Moody's changes outlook on Turkish Airlines to stable from negative; affirms Ba3 rating

DIFC - Dubai, December 14, 2017 -- Moody's Investors Service, ("Moody's") today changed the rating outlook on Turk Hava Yollari Anonim Ortakligi (Turkish Airlines) to stable from negative. At the same time, Moody's affirmed the Ba3 corporate family rating (CFR) and Ba3-PD probability of default rating (PDR).

Moody's also changed the outlook on Turkish Airlines' Enhanced Equipment Trust Certificates (EETCs) to stable from negative and affirmed its EETC ratings: The Baa1 rating on Bosphorus Pass Through Trust 2015-1A, the Baa1 rating on Anatolia Pass Through Trust 2015-1 Class A and the Ba1 rating on Anatolia Pass Through Trust 2015-1 Class B.

"The decision to change the outlook to stable reflects the visible recovery in passenger demand in the Turkish market since June 2017, resulting in Turkish Airlines reporting a strong set of third quarter earnings and improved credit metrics." says Rehan Akbar, a Moody's Vice President -- Senior Analyst. "Proactive capacity management and cost saving measures undertaken since late 2016 have also positively contributed to the airline's financial performance."

A complete list of affected companies and rating actions can be found at the end of this press release.

RATINGS RATIONALE

-- OUTLOOK ON TURKISH AIRLINES' RATINGS CHANGED TO STABLE; RATINGS AFFIRMED

The outlook change to stable from negative is driven by the rebound in passenger demand in the Turkish market as a result of a recovery in the country's tourism sector. Passenger load factor increased to 78.8% for the first nine months of 2017 from 74.6% at the end of 2016. Demand last year had declined because of several terror attacks in Turkey which was compounded by the failed coup attempt in July 2016.

Turkish Airline also implemented capacity management measures and cost-cutting initiatives since last year in order to improve profitability. Comparing the first nine months of 2017 to the same period a year earlier, revenues increased by 8.5%, expenses decreased by 5.6%, while available seat kilometres (ASK, a measure of capacity) remained broadly flat. For the last twelve months to 30 September 2017, the airline's adjusted debt to EBITDA (FX-adjusted) stood at 4.9x and adjusted EBIT/interest expense (FX-adjusted) stood at 3.0x, and Moody's forecasts similar levels for YE2017 and YE2018.

The affirmation of the Ba3 CFR reflects the airline's strong market position in Turkey and its role as the national flag carrier as well as the risks associated with the operator's medium and long-term expansion plans. The company's financial profile is underpinned by its efficient cost structure. Passenger revenue base is well-diversified and historically been supported by the economic and tourism growth seen in Turkey (2016 being an exception) while Istanbul's geographic location allows Ataturk International Airport to act as a hub for international transfer traffic.

The rating also incorporates the challenges that Turkish Airlines faces, including exposure to an inherently cyclical industry and the risk of yield and margin pressure should there be increased competition and capacity supply. Its fleet expansion strategy makes Turkish Airlines more sensitive to global and domestic economic weakness as well as to foreign-currency volatility and geopolitical risks. In addition, the company has limited earnings diversification from other business segments such as MRO (maintenance, repair and overhaul) and catering.

The Ba3 CFR incorporates a one-notch uplift from a baseline credit assessment (BCA) of b1 given Moody's assumption of moderate government support, which has not changed as a result of this rating action. Moody's classifies Turkish Airlines as a government-related issuer (GRI) because of the Government of Turkey's 49.12% ownership stake held through its sovereign wealth fund.

-- OUTLOOK ON EETC RATINGS CHANGED TO STABLE, RATINGS AFFIRMED

The change in outlook on the EETCs corresponds with the change in outlook on the corporate ratings.

EETC ratings are assigned by applying notching to an issuer's CFR, factoring in protective features such as (1) the importance of the aircraft collateral to the airline's network; (2) a legal framework that provides timely access to collateral following an insolvency where the airline no longer wants to use the aircraft; (3) liquidity facilities that fund a number of interest payments following the rejection of an EETC financing; and (4) the equity cushion.

The EETC ratings reflect Moody's favorable assessment of these factors.

