Fitch Upgrades Virgin Australia 2013-1 A, B & C Notes; Affirms D Notes
--Class A notes (expected maturity October 2023) upgraded to 'A+' from 'A';
--Class B notes (expected maturity October 2020) upgraded to 'A-' from 'BBB';
--Class C notes (expected maturity October 2018) upgraded to 'BB+' from 'BB';
--Class D notes (expected maturity October 2016) affirmed at 'B+'.
The ratings cover approximately $457 million of outstanding senior and subordinated notes.
The upgrades of the A, B and C tranches are driven by a significant increase in overcollateralization as the transaction amortized by $138.2 million since the previous review in October 2015. The amortization of the notes significantly outpaced the depreciation of the supporting collateral which resulted in higher LTVs and recovery prospects for all tranches. Fitch's affirmation of the class D notes is driven by the notes' deeply subordinated position. The class D notes are scheduled to be repaid on Oct. 23, 2016.
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, VAH's credit quality, and various additional structural elements.
Positive credit factors include the absence of balloon payments for the A and B tranches, low balloon payments for the C and D tranches, short remaining expected maturities for the subordinated classes of notes, and rapid amortization of the notes resulting in expected LTV improvements for all tranches within the next several years.
VAH 2013-1 is the first EETC-type transaction relying on the Australian insolvency regime, which is different in key aspects compared to Section 1110 and the 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 ratified the CTC Alternative A on Sept. 1, 2015, the CTC rules do not apply retroactively, and Fitch expects VAH 2013-1 notes will be governed under the Australian insolvency law until maturity.
New Zealand is a CTC signatory, and the CTC covers the six aircraft in this transaction that are leased in New Zealand. 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.
KEY RATING DRIVERS
Stress Case: The ratings for the class A and the class B notes are primarily based on collateral coverage in a stress scenario. The analyses utilize a top-down approach assuming a rejection of the entire pool in a severe global aviation downturn. The scenarios incorporate a full draw on the liquidity facility, and an assumed repossession/remarketing cost of 5% of the total portfolio value. Fitch then applies significant haircuts to the collateral value.
The earlier vintage 737-800s (2003 and 2004) in the pool receive a 25% haircut in Fitch's 'A' stress scenario representing the mid-range of Fitch's stress ranges reflecting the firm's view of these models as a good quality tier 1 aircraft. The later vintage 737-800s (2010 and 2011) receive a 20% haircut in the 'A' stress scenario, representing the low end of Fitch's stress ranges. The 777-300ER received a 30% haircut in the 'A' stress scenario.
The A-tranche ratings are supported by a strong collateral package consisting of tier 1 aircraft with vintages ranged from 2003 to 2011. Since the inception of the transaction, two 737-700 aircraft have dropped out of the pool as the related equipment notes have been repaid. Market values for the remaining collateral aircraft (777-300ER and 737-800) have performed mostly in line with Fitch's expectations since the launch of the transaction. The class A notes benefit from rapid principle amortization of the notes which outpaces depreciation of the collateral resulting in a relatively rapid decline in the transaction's loan to value (LTV).
The one notch upgrade for the class A notes is supported by a significant improvement in collateral coverage over the past year. Fitch's 'A' level stress scenario produces the maximum remaining LTV of 75% as of October, 2016, down from 85% as of October 2015. The improvement in LTV is in line with Fitch's initial expectations and the stressed LTV of 75% implies a significant amount of cushion for the senior tranche noteholders. The class A notes have a remaining weighted average life of 2.7 years. The class A notes also pass Fitch's 'AA' level stresses, but the pool size eventually falls below the 10 aircraft minimum needed to qualify for 'AA' category ratings in Fitch's criteria.
Unlike many other EETC transactions that feature smooth and constant LTV declines, LTV values of VAH 2013-1 are expected to increase on several occasions as older vintage aircraft are paid off and removed from the collateral pool. The largest increase in LTV is expected to occur in October 2018 when seven 2004 vintage 737-800s and the 777-300ER will be fully paid off. The eight aircraft will represent approximately 50% of the pool's value and their exclusion from the collateral will increase Fitch's forecasted 'A' level stressed LTV for the class A notes to 70% as of Oct. 23, 2018, up from 56% as of July 23, 2018. The ratings are also supported by an 18-month liquidity facility provided by Natixis ('A'/'F1'/Outlook Stable by Fitch).
During this review, Fitch changed its approach for rating the class B notes of the VAH 2013-1 transaction to a top-down analysis from the previously utilized bottom-up approach due to significant collateral coverage of the notes. The 'A-' rating of the subordinated class B notes is supported by a sufficient amount of overcollateralization as the tranche passes Fitch's 'A' level stress scenario. Fitch's 'A' level stress scenario produces the maximum remaining LTV of 86% as of October 2016, down from 96% as of October 2015. The B tranche has a remaining weighted average life of 1.9 years. The rating of the B tranche is also supported by the presence of an 18-month liquidity facility provided by Natixis.
