S&P: American Airlines' Series 2016-3 AA And A Pass-Through Certificates Assigned Preliminary 'AA+ (sf)' And 'A+ (sf)' Rating
At the same time, we assigned our preliminary 'A+ (sf)' issue-level rating to the company's series 2016-3 class A pass-through certificates (with an expected maturity date of Oct. 15, 2028).
The final legal maturities will be 18 months after the expected maturities. American Airlines is issuing the certificates under a Rule 415 shelf registration. We will assign final ratings upon the completion of our legal and documentary review.
We base our preliminary ratings on these issues on the credit quality of American Airlines' parent, American Airlines Group Inc. (BB-/Stable/--), the substantial collateral coverage by good-quality aircraft, and the legal and structural protections available to the certificates. The company will use the proceeds from these offerings to finance or refinance five Airbus A321-200 aircraft, eight Boeing B737-800 aircraft, four Boeing B787-9 aircraft, and eight Embraer ERJ175LR aircraft. The secured notes relating to each aircraft are cross-collateralized and cross-defaulted--a provision that we believe increases the likelihood that American Airlines would cure any defaults and agree to perform its future obligations (including its payment obligations) under the indentures in bankruptcy.
The pass-through certificates are a form of enhanced equipment trust certificate (EETC) that benefit from the legal protections afforded under Section 1110 of the U. S. Bankruptcy Code and the liquidity facilities provided by KfW IPEX-Bank GmbH. The liquidity facilities would cover up to three semiannual interest payments, a period during which the certificateholders could repossess and remarket the collateral if American Airlines does not enter into an agreement under Section 1110, or the facilities could be used to maintain the continuity of interest payments on the certificates as the certificateholders negotiate with American on revised terms.
We believe that our corporate credit rating on KfW IPEX-Bank is sufficiently high so that, based on our counterparty criteria, it does not represent a constraint on our preliminary ratings on the class AA and class A certificates. We note that the threshold ratings below which KfW IPEX-Bank would have to replace itself are 'AA-' for the class AA certificates and 'BBB' for the class A certificates. Accordingly, if we downgraded KfW IPEX-Bank to 'AA', we would lower our preliminary rating on the class AA certificates by one notch. However, any further downgrades would not cause us to lower our preliminary rating on the class AA certificates because a 'AA-' rated liquidity provider can support a 'AA' rated certificate if it has a qualifying commitment to either find a suitably rated replacement or fund a liquidity account with cash. In contrast, the gap between our preliminary 'A+ (sf)' issue-level rating on the class A certificates and the threshold rating applicable to those certificates' liquidity provider is unusually wide, meaning that if we were to lower our rating on KfW IPEX-Bank below 'A', we would also lower our preliminary rating on the class A certificates in lockstep for up to three notches until the liquidity provider replacement mechanism was triggered.
The preliminary ratings apply to a unit consisting of certificates that represent the trust property and escrow receipts that represent interests in deposits that will be made with the proceeds from the offerings. The proceeds will be deposited with Citibank N. A., pending delivery of the new aircraft. The amounts deposited under the escrow agreements are not the property of American Airlines and are not entitled to protection under Section 1110 of the bankruptcy code. Our corporate credit rating on Citibank is lower than our preliminary rating on the class AA notes; however, because the proceeds from the certificates and accrued interest will be held in a trust account, our rating on Citibank is sufficiently high under our counterparty criteria to support our preliminary rating on the class AA notes. The proceeds and accrued interest on the class A certificates will not be held in a trust account, but Citibank's rating is high enough to support the preliminary rating on those certificates without that arrangement.
We believe that American Airlines views these aircraft as important and would, given the cross-collateralization and cross-default provisions, likely cure any defaults and agree to perform its future obligations (including its payment obligations under the indenture) in any future bankruptcy. In contrast to most EETCs that airlines issued before 2009, the cross-default would take effect immediately in a bankruptcy if American Airlines rejected any of the aircraft notes. This should prevent the company from selectively affirming some aircraft notes and rejecting others (cherry picking), which often harms the certificateholders' interests in a bankruptcy.
The largest proportion of the value of the collateral pool is represented by the Boeing B787-9 aircraft (39%). The B787-9 is a member of Boeing's new long-range, midsize family of widebody planes. Boeing began delivering the smaller B787-8 (after long delays) in September 2011. The first delivery of the somewhat larger B787-9 (with a slightly longer range than the B787-8) occurred in 2014. The B787 family, which will also include a still-larger B787-10 version that currently has an expected delivery date in 2018, has been a huge success in terms of orders. There are currently 569 787-9s that have been delivered or are on order (and well over 1,000 for the whole 787 family). The companies that operate this plane are globally diversified and include a mix of airlines and aircraft leasing companies. The B787-9 is intended to fill the size gap between the B787-8 and the B777-200ER. We currently expect that the B787-9 will prove to be the most popular version of the 787 family.
