It hasn't been smooth sailing for cruise ship transactions recently. Following the downgrade of Royal Caribbean Cruises Ltd. (RCCL) to double-B-plus from triple-B-minus, S&P and Moody's placed both the Cruise Ship Finance transactions' triple-B-minus ratings on watch negative.

Despite an earlier action taken by S&P to remove both the Cruise Ship Finance I & II from negative watch in late September, last week Moody's downgraded the 324 million tranche of Cruise Ship Finance II to Baa3 from Baa2. It's a move that comes as little surprise as market analysts protested the earlier S&P action based on reservations regarding the length of time still left on the deal.

According to Dresdner Kleinwort Wasserstein the earlier decision to remove both transactions from negative watch did not reflect the consideration that the note holders would be repaid from the payment made by RCCL to the originator, Chantiers de L'Atlantique, for the vessel. Cruise Ship Finance Ltd., the first in the series completed last year, was expected to include payment for three vessels. However, amid the construction of the first two vessels, RCCL was placed on negative watch; as a result the third vessel was funded through Cruise Ship II.

Credit quality woes

In early September, following the terrorist attacks, both Cruise Ship transactions were placed on negative watch. Shortly thereafter, S&P and Moody's took the first transaction off watch because the deal was near completion. It was determined that with so little time left in the transaction life the RCCL downgrade, which took place earlier in the year, would be of little consequence

The final payment date for the ships, to fully amortize the notes, was made on September 3, 2001, leaving no further dependence on RCCL's credit quality.

However, the third vessel accounted for in Cruise Ship II has an expected delivery date scheduled for April 26, 2002. The six-month grace period allotted for payments in the transaction would mean that RCCL would have until late October 2002. Since the note holders have exposure to the credit quality of RCCL, should RCCL default and a buyer for the ship cannot be found, the deal may be exposed to term extended beyond maturity, reports Dresdner.

Cruise Ship II, which closed in March 2001, securitizes future receivables related to the construction and delivery of one cruise vessel. The notes are backed by units issued by the French Fonds Commun de Creance, a vehicle established under French securitization law, which are in turn backed by a receivable payable by RCCL upon the delivery of a cruise vessel provided by Chantiers de L'Atlantique, the originator.

Judging by the continuing deterioration of the tourism industry, there is also concern that the credit quality of RCCL might continue to disintegrate. Shortly after the September 11 attacks RCCL share prices fell over 50%. An analyst at Dresdner explained: "Noteholders could be exposed to the credit quality of RCCL for as long as 12 months should the company take full advantage of its grace period [and] S&P states that going forward any further changes in RCCL's credit quality may still affect the rating of Cruise Ship Finance II."

Cruise ship mitigants

keep deal afloat

While Moody's has assigned a downgrade, the fact that the rating's group chose to downgrade the deal by one notch rather than two notches highlights that the transaction contains mitigating factors that shield it from an RCCL default.

"The risk is relative to RCCL - but it is not a pure RCCL risk," said Paul Mazataud, vice president and senior credit officer at Moody's. "There are actually two mitigants - ALSTOM is providing a performance guarantee and a guarantee on the sale price. If for some reason RCCL does not pay for the vessel then it could be sold on the secondary market. If the sale price were below $290 million, ALSTOM would provide the difference between $290 million and the sale price with a maximum of $85 million. With the two-notch downgrade of RCCL, it could have led some to assume that a two-notch downgrade was in order but the impact of the guarantees made us decide that one notch was in order."

Hypothetically, if the best price the transaction can get in the secondary market is limited to only 10% of what was due by RCCL ($290 million), the Guarantor is committed to pay an extra 29% (or $85 million). From an SPV point of view it would still be considered as a 61% loss. Mazataud explains: "Under the terms of the deal the SPV can claim the remaining amount from RCCL and it could expect to receive some cash, thanks to this unsecured claim."

To be sure, Moody's assessment of the third vessel considered the possible scenarios that could occur during the remaining term of the transaction. The three determining factors included the rating of RCCL; the credit quality of the guarantee provider, ALSTOM, and the vessel's state of completion, which is due to be delivered early next spring.

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