TEXT-Fitch rates Continental's proposed certificates 'BBB-'
Sept 19 - Fitch Ratings assigns the following ratings to Continental Airline's (CAL) proposed Pass Through Trusts Series 2012-2: --$711.6 million Class A Certificates (A-tranche) with an expected maturity of Oct. 2024 'A'; --$132.3 million Class B Certificates (B-tranche) with an expected maturity of Oct. 2020 'BBB-'. The final legal maturities are scheduled to be 18 months after the expected maturities. The proceeds of the certificates will be used to acquire class A and class B equipment notes, i.e. the aircraft mortgage obligations issued by Continental (CAL, rated 'B' with a Stable Outlook by Fitch) and secured by 21 brand-new aircraft including 18 Boeing 737-900ERs and three 787-8 aircraft scheduled for delivery between November 2012 and July 2013. The 737-900ERs are expected to replace the aging 757-200s in the company's domestic fleet, while the 787-8s are expected to supplant older vintages of the smaller widebodies (767s) used for international service. Each note will be fully cross-collateralized and all indentures will be fully cross-defaulted from day one, limiting CAL's ability to 'cherry-pick' aircraft in a potential restructuring. CAL is a unit of United Continental Holdings (UAL, rated 'B' with a Stable Outlook). Proceeds from this transaction will initially be held in escrow and deposited with the designated depository, Natixis S.A. (rated 'A+/F1+' with a Negative Outlook) and withdrawn to purchase the notes as the aircraft are financed upon delivery. Natixis is also the liquidity facility provider in this transaction. Both A and B tranches each have a dedicated liquidity facility that provides three consecutive interest payments over a period of 18 months in a potential default scenario which is incorporated in the ratings for both tranches. The 'A' rating for the A-tranche has been assigned as per Fitch's EETC methodology which prescribes a 'top-down' analysis for the senior tranche ratings that focuses primarily on the collateral, the structure's ability to withstand severe stresses, and legal enhancements (Section 1110) with a secondary dependence on the airline issuer default rating (IDR). Accordingly, the rating on the senior tranche is supported primarily by the significant level of overcollateralization (OC) through the A-tranche (Fitch's base loan to value of 61.1%), even in a distressed scenario (Fitch's maximum LTV is 96.2%) and the inclusion of brand-new, high-quality aircraft that are core to UAL's fleet. Fitch rates all the aircraft collateral as Tier 1 aircraft, although the stresses applied to the 737-900ERs (considered mid-range Tier 1) are harsher than the haircuts assumed for the 787-8s (solid Tier 1) in the transaction. Given the LTV level and the Tier 1 collateral, Fitch estimates that the structure can withstand acute stresses in a potential aviation or economic downturn. The 'BBB-' rating of the B-tranche has been assigned by notching up from CAL's IDR of 'B', based on the Affirmation Factor, although the five-notch uplift in this transaction reflects an exception to Fitch's criteria which stipulates notching up to four notches from the IDR. Fitch believes that an additional notch is appropriate in this case to reflect the strong credit quality of the B-tranche based on the strength of the Affirmation Factor as well as the quality of the collateral (entirely new, Tier 1 aircraft), the amount of OC, and the low funding cost expected for this transaction. The B-tranche rating also incorporates UAL's credit profile supported by its leadership positions across its extensive global route network, strong liquidity profile and growing unencumbered asset base. In addition, the initial LTV of 65% through the B-tranche is lower than recent deals, and importantly, it passes Fitch's 'BBB' test even after applying severe stresses to the aircraft collateral. The inclusion of all brand-new aircraft including the 'game-changing' 787-8 is also a distinguishing factor, as Fitch expects demand for this aircraft to remain robust over the next decade supporting secondary aircraft values even in a potential downside scenario. Importantly, Fitch considers the Affirmation Factor to be extremely high for this transaction. The 737-900ERs currently make up roughly 5% of UAL's narrowbody fleet, but are expected to constitute a much larger portion of the narrowbody fleet, estimated at 9% by the end of 2013 when incorporating the current order book. The 737-900ER is the narrowbody aircraft of choice for UAL (and a few of its U.S. peers including Delta and Alaska) and is expected to become the backbone of its domestic operations. The 787-8 