Fitch Downgrades Lancer Finance Company Ltd's Sr Secured Notes to 'C'
The notes were backed by flows related to a long-term charter and services agreement signed with Petroleo Brasileiro S.A (Petrobras: 'BBB-'; Negative Outlook) for the use of the drillship S.C. Lancer. Schahin Engenharia S.A. was the operator of the drilling rig. The notes also benefit from a naval mortgage on the vessel S.C. Lancer, a dynamically positioned drilling unit that until April 2014 was operating on the offshore waters of Brazil.
KEY RATING DRIVERS
Fitch's rating action on the notes reflects the depletion of reserve funds available to pay debt service. On July 20, 2015 Fitch received notification from the indenture trustee indicating that the majority controlling party had instructed the indenture trustee to use available reserve account funds to fund a legal reserve account, pay transaction expenses, pay interest due on the notes and prepay the notes in an amount equal to approx. $21.8 million. The current reserve consists of $2 million deposited in an account to cover future legal expenses and fees and $370 thousand in the operations reserve account in the form of a letter of credit.
The indenture trustee does not expect to receive any collections or cashflows over the near term. While noteholders may have maximized their recovery in net present value terms by using the reserve fund to prepay debt, this reduces the available liquidity within the transaction and reduces the available time to sell the vessel to meet debt service payments on a timely basis.
As previously noted by Fitch, the accelerated deterioration of the credit quality of the Schahin group (Schahin) heightened the risk of a termination of the charter and services agreements for the S.C. Lancer. As a direct result of its financial problems, Schahin suspended operations of five drilling vessels including S.C. Lancer on April 2015. The long-term charter and service agreements with Petrobras were the main source of cashflows to the transaction. Since May 2015, timely debt service payment has relied on funds available in the reserve accounts. Now that these funds have been depleted to partially prepay the notes, the transaction is at risk of imminent default.
RATING SENSITIVITIES
Failure to make contractually required payments of principal or interest would cause Fitch to downgrade the bonds to 'D'.
DUE DILIGENCE USAGE
No third party due diligence was provided or reviewed in relation to this rating action.
RECOVERY ESTIMATES
Fitch assigned an RE100 to the notes. Fitch assigns recovery estimates (REs) to all classes rated 'CCC' or below. REs are forward-looking, taking into account Fitch's expectations for principal repayments on a distressed structured finance security.
Fitch's RE relates to an estimate of the potential cash flows generated by the liquidation of the assets under current market conditions. REs are not intended to represent the actual recovery noteholders may get upon sale of the underlying vessels or potential restructuring of the notes.
On December 2014, Fitch received an appraisal from DNV GL Noble Denton Marine Assurance and Advisory for the S.C. Lancer drillship. According to this appraisal, the value of S.C. Lancer without giving credit to the Petrobras contracts was approximately 199 million. Fitch notes this valuation does not reflect current market conditions including the dramatic change in supply and demand dynamics over the past year. Additionally, the potential legal fees and complexities incurred to repossess and sell the asset could result in significantly lower net proceeds from liquidation. The agency also notes given current market conditions, the noteholders may not choose to incur additional expenses to repossess and attempt to sell the asset. However, given the relatively low outstanding balance on the notes, the collateral could be liquidated using a significant haircut and recovery proceeds would still be sufficient to cover the current outstanding principal amount. Therefore, Fitch assigned an 'RE100' to the notes.
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