OREANDA-NEWS. Fitch Ratings has affirmed Punch Tavern Finance B Limited's (Punch B) swap loan and senior debt (A3, A6 and A7 notes) and revised the Outlook on the class A notes to Negative, as follows:

GBP18.2m floating-rate swap loan due 2019: affirmed at 'BB', Outlook Stable

GBP128.8m Class A3 fixed-rate notes due 2021: affirmed at 'B+'; Outlook revised to Negative from Stable

GBP220m Class A6 fixed-rate notes due 2022: affirmed at 'B+'; Outlook revised to Negative from Stable

GBP139.7m Class A7 fixed-rate notes due 2024: affirmed at 'B+'; Outlook revised to Negative from Stable

During the 12 months to March 2016 Punch continued its strategy of selling off non-core pubs to improve the overall quality of the remaining estate and pay down debt. Key performance indicators have fallen as a result, but performance on a per pub basis is more stable, and investment has continued, which should support future stable performance. FY15 like-for-like net income growth of 0.3% at group level also highlights ongoing stabilisation. However, during the year class A leverage has remained flat and not improved in line with Fitch's expectations. This has reduced the limited cushion in the rating of the class A notes, and we have therefore revised the Outlook to Negative from Stable.

The revision of the Outlook is also supported by the peer comparison, as the class A leverage is relatively high for the rating.

TRANSACTION PERFORMANCE

The ongoing disposals mean that revenues and EBITDA continued to decline on an absolute basis by 5% and 8%, respectively, after adjusting for the 53 week previous year. This resulted in trailing 12 months EBITDA to March 2016 of GBP69m. However, performance was slightly stronger on a per pub basis, with revenues growing by 3% and EBITDA by 0.1%. The relatively weaker EBITDA performance was driven by a substantial increase in opex over the year due to the development of the Retail Agreement team, which we expect to be an initial one-off setup expense. EBITDA margins therefore also deteriorated slightly by 1ppt to 44%.

The ongoing disposals facilitated further investment and debt prepayments. Punch spent GBP24m on the Punch B estate over the year, which equates to around GBP17,000 per pub - well in excess of the minimum required spend of GBP8,000 per pub. The Swap Loan balance reduced to GBP18m from GBP41m, representing a 56% reduction in principal outstanding over the year. However, the ongoing scheduled amortisation of the class A combined with disposal driven prepayments were insufficient to drive further deleveraging of the class A notes. Total leverage remained flat at 7.4x and this lack of deleveraging places some pressure on the ratings. The updated projected synthetic DSCR metrics improved significantly to over 20x for the Swap Loan, but deteriorated slightly for the class A notes to 0.9x. Reported metrics were relatively stable over the year, but the EBITDA ICR covenant declined slightly.

In comparison with peers such as Unique Pub Finance Company plc (another predominantly leased/tenanted pubco), Punch B's one-year projected leverage is reasonably high, which leaves limited cushion in the rating, particularly after adjusting for differences in the financial structure such as Punch B's exposure to refinancing risk. This supports the revision of the Outlook to Negative from Stable.

KEY RATING DRIVERS

Industry Profile - Midrange

The pub sector in the UK has a long history, but trading performance for some assets has shown significant weakness in the past. The sector has been in a structural decline for the past three decades due to demographic shifts, greater health awareness and the growing presence of competing offerings. Exposure to discretionary spending is high and revenues are therefore inherently linked to the broader economic cycle. We view competition as high including off-trade alternatives, and barriers to entry are low, despite increasingly demanding regulations. Despite the on-going contraction, Fitch views the eating - and drinking-out market as sustainable in the long term, supported by the strong pub culture in the UK.

Sub-key rating drivers (KRD) Operating environment: Weaker; Barriers to entry: Midrange; Sustainability: Midrange

Company Profile - Midrange

EBITDA per pub has stabilised over the past five years, mainly as a result of extensive disposals of weakly performing non-core pubs and increased investments in the core estate following years of capex underspend. The leased/tenanted business model makes it more challenging for the Punch group to adapt to the growing eating-out market in the UK, as it has reduced control over publicans' strategy and less cash for capex due to performance declines. Furthermore, limited visibility with respect to tenants' profitability means that the sustainability of the cash flows generated by tenanted pubs is more difficult to estimate. However, we expect the continued disposals of non-core pubs, combined with increased capex invested in the core estate, to result in an overall improved quality of the estate in the foreseeable future.

Sub-KRDs: Financial performance: Weaker; Company operations: Midrange; Transparency: Weaker; Dependence on operator: Midrange; Asset quality: Weaker

Debt Structure - Midrange (swap loan)/ Midrange (class A)

The swap loan benefits from a favourable repayment profile with a combination of front-loaded scheduled amortisation and a cash sweep mechanism. We also forecast it will fully repay by expected maturity under our base case. However, we have limited our assessment to Midrange as Fitch views the probability of default of the swap loan and the class A to be much more closely aligned than in other tranched UK whole business securitisations (WBS). Unusually for such securitisations, only the most junior class B3 notes can defer interest payments. Consequently, failure to pay interest and scheduled amortisation (or final principal) on the class A notes would result in an issuer event of default due to the class A notes' non-deferability. The interest rate exposure of the floating-rate swap loan is deemed immaterial given its small size and quick repayment.

The Weaker debt profile assessment for the class A notes reflects the partial amortisation and the large bullet maturities in 2021, 2022 and 2024. These cannot be met out of excess cash flows in Fitch's base case, requiring either a debt refinancing or significant disposals of core pubs.

The security package is standard for UK WBS transactions. Operational and financial covenants are satisfactory, although Fitch notes the exclusion of the bullet repayments for the purpose of calculating the free cash flow (FCF) debt service coverage ratio (DSCR) as well as the possibility of preventing a covenant breach through the availability of disposal proceeds as part of the FCF definition. Fitch considers the inclusion of a leverage covenant mitigates this relative weakness. A reduced liquidity facility is structured to cover 18 months of peak debt service. However, this is effectively only interest payments and scheduled principal (excluding final bullets).

Sub-KRDs: Debt profile: Midrange (swap loan)/Weaker (class A); Security package: Stronger; Structural features: Midrange

RATING SENSITIVITIES

Swap Loan and class A - Negative: Given that the class A projected DSCR and leverage metrics both look reasonably weak at the current rating relative to peers, any deterioration in these metrics could lead to a downgrade. This could be driven by declining performance or disposal proceeds being insufficient to lead to deleveraging via prepayments. Furthermore, the anticipation of a failure to refinance maturing debt tranches would lead to negative rating action.

Swap Loan, class A - Positive: The notes are unlikely to be upgraded in the foreseeable future.

SUMMARY OF CREDIT

Punch B is a whole business securitisation of tenanted pubs located across the UK owned by Punch Tavern Plc (the group). As of March 2016, the transaction consisted of 1,345 pubs in total, consisting of 1,116 pubs in the core estate and 229 pubs in the non-core estate, versus 1,484 at March 2015 (1,131 core and 353 non-core), a reduction of 9%.