Oct 7 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings expects to assign the following expected ratings to Virgin Australia’s proposed enhanced equipment notes (EEN), series 2013-1 (VA 2013-1) subject to review of final documents:
--$474.0 million Class A Notes (A-Tranche) with an expected maturity of October 2023 ‘A(EXP)';
--$120.7 million Class B Notes (B-Tranche) with an expected maturity of October 2020 ‘BB+(EXP)';
--$137.9 million Class C Notes (C-Tranche) with an expected maturity of October 2018 ‘B+(EXP)';
The final legal maturities for the Class A and B notes are scheduled to be 18 months after the expected maturities.
The ratings reflect the application of Fitch’s criteria for rating aircraft enhanced equipment trust certificates (EETC). 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 facilities, Virgin Australia Holdings Limited’s (VAH, not rated) credit quality, and various additional structural elements.
Fitch also noted such positive credit factors as low balloon payments for all tranches, short 7.0 year and 5.0 year expected maturities for the class B and the class C notes with weighted average maturities of 3.3 and 2.8 years, respectively, and rapid amortization of the notes resulting in significant LTV improvements for all tranches within one to two years.
This is the first EETC-type transaction relying on the Australian insolvency regime, which is different in key aspects compared to the Section 1110 and 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 signed the CTC into law in late June of 2013, its implementation will not be completed prior to the issuance of the notes. The CTC rules are not expected to apply retroactively and VA 2013-1 will be governed under the current Australian insolvency law. New Zealand is a CTC signatory and the CTC will cover the six aircraft in this transaction that are leased in New Zealand.
This will be VAH’s first EEN transaction, and the structure largely follows the U.S. EETC template (SPV, debt tranching, liquidity facility, cross-provisions, etc.) with aircraft collateral and initial LTVs comparable to recent EETCs. The structure crosses three legal jurisdictions (Australia, New Zealand, and the United States) and it contains several SPVs. All of the aircraft to be included in the VA 2013-1 transaction are currently owned by subsidiaries of VAH and will be unencumbered by existing debt within several months of the time the transaction prices and immediately prior to delivery into the transaction. Through this transaction VAH will refinance some existing debt and generate some additional funds for general corporate purposes.
The issuer will be Perpetual Corporate Trust Limited, an Australian company acting solely in its capacity as trustee for the Class A, B, and C trusts (EEN Trusts). The proceeds of the proposed EEN transaction will be used to acquire the underlying equipment notes from Virgin Australia 2013-1 Issuer Co Pty Ltd (VA 2013-1 Issuer), an Australian special purpose entity which will be an indirect wholly-owned subsidiary of VAH. VA 2013-1 Issuer will own a pool of 24 aircraft (21 737-800s, two 737-700s and one 777-300ER). It is anticipated that the issuance of the equipment notes and the delivery of each aircraft into the transaction will occur simultaneously.
As the equipment notes are issued, VA 2013-1 Issuer will purchase the underlying aircraft from VAA/VA LeaseCo. VA 2013-1 Issuer will lease the aircraft to various indirect wholly-owned subsidiaries of VAH and its affiliate Virgin Australia International Holdings Pty Ltd (VAIH) (finance leases). Six of the leased aircraft are expected to be sub-leased (operating leases) to Virgin Australia Airlines (NZ) Limited, a subsidiary of VAIH organized under New Zealand law, pursuant to a separate sub-lease agreement. The aggregate payments of leases will cover the interest and principal payments on the equipment notes which will be passed through to make corresponding payments on the notes issued by VA 2013-1. VAH will guarantee obligations under the equipment notes, as well as obligations under lease and sub-lease agreements. The purpose of the various transactions is to create a favorable structure in the context of the Australian and New Zealand insolvency regimes, as discussed below.
Security for the EEN’s will consist of all of the assets of the issuer (in its capacity as trustee of the EEN trust) and the EEN Trusts, consisting mainly of the equipment notes. Security for the equipment notes will consist of all of the assets of VA 2013-1 Issuer, including the aircraft, as well as the assets of several other VAH subsidiaries.
