Moody's downgrades the UK Whole Business Securitisation Notes issued by Punch Taverns Finance plc and Punch Taverns Finance B Limited
London, 30 November 2012 -- Moody's Investors Service has downgraded the ratings of notes issued by Punch Taverns Finance plc ("Punch A") and Punch Taverns Finance B Limited ("Punch B").
Issuer: Punch Taverns Finance plc
....GBP270M A1(R) Notes, Downgraded to Baa3 (sf); previously on Apr 5, 2011 Downgraded to Baa1 (sf)
....GBP300M A2(R) Notes, Downgraded to Baa3 (sf); previously on Apr 5, 2011 Downgraded to Baa1 (sf)
....GBP200M M1 Notes, Downgraded to B1 (sf); previously on Apr 5, 2011 Downgraded to Ba1 (sf)
....GBP400M M2(N) Notes, Downgraded to B1 (sf); previously on Apr 5, 2011 Downgraded to Ba1 (sf)
....GBP140M B1 Notes, Downgraded to Caa1 (sf); previously on Apr 5, 2011 Downgraded to Ba3 (sf)
....GBP150M B2 Notes, Downgraded to Caa1 (sf); previously on Apr 5, 2011 Downgraded to Ba3 (sf)
....GBP175M B3 Notes, Downgraded to Caa1 (sf); previously on Apr 5, 2011 Downgraded to Ba3 (sf)
....GBP215M C(R) Notes, Downgraded to Caa3 (sf); previously on Apr 5, 2011 Downgraded to B3 (sf)
Issuer: Punch Taverns Finance B Limited
....GBP201M A3 Notes, Downgraded to Ba2 (sf); previously on Apr 5, 2011 Downgraded to Baa3 (sf)
....GBP220M A6 Notes, Downgraded to Ba2 (sf); previously on Apr 5, 2011 Downgraded to Baa3 (sf)
....GBP250M A7 Notes, Downgraded to Ba2 (sf); previously on Apr 5, 2011 Downgraded to Baa3 (sf)
....GBP250M A8 Notes, Downgraded to Ba2 (sf); previously on Apr 5, 2011 Downgraded to Baa3 (sf)
....GBP77.5M B1 Notes, Downgraded to B3 (sf); previously on Apr 5, 2011 Downgraded to Ba3 (sf)
....GBP125M B2 Note, Downgraded to B3 (sf); previously on Apr 5, 2011 Downgraded to Ba3 (sf)
....GBP125M C Notes, Downgraded to Caa3 (sf); previously on Apr 5, 2011 Downgraded to B3 (sf)
The A3 (sf) ratings of the liquidity facilities in both transactions are unaffected by today's action.
Moody's does not rate the Class D1 Notes issued by Punch A. The ratings of the Class A2(R) Notes, Class M2(N) Notes and Class B3 Notes of Punch A are based on the underlying rating of the notes and are no longer based on the financial guarantee policy provided by AMBAC Assurance UK Limited (rating withdrawn). The ratings of the Class A7 and Class A8 Notes of Punch B are based on the underlying rating of the notes and are no longer based on the financial guarantee insurance policy issued by MBIA UK Insurance Limited (B3).
Punch A and Punch B represent whole-business securitisations (WBS) of portfolios of 2,604 and 1,850 leased pubs (as of Q4 2012) respectively, located across the UK. Punch A closed in March 1998 and has been subject to tap issuances in October 2000, November 2003 and July 2007 whereas Punch B closed in November 2002 and was restructured in August 2005.
The downgrade of the Notes reflects Moody's concerns on the deteriorating operating conditions in the UK pub industry and the persistently high leverage of the underlying securitisations. Moody's believes that the parent company's (Punch Taverns plc) plans to sell the non-core pubs in the underlying portfolios (32% of the portfolio in Punch A; 39% of the portfolio in Punch B by number of pubs) carries execution risk and will likely not be sufficient to manage the required debt repayment over time. Further, Moody's believes that the total leverage in the transactions will increase in the near term as the parent company plans to utilise a portion of the disposal proceeds for investing into the core estate to stimulate growth in the long term rather than prepaying debt.
