Moody's Approach To Enhanced Equipment Trust Certificates In Bankruptcy

Summary

Enhanced Equipment Trust Certificate ("EETC") ratings are based on a combination of the risks of a cessation of payments from the airline obligor and the potential recovery available through the rapid access to and liquidation of collateral as provided for under Section 1110 of the U.S. Bankruptcy Code. The risk, and therefore the ratings, ofEETC's associated with an airline that has filed for bankruptcy protection will initially depend on:

1. The ability of the issuing Trust to continue making interest payments with advances from the liquidity facility,

2. The decision of the airline to use the aircraft in reorganization or return it to investors for liquidation, and

3. The value of the collateral and whether it is considered sufficient to prevent a loss of principal to Certificateholders if it is liquidated.

In rating EETC's after the bankruptcy of the underlying obligor, Moody’s expects:• The initial impact of the default to be muted, as the liquidity facility will function as intended, avoiding an immediate default of the Certificates. In many cases, the most senior tranches of EETC’s will retain low investment grade ratings at the time of bankruptcy of the underlying carrier.

• The airline will attempt to reorganize rather than liquidate. Under reorganization, the airline will affirm its obligations for some, if not most, of its aircraft. Pursuant to the provisions of section 1110, all payments due on related EETC’s will be brought current.

• Some aircraft will be returned to the Trust for liquidation within the 60 day guideline prescribed bysection 1110.

• The need to repossess and liquidate aircraft within a EETC will potentially have more negative rating implications for the transaction than if all aircraft were affirmed by the carrier.

• The loan to value exposure of Certificate holders will be a key element of risk, and any changes in Moody's assessment of realizable value of the relevant aircraft can cause a change in the ratings. The ratings impact will be more significant on the junior debt classes than on the senior classes.

• Absent a full resumption of payments from the airline or liquidation of collateral at adequate values, ratings of even the senior tranches of EETC’s could be adjusted by multiple notches over time, declining to a Caa level no less than six months prior to a potential default on the Certificates.

In the current environment, with multiple carriers in bankruptcy and significant pressure on aircraft values due to the surplus of unused jets in the market, some carriers have sought to reduce the rent and/or debt payments they make to the trusts that issue EETC’s. While such a change would not constitute a default at the EETC certificate level, it is not specifically contemplated in the documentation. Yet it could be achieved with investor consent.

Nevertheless, such reductions could increase expected loss for investors, and the loss will primarily affect junior tranches of EETC’s. In instances where such reductions occur, Moody’s will adjust ratings to reflect the new economics of the transaction; generally we anticipate that junior tranche ratings would fall by multiple notches while senior tranche ratings could be less severely impacted to the extent that full economic recovery is preserved.