In this market, any deal is news. But the BAA deal is big news. It is a complex refinancing involving the separation of regulated and non-regulated assets and the establishment of a single funding vehicle for BAA under which it can tap various sources of finance.
"I don’t think that I have ever been involved in a transaction presented with so many challenges," says Steve Curtis, partner at Clifford Chance, which advised the arranging banks. "There were so many constituencies that needed to agree: shareholders, existing bondholders, junior lenders, new senior lenders, rating agencies and pension trustee – which was an enormous undertaking even before you consider the impact of the credit markets, the price review for the London airports, the market investigation and other regulatory matters."
The deal involves the establishment of a £50 billion ($90.1 billion) multi-currency programme (BAA Funding) under which BAA has access to both the bank and bond markets. It has entailed a corporate reorganization of the company into separately financed designated and non-designated airports. The designated airports include Heathrow, Gatwick and Stansted and the non-designated airports are Edinburgh, Glasgow, Aberdeen and Southampton. The structure is designed to cope with the sale of one or more airports and if, as has been proposed, BAA is forced to sell Gatwick and Stansted the company will pay down debt in order to remain within its covenants.
"As and when the bank facilities are replaced with bond facilities the cost savings will be realized"
These facilities are being refinanced via a £7.15 billion bank facility. This comprises £4.4 billion of new bank facilities and £2.75 billion of new committed, undrawn facilities to fund working capital and planned investment projects. The MLAs are Banco Santander, BBVA, BNP Paribas, Caja Madrid, Calyon, Citi, HSBC, RBC and RBS. Five of these eight banks – BSCH, Calyon, Citi, HSBC and RBS – arranged the original £8.97 billion acquisition loan for the LBO of BAA by Ferrovial.
The designated airports are being additionally funded with a £440 million loan from the European Investment Bank and a £1.56 billion subordinated loan facility. $400 million of the existing subordinated debt has been paid down.
The non-designated airports are being refinanced via £1.25 billion of seven-year bank facilities – £1 billion of term loans and £255 million capex and working capital facilities. MLAs on these loans are Citi, Export Development Bank of Canada, HSH Nordbank, ICO, ING, La Caixa and RBS.
Secured corporate debt
Although the refinancing has been touted as the largest ever whole-business securitization, it seems curious to describe it as such when not a single new bond has been issued. "This is a secured corporate debt programme," says Simon Dudley, managing director at Citi, which co-arranged the deal with RBS. Perhaps the closest comparison is the Land Securities Capital Markets deal of 2004, which involved the property company incorporating bond and bank funding into a single structure to fund its business. It is no accident that many of the parties involved in BAA Funding were also involved in the LandSec deal. The two-tier investment-grade structure gives BAA substantial flexibility and gives the company five years’ breathing space. "The company has established a platform for programmatic issuance, allowing it to issue investment-grade paper at short notice as and when the bond market returns," says Curtis at Clifford Chance.
But a mix of bank and bond funding is rare in a whole-business securitization, because of the need to have separate floating charges over the bond and bank assets. Under the UK Enterprise Act, companies with more than £50 million of capital markets issuance are exempted from the abolition of administrative receivership. But bank debt is not exempt. The greater the bank debt in the structure, the greater the challenge for the structures. But in this case the likelihood of BAA, a regulated utility, entering receivership must be remote.
The bond element of the deal is the result of the transfer of the outstanding BAA bonds into the new BAA Funding structure. This process has been protracted given existing bondholder concerns about regulatory uncertainty (see "Why BAA’s refinancing can’t get off the ground", Euromoney, April 2007). Once the regulatory position became clear in March, negotiations with the Association of British Insurers (ABI) could proceed. Getting the existing bondholders to migrate to the new structure proved to be a time-consuming exercise fraught with difficulty but eventually 99% of bondholders by volume signed up.
Although various bondholders considered and were in a position to exercise blocking stakes, the delay to the refinancing drew the threat of downgrade to the existing bonds ever closer (although the agencies themselves were prepared to exercise patience as the delay to the deal stretched on). Although the original timetable envisaged the deal being wrapped up before March 2008, existing bondholders were never going to get comfortable until the Civil Aviation Authority’s position on BAA price controls was clear.
Following protracted negotiation between the liability management desks of Citi and RBS and the ABI (and coupon pick-ups of 70 basis points for post-2002 bonds and 10bp for pre-2002 bonds), agreement was reached. The cost to the structure of getting the bondholders on side was £12 million to cover the early acceptance fee and £15 million for extra coupon payments.
"There was a lot of noise around existing bondholders but in the event they supported the proposal," says Richard Bartlett, head of corporate origination at RBS. Rumours were rife that BAA had been forced to buy back bonds from holders that were not happy but Dudley at Citi denies this. "BAA did not purchase any bonds," he states, adding: "It was not in anyone’s interests to see the existing bonds downgraded."
The migrated bonds proved to be the entire bond component of the deal, as no new bonds were issued. "When we started it was always the view that £4.5 billion would be executed in the bond markets," explains Dudley. "But in the latter stages of 2007 we and the sponsors arrived at the decision that we needed to have a component of bank financing in there."
BAA chief executive Colin Matthews: complex deal
The £4.4 billion loan element of the designated airports financing fills the gap where a capital markets bond issue should have been. As recently as the early summer, sources close to the deal were admitting that the bond element of the refinancing "might be smaller than originally envisaged" but did not write off an issue altogether. Some were even speculating that unwrapped BAA bonds would be possible. The reality of the situation became clear when the final structure of the deal was announced with a new bond issue element of… zero.
The £4.4 billion loan is split into a £3.4 billion tranche A loan rated single-A minus and paying a margin of 1.75% over Libor. The remaining £1 billion tranche B loan is rated triple-B and pays 2.25% over Libor. Both loans have step-up margin levels dependent on the aggregate amount outstanding – but as they are both fully drawn down are paying the highest margin level at launch. Given that the original bridge financing paid an initial margin of 100bp on the senior acquisition debt (with step-ups over time) and 400bp on the junior, the cost savings from the refinancing do not look initially compelling.
"As and when the bank facilities are replaced with bond facilities the cost savings will be realized," says Dudley at Citi. "Over time the structure will achieve pricing benefits relative to where the new bank facilities have priced."
The arrangers have achieved a structure similar to what was envisaged when the refinancing was proposed in the very different credit markets that prevailed at the time of the LBO. The only real difference is that it is bank-funded, not bond-funded. That is no small achievement.
"This has been the biggest liability management exercise in Europe ever – which was done simultaneously with getting the banks on board, restructuring the junior facility and financing the non-regulated assets. And it was all done in the middle of August during the most challenging market environment we have seen," says Bartlett.
But the problem remains that for the refinancing to achieve the cost savings for BAA that it is designed to achieve, that elusive bond exit must still be realized at levels that are much cheaper than those on offer in the bank market. The banks are confident that this will be done – eventually. But it will have to be without monoline guarantees. "Undoubtedly, BAA will have very good market access on an unwrapped basis," predicts Dudley. "It will issue as and when it is ready."
But when will the market be ready? As the recent AirTanker deal (see "PFI: AirTanker decision fuels bond market gloom", Euromoney, May 2008) and now BAA have shown, the bond market is not yet in any shape to compete with bank finance for these large corporate deals. BAA’s bonds were trading in the mid-200bp in late August, which leaves a wide gap between bond and bank finance – even if sufficient investors could be tapped to make a bond issue feasible. "There is still healthy appetite out there for bond deals from regulated utilities such as the water companies," says a corporate securitization expert. "But BAA is not viewed in the same light, as its regulatory position is not as clear."