OREANDA-NEWS. August 31, 2015. Fitch Ratings downgrades the senior secured series 2010-1 notes issued by Lancer Finance Company Ltd to 'D' from 'C' following the recent missed payment of scheduled interest due in August 2015. The Recovery Estimate (RE) is revised to 'RE20' from 'RE100'. The outstanding balance of the notes is approximately \\$42 million.

The notes currently benefit from a naval mortgage on the vessel S.C. Lancer, a dynamically positioned drilling unit that until April 2015 was operating on the offshore waters of Brazil. Initially, the notes were also 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 this drillship. Schahin Engenharia S.A. was the operator of the drilling rig.

KEY RATING DRIVERS
Missed Scheduled Interest Payment: Lancer Finance Company failed to make the scheduled monthly interest payment due in August 2015. This follows the majority controlling party's opting to use the bulk of available reserve funds to partially prepay principal and interest.

Outstanding Reserves: Current reserves consist of \\$2 million for any future legal expenses and fees and a \\$370,000 operations reserve account in the form of a letter of credit. Approximately \\$20 million of debt service reserves were used to reduce the overall debt outstanding from \\$62 million to approximately \\$42 million on July 20, 2015.

RECOVERY ESTIMATES
Fitch revised the notes' RE to 'RE20' from 'RE100', reflecting the reliance on the disposition of the asset as the majority of reserves have been depleted. It is an estimate of the potential cash flows generated by the liquidation of the assets under market conditions.

Fitch assigns 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. REs do not reflect the potential recovery noteholders may get upon sale of the underlying vessels or potential restructuring of the notes.

Offshore drillers have been facing softening market conditions due to decreased demand and a significant backlog of newbuilds. The more than 50% drop in oil prices has compounded the effects of the oversupply cycle, resulting in a decline in market dayrates of roughly 50% from pre-cycle levels and heightened pressure on utilization rates. Fitch continues to believe that medium-term demand will rebound and absorb newer high-quality assets that operate more efficiently. However, Fitch has seen that older assets of lesser capabilities are being scrapped, since stacking these units may be expensive and unjustifiable in current market conditions.

While the S.C. Lancer could potentially be used in alternative markets meriting a higher value, Fitch is adjusting its RE to reflect its view that scrapping is the most likely recovery method. There have been several recent cases of rigs being scrapped worldwide. According to Fitch's estimates and considering the steel value of the rig at current prices plus the potential liquidation of spare parts such as risers, cranes and blow-out preventer (BOP), the agency has revised the notes' REs to 'RE20'.

While the liquidation of the reserve accounts increased overall recovery proceeds and reduced the debt outstanding to \\$42 million, the remaining recovery prospects now completely rely on liquidation of the asset. Additionally, Fitch notes that the potential legal fees and complexities related to repossession and sale of the S.C. Lancer could discourage the noteholders from choosing to incur additional expenses to repossess and attempt to sell the asset.

RATING SENSITIVITIES
The 'D' rating will be withdrawn within 11 months of today's date.

DUE DILIGENCE USAGE
No third-party due diligence was provided or reviewed in relation to this rating action.