Fitch Ratings-New York-14 March 2018: Fitch Ratings has assigned the following ratings to British Airways Plc's (BA; Issuer Default Rating BBB-/Stable) proposed pass-through certificates series 2018-1:
--$409,783,000 class AA certificates with an expected maturity of September 2031 'AA-';
--$198,957,000 class A certificates with an expected maturity of September 2031 'A-'.
KEY RATING DRIVERS
The rating on the class AA certificates is driven by a top-down analysis incorporating a series of stress tests that simulate the rejection and repossession of the aircraft in a severe aviation downturn. The 'AA-' rating is supported by a high level of overcollateralization (OC) and high-quality collateral supporting Fitch's expectations that senior tranche holders should receive full principal recovery prior to default even in a severe stress scenario.
The initial 'AA' tranche loan to value (LTV), as cited in the offering memorandum (OM) is 48.6% and 49.2% as calculated by Fitch as of Dec. 20, 2018. Typically, Fitch uses appraisal values from three independent appraisal firms in assessing a transaction's LTVs; however, Fitch utilized the values from the appraisers quoted in the OM because the aircraft appraised values cited in the OM are more conservative. Fitch's maximum stress case LTV (the primary driver for the AA tranche rating) through the life of the transaction is 95.3% (when stresses are applied two years in the future). This level of OC provides a sufficient amount of protection for the senior tranche holders to support a 'AA-' rating.
The 'A-' rating for the A-tranche is based on a ratings uplift compared with BA's stand-alone credit profile, based on a high affirmation factor, presence of a liquidity facility and superior recovery prospects as discussed below. The affirmation factor for this pool is considered high as all three aircraft types (see below) in the transaction are core to BA's fleet plan. Fitch believes that the likelihood of these aircraft being affirmed in a restructuring scenario effectively reduces the A- tranche's probability of default compared to BA's credit profile.
This will be BA's second EETC, and the structure largely follows the U.S. EETC template (pass-through SPV, debt tranching, liquidity facility, cross-provisions, etc.). BA plans to raise $608.7 million, which will be used to pre-fund the purchase of 10 new aircraft (seven Airbus A320neo, one Boeing 787-8, and two Boeing 787-9s) and to refinance one 787-8 that was delivered in September 2017. The 10 pre-funded aircraft are scheduled to be delivered between March 2018 and October 2018. Accordingly, the majority of the proceeds will initially be held in escrow by National Australia Bank Limited's (NAB: rated AA-/F1+/ Stable) New York Branch, the designated depository, until the aircraft are delivered.
The AA-tranche will be sized at $409.8 million and the A-tranche will be sized at $199 million with both tranches featuring a 13.5-year tenor, and a weighted average life of 7.4 years. Both tranches will amortize fully and will not have a balloon payment, unlike the majority of currently issued EETC transactions, which typically have balloon payments in the range of 30% to 50% of the initial offering amount. The full amortization of the certificates will provide higher collateral coverage to the certificate holders as the transaction ages and is credit positive.
The structure crosses several legal jurisdictions, and will contain several SPVs. It also combines two common aircraft finance structures, the EETC and the JOLCO (Japanese operating lease with call option). The aircraft will be financed by the proceeds from the transaction and the equity contributions from the Japanese JOLCO investors. The debt (BA 2018-1 certificates) and the equity investments will be serviced by lease payments from BA and the payments under the leases will be at least equal to the debt service on the equipment notes and all ongoing transaction expenses.
The JOLCOs contain early buy-out options (EBO) at approximately year 10 for the A320neos and at approximately year 12 for the 787s. If BA exercises the EBO under an aircraft lease, the equipment notes will either be redeemed or the JOLCO will be replaced with a finance lease. Fitch's models assume that all of the aircraft remain in the transaction until their final note payment date, meaning that BA either does not exercise its EBO or that BA exercises the EBO and opts to swap the JOLCOs for finance leases. There is no impact on the certificate holders if BA chooses not to exercise the EBO since the leases are structured to cover all principal payments through the life of the EETC.
High Collateral Quality:
The transaction will be secured by a perfected first priority security interest in seven Airbus A320neoss, two Boeing 787-8s, and two Boeing 787-9s. Fitch considers all to be high-quality Tier 1 aircraft.
