Fitch Downgrades Schahin-Sponsored Oil-Vessel-Backed Transactions, Remains on Watch

CHICAGO--()--Fitch Ratings has downgraded the following Schahin II Finance Company (SPV) Limited and Lancer Finance Company Ltd. notes:

--Schahin II Finance Company (SPV) Limited (Schahin II)

--Series 2012-1 senior secured notes due 2023 downgraded to 'BB-' from 'BB+' ($650 million outstanding).

--Lancer Finance Company Ltd. (Lancer Finance)

--Series 2010-1 senior secured notes due 2016; downgraded to 'BB+' 'from BBB-' ($80 million outstanding).

The ratings remain on Rating Watch Negative.

The Schahin II notes are backed by flows related to a long-term charter and services agreement signed with Petroleo Brasileiro S.A. (Petrobras) for the use of the dynamically positioned ultra-deepwater (UDW) drillship called 'Sertao'. Schahin Petroleo e Gas S.A. (Schahin P&G), the oil and gas arm of Brazilian-based Schahin Group (Schahin), is the operator of the vessel and primary sponsor of the transaction. The Lancer Finance notes are backed by flows related to a long-term charter and services agreement signed with Petrobras for the use of the dynamically positioned drillship S.C. Lancer. Schahin Engenharia S.A. is the operator of the drilling rig.

The rating actions reflect: (i) exposure to the deteriorating credit quality of the Schahin group; (ii) Fitch's view related to Petrobras' willingness to honor existing offshore charter and service agreements in the event of an operator or performance-related breach; and (iii) continued pressure on global day rates and asset values caused by stressed oil prices. Many of the risks facing Lancer Finance are significantly mitigated by the low leverage of the asset and additional structural enhancements. The Negative Watch primarily reflects the weakening credit quality of the sponsor.

KEY RATING DRIVERS

Credit Quality of Schahin: Fitch recently downgraded the Issuer Default Rating (IDR) assigned to Schahin Oil and Gas Ltd. (holding company) to 'B-' from 'B+' and placed it on Rating Watch Negative due to higher leverage, tighter liquidity, and the company's potential inability to roll over debt. The deteriorating credit quality of the Schahin group exposes both transactions to the potential risk of early termination under the charter and services agreements. These transactions are directly and indirectly exposed to sponsor risk as the underlying contracts have termination clauses that include operator bankruptcy and performance weaknesses. Furthermore, the deteriorating credit quality of the sponsor may affect its ability to operate the vessel, potentially impacting overall maintenance, general safety, and uptime performance.

Petrobras' Willingness and Ability to Honor Existing Agreements: Petrobras' rating ('BBB-'; Negative Watch) acts as ultimate cap to the structured finance (SF) transaction ratings. Fitch believes continued financial pressure on Petrobras may affect the company's ability to meet its projected capital expenditures (capex) and therefore its willingness to honor all existing charter agreements. While the exploration and production (E&P) contracts remain a strategic capex investment and the bulk of Petrobras' contracted fleet relates to production, Petrobras may decide to keep the most strategic and best operating assets within the chartered fleet while reducing costs on those vessels perceived as less attractive. Although the underlying assets backing the SF transactions have relatively strong historical performance, any considerable downtime in the future might increase the risk of contract termination.

Underlying Charter Agreements: While Petrobras has indicated its intention to continue honoring the terms of its existing offshore charter and service contracts, the company may choose to differentiate these payments in the future. In Fitch's view, the existing chartered day rates supporting the transactions remain in line with market prices, and the drilling rigs continue to remain essential to Petrobras' offshore production plans. While global supply may increase during 2015 and 2016, local supply of UDW drillships will continue to be constrained by the delayed delivery of the 28 new drillships from Sete Brazil. Existing local content requirements further protect these transactions, since typically international players do not have the same level of local content as existing Brazilian operators. Any changes in local content requirements must be approved by the federal government.

Exposure to Market Day Rates and Asset Prices: Fitch's base case analysis for the oil vessel-backed SF transactions assumes that the existing underlying contracts remain in place for the duration of the agreements. However, if any of these agreements terminate for any reason, the related transactions could be exposed to then current market conditions. Currently, contracted day rates remain in line with current market rates; however, a further long-term decline in oil prices may decrease market day rates below contracted day rates. Fitch believes exposure to contract termination varies for each transaction given the different loan-to-value (LTV) levels.

Low Leverage and Structural Enhancements Support Lancer Finance: The transaction benefits from extremely low leverage as the structured financing has continuously de-levered since closing in 2010. Assuming no payment delays under the charter and service agreements, the transaction is expected to fully amortize by June 2016. Furthermore, reserves provide six months of debt service and three months of operating expenses, which allows the transaction to have net debt close to zero within the next 6-9 months. Fitch conservatively estimates current LTVs to be in the range of 20%-30%, depending on various assumptions.

RATING SENSITIVITIES

The ratings are sensitive to conclusions of the Lava-Jato investigations and their impact on Schahin and the Brazilian oil and gas industry, changes in the credit quality of Petrobras as offtaker and its willingness to honor existing agreements, the operating performance of the rigs, and further deterioration of Schahin's quality as sponsor of the transactions.

Additional information is available at www.fitchratings.com.

Applicable Criteria and Related Research:

--'Global Structured Finance Rating Criteria' (Aug. 4, 2014);

--'Criteria for Rating Oil Vessel-Backed Financing in Latin America' (Dec. 18, 2014);

--'Fitch Downgrades Petrobras' IDRs to 'BBB-', Places Ratings on Watch Negative' (Feb. 3, 2014);

--'What Investors Want to Know: Lava Jato Implications' (Jan. 29, 2014);

--'Schahin II Finance Company (SPV) Limited' (April 9, 2012);

--'Lancer Finance Company (SPV) Limited Series 2010-1' (Sept. 30, 2010)

--'Petroleo Brasileiro S.A. (Petrobras) (Political Labyrinth)' (Feb. 213 2015)

Applicable Criteria and Related Research:

Petroleo Brasileiro S.A. (Petrobras) (Political Labyrinth)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=861961

Lancer Finance Company (SPV) Limited, Series 2010-1 (ABS)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=563549

Schahin II Finance Company (SPV) Limited

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=675613

What Investors Want to Know: Lava Jato Implications (Scandal Impacts Petrobras' Suppliers, Construction Companies and Drilling Rigs)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=861361

Criteria for Rating Oil Vessel-Backed Financing in Latin America

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=834309

Global Structured Finance Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=754389

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981220

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Contacts

Fitch Ratings
Primary Analyst
Cinthya Ortega
Director
+1 312-606-2373
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gregory Lane
Director
+1 312-606-2304
or
Committee Chairperson
Greg Kabance
Managing Director
+1 312-368-2052
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Cinthya Ortega
Director
+1 312-606-2373
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gregory Lane
Director
+1 312-606-2304
or
Committee Chairperson
Greg Kabance
Managing Director
+1 312-368-2052
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com