Fitch Ratings-New York-25 September 2018: Fitch Ratings has affirmed the following ratings on Virgin Australia Holdings Limited's (VAH, not rated) enhanced equipment notes (EEN) series 2013-1 (VAH 2013-1):
--Class A notes (expected maturity October 2023) at 'A+';
--Class B notes (expected maturity October 2020) at 'A-';
--Class C notes (expected maturity October 2018) at 'BB+'.
The ratings cover approximately $204.9 million of outstanding senior and subordinated notes.
KEY RATING DRIVERS
The ratings of the A-tranche and B-tranche notes are primarily driven by a top-down analysis which evaluates the level of overcollateralization and likely recovery in a stress scenario. Key ratings considerations include the quality of the aircraft collateral, significant overcollateralization, the Australian and New Zealand insolvency regimes coupled with the transaction's underlying structure, the liquidity facility, VAH's credit quality, and various additional structural elements.
Positive credit factors include the absence of balloon payments for the A and B tranches, short remaining expected maturity for the C tranche, and rapid amortization of the notes resulting in expected LTV improvements for all tranches within the next several years, until some aircraft fall out of the collateral pool, as described below.
The ratings for the class A and the class B notes are primarily based on collateral coverage in a stress scenario. The analyses utilize a top-down approach assuming a rejection of the entire pool in a severe global aviation downturn. The scenarios incorporate a full draw on the liquidity facility, and an assumed repossession/remarketing cost of 5% of the total portfolio value. Fitch then applies significant haircuts to the collateral value.
The earlier vintage 737-800s (2003 and 2004) in the pool receive a 25% haircut in Fitch's 'A' stress scenario representing the mid-range of Fitch's stress ranges reflecting the firm's view of these models as a good quality tier 1 aircraft. The later vintage 737-800s (2010 and 2011) receive a 20% haircut in the 'A' stress scenario, representing the low end of Fitch's stress ranges. The 777-300ER received a 30% haircut in the 'A' stress scenario.
Both A-tranche and B-tranche remain sufficiently overcollateralized to pass Fitch's 'A' level stress tests when incorporating the latest available aircraft appraisal data. This suggests that both the class A and the class B noteholders would be expected to achieve full principal recovery prior to the expiration of the transaction's liquidity facility even in a harsh downturn scenario.
The maximum loan to value (LTV) produced by Fitch's 'A' level stress scenario for the class A notes and the class B notes are 76.0% and 86.1%, respectively, which implies a material amount of cushion for both tranche holders. The maximum LTV in Fitch's stress scenario has increased incrementally from our last review, driven by deterioration of the aircraft appraised values compared to our previous expectations.
Unlike many other EETC transactions that feature smooth and constant LTV declines, LTV values of VAH 2013-1 are expected to increase on several occasions as older vintage aircraft are paid off and removed from the collateral pool. The largest increase in LTV is expected to occur in October 2018 when seven earlier vintage 737-800s and the 777-300ER will be fully paid off. The eight aircraft will represent approximately 50% of the pool's value and their exclusion from the collateral will increase Fitch's forecasted 'A' level stressed LTV for both the class A notes and the class B notes to 76.0% and 86.1% as of Oct. 23, 2018, respectively, up from 57.2% and 64.6% as of July 23, 2018.
The two-notch differentiation between the class A and the class B notes is driven by a higher level of overcollateralization and corresponding lower stressed LTV of the class A notes, and the subordinated position of the class B notes in relation to the class A notes.
The rating for the C-tranche is driven by Fitch's view of VAH's corporate credit profile, a high affirmation factor, superior recovery prospects driven by current collateral coverage and the rights of the C class note holders to purchase all of the senior notes in certain cases. The affirmation factor for this pool is considered high because both aircraft types in the transaction are core to VAH's fleet plan. The relatively large percentage of the company's primary aircraft type contained in this transaction makes it unlikely that the company would reject the pool in the case of administrative proceedings, in Fitch's view.
The ratings are also supported by a strong collateral package consisting of Tier 1 aircraft, an 18-month liquidity facility for class A and class B notes provided by Natixis S.A (Natixis, A/F1/Positive), cross-collateralization/cross-default features, and Fitch's assessment of the Australian insolvency regimes. The rating incorporates a secondary dependence on Fitch's assessment of the credit quality of VAH.
VAH 2013-1 is the first EETC-type transaction relying on the Australian insolvency regime, which is different in key aspects compared to Section 1110 and the Cape Town Convention (CTC, which incorporates most elements of Section 1110 protection in countries that have ratified the treaty) legal frameworks seen in most EETCs. Even though Australia ratified the CTC Alternative A on Sept. 1, 2015, the CTC rules do not apply retroactively, and Fitch expects VAH 2013-1 notes will be governed under the Australian insolvency law until maturity.
At the inception of the transaction, the pool contained six aircraft leased in New Zealand, a CTC signatory, and were covered by the CTC. In 2015, these aircraft were transferred to Virgin Australia International Airlines Pty Ltd, a subsidiary of VAH, and are currently governed by the Australian insolvency regime. Fitch believes Australia's legal framework, combined with the structure of this transaction, create a situation similar to Section 1110/CTC as it allows creditors access to collateral in the event of insolvency.