Proceeds from the transaction will be used to pre-fund deliveries through October 2018. Accordingly, the majority of the proceeds will initially be held in escrow by NAB, until the aircraft are delivered.
Class AA and A certificates benefit from a dedicated 18-month liquidity facility that will be provided by NAB, acting through its New York Branch.
The ratings for the class AA certificates are primarily based on collateral coverage in a stress scenario. The analysis uses a top-down approach assuming a rejection of the entire pool in a severe global aviation downturn. The analysis incorporates a full draw on the liquidity facility and an assumed repossession/remarketing cost of 5% of the total portfolio value. Fitch then applies immediate haircuts to the collateral value.
In its 'AA' level stress analysis, Fitch has opted to apply a 45% value stress to the 787-8s in this transaction while the A320neos and the 787-9s receive a 40% value stress. The 45% value haircut for the 787-8s represents the middle of Fitch's 'AA' stress range for Tier 1 aircraft, which reflects the agency's view of how the aircraft compare to other high quality assets. Concerns around the 787-8 include the recent order history, which indicates that demand is higher for its sister aircraft, the 787-9. Future values for the 787-8 could be pressured by the higher popularity of the 787-9 aircraft. The 40% stress for A320neos and the 787-9s reflect Fitch's view of those assets as top-quality tier 1 planes that are likely remain highly desirable and highly liquid in the event of a downturn.
Fitch's 'AA' level stress scenario produces a maximum LTV of 95.3% when stress rates are applied two years in the future (as stipulated in Fitch's EETC criteria for airlines with corporate ratings in the BB category or higher). This compares to 86.4% for the United Airlines 2018-1 EETC, 80.4% for American Airlines 2017-2 transaction, 82.3% for the United 2016-2 transaction, three recent deals that Fitch rated in the 'AA' category. The LTV in this transaction is significantly higher than those of recent Fitch-rated transactions, which warrants a one notch differentiation. Fitch believes there is adequate overcollateralization in this deal to support the 'AA-' rating.
The rating of 'A-' for the A-tranche represents a three-notch uplift from BA's Issuer Default Rating (IDR) of 'BBB-'. The three-notch uplift reflects Fitch's view of the affirmation factor for this collateral pool (the likelihood that BA would choose to affirm the aircraft in a potential default scenario). In addition, factors for the A-tranche rating include the presence of an 18-month liquidity facility and Fitch's view of recovery prospects in a stress scenario. In this case the uplift is based on a high affirmation factor (one notch), availability of the liquidity facility (one notch) and strong recovery prospects (one notch). The rating is also supported by the class A certificate holders' right in certain cases to purchase all of the class AA certificates at par plus accrued and unpaid interest.
Fitch considers the affirmation factor for this pool of aircraft to be high. In the agency's view, the likelihood that BA would ultimately affirm these aircraft in a scenario where the airline enters administration is supported by the strategic importance of this collateral, the fact that A320neos and 787s represent the newest aircraft technology available in the market today, and the large number of older aircraft in BA's fleet that are more likely be rejected in a restructuring scenario.
BA has firm orders for 25 new A320neos and currently operates a fleet of 67 A320ceos. The seven aircraft in the pool represent 7.6% of the A320neos on order, representing a sizeable portion of some of the airline's most fuel efficient aircraft. The A320neos are approximately 14% more fuel efficient and significantly quieter than BA's existing A320-200s, making them less likely to be rejected since fuel is such a large portion of an airline's overall cost structure.
The four 787s in the portfolio represent 9.5% of the 42 787s that BA operates or has on firm order (including all variants of the 787), also representing a sizeable piece of the 787 fleet. The 787-8 is important for BA due to the aircraft's unique ability to open new markets and because it serves as an efficient replacement for the 767-300 (of which BA still operates seven). The 787-8's relatively small size for a widebody aircraft, combined with its range make it ideal for opening relatively long-haul routes to smaller cities. For instance, BA has used the 787-8 to start service to destinations like Nashville and Baltimore, that wouldn't have sufficient passenger demand to fill a larger widebody. The 787-9 is also likely to remain a meaningful part of BA's widebody fleet for the foreseeable future due to the range, technological features, and fuel efficiency of the aircraft.
