S&P: Heathrow Funding's ?400 Million Class A-37 Fixed-Rate Notes Assigned 'A - (sf)' Rating; Other Ratings Affirmed
We have removed our stable outlook on the ratings to reflect our view that outlooks, which are generally assigned, where appropriate, to corporate and government entities and some structured finance ratings, are no longer appropriate for our ratings on the notes issued by Heathrow Funding, given that our ratings approach assumes that we can rate through the insolvency of the borrower.
Under Heathrow Funding's transaction documents, further debt issuance, including bank debt and rated notes, is permitted, provided that:The total ratio of senior net debt to the regulatory asset base (RAB) is lower than 72.5%. Total senior net debt comprises the class A notes, plus any senior debt issued by the borrower group and ranking pari passu with the class A notes (including accretion on retail price index [RPI] swaps), less any cash or amounts held in authorized investments; andThe total net-debt-to-RAB ratio is below 90%. Total net debt is senior net debt together with the class B notes, plus any junior debt issued by the borrower group and ranking pari passu with the class B notes. However, we note that:Before 2018, the total senior net-debt-to-RAB is unlikely to exceed 70% as a result of further debt issuance, as this would lead to a dividend lock-up at Heathrow Funding;As long as certain additional debt exists outside the securitization group at Heathrow Finance PLC (beyond the scope of our rating), the total net-debt-to-RAB ratio would be unlikely to exceed 82% as a result of further debt issuance, as this would lead to a dividend lock-up at Heathrow Finance; andIndependent of the financing arrangements outside of the securitization, a total net-debt-to-RAB ratio above 85% would also lead to a dividend lock-up at the securitization group level. Our base-case assumption is therefore an increase in leverage as a result of additional debt, while maintaining headroom under the financial covenants.
Heathrow Funding onlent the issuance proceeds to Heathrow Airport Ltd., the borrower in the corporate securitization. We have been informed that the borrower will invest the proceeds in anticipation of the upcoming maturity of the class A-12 notes in October 2016 or may use the proceeds for general corporate purposes. As long as the proceeds are retained in cash or authorized instruments, the issuance of the new class of notes will not lead to a material increase in leverage within the securitization based on the terms of the transaction documents. However, we note that our analysis gives no credit to new issuance proceeds unless earmarked for debt-service purposes.
The class A-37 notes have a scheduled redemption maturity in 2049 and, in line with the other rated senior bonds issued by Heathrow Funding, a legal maturity two years after that. The borrower's failure to repay the full principal on the scheduled redemption date would trigger a loan event of default under the issuer-borrower loan, and could ultimately lead to an enforcement of the security by the noteholders.
Our ratings assigned to the notes issued by Heathrow Funding reflect our opinion that Heathrow Airport is capable of servicing and refinancing its debt under adverse conditions, which are commensurate with 'A-' and 'BBB' rating scenarios for the class A and class B notes, respectively. This, in conjunction with the structural and liquidity enhancements, supports our view that the issuer would be able to meet its obligations at the currently assigned rating levels.
We continue to assess Heathrow Airport's business risk profile as excellent, reflecting its strong competitive position and supportive regulatory regime. These positive features have made Heathrow Airport's performance less vulnerable to economic conditions and operational disturbances, in our view.
Since we assigned ratings to the class B-5 notes in April 2016, our economists have updated their economic outlook for the U. K., (see "As Brexit Takes Shape, Europe Is Set To Slow--Not Stall," published on July 8, 2016, and "Europe's Economic Outlook After The Brexit Vote," published on July 4, 2016). In conjunction with that update, we have revised our assumptions for RPI that have been incorporated into the flat case and our stresses. In our flat case, we assume that RPI will average 2.76% through 2021 (increasing to 3.41% in 2021 from 1.83% in 2016) and be at 0.0% thereafter. Beyond 2026, we have increased our RPI assumptions to 3.0% from 2.0% in our stresses during recovery periods. In our stresses, we assume that each two-year recession is followed by a two-year recovery. The effect of the change in our RPI forecast is a higher flat case, due to additional growth through 2020 owing to the effect of the higher RPI on aeronautical/passenger revenues. However, the growth in passenger numbers is limited by the capacity constraints that Heathrow continues to experience, in our view, leading to lower passenger growth than would otherwise be the case. In fiscal year 2015, the number of passengers grew by 2.2%. In the first quarter of 2016, the number of passengers was 2.6% higher than in the comparable period of 2015, but the high growth was partially due to the extra day in February 2016 and Easter, which occurred in March.
In the year to December 2016, we expect tariffs at Heathrow to decline by 0.6%. This is because Heathrow is allowed to increase aviation fees by RPI minus 1.5%, and RPI as of April 2015 was 0.9%. We expect that Heathrow's retail income per passenger will increase by between 5% and 7% in 2016, reflecting primarily the performance of the refurbished and expanded Terminal 5 luxury retail space and the continued growth in car parking. However, this could still be a conservative estimate if this retail space continues to be very successful. Based on these forecasts, we expect Heathrow's revenues to increase by between 1% and 3% in 2016.
Heathrow made significant progress in reducing its operating costs in 2015, and in our base-case scenario we expect further reductions in 2016. In our view, this will likely lead to an improvement in S&P Global Ratings'-adjusted EBITDA margins to 59% in 2016 from 57% in 2015. We forecast that capital expenditure will be about ?700 million-?800 million in 2016.
In our downside rating scenarios, however, we only give credit to cost efficiencies that have either already been achieved, or that we consider as having a high likelihood of being achieved. Therefore, we anticipate that the transaction would breach dividend lock-up triggers when a mix of stresses that we view as commensurate with the rating on the notes--including deflation, stressed cost of debt, and stressed RPI-hedging assumptions--are overlaid on a capital structure that we deem to be aggressive. These covenants are designed to support the transaction's credit quality during a stress scenario by limiting dividends and other subordinated payments from the structure. In none of these cases, however, would the notes be exposed to a payment default or a breach of the financial default ratios at the current rating levels and under the current regulatory framework.
Our analysis assumes that Heathrow Airport will have continued access to the markets to refinance debt coming due and make restricted payments. Refinancing risk is therefore the main risk factor in our analysis. We consider that it is partly mitigated by a set of covenants that give management an incentive to keep debt under a predetermined proportion of RAB. This makes for a relatively stable and predictable asset valuation proxy.
We could lower our rating on the notes if the regulatory framework changes substantially over time--becoming less supportive of Heathrow Airport's ability to finance its operations in the banking and capital markets. In such a scenario, we anticipate that the weaker debt structure of the class B notes would make them more exposed to a downgrade. We could also lower the rating if the company is faced with an operational shock that leads to a significant reduction in passenger volumes, or if it faces material regulatory penalties due to its failure to meet regulatory targets. We could also take a negative rating action if the company were to adopt more aggressive financial policies.
At this stage, we see limited scope for higher ratings on Heathrow Funding's notes, as the financial covenants set in the bond structure allow Heathrow Airport to operate with high leverage.
Heathrow Funding is a corporate securitization, which grants bondholders first-ranking security over Heathrow Airport and the Heathrow Express rail link. The transaction closed in 2008. Principal and interest for the financing group's obligations is serviced through various revenue sources, but primarily through passenger charges.
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