Unlike the majority of the EETC transactions rated by Fitch, VAH 2013-1 does not have large balloon payments for senior and subordinated tranches and amortizes rapidly. As a result, debt amortization significantly outpaces the depreciation of the asset values. This differentiates VAH 2013-1 from the majority of Fitch rated EETC transactions.
The 'A+' ratings on the class A notes is higher than the ratings of the class A notes for the majority of EETC transactions rated by Fitch driven by higher overcollateralization. The class A notes' LTV is comparable with those of 'AA' rated class AA certificates issued by both American Airlines (2017-2) and United Airlines (2016-1 and 2016-2), but the class A notes of VAH 2013-1 are not eligible for 'AA' category ratings per Fitch's criteria.
Fitch expects transactions rated in the 'AA' rating category not only to withstand the 'AA' level stress but also to exhibit certain qualitative characteristics including the expectation that a collateral pool backing a transaction will consist of 10 aircraft in all-narrowbody pools. Unlike the majority of EETC transactions, the VA 2013-1 collateral pool will decrease in size as the paid off aircraft are removed from the collateral pool. As a result, the collateral pool will fall below the 10 aircraft threshold by the end of 2019, rendering the transaction ineligible for the 'AA' category rating.
Similarly, the 'A-' ratings for the class B notes are higher than the ratings of the class B notes for the majority of EETC transactions rated by Fitch. The LTV of the class B notes of VAH 2017-1 transaction is comparable with those of 'A' rated class A certificates issued by both American Airlines (2017-2) and United Airlines (2016-1 and 2016-2). Fitch has derived the ratings of the class B notes utilizing a top-down approach that is a variation to Fitch's criteria, as described below.
The 'BB+' rating on the class C certificates is the highest rating assigned to a class C tranche by Fitch and is one notch higher than the class C certificates of two EETC transactions issued by Air Canada (AC 2015-1). The notching differential between the VAH 2013-1 class C notes and AC EETC class C certificates is driven by differences in recovery prospects (significantly higher for VAH). The ratings of the class C notes/certificates for both VAH and AC are also based on high affirmation factors.
Variation to Criteria:
Fitch may utilize either a bottom-up or top-down approach when initially rating senior subordinated tranches. Per Fitch's EETC criteria, for consecutive rating review purposes, Fitch will generally continue to rate a given sub-tranche by whichever method the initial ratings were assigned (i.e. a sub-tranche initially rated via the top-down approach will be rated via the same approach).
In 2016, Fitch changed the approach for rating the B tranche of the VAH 2013-1 transaction to top-down from the bottom-up approach utilized when Fitch initially rated the tranche B notes. Fitch utilized a bottom-up approach when the transaction was reviewed in 2014 and 2015. The rapid amortization of the transaction has resulted in significant and uncharacteristic overcollateralization of the class B notes, warranting a change in the rating approach for the senior subordinated tranches to a top-down approach. Fitch does not anticipate a change in approach for the majority of the other Fitch-rated senior subordinated tranches during subsequent reviews.
The change in the approach results in a two notch upgrade of the class B notes to 'A-' from 'BBB', while the bottom-up approach would have resulted in an affirmation of the notes at 'BBB'.
Ratings for this transaction are primarily driven by Fitch's assertion that the key nature of the aircraft collateral to the underlying airline effectively reduces the probability of default for the certificates due to the likelihood that VAH would affirm its obligations on these aircraft if it were to file bankruptcy (i.e. the affirmation factor). Fitch's recovery analysis gauges the transactions' recovery prospects if the aircraft were to be rejected amidst a harsh aviation downturn. The recovery analysis incorporates a full draw on the 18-month liquidity facility plus an assumption for repossession and remarketing costs of the aircraft.
Senior tranche ratings are primarily driven by a top-down analysis based on the value of the collateral. Therefore, a negative rating action could be driven by an unexpected decline in collateral values. For the 737-800s in the deal, values could be impacted by the entrance of the 737-8 MAX, or by an unexpected bankruptcy by one of its major operators. Fitch does not expect to upgrade the ratings of the senior tranche and senior subordinate tranche above the 'A+' and 'A-' levels, respectively.
The rating of the junior subordinated tranche is influenced by Fitch's view of VAH's corporate credit profile. Fitch will consider either a negative or a positive rating action if VAH's credit profile changes in Fitch's view. Additionally, the ratings of the junior subordinated tranches may be changed should Fitch revise its view of the currently incorporated affirmation factor.
Liquidity Facility: The class A notes and the class B notes of VAH 2013-1 feature an 18-month liquidity facility provided by Natixis, sufficient to cover six quarterly interest payments.
Transaction Overview / Debt Structure: VAH issued enhanced equipment notes (EEN) into the market to refinance a pool of owned Boeing aircraft. The initial collateral consisted of 21 Boeing 737-800s, two Boeing 737-700s and one Boeing 777-300ER and was sized at $797.3 million. In addition, the original transaction consisted of A, B, C and D tranches, however the D tranche was paid in full in the fourth quarter of 2016. The class C notes will be repaid on Oct. 23, 2018.