October 25, 2017 / 9:50 AM / a year ago

Etihad-linked bonds stay afloat despite downgrade

DUBAI, Oct 25 (Reuters) - Some $1.2 billion in bonds issued by an Etihad Airways-linked special purpose vehicle only lost a few points in the secondary market after Fitch downgraded them to “CC” last Friday, putting the paper just two notches above default.

The bonds’ cash price was a few points above 80 cents on the dollar on Wednesday. Fund managers say they should be at least 20 points below that, but the discrepancy reflects expectations of financial backing by Etihad, the borrower of reference under the special purpose vehicle.

However, investors are questioning whether such support would actually materialise.

The special purpose vehicle EA Partners was established in 2015 to raise funding for Etihad and airlines it partly owned. It issued a $700 million bond maturing in 2020 and, in 2016, $500 million bond due in 2021. The proceeds of both the debt sales were used to enter into separate debt obligations with the SPV airlines.

The bonds began falling in April after workers at Alitalia, in which Etihad had a 49 percent stake, rejected its latest turnaround plan leading to the Italian carrier filing for bankruptcy. The paper took another hit in August, when Air Berlin, in which Etihad also had a large minority stake, filed for bankruptcy protection.

But despite the bankruptcies of two airlines that have borrowed under the financing vehicle, corresponding to around 40 percent of the debt being in default, the bonds did not drop dramatically because of the implicit assumption that Etihad would bear the liabilities of the two airlines.

“The only investment case for these bonds at these levels would be if Etihad decides to support the structure,” said Zeina Rizk, director, fixed income asset management at Arqaam Capital.

Etihad declined to comment.

The Fitch downgrade – reflecting concerns that a credit enhancement mechanism part of the bonds would be insufficient to compensate for lost contributions from Alitalia and Air Berlin – eroded the cash price of the paper by about 2 points but the bonds stayed above 80 cents on the dollar.

Expectations of intervention by Etihad increased after an agreement between Etihad and Alitalia emerged after the Italian carrier’s default, guaranteeing that Etihad would cover Alitalia’s $264 million exposure to the bonds. However, there is no similar guarantee for Air Berlin’s portion of debt.

Etihad may want to avoid being associated to a defaulting bond which, additionally, is largely held by Abu Dhabi family offices, some fund managers said.

Rizk said: “Etihad is not legally obligated to do so because there is no cross-default. From public statements, it appears that Etihad’s strategy in relation to its partners may be changing, which can lead us to suppose that the business case for supporting the structure is also weaker than when it was put together.”

Editing by David Evans

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