Fitch Expects to Rate United's 2016-2 Class AA Ctfs 'AA' & Class A Ctfs 'A'
--$636,512,000 class AA certificates due in October 2028 'AA(EXP)';
--$283,081,000 class A certificates due in October 2028 'A(EXP)'.
The ratings on both classes of certificates are primarily driven by a top-down analysis incorporating a series of stress tests which simulate the rejection and repossession of the aircraft in a severe aviation downturn. The 'AA' level rating is supported by a high level of overcollateralization (OC) and high-quality collateral supporting Fitch's expectations that senior tranche holders should receive full principal recovery prior to default even in a severe stress scenario. Likewise, the 'A' rating on the subordinated certificates is supported by OC sufficient for the tranche to pass Fitch's 'A' level stress scenario. The ratings are also supported by the inclusion of 18-month liquidity facilities, cross-collateralization/cross-default features and the legal protection afforded by Section 1110 of the U. S. Bankruptcy Code. The structural features increase the likelihood that the certificates could avoid default even if United were to file bankruptcy and subsequently reject the aircraft.
The initial 'AA' tranche loan to value (LTV), as cited in the prospectus, is 38.7%, and Fitch's maximum stress case LTV (the primary driver for the 'AA' tranche rating) through the life of the transaction is 82.3%. This level of OC provides a significant amount of protection for the senior tranche holders.
The initial 'A' tranche LTV, as cited in the prospectus, is 55.8%, and Fitch's maximum stress case LTV through the life of the transaction is 89.5%, using our 'A' category stress scenario.
UAL plans to raise $919,593,000 in an EETC transaction to fund 13 new aircraft that are expected to be delivered between December 2016 and June 2017.
The 'AA' tranche will be sized at $636,512,000 with a 12-year tenor and a weighted average life of 9.1 years.
The subordinate 'A' tranche will be sized at $283,081,000 and will also feature a 12-year tenor and a weighted average life of 9.1 years.
Collateral Pool: The transaction will be secured by a perfected first-priority security interest in 13 new delivery aircraft including seven Boeing 777-300ERs, two 787-9s, three 737-900ERs and a 737-800. Fitch considers all four aircraft types to be tier 1 collateral, though we view the 777-300ER and 737-900ER as weaker tier 1 assets. All four types are considered strategically important to UAL's fleet.
Liquidity Facility: The class AA and class A certificates benefit from dedicated 18-month liquidity facilities which will be provided by Commonwealth Bank of Australia acting through its New York branch (rated 'AA-'/'F1+'/Stable Outlook).
Cross-default & Cross-collateralization Provisions: Each note will be fully cross-collateralized and all indentures will be fully cross-defaulted from day one, which Fitch believes will limit UAL's ability to 'cherry-pick' aircraft in a potential restructuring.
Pre-funded Deal: Proceeds from the transaction will be used to pre-fund deliveries expected to be completed by June of 2017. Accordingly, proceeds will initially be held in escrow by Natixis ('A/F1'/ Stable Outlook), the designated depositary, until the aircraft are delivered.
Fitch notes that this transaction features a 35-day replacement window in the event that the liquidity facility provider or depositary should become ineligible. This is inconsistent with Fitch's counterparty criteria which generally stipulate a maximum 30-day replacement period. However, Fitch does not consider the longer replacement window to be material given that the additional time period is not significant. The transaction also features a downgrade threshold of 'BBB+' for the 'AA' tranche liquidity facility provider, whereas Fitch's counterparty criteria generally stipulate a minimum threshold of 'A-'. This is discussed in more detail below.
KEY RATING DRIVERS
Stress Case: The ratings for both classes of certificates are primarily based on collateral coverage in a stress scenario. The analysis uses 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 787-9s and the 737-800s in this pool receive a 40% haircut in Fitch's 'AA' stress scenario and a 20% haircut in the 'A' stress scenario, representing the low end of Fitch's stress ranges, and reflect the firm's view of these models as top-quality aircraft. The 737-900ERs receive a more severe haircut of 45% in the 'AA' scenario and 25% in the 'A' scenario, which incorporates the 737-900ER's limited user base, which could translate into a more difficult remarketing process if the aircraft had to be repossessed and sold. The 777-300ER received a 45% haircut in the 'AA' scenario and a 30% haircut in the 'A' scenario.