The second largest proportion of the value (26%) of the collateral pool is represented by the Boeing B737-800 aircraft. The B737-800 is the most successful of Boeing's family of current technology narrowbody planes, with more than 5,000 orders since its introduction. Its direct competitor is Airbus' A320, which is also a very successful airplane. We consider the B737-800 to be the best aircraft collateral currently available, given its very extensive user base and strong residual value performance, narrowly placing it ahead of the A320. However, as is the case for the Airbus narrowbody aircraft, a successor model will be introduced later this decade--the MAX versions of the B737 featuring new, more fuel efficient engines and some other changes. Also, Airbus has already introduced its new engine option (neo) version of the A320, while Boeing's MAX version of the B737 will not be released until next year. Still, given the size of the existing B737-800 fleet and the long backlog for both this model and its successor MAX version, we do not expect there to be material downward pressure on the value of these planes until the next decade.
The third largest proportion of the value of the collateral pool is represented by the Airbus A321-200 aircraft (19%). The A321-200 is the largest narrowbody aircraft manufactured by Airbus. Although not as popular as the company's medium-size narrowbody A320-200 from the same family of planes, the A321-200 has seen a greater number of orders in recent years as increasing air traffic and airport capacity constraints have caused airlines to gradually shift to larger planes. Airbus will introduce neo versions of its three narrowbody planes (the A319-100, A320-200, and A321-200), which will be more fuel efficient. With a fairly large existing base of A321-200s currently in service with many airlines, we do not expect that there will be pronounced pressure on the value of these planes (which already, to some extent, anticipate the delivery of the new A321neo), though there could be greater downside risk if an industry downturn occurs later this decade. The A321-200s in this collateral pool have "sharklets", which are a refinement of the wing that provide some fuel savings and should make them more valuable than earlier versions of the plane.
The final 16% of the value of the collateral pool is represented by the Embraer ERJ175LR (long range) regional jets. The ERJ175LR is the second smallest (typically seat 76) member of Embraer's E-Jet family, which has recently enjoyed a higher level of sales than its main competitors (Bombardier's CRJ-700 and CRJ-900 models). Embraer plans to introduce an E175-E2 version of the regional jet, which will have new engines and a new wing intended to provide better fuel efficiency, around 2020. With a smaller user base than the B737-800 or A321-200, there is somewhat greater risk that the value of these planes will be negatively affected when the newer E2 model enters service.
We apply a 6.0% annual depreciation rate to the B787-9 aircraft, a 5.0% annual depreciation rate to the B737-800, a 6.5% annual depreciation rate to the A321-200, and a 7.0% annual depreciation rate to the ERJ175LR. Our depreciation rates, which generally correlate with our views on the aircraft models' resale liquidity and technological risk, are materially more conservative than those used in the prospectus for these certificates.
The pass-through certificates' initial loan-to-value (LTV) ratios are 38.7% for the class AA certificates and 56.4% for the class A certificates, using the appraised base values and depreciation assumptions in the offering memorandum. When we evaluate an EETC, we compare the values provided by the appraisers that the airline hired with our own sources. In this case, we used initial values that are very close to those in the prospectus. However, because we apply more conservative (faster) depreciation rates than those in the prospectus (3% of initial value each year), our LTV ratios gradually diverge from those in the prospectus, reaching a maximum of about 40% for the class AA certificates and about 58% for the class A certificates. Our analysis also considered that a full draw on the liquidity facility, plus the interest on those draws, represents a claim that is senior to the certificates'. This amount is typical of recent EETCs and is equal to less than 5% of the collateral value. We factored that added priority claim into our analysis. We also note that the transaction is structured so that American Airlines could subsequently issue subordinated classes of certificates without a liquidity facility. In the past, airlines have structured follow-on certificates of this kind in such a way as to not affect the ratings on their outstanding senior certificates.
We expect American Airlines Group Inc.'s (AAG) 2016 earnings and cash flow to be weaker than the very strong levels the company posted in 2015. Nonetheless, we anticipate that they will remain good in absolute terms and by historical standards. The company's credit ratios will likely deteriorate somewhat, as management continues to spend heavily on new aircraft and share repurchases, pushing AAG's funds flow-to-debt ratio to around 20%. We could lower our ratings on AAG if the company's revenue and earnings deteriorate and reductions in its share repurchases or capital spending do not offset the decline, leading AAG's funds from operations (FFO)-to-debt ratio to fall below 15% for a sustained period and causing us to revise our assessment of the company's liquidity to adequate from strong. Although unlikely, we could raise our ratings on AAG if stronger-than-expected earnings and cash flow or reduced levels of capital spending and share repurchases cause its funds flow-to-debt ratio to rise to more than 30% on a sustained basis.