The Bosphorus Trust (Series 2015-1) transaction is secured by three Boeing B777-300ER aircraft delivered new in 2015. The Anatolia Trust (Series 2015-1, JPY-denominated) is secured by three Airbus A321-200 aircraft delivered new in 2015. Moody's believes these aircraft models will remain integral to the airline's respective long-haul and medium-haul network over the remaining lives of the EETCs. The aircraft that secure each transaction will remain younger than the average age of these aircraft types in Turkish Airlines' fleet over the transactions terms. These factors support the expectation of affirmation under an insolvency scenario.

Pressure on the values of B777-300ERs relative to expectations and the depreciation of the US dollar versus the Japanese yen since these transactions were issued have modestly lowered the equity cushions versus Moody's expectations, but not sufficiently to cause Moody's to reduce notching relative to the CFR.

The leases in the transactions are subject to the Cape Town Convention as implemented in Turkish law. Turkey adopted a 60-day Alternative A waiting period. Turkey also adopted the use of Irrevocable De-registration and Export Request Authorizations (IDERAs), which are meant to facilitate timely de-registration of an aircraft which is required when repossessing an aircraft. These factors inform our expectation of timely repossession in an insolvency scenario where the airline determines it no longer needs the aircraft in the collateral of either transaction.

WHAT WOULD CHANGE THE RATING UP/DOWN

The rating could be upgraded if Turkish Airlines sustainably maintains adjusted debt to EBITDA below 5.0x and EBIT interest coverage above 2.5x.

The rating could be downgraded if Turkish Airlines' gross leverage trends toward 7.0x, and its EBIT interest coverage trends toward 1.5x.

Any change in Moody's current GRI support assumptions could also negatively affect ratings. In addition, a downgrade could also occur if the company's liquidity became strained, potentially as a result of its aircraft acquisition programme combined with weak operating cash flows.

Any combination of future changes in the underlying credit quality or ratings of Turkish Airlines, unexpected material changes in the market value of the aircraft and/or changes in the airline's network strategy that de-emphasize the subject aircraft models could cause Moody's to change its ratings of the EETCs as would indications that the operation of Cape Town provisions in Turkish law would not be effective for timely repossession.

The EETC ratings on the senior tranches might also be downgraded if Moody's were to downgrade the long-term local currency bond and deposit ceilings below Baa1. EETC ratings are capped by one notch above a country's long-term local currency bond and deposit ceilings. Moody's discusses the factors it considers when deciding whether to pierce Country Risk Ceilings in "How Sovereign Credit Quality Can Affect Other Ratings" and "Local Currency Country Risk Ceiling for Bonds and Other Local Currency Obligations" both linked here and available on Moodys.com.

List of affected ratings:

Affirmations:

..Issuer: Turk Hava Yollari Anonim Ortakligi

.... Corporate Family Rating, Affirmed Ba3

.... Probability of Default Rating, Affirmed Ba3-PD

..Issuer: Anatolia Pass Through Trust

....Enhanced Equipment Trust, Affirmed at Ba1

....Enhanced Equipment Trust, Affirmed at Baa1

..Issuer: Bosphorus Pass Through Trust 2015-1A

....Enhanced Equipment Trust, Affirmed at Baa1

Outlook Actions:

..Issuer: Turk Hava Yollari Anonim Ortakligi

....Outlook, Changed To Stable From Negative

..Issuer: Anatolia Pass Through Trust

Outlook, Changed To Stable From Negative

..Issuer: Bosphorus Pass Through Trust 2015-1A

Outlook, Changed To Stable From Negative

Founded in 1933, Turkish Airlines is the national flag carrier of the Republic of Turkey and is a member of the Star Alliance network since April 2008. Through the Ataturk International Airport in Istanbul acting as the airline's primary hub, the airline operates scheduled services to 251 international and 49 domestic destinations across 120 countries globally. It operates a fleet of 223 narrow-body, 90 wide-body and 15 cargo planes.

The airline is 49.12% owned by the Government of Turkey through its sovereign wealth fund while the balance is public on Borsa Istanbul stock exchange. For the last twelve months to 30 September 2017, the company reported revenues of $10.4 billion and a net profit of $649 million.

The principal methodologies used in rating Trust Hava Yollari Anonim Ortakligi were Global Passenger Airlines published in May 2012, and Government-Related Issuers published in August 2017. The principal methodology used in rating Anatolia Pass Through Trust and Bosphorus Pass Through Trust was Enhanced Equipment Trust and Equipment Trust Certificates published in December 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.