The low expected cost of funding for this transaction is also supportive of the affirmation factor. The EETC market has been healthy in recent months, with recent deals issuing at or near record low coupons. We expect a weighted average coupon for this transaction will be lower than the 4.85% weighted average coupon achieved in BA's 2013 transaction. The company would be unlikely to reject aircraft that are financed with low-cost debt.
Fitch upgraded BA's corporate rating to 'BBB-' from 'BB+' in March 2017. The Rating Outlook is Stable. The upgrade was supported by BA's strong credit metrics and adherence to prudent financial policy including cost control. The rating also reflects the company's extensively diversified route network, strong hub position at Heathrow and strong position on the cash flow-generative routes to the U.S. Fitch rates BA on a stand-alone basis. Fitch expects BA to be one of a very few EMEA airlines generating positive FCF over 2018-2020.
Fitch rates BA on a stand-alone basis as the agency assess the legal and operational ties between IAG and BA as moderate. This reflects IAG's principle of the stand-alone management of its operating entities. In BA's financing, there are no cross-default provisions to other IAG-owned entities. There are no cross-guarantees among the entities in IAG, with independent debt management at subsidiary airlines. In addition, BA has an independent board of directors.
Fitch's EETC rating methodology reflects considerations of the speed, certainty and costs associated with repossession, deregistration and export of aircraft in different jurisdictions. It also reflects consideration of the influence of creditors' ability to quickly repossess aircraft or an airline's incentive to affirm aircraft in bankruptcy (while paying all interest and principal on time and in full).
Certificate holders in this transaction benefit from the provisions of the Cape Town Convention Alternative A (CTC), which came into force in the United Kingdom (UK) in November 2015. The CTC establishes an international legal framework to facilitate financing of mobile equipment, and it is similar in many ways to Section 1110 of the US bankruptcy code. The creditor protections provided by CTC and by section 1110 are integral to Fitch's EETC analysis as they provide comfort that creditors will be able to quickly repossess and re-sell aircraft collateral in the case that the underlying airline defaults. Both CTC and 1110 contain provisions that ensure that aircraft are not subject to the typical stays that delay asset repossessions in bankruptcy. As such, creditors in EETC transactions have sufficient time to repossess their aircraft and re-sell them on the open market, allowing principal to be repaid prior to the expiration of the liquidity facility and thus avoiding an event of default.
In the UK (like in the U.S.), airlines have a period of 60 days to either cure all defaults under the leases or allow the creditors to repossess the planes. However, there is a scenario where repossession could take three to five months if BA were to assert that the repossession was being pursued for improper reasons and court proceedings were necessary. Fitch does not view the three-to-five month time frame as being problematic for two reasons: 1) the liquidity facility is sufficiently long, so that creditors would still have ample time to repossess the aircraft while avoiding a default, and 2) the scenario of the repossession being challenged in court is relatively unlikely. The three-to-five month timeframe is also present in the BA 2013-1 transaction, which Fitch rates.
CTC and Brexit
There is some uncertainty around the future of certain provisions within CTC in the UK due to Brexit. Fitch does not expect Brexit to have any impact on CTC in the UK because UK is currently a contracting state under the CTC and that this is unlikely to be affected by the UK leaving the EU. Additionally, the BA 2013-1 EETC transaction, which Fitch currently rates, relied upon existing UK law, and not the CTC which was not in effect at the time of the issuance of the transaction. Fitch viewed local law in the UK as being sufficiently creditor-friendly that we did not make a distinction between the BA 2013-1 transaction and similar transactions that were issued in the US under section 1110.
The 'AA-' rating on the senior certificates is lower than the 'AA' ratings assigned to the class AA certificates of recent senior classes of EETCs issued by Air Canada, United and American. The one notch differentiation is driven by significantly higher stressed LTV when comparing to the other class AA certificates. Even though the level of overcollateralization is lower than those of the comparable transactions, it passes Fitch's 'AA' level stresses. The 95.3% maximum stressed LTV two years after inception in combination with a strong collateral pool provides adequate collateral coverage for the 'AA-' ratings.