The proceeds from the offered notes will initially be held in escrow by Credit Agricole (rated ‘A’/‘F1’ with a Stable Outlook) the designated depository, until the aircraft are delivered.
The A-Tranche will feature a 10-year tenor and an initial LTV (per the offering circular) of 55.5%. Fitch calculates the initial LTV at 60.3% using values from an independent appraiser. The B-Tranche will feature a seven-year tenor and an initial offering circular LTV of 69.7%. Fitch calculates the initial B-Tranche LTV at 75.6%. The C-Tranche will feature a five-year tenor and an initial offering circular LTV of 85.8%. Fitch calculates the initial C-Tranche LTV at 93.3%. The weighted average (WA) lives for the A-Tranche, the B-Tranche and the C-Tranche are 4.0 years, 3.3 years and 2.8 years, respectively. Overall, the valuations Fitch used to calculate initial LTVs were approximately 9% below the appraisals (lower of mean or median) in the transaction documents.
Key Rating Drivers
Strong Collateral Pool (Tier 1 aircraft): The transaction will be secured by a perfected first priority security interest in 24 Tier 1 aircraft: 21 737-800s, two 737-700s and one 777-300ER. The aircraft vintages range from 2003 to 2011, making the initial age of the pool older than in most recent EETCs. Fitch considers the 737-800 to be the highest quality Tier 1 narrow body aircraft due to its wide user base, large number of aircraft in service, and single engine option. The popularity of this aircraft mitigates the risk of remarketing/re-selling the planes in the event of a bankruptcy/rejection by VAH. The 777-300ER is also a strong Tier 1 aircraft which is considered the most popular wide body aircraft in use. The 737-700 is also a Tier 1 aircraft, with 1,096 aircraft delivered as of September 2013.
The quality of the collateral remains strong throughout the life of transaction as older aircraft gradually drop out of the pool, maintaining the weighted average age of the pool below 12 years throughout the majority of the transaction’s life. Additionally, all aircraft are expected to be phased out of the pool before reaching 15 years of age, the point at which aircraft migrate from Tier 1 to Tier 2 in Fitch’s analysis. The first two aircraft drop out in Oct. 2015 (two 737-700s). Thereafter, the aircraft drop out of the collateral gradually with four in Oct. 2017, seven (including the 777-300ER) in Oct. 2018, four in Oct. 2019, one each in Oct. 2020 and Oct. 2021, and three more in Oct. 2022. As the older collateral begins to fall out of the pool, the average age of the pool improves, leaving the newer and more attractive aircraft in the pool towards the end of the transaction’s life.
Amortization Profile: VA 2013-1 features a rapid amortization schedule and low balloon payment for the A-Tranche, resulting in a rapid decline of the collateral LTV and significant improvements in the transaction’s overcollateralization. Within three years from the issuance, Fitch’s base value LTVs will decline to approximately 44% from 60% for the A-Tranche, 53% from 76% for the B-Tranche and 62% from 93% for the C-Tranche. This compares favorably to recently issued EETC transactions which tend to feature balloon payments of approximately 30% to 35%, significantly reducing the pace of LTV improvement. Even though the maturities of VA 2013-1’s tranches are comparable with those of the recently issued EETC transactions, the low balloon payment results in significantly shorter WA lives. For instance, the 4.0 year WA life for A-Tranche is approximately five years shorter than an approximately nine years WA life for a typical EETC A-Tranche.
High Affirmation Factor: 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 737-800 is VAH’s main aircraft type, fitting well with the airline’s primarily short-haul business profile. The importance of the 737-800 to VAH is supported by the company’s order book, which consists mainly of 737‘s, other than a few A320’s on order at a recently-acquired subsidiary. The 21 737-800 aircraft in the VA 2013-1 pool represent approximately 30% of VAH’s current 737-800 fleet. The total pool of 24 aircraft makes up 18% of VAH’s fleet of 133 aircraft excluding Tigerair’s eleven A320s. This constitutes the highest fleet percentage among recent EETC transactions, which have generally contained between 2 - 4% of the issuer’s total fleet.
