Fitch Ratings-London-11 June 2018: Continuing uncertainty over the planning, pricing and execution of the third runway at Heathrow Airport, and ongoing Brexit concerns were the main reasons for Fitch Ratings to revise the Outlook on Heathrow Funding's bonds to Stable from Positive in June 2018. There is uncertainty over whether the regulator will allow the airport to generate, through tariffs, additional cash flows to build up metrics consistent with the higher ratings on top of full recovery of costs associated with the project. Furthermore, protracted planning and approval processes and the risks of higher costs, together with increasing debt related to this significant capex limit the potential for an upgrade in the medium term.

The third runway at Heathrow epitomises the problems that mega infrastructure projects in densely populated areas face. It has been in planning for nearly 20 years with the government approval process alone running for over 10. Although there were breakthroughs in the process in 2015 and 2016, when the Airport Commission and the UK government backed the project, it has many more hurdles to clear including parliamentary approval before construction can commence, currently expected in 2021 with an estimated completion in 2025. The plans have been, and will continue to be subject to numerous revisions that add complexity to the project. For example, the most recent revision includes a requirement to relocate a part of the M25 carriageway into a tunnel. The relocation of villages such as Harmondsworth provides additional difficulties.

Heathrow and its shareholders have vast experience in planning and executing large infrastructure projects, but each one is unique and carries distinctive challenges. Construction of Terminal 5, the holder of the previous record for the longest-ever approval process in the UK of eight years, was done largely on time and on budget. However, the rush to complete by the deadline led to a slackening of testing procedures and the terminal opening was marred by a baggage handling system failure resulting in flight delays and cancellations.

The estimated costs of the runway construction range between GBP14.0 billion and GBP17.6 billion and are expected to be borne by Heathrow, largely through additional borrowings. There are contingencies incorporated in the estimate, but cost revisions may push the budget higher than expected. For example, it was recently announced that up to GBP2.6 billion would be paid towards compensation, noise insulation and improvement to amenities. This amount is 10 times larger than the original estimate for mitigation and compensation put forward in 2009.

Heathrow benefits from a supportive regulatory regime that allows capital costs recovery, but this also creates material uncertainties each time a price cap is reset, usually every five years. However, there is the regulator's mandate in its oversight capacity to ensure a project's financeability and affordability. Despite the temporary uncertainty, which limits the potential for an upgrade, we expect the final regulatory decision to be in line with Heathrow's ability to recover costs and maintain metrics commensurate with its current rating level.

Concerns over the outcome of the Brexit negotiations and the possibility of a marked and durable degradation of the British economy as a result are another downside risk for Heathrow. Around a third of all Heathrow traffic is EU-bound, which might be affected by new rules and regulations following Brexit.