These assumptions produce a maximum stress LTV of 82.3% for the class AA certificates using Fitch's 'AA' category scenario and a maximum LTV of 89.5% for the class A certificates using an 'A' level stress scenario. These outcomes support a high likelihood that both classes of certificates should receive full recovery with a significant amount of headroom, even in a harsh downside scenario. The highest stress LTVs are experienced early in the life of the transaction and are expected to decline gradually as the deal amortizes.
High Collateral Quality: The quality of the collateral pool underlying the transaction is considered solid.
777-300ER (71% of collateral pool value per Fitch's valuations): Fitch considers the 777-300ER to be a high-quality tier 1 aircraft, but arguably weaker than other tier 1's such as the 737-800 or 787-9. The 777-300ER is the best-selling aircraft of its size with a diverse base of global operators and limited competition. With an average age of five years, the 777-300ER fleet is still a relatively young aircraft, though Boeing is preparing to launch its replacement, the 777x, in the early 2020 timeframe.
Asset values for 777s have come under some scrutiny over the past year or so as some older 777-200s have been sold for well below what market observers would have expected. However, we note that value pressures have primarily centered on older vintage 777s with Rolls Royce engines, while the demand for newer models has remained intact. According to the Ascend database there is currently only one 777-300ER listed as 'in storage' - meaning that there is essentially no immediate availability for this aircraft type.
Fitch notes that there is some concern over the high number of 777-300ERs scheduled to come off of their existing leases in coming years. Ascend lists 58 777-300ERs with lease expiries between now and 2023, 32 of which are from one user, Emirates. It is unclear whether a material number of lease expiries will pressure asset values over the intermediate term. Boeing also faces a gap between the end of its production run for the current 777 and the beginning of production of the 777x. The company still needs to sell a number of the current generation 777s to bridge production to the new model, which could lead to discounting that would pressure existing asset values. As such, Boeing recently cut its production rate on the 777 from 8.3/month to 7/month and is likely to cut production to 5.5/month over the transition period. Fitch's concerns are mitigated by the significant amount of overcollateralization included in this transaction. Fitch estimates that the senior tranche should continue to pass our 'AA' level stress test even if depreciation rates materially outpace our initial expectations.
787-9 (17%): Fitch considers the 787 Dreamliner to be a high-quality tier one aircraft. Despite technical issues early in the life of the smaller 787-8, backlogs for the aircraft family remain strong and delivery slots are scarce, which would support strong re-sale values if any of these planes were to come on the market. For that reason, Fitch applies the low end of its tier 1 stress range to the 787-9. The -9 variant has built up a sizeable backlog of 435 aircraft as of August 2016. Carrying 250 passengers in a standard arrangement, the 787-9 acts as a bridge in Boeing's product line between the 787-8 (typical capacity 224 passengers), and the 777-200ER (300 passengers). In addition, the 787-9 is capable of a similar range as the 777-200ER, but at an improved fuel burn rate.
737-900ER (9%): Fitch views the 900ER as a low tier 1/high tier 2 aircraft due to its attractive operating economics which make it an ideal replacement for older narrowbodies. However, the aircraft has a somewhat limited user base concentrated among a few large carriers. Lion Air and United operate nearly 50% of the fleet while the top four users (Lion, United, Delta and Alaska) operate some 75% of the 900ERs in service. The limited user base may make resale more difficult if the aircraft were to have to be repossessed or re-leased.
737-800 (3%): Fitch views the 737-800s as one of the most popular narrowbody aircraft currently in operation, and classifies it as top-quality tier 1 due to its market depth and desirability among approximately 185 global operators. The 737-800 is one of the world's most widely used aircraft and most attractive narrowbodies to finance.
