Securitization: Too clever by half
Inaugural slot securitization deal pulled from a market in no mood for complexity.
Innovation in financial engineering was one of the first casualties of the credit crisis. Before 2007 the overheated conditions in the credit market led to innovation for innovation’s sake (remember the CPDO?) but since then as the full extent of the dysfunction in the market became apparent the mantra has been simplicity, and vanilla structures the norm.
For that reason it was a surprise last month when British Airways announced an envelope-pushing securitization backed by airline landing slots at Heathrow. Wasn’t this the kind of thing that five years of sustained attack on the securitization market by the regulators was supposed to have put paid to?
International Airlines Group, which owns BA, planned to monetize its extensive slot network at Heathrow by setting up a subsidiary airline to which the slots would be transferred. The idea behind the structure was to mitigate the fundamental difficulty of such a deal: landing slots are rights controlled by regulatory authorities and the airlines hold no liens over them.
Slots have been used to back bond and loan deals in the US before. Deals have been done by American Airlines, Delta Airlines and United Airlines, but the rights of bondholders in a bankruptcy have never really been tested – when American Airlines became insolvent the bankruptcy judge indefinitely delayed a decision. By setting up a direct subsidiary, BA hoped to give protection in the event that it became insolvent – the subsidiary could be granted a temporary licence and assume operating control of the slots (incumbent airlines have renewal rights over slots unless usage falls below 80%). The driver behind the structure is also that the subsidiary company would be able to achieve a lower cost of funds than BA itself – the deal was rated seven notches above the corporate rating by Moody’s (A3) and four notches above it by S&P (triple-B).
The subsidiary that has been established for the purpose – BA Ltd – is essentially a virtual airline. It has wet leased two aircraft from IAG that it can operate between London City Airport and JFK and has also set itself up as a travel agent. This is sufficient to gain it EU certification as an operating airline. Thirty-one slots have been transferred to the subsidiary so far, which have a value of about £600 million ($930 million). The first issue – sized at around £250 million and arranged by BNP Paribas – was given the green light in July.
However, when the structure was roadshowed in July it seems that investors had other ideas. Concerns about regulatory interference and the rights of bondholders in bankruptcy seem to have proved too much for the market.
On July 20, IAG announced that: "There was a lack of demand for this bond at a price which would compare with financing alternatives. IAG has therefore decided not to progress with the bond issue." Given the time and expense that has gone into creating the structure, the airline must be fervently hoping that this does not remain the case. But in an atmosphere of such febrile uncertainty it was a punchy decision to market an untested structure of this complexity. As analysts at CreditSights observed before the deal was pulled: sometimes clever can be too clever.