Fitch Downgrades Rio Oil Finance Trust Notes to 'B'; Outlook Remains Negative
--USD2 billion series 2014-1 notes to 'B' from 'BB-';
--BRL 2.4 billion series 2014-2 special indebtedness to 'BB+ sf (bra)' from 'Asf (bra)';
--USD1.1 billion series 2014-3 notes to 'B' from 'BB-';.
The Rating Outlook remains Negative. Fitch's ratings on the notes address timely payment of interest and principal. Interest payments reflect the amended cash flow distributions and principal payments consider all monthly early principal amortization payments received during a given quarter.
The issuances are backed by royalty flows owed by oil concessionaires, predominantly operated by Petroleo Brasileiro S. A. (Petrobras), to the government of the State of Rio de Janeiro (RJS). The State of Rio de Janeiro assigned 100% of these flows to RioPrevidencia (RP), the state's pension fund, and RP sold these rights to Rio Oil Finance Trust, the issuer.
The downgrade of the notes reflects the adjustments in cash flow distributions during the early amortization period which include a change in the interest payment schedule and the monthly release of the debt service reserve account. While these mechanisms provide for a more rapid amortization of the notes, in Fitch's opinion, these structural changes increase potential liquidity risk of the transaction. Although the overall cash flows have stabilized and the transaction has partially de-levered, timely debt service is more exposed to any potential disruptions.
KEY RATING DRIVERS
Increased Exposure to Liquidity Risk: In Fitch's opinion adjustments in the cash flow distributions during the early amortization period which include a change in the interest payment schedule to monthly from quarterly and the monthly release of the debt service reserve account increase the transaction's exposure to liquidity risk. With this change the structure does not benefit from the existing liquidity reserve account and can no longer withstand short term variations in cash flows.
Faster Than Expected Deleveraging: Given the monthly release of the debt service reserve account the transaction will benefit from a faster than pace of amortization than originally expected, reducing overall debt service. However, this accelerated amortization reduces excess cash flows returned to the State, and, in turn, increases the transaction's exposure to potential political risk. In addition, the state's liquidity constraints, evidenced by various delays in commercial and other payments, have heightened this political risk
Oil Prices Impact Performance: The reduction in oil prices depleted oil royalty flows such that Annualized Average DSCR (AADSCR) as of Q2 2016 fell to 1.8x. Although a recent uptick in oil prices benefits royalty flows, which coupled with the deleveraging of the transaction, is expected to translate into higher AADSCRs going forward, a sustained low oil price environment will limit royalty flows used to pay debt service.
Future Expected Production Increases at Risk: The transaction benefits from growth in production levels as it increases the total royalty flows. Depressed oil prices have led Petrobras to reduce production targets on multiple occasions. Therefore, sustained low oil prices could translate into further capital expenditure cuts by Petrobras.
The ratings are capped by the credit quality of Petrobras, the main obligor generating cash flows to support the transaction, and to the sovereign rating and country ceiling assigned to Brazil.
The transaction is exposed to oil price and production volume risks. Declines in prices or production levels significantly below expectations may trigger downgrades.
Additionally, the ratings are sensitive to the rating of Banco do Brasil as a direct counterparty to the transaction.
USE OF THIRD-PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G-10
Form ABS Due Diligence-15E was not provided to, or reviewed by, Fitch in relation to this rating action.