opens up new destinations for UAL and offers superior performance and operating economics (estimated 20% lower fuel consumption, and 30% lower airframe maintenance costs). Notably, UAL is the first U.S. carrier, and the only one for the next several years to fly this aircraft. Fitch believes that the collateral aircraft play a vital role in UAL's domestic and international network, which along with the cross-provisions, and (expected) record low coupons, significantly increase the probability that UAL will affirm this deal in a potential restructuring. UAL's Outlook remains Stable for now as the company goes through its merger integration process. UAL remains on track with its deleveraging plan as evidenced in the $2.6 billion debt reduction since the merger. Notably, at 22% of revenues (as of June 30, 2012) total liquidity is currently one of the strongest amongst its peers; while expected to decline as the company continues to pay down debt through the integration period, it nonetheless remains solid. Importantly, UAL is expected to shore up a sizeable pool of unencumbered assets as it pays down its non-aircraft debt over the next few years. By year-end 2012, the unencumbered asset pool is estimated to be about $3 billion but is expected to approach levels similar to Southwest (the only investment-grade rated carrier in the U.S.) in just two years. This is an important consideration for UAL's ratings that could significantly boost the carrier's credit ratings over time. AIRCRAFT COLLATERAL ANALYSIS The collateral underlying the transaction consists of 18 new Boeing 737-900ERs and three new 787-8s with expected deliveries from November of 2012 through July of 2013. The collateral pool is similar in size and makeup to CAL 2012-1, which was issued in March, with the key distinction being that this deal is comprised entirely of brand new deliveries. With only two aircraft types, the collateral in the 2012 EETCs is less diversified than some of CAL's other EETCs (such as 2010-1) but the older deals are diversified with older Tier 2 aircraft. However, with a total of 21 aircraft, the aircraft pool for the 2012 EETCs is larger than some of the other recent deals. Collateral Appraisal For the analysis of the CAL 2012-2 EETC, Fitch uses base values provided by a third party appraiser not included in the transaction documents, and incorporates depreciation assumptions that are generally more aggressive than the schedule provided in the offering memorandum. By Fitch's estimates, total appraised value for the aircraft portfolio is approximately 9% lower than the appraised value (lesser of the average and median values provided by three appraisers) in the offering memorandum. Collateral Coverage: LTV Calculation - Base Case Using Fitch's very conservative valuation for the aircraft, the initial LTV is estimated at 61.1% for the A-tranche and 72.4% for the B-tranche, compared to 55.0% and 65.2%, respectively, as per the prospectus. Fitch's depreciation assumption of 5% is in accordance with the depreciation rates applied to Fitch's Tier 1 aircraft but more conservative than the 3% depreciation rate in the prospectus. Using the more conservative depreciation curve, and the amortizing schedule outlined in the prospectus, and assuming no cyclical fluctuations, Fitch estimates the LTV for the A-tranche gradually declines to the a low-50% range while the B-tranche LTV declines to a low-60% range prior to final maturity of each tranche. LTV Calculation - Stress Case (Primary Rationale for A-Tranche Rating) Fitch's stress case simulates a severe downside scenario which assumes aircraft rejection during a downturn. Fitch puts the aircraft collateral and structure through different ratings stress scenarios based on Fitch's aircraft Tier classification, and recalculates collateral coverage after applying these stresses to determine the highest rating category where the senior A-tranche LTV does not exceed 100%, as per Fitch's EETC criteria. This downside case reflecting a severe global aviation downturn is what drives Fitch's senior tranche rating methodology. Accordingly, in its stress case, Fitch assumes: i) a full liquidity draw that adds 5.5% LTV as the senior most claim, (ii) 5% repossession and remarketing costs, and (iii) applies 20%-30% haircut (Tier 1 value stresses) to the aircraft collateral to determine the highest rating category where the senior A-tranche LTV does not exceed 100%. Fitch considers both the 737-900ERs and the 787-8s to be Tier 1 aircraft, but applies harsher stress on the 737-900ERs which are considered good-quality, mid-range Tier 1 aircraft than on the 787-8s which are viewed as exceptional Tier 1 