The transaction’s percentage of the fleet is projected to decline to below 4% beginning 2021, weakening the affirmation factor of the remaining pool as the transaction ages; however Fitch believes this is mitigated by the low expected LTVs at that time. The pool’s characteristics and composition are consistent with those of VAH’s fleet as a whole, with the average age of the pool at 6.4 years, slightly younger than the average age of VAH’s full fleet of approximately 6.8 years.
Cross-default and Cross-collateralization Provisions: All equipment notes are fully cross-collateralized, and all indentures and leases will be cross-defaulted from the beginning of the transaction, limiting VAH’s ability to ‘cherry-pick’ aircraft within this EEN. The rest of VAH’s fleet is largely financed through bank debt and other sources of funding, where the aircraft are not cross-collateralized. The large percentage of other aircraft in VAH’s fleet that are not subject to cross collateralization/cross default provisions supports the high affirmation factor.
Liquidity Facilities: The Class A and Class B certificates will benefit from 18-month liquidity facilities provided by Natixis (rated ‘A’/‘F1’ with a Stable Outlook).
The A-Tranche rating is primarily driven by a top-down analysis which evaluates the level of overcollateralization and likely recovery in a stress scenario. The initial offering circular loan-to-value ratio (LTV) is listed at 55.5%, and the maximum LTV produced by Fitch’s ‘A-rating’ stress scenario is 94.8%, which implies a significant amount of cushion for senior tranche note holders. The ratings are also supported by a strong collateral package consisting of Tier 1 aircraft, an 18-month liquidity facility, cross-collateralization/cross-default features, and Fitch’s assessment of the Australian and New Zealand insolvency regimes. The rating incorporates a secondary dependence on the credit quality of VAH as the guarantor of the equipment notes and the lease payments of its indirect wholly owned subsidiaries as the obligors under the leases. VA 2013-1 benefits from strong collateral as the bulk of the pool consists of 737-800s, which are generally considered the most liquid collateral in the aircraft finance industry; a strong affirmation factor as the pool of the collateral represents nearly 18% of VAH’s total fleet; short weighted average life of the transaction at 3.7 years; and moderate diversification of the pool by inclusion of a 777-300ER and two 737-700 aircraft. The transaction features a low 2% balloon payment driven by the maturity schedule of the underlying equipment notes with the largest quarterly payment equaling approximately 9.9% of the initial balance of the notes and 8.4% of the collateral’s offering circular base value.
Stress Case: Fitch’s stress analysis assumes that all aircraft are rejected in a severe global aviation downturn. The analysis incorporates a full draw on the liquidity facilities (increasing the LTV by roughly 6.4%) and an assumed repossession/remarketing cost of 5% of the total portfolio value. Various haircuts are then applied to the aircraft values according to Fitch’s assessment of the quality of the collateral. As all aircraft in this transaction are considered to be Tier 1 collateral, Fitch’s analysis incorporates a value stress range of 20 - 30% for the A-rating level test, which this transaction passes. Additionally, Fitch uses its own depreciation assumption of 5%/year for the younger aircraft in the portfolio and 6%/year as the aircraft age beyond 10 years. This compares to blended depreciation rates utilized in the transaction documents of roughly 3.8% at the beginning of the transaction, increasing to between 4 - 5% as the deal ages.
The newer vintage 737-800s (2010 - 2011, 30% of the collateral pool value) receive a 20% haircut in Fitch’s stress case. Fitch applied a 25% stress to the 2003-2005 vintages (47% of the pool) to account for higher price volatility of the older aircraft. The 737-800 is considered the strongest tier one aircraft due to its large operator base and the size of the active fleet (more than 2,600 aircraft in service with more than 130 operators). Boeing’s current backlog for the model stands at 1,370 planes as of the end of September, not including the popular new MAX version. The popularity and wide user base of this aircraft are well above nearly any other model (aside from the A320) on the market, making it one of the highest grades of collateral available to back an EETC.