The quality of the underlying collateral pool is as good as or better than what was included in other transactions rated in the 'AA' category. Fitch considers the quality of the BA 2018-1 collateral to be better than that of United's 2018-1, which includes Boeing 777-300ERs. Fitch also considers this collateral pool to be stronger than the recent Spirit 2017-1 pool, which had a relative lack of diversity, featuring only A320 family aircraft.
The 'A-' rating for the class A certificates is the highest rating assigned by Fitch when utilizing a bottom-up rating approach and is partly driven by BA's 'BBB-' corporate rating, which is higher than those of the other EETC issuers. Fitch considers the two notch uplift due to the high affirmation factor (one notch) and the presence of the liquidity facility (one notch) to be comparable to those seen in the other recent Fitch rated transactions. The recovery prospects of the class A certificates are superior to those of the majority of the tranches rated by Fitch's bottom-up approach and warrants an additional uplift by one notch. The 'A-' rating for the class A certificates is also supported by a relatively high seniority of the class A certificates. The majority of the tranches rated by the bottom-up approach have lower seniority in a transaction's structure.
Fitch's key assumptions within its rating case for the issuer include a harsh downside scenario in which BA declares bankruptcy, chooses to reject the collateral aircraft, and where the aircraft are remarketed in the midst of a severe slump in aircraft values. Please see the Key Rating Drivers section of this release for more details on specific assumptions.
Variation from Fitch's EETC Criteria
The BA 2018-1 transaction varies from one of the qualitative characteristics for the 'AA' rating category consideration as specified in Fitch's EETC criteria. Fitch expects collateral pools of less than 10 aircraft should contain at least five widebody aircraft.
The collateral pool of the BA 2018-1 transaction is initially comprised of 11 aircraft, qualifying it for the 'AA' rating consideration; however certain aircraft are scheduled to be released from the pool prior to the final expected maturity. In March 2030, three A320neos are expected to be released from the pool, followed by three more in June 2030 and the last A320neo in September 2030. As a result, the pool will be comprised of less than 10 aircraft of which only four will be widebodies from the March 2030 through September 2031.
Even though the transaction will not meet Fitch's minimum number of aircraft consideration for the 'AA' rating category for the last 18 months of the transaction, Fitch has assigned 'AA-' rating to the AA certificates because we believe the significant expected overcollateralization and the high quality of the aircraft in the pool mitigate the qualitative constraint tied to the pool's size:
--The transaction will be significantly over collateralized by March 2030 and Fitch estimates the stressed LTV will be approximately 20% when applying 'AA' level stresses;
--The four widebody aircraft in the pool are Boeing 787-8s and 787-9s, the newest generation and some of the most technologically advanced commercial aircraft to date. Fitch does not expect better technology substitute aircraft to be available throughout the life of the transaction and anticipates these aircraft will remain competitive and highly marketable throughout the life of the transaction.
Ratings for the class AA certificates are primarily based on 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. Fitch does not expect to upgrade either class of certificates above their proposed ratings in the near term.
The ratings of the subordinated the class A certificates are influenced by Fitch's view of BA's corporate credit profile and by recovery prospects. A positive rating action could be considered if BA's credit profile were to strengthen in Fitch's view. Conversely, Fitch's EETC methodology allows for wider subordinated tranche notching for airlines in the 'BB' category, therefore if BA were downgraded to 'BB+' from 'BBB-' Fitch may affirm the ratings of the class A certificates at 'A-'. Fitch may also consider a negative rating action for the class A certificates if the recovery prospects change significantly due to an unexpected decline in collateral values.
Liquidity Facility: The certificates benefit from dedicated 18-month liquidity facilities which will be provided by NAB. Fitch notes that this transaction features a 35-day replacement window in the event that the liquidity facility provider or depositary should become ineligible. This is inconsistent with Fitch's counterparty criteria which generally stipulate a maximum 30-day replacement period. However, Fitch does not consider the longer replacement window to be material given that the additional time period is not significant.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
British Airways Pass Through Certificates, Series 2018-1
--Class AA certificates 'AA-';
--Class A certificates 'A-'.
Fitch currently rates British Airways as follows:
British Airways Plc
--Long-Term IDR 'BBB-'.