Affirmation Factor: Fitch considers the Affirmation Factor (i. e. the likelihood that UAL would affirm these aircraft in the event of a bankruptcy) for the aircraft in this portfolio to be high, as all are considered strategically important for UAL. The 777-300ERs, which make up the largest portion of the collateral, are a key element of UAL's widebody fleet. UAL placed the order for these 777s in 2015, with the goal of replacing older aircraft and modernizing its fleet. United currently operates 20 747s, and as those aircraft leave the fleet, the 777-300ER will represent UAL's premier large widebody aircraft. Importantly, United will operate a fleet of only 14 777-300ERs in total, seven of which are included in this transaction. Along with the 787-9s, the UAL 2016-2 collateral pool will be around 5% of UAL's widebody fleet, making it unlikely that the company would reject these aircraft in the event of a bankruptcy.
The 787s are a meaningful addition to the fleet, allowing UAL to serve city pairs that were not previously accessible with older 767s. In addition, the 787 features significantly lower costs, including 20% lower fuel consumption, and 30% lower airframe maintenance costs, compared to similarly sized aircraft.
The 737-900ER comprises 18% of UAL's mainline fleet, making this one of the key aircraft in its lineup. The new deliveries will largely be used to replace older 757-200s as they are taken out of the fleet. The range of the 900ER makes it an ideal plane for longer distance domestic routes, while incorporating significantly lower trip costs than the less fuel efficient 757-200. United still operates 77 757s between the -200 and -300 model, which are much more likely to be rejected in a bankruptcy scenario compared to the -900ERs in this portfolio.
The 737-800 is also one of United's workhorse aircraft. The company operates 134 of them, with 737-800s serving each of United's hubs. UAL is one of the largest operators of the aircraft today, ranking just behind the likes of Southwest and American Airlines, which illustrates the importance of the 737 to United's fleet.
The fact that this transaction consists entirely of brand-new deliveries and has a low total expected cost of funding also makes it unlikely that the aircraft would be rejected in a distress situation.
Ratings for this transaction are driven by a harsh downside scenario in which United declares bankruptcy, chooses to reject the collateral aircraft, and where the aircraft are remarketed in the midst of a severe slump in aircraft values. Specific assumptions regarding value stress rates, etc. are covered elsewhere in this press release.
Both the AA and A tranche ratings are primarily based on 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. Potential risks for the 777-300ER include potential impacts from the entry of the 777x, which is scheduled to enter into service in 2020, and from the potential for discounting as Boeing looks to fill its production gap. Current generation 737s (both the 800 and 900ER) could be affected by the entry of the MAX. Senior tranche ratings could also be affected by a perceived change in the affirmation factor or deterioration in the underlying airline credit. The 'AA' tranche may also be downgraded to below the 'AA' category if United's IDR were downgraded to 'B-' or below, as stipulated in Fitch's EETC criteria. Fitch currently rates United at 'BB-'/Outlook Positive.
Variation from Criteria:
Fitch looks to its Counterparty Criteria for Structured Finance dated Sept 1, 2016 for guidance on rating requirements for direct counterparties including liquidity facility providers. Criteria stipulate that in cases where the senior-most tranche of rated debt is rated in the 'AA' category, the liquidity provider should maintain an Issuer Default Rating (IDR) of at least 'A-'. Note that the transaction documents that govern this EETC stipulate a downgrade threshold for the 'AA' tranche liquidity facility provider of 'BBB+', representing a variation from Fitch's criteria.
The variation recognizes that this aspect of the counterparty criteria does not directly apply to EETC ratings. In particular, Fitch's EETC criteria stipulate that in order to maintain a senior tranche rating in the 'AA' rating category, the underlying airline must be rated at least 'B'.
However, if the liquidity facility were to be drawn due to non-payment of interest, the airline would be rated below the 'B' rating level. Thus, the ratings on the senior tranche would have already been downgraded below the 'AA' category, at which point, the threshold rating of 'A-' stipulated in our counterparty criteria is not applicable.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
United Airlines 2016-2 pass-through trust:
--Series 2016-2 class AA certificates 'AA (EXP)';
--Series 2016-2 class A certificates 'A (EXP)'.
Fitch currently rates United as follows:
United Continental Holdings, Inc.
--Senior unsecured rating 'BB-/RR4'.
United Airlines, Inc.
--Secured bank credit facility 'BB+/RR1'.