senior costs.
Interest due on the term loan and the term notes is subject to a step-up from the start of the scheduled amortization period, which is subordinated in the priorities of payments. Our ratings do not address the payment of such step-up.
Our analysis indicates that the dynamic credit enhancement available to the term loan and the term notes--derived from the advance rates for each subpool--is sufficient to withstand the credit and cash flow stresses that we apply at the 'BBB (sf)' rating level (see "Global Framework For Cash Flow Analysis Of Structured Finance Securities," published Oct. 9, 2014).
Counterparty Risks The transaction is exposed to counterparty risk through seven account banks providers, six hedging providers, and six liquidity providers. On the asset side, the underlying leases pay constant monthly rents. On the liability side, the term loan granted by CACIB to FA pays at a fixed rate, as do the term notes issued by ETL III. However, the RCF granted by CACIB to FA, alongside the term loan facility, pays a floating interest rate. To hedge this interest rate risk, FA entered into a basket of hedging contracts.
The downgrade and replacement languages are in line with our current counterparty criteria to mitigate these risks (see "Counterparty Risk Framework Methodology And Assumptions," published on June 25, 2013).
Legal Risks FA, the term loan debtor, is an operating company into which the bulk of the assets of Fraikin have been isolated for the purpose of the securitization. We analyzed this entity under our European legal criteria and consider it to be bankruptcy remote (see "Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance," published Sept. 13, 2013). The term notes issuer, ETL III, is a "fonds commun de titrisation" (FCT), a special-purpose entity (SPE) dedicated to securitization, which is bankruptcy remote under French law.
In our view, the transaction is not exposed to commingling risk, as all lessees have been notified and pay directly into FA's general account. The transaction is not exposed to deposit set-off risk, as the originator is not a deposit-taking institution. Furthermore, transaction counsel has confirmed that intra-group leases do not generate any set-off risk. Finally, some specific Spanish law risks are covered by dedicated cash reserves.
Scenario Analysis We have analyzed the effect of a moderate stress on the credit variables, and the ultimate effect on our ratings on the notes (see "Scenario Analysis: Gross Default Rates And Excess Spread Hold The Answer To Future European Auto ABS Performance," published May 12, 2009). To this end, we ran one scenario, the results of which are in line with our credit stability criteria (see "Methodology: Credit Stability Criteria," published May 3, 2010).
Sovereign Risk The maximum exposure of the transaction to public lessees is limited to 20% of the aggregate long-term lease value. Our long-term ratings on France and Spain are 'AA' (unsolicited) and 'BBB+', respectively. Therefore, our nonsovereign ratings criteria do not constrain our ratings on the classes of notes rated below BBB+ (sf) (see "Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," published June 14, 2011).
However, our recent update to these criteria, which become effective on Aug. 29, 2016, may affect the ratings on the senior outstanding VFN in the ETL II transaction (see "Structured Finance Criteria For Rating Above The Sovereign Published," published on Aug. 8, 2016). Until such time that the new criteria become effective, we will continue to rate and surveil this transaction using our existing criteria (see "Related criteria").