The 777-300ER (18% of the collateral pool) received a 30% haircut, or the high-point of the Tier 1 stress range. Fitch considers the 777-300ER a solid Tier 1 aircraft, but applies a harsher stress level to account for the greater historical volatility experienced by wide-body jets compared to the most popular narrow bodies. The 777-300ER is the best-selling aircraft of its size with a diverse base of global operators, solid backlog and limited competition. With an average age of 3.8 years, the 777-300ER is relatively young in its life cycle, with no replacement aircraft in near term, although Fitch expects Boeing to officially launch the 777X, with delivery likely in the 2019 - 2020 timeframe. While Airbus’ A350-1000 will feature a longer range and lower fuel consumption and is expected to compete with the 777-300ER, its first delivery is not expected until 2017.
The 737-700s (5% of the collateral pool) receive a 25% haircut. Although Fitch considers the 737-700 to be a solid Tier 1 aircraft due to its wide user base and considerable market penetration (more than 1,000 aircraft in service with roughly 74 operators), the middle of the Tier 1 stress range is applied to reflect higher popularity of 737-800s.
These assumptions produce a maximum stress LTV of 94.8% throughout the life of the transaction, suggesting full recovery for the A-Tranche holders. The highest stress LTV occurs immediately upon issuance and declines throughout the life of the transaction due to the pool’s weighted average age of 6.4 years and the rapid scheduled amortization of A-Tranche notes. The A-Tranche stressed LTV declines faster than those of recent EETC transactions due to the rapid amortization and a low balloon payment percentage. Fitch expects VA 2013-1’s LTV to decline to approximately 60% by the end of four years since the date of issuance under Fitch’s ‘A’ level stresses as compared to a stressed LTV of approximately 80% for recent EETC transactions. The stressed LTV for the A-Tranche is expected to remain around 60% from 2018 to 2020, gradually declining thereafter to 39% by expected maturity.
Fitch’s analysis considers the potential impact on 737NG (including the -800 and -700) valuations from Boeing’s new 737 MAX family, which had accumulated 1,567 orders through the end of September. Final assembly for the MAX should begin in 2015, with first flight in 2016 and entry into service in the third quarter of 2017. VAH ordered 23 MAX aircraft in July 2012, and deliveries will reportedly be in the 2019 - 2021 timeframe.
Fitch believes that the NG’s fleet size and large operator base will mitigate the MAX impact on NG valuations, possibly into the next decade. The NG continues to perform well, with an order backlog of 1,900 aircraft (1,370 for the -800) as of the end of September. Delivery slots are scarce, and production rates are scheduled to increase to 42/month in the first half of 2014, up from the current rate of 38/month. Orders continue to be healthy, including 305 through September for the 737-800, with 175 of those coming from a large Ryanair booking.
The ‘BB+’ rating for the B-Tranche is based on an estimated uplift compared with VAH’s stand-alone credit profile, largely based on a high affirmation factor and availability of the liquidity facility, as discussed above. The affirmation factor for this pool is considered high and Fitch believes that the likelihood of these aircraft being affirmed in a restructuring scenario effectively reduces the B-Tranche probability of default compared to VAH’s credit profile. The rating is also supported by the Class B note holders’ right in certain cases to purchase all of the Class A notes at par plus accrued and unpaid interest. Additionally, the interest payments on the Class B notes are senior to the principal distributions to the Class A notes.
The ‘B+’ rating for the C-Tranche is based on an estimated uplift compared with VAH’s stand-alone credit profile, largely based on a high Affirmation Factor and expected collateral recovery prospects. While the affirmation factor for this pool is considered high, collateral coverage for the C-Tranche is considered weak, which combined with the absence of a liquidity facility supports the rating differential from the B-Tranche. The rating is also supported by the Class C note holders’ right in certain cases to purchase all of the Class A notes and Class B notes at par plus accrued and unpaid interest. Additionally, the interest payments on the Class C notes are senior to the principal distributions to the Class A and B notes.