aircraft. The recent ramp-up in orders for the 737-900ER is impressive, but even with the growing customer base (which doubled to 17 since the beginning of 2010) ownership for this aircraft remains highly concentrated amongst a handful of operators, with Lion Air in Indonesia with the largest fleet (49%) followed by UAL(33%). The 787-8s, on the other hand, boast a customer base of 46 airline operators and lessors with a robust orderbook of 520 aircraft with deliveries scheduled well into the latter part of the decade. Accordingly, Fitch expects secondary liquidity to be very strong for this aircraft in a potential aviation downturn in the near-to-intermediate term. The structure for this transaction comfortably passes Fitch's 'A' rating category stress test. This stress scenario produces a maximum LTV of 96.2% for the 'A' tranche through the life of the security, which suggests a full recovery of principal for the bondholders with some headroom. The highest LTVs are experienced early in the life of the deal, and decline as the tranche amortizes, falling below 80% as the deal nears maturity. For the 'A' tranche LTV to breach 100% base values must be stressed by nearly 33%, which is above our normal stress range for Tier 1 aircraft. The Affirmation Factor (Primary Rationale for B-Tranche Rating) Fitch considers the Affirmation Factor for the aircraft in this portfolio to be very high as both the 737-900s and 787-8s are both considered to be strategically important to UAL. The 737-900ER is the premier narrowbody of choice for UAL as it is expected to replace the aging 757-200s in its domestic fleet. The company's commitment to this aircraft was recently evidenced when it placed a firm order for 50 737-900ERs (with options for 60 more) in July, in addition to its order for 100 737 MAX aircraft. The 737-900ERs constitute 5% of the current fleet, but as new orders are delivered Fitch expects that percentage to grow significantly, making this the core narrowbody aircraft in UAL's lineup. Incorporating the current order book, Fitch expects the 737-900ER to make up 9% narrowbody fleet by the end of 2013. The range of the 737-900ER makes it an ideal plane for longer distance domestic routes, while incorporating significantly lower trip costs than the less fuel efficient 757-200. The 787-8s are expected to revamp UAL's international fleet, allowing UAL to serve city pairs that were not previously accessible with older 767s. In addition the 787-8 features significantly lower estimated costs, including 20% lower fuel consumption, and 30% lower airframe maintenance costs, compared to similarly sized aircraft. The fact that this transaction consists entirely of brand new deliveries and has a relatively low total expected cost of funding also makes it very unlikely that the aircraft would be rejected in a distressed situation, in Fitch's view. Rating Risk Factors Much like the A320 family, future market values for the 737-900ER are likely to face some risk from the introduction of the re-engined 737-MAX program. Boeing announced the MAX program in 2011, which will include three variants, the 737-7, the 737-8, and the 737-9, intended to replace the 737-700, 737-800, and 737-900ER, respectively, over time. The new-engine variant powered by the CFM International LEAP-1B engine reduces fuel burn and CO2 emissions by an additional 13% over today's most fuel-efficient single-aisle aircraft. It also features fly-by-wire technology, and changes to the nose and landing gear. The introduction of the new models will likely place pressure on older variants, but Fitch views this as a bigger threat to older generation aircraft rather than the aircraft in this portfolio given that they are some of the youngest vintage. The first delivery of the MAX is not expected until fourth quarter 2017 and it will take some time to produce a significant number of the new planes before it starts pressuring market values. Fitch has assigned the following ratings: Continental Airlines 2012-1 Pass Through Trust -- Series 2012-2 Class A certificates 'A'; -- Series 2012-2 Class B certificates 'BBB-'. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --- Rating Aircraft Enhanced Equipment Trust Certificates (Sept. 15, 2011) --- Corporate Rating Methodology (Aug. 12, 2011); --- Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers (May 12, 2011); --- Global Rating Criteria for Aircraft Operating Lease ABS (April 17, 2012). Applicable Criteria and Related Research: Global Rating Criteria for Aircraft Operating Lease ABS Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers Corporate Rating Methodology Rating Aircraft Enhanced Equipment Trust Certificates