The ratings for the junior subordinated tranches are driven by Fitch's view of VAH's corporate credit profile, a high affirmation factor, superior recovery prospects driven by current collateral coverage and the rights of each subordinated class note holders to purchase all of the senior notes in certain cases. The upgrade of the class C notes was supported by significant increase in collateral coverage compared to the previous review. The ratings of junior subordinated notes are also supported by seniority of interest payments for all subordinated notes over the principal distributions to the senior notes.
The affirmation factor for this pool is considered high as both aircraft types in the transaction are core to VAH's fleet plan. 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 transaction's percentage of the fleet is projected to decline to below 4% beginning 2021, weakening the affirmation factor of the remaining pool. However, this is mitigated by the low LTV values expected by that time. Fitch believes that the likelihood of these aircraft being affirmed in a restructuring scenario effectively reduces the probability of default of subordinated tranches compared to VAH's credit profile.
Each note is fully cross-collateralized, and all indentures are fully cross-defaulted from the date of the issuance of each applicable note. Fitch believes these provisions in VAH 2013-1, which are standard enhancements of the modern EETC template, increase the likelihood that VAH would affirm these notes and the underlying aircraft and continue to make payments on the notes in the case of in the case of administrative proceedings. Taken together, these provisions treat all the aircraft as one pool of assets as the collateral supporting this transaction.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for VAH 2013-1 include:
--A high affirmation factor for the collateral aircraft in this pool;
--Current aircraft base values consistent with those provided by independent appraisers;
--Depreciation rates and value stresses incorporated into Fitch's base and stress case scenario are in line with those used for similar Tier 1 assets as described in Fitch's EETC criteria.
RATING SENSITIVITIES
Senior tranche ratings are primarily driven by a top-down analysis based on the value of the collateral. Therefore, a negative rating action could be driven by an unexpected decline in collateral values. For the 737-800s in the deal, values could be impacted by the entrance of the 737-8 MAX, or by an unexpected bankruptcy by one of its major operators. Fitch does not expect to upgrade the ratings of the senior tranche and senior subordinate tranche above the 'A+' and 'A-' levels, respectively.
The ratings of the junior subordinated tranches are influenced by Fitch's view of VAH's corporate credit profile. Fitch will consider either a negative or a positive rating action if VAH's credit profile changes in Fitch's view. Additionally, the ratings of the junior subordinated tranches may be changed should Fitch revise its view of the affirmation factor which may impact the currently incorporated uplift or if the recovery prospects change significantly due to an unexpected decline in collateral values.
LIQUIDITY
Both the A and B tranches feature an 18-month liquidity facility provided by Natixis, which Fitch rates 'A'/'F1' with a Stable Outlook. Natixis' 'A' rating provides ample room above Fitch's liquidity provider threshold. If the liquidity service provider is downgraded below the level required by Fitch to support the EEN, VAH must find an alternative provider that is suitably rated to replace the downgraded provider or fund with incremental cash collateral to the full committed amount. Otherwise, the affected VAH 2013-1 will likely be downgraded.
The liquidity facility is expected to cover up to six consecutive quarterly interest payments during an 18-month period in the event VAH defaults on its obligations, representing an additional source of default risk protection. The liquidity facility does not support principal payments. The liquidity service provider has the first priority claim, ahead of all EEN holders including the senior A tranche. Accordingly, Fitch's Stress Case assumes a fully drawn liquidity facility on top of the waterfall, which adds an additional 4.5% of LTV through the facility as the most senior claim.
Variation from Criteria:
Fitch may utilize either a bottom-up or top-down approach when initially rating senior subordinated tranches. Per Fitch's EETC criteria, for surveillance purposes, Fitch will generally continue to rate a given sub-tranche by whichever method the initial ratings were assigned; i. e. a sub-tranche initially rated via the top-down approach will be surveilled via the same approach.
Fitch has decided to change the approach for rating the B tranche of the VAH 2013-1 transaction to top-down from bottom-up approach which was utilized when Fitch initially rated the tranche B notes. Fitch also utilized bottom-up approach when it surveyed the transaction in 2014 and 2015.
Unlike the majority of the EETC transactions rated by Fitch, VAH 2013-1 does not have large balloon payments for senior and subordinated tranches and amortizes rapidly. As a result, debt amortization significantly outpaces the depreciation of the asset values. This differentiates VAH 2013-1 from the majority of Fitch rated EETC transactions and warrants a change of the rating approach for the senior subordinated tranches. The agency does not anticipate a change in approach for the majority of the other Fitch rated senior subordinated tranches during subsequent reviews.
The change in the approach has resulted in a two notch upgrade of the class B notes to 'A-' from 'BBB' whereby the bottom-up approach would have resulted in an affirmation of the notes at 'BBB'.
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