Bankruptcy/insolvency law is a key component of Fitch’s aircraft EETC rating methodology. Fitch’s EETC rating approach largely rests on creditors’ ability to quickly repossess aircraft, and the influence this has on airlines’ incentive to affirm aircraft in bankruptcy (while paying all interest and principal on time and in full). Section 1110 of the U.S. Code (which offers unique legal protection to aircraft creditors in U.S.) and the CTC are two examples of legal frameworks applied in Fitch’s EETC rating methodology.
The VA 2013-1 transaction is governed by both Australian law and the CTC in New Zealand. Fitch’s legal analysis focused on the Australian insolvency regime for EEN trusts, the equipment notes, and the Australian leases. The analysis focused on the CTC for the New Zealand sub-leases (six out of 24 aircraft). Fitch considers Australia’s general insolvency regime to be strong and reliable for creditors, including definite time periods for repossession of the collateral during an insolvency process if certain structures are in place. However, Fitch notes that there are no special carve-outs for aviation assets similar to 1110 or the CTC. The Australian legal framework and several structural elements of the transaction provide significant credit protection, making possible the application of Fitch’s EETC criteria to this transaction. 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. Under Australian insolvency law, a creditor with security from all or substantially all of a debtor’s assets is known as a ‘substantial chargee’ and has the ability to enforce its security within 13 business days of the beginning of an administration without the approval of the court or the administrator. In this transaction the Security Trustee is a substantial chargee over the equipment note issuer.
In addition, there are creditor protections at the lease level in this transaction. For leased assets, an administrator has five business days to decide whether to keep or reject an aircraft and will become personally liable for the lease payments attributable to the period from the end of five business days after the administration until the end of the administration or return of the aircraft. Repossession in Australia is expected to take approximately one to two months with an additional 10 days if court orders are required.
Fitch believes the Australian insolvency regime is slightly less beneficial to note holders than Section 1110 or the CTC, although the ratings in this transaction were not affected. The Australian regime is not aircraft-specific, unlike Section 1110 and the CTC. Also, the structure in this transaction has not been tested in court to the extent that Section 1110 has been tested. Finally, the Australian insolvency regime does not have a cure requirement, unlike Section 1110/CTC. If a distribution date falls within the five business day decision period (described above) and the decision was made to retain the aircraft and continue paying rent, the administrator does not have an obligation to cure the default during the prior period. VA 2013-1’s structure addresses the lack of a cure requirement as the liquidity provider would step in to pay uncured interest and future excess lease payments will flow through the waterfall first to pay the liquidity provider, and thereafter to pay outstanding principal.
While Fitch concluded that with VA 2013-1’s specific structure the EETC would work in Australia, Fitch believes that this type of structure would not likely work in other countries with less proven, more debtor-friendly legal systems. Fitch views the creditor protection provided by CTC as ratified in New Zealand to be similar to the legal protection provided by Section 1110 in the U.S. New Zealand adopted Article XI, Alternative A of the CTC with a 60 day waiting period. However, the CTC has yet to be tested in New Zealand courts, adding some uncertainty, but Fitch does not view this as a significant concern given the reliability of its legal system.
Fitch does not expect positive rating actions for the senior tranche. Potential ratings concerns for the senior tranche primarily consist of unexpected declines in aircraft values. For the 777-300ER, Fitch is concerned by the possible devaluation of the aircraft following the introduction of A350-1000 and 777-9X. Similarly, the values of 737-800 could eventually be impacted by the introduction of A320 NEO and 737-8 MAX. Fitch does not expect these risks will have a material impact on market values in the near-to-intermediate term. The ratings of the subordinated tranches are influenced by Fitch’s view of VAH’s credit quality. A negative rating action could be considered if Fitch believes VAH’s credit profile weakens.
Pre-sale Report: Fitch will publish a pre-sale report for VA 2013-1, which will be available at www.fitchratings.com.
Fitch expects to assign the following ratings:
Virgin Australia Enhanced Equipment Notes 2013-1
--Class A Notes ‘A(EXP)';
--Class B Notes ‘BB+(EXP)';
--Class C Notes ‘B+(EXP)'.