With a current underlying EBITDA of GBP 145 million in Punch A and GBP 91 million in Punch B for FY 2012, the debt service coverage ratio (DSCR) in both securitisations would have been below the default covenant (1.25x) had the parent company not provided external cash support. During the financial year, total support amounted to GBP 79 million compared with approximately GBP 69 million in the previous year (+14%). Excluding the support to the portfolios' EBITDA, the DSCR for the quarter ended in Q4 2012 and for the rolling four quarters would have been 1.08x for Punch A whilst the same ratios would have been 1.07x and 1.04x respectively for Punch B.
Moody's expects that the cash flows from the portfolios will decline further in 2013, by approximately 7% from the trailing twelve month (TTM) EBITDA as of Q4 2012 and stabilise in 2013. As in its previous analysis, Moody's expects that an event of default will materialise under the Issuer-Borrower loan agreement in each of the transactions if and when the parent company stops its support. In the parent company's view, restructuring of both securitisations is required to avoid covenant defaults and deliver value to their stakeholders. Importantly, the parent company views both transactions, which securitises substantially all their pub estate, as over levered, unsustainable and in need of significant amendments. Moody's understands that the aim of the company is to achieve a consensual restructuring with their various stakeholders. At this time, the timing and terms of a likely restructuring are unknown to Moody's.
Primary sources of assumption uncertainty in relation to today's rating actions are (a) the current stressed macro-economic environment and (b) the viability of the UK pub industry which drive the operations of the borrowers in both transactions. Moody's assessment of these whole business securitisations relies on the structural and legal integrity of the transactions; in particular its assumption that the borrowers could be replaced by alternative operators in case of insolvency or default under their obligations. A deviation from this scenario whereby the assets and businesses of the borrowers would be liquidated in a shorter term or any other amendments to the current structures which would result in a change of the economic benefit to the noteholders will require Moody's to review its rating of the notes.
MOODY'S PORTFOLIO ANALYSIS
During FY 2012, the borrower under the Punch A portfolio sold 272 pubs (9% of the portfolio) and the total portfolio EBITDA (excluding parent support) declined by 9% to GBP 145 million. A total of GBP 49 million of debt (3%) was repaid in the financial year and as of end of Q4 2012, GBP 105 million was held as cash within the securitisation. As for Punch B, the borrower sold 189 pubs during the past year and the total portfolio EBITDA (excluding parent support) declined by 9% to GBP 91 million. A total of GBP 39 million of debt (4%) was repaid in the financial year and as of end of Q4 2012, GBP 69 million was held as cash within the securitisation.
While the parent company was able to achieve the book value on the disposals to-date, its target to dispose of c. 400 non-core pubs per annum over the next 3-4 years remain questionable to Moody's. Moody's is cautious with respect to achievement of certain price targets and the timing of the future disposals due to the increasing number of pub sales in the market combined with the lack of available funding for interested purchasers. As part of the company's strategy to drive growth in the core estate, among other initiatives, the parent company plans to spend approximately GBP 40 million (100k per pub) per annum over the next five years. Moody's understands that the return on such investments exceed the required hurdles. However, the long term positive effects are uncertain to Moody's especially considering the changing business risk profile for some of the tenants who will focus on increasing food sales. The pubs should become more resilient to the declining beer sales and improve their value proposition over time, but at the same time will be exposed to more price-elasticity and direct competition with the restaurant industry.
Given the adverse cash flow profiles of the pub portfolios combined with the weak credit strength of the pub operator, Moody's put considerable weight on the leverage of the notes when determining its ratings. In Moody's opinion, the current value of the pub portfolio in Punch A is approximately GBP 1.35 billion and in Punch B is GBP 861.6 million. The 11-13% haircuts to the book values of the portfolios stem from Moody's expectation of further cash flow declines to approximately GBP 135 million for the Punch A portfolio and GBP 86 million for the Punch B portfolio, and the overall weak state of the UK pub sector together with the low level of transactional activity. The downgrade of all notes today takes into account the leverage of the notes including the senior ranking swap mark-to-market (MtM) exposures associated with the floating rate notes in the transactions. In most of our scenarios, however, we do not assume the full MtM would crystallise. In Moody's opinion and in light of the pending restructuring, the likelihood of principal losses for the junior notes in both securitisation have increased since Moody's last review.
The principal methodology used in these ratings was Moody's Approach to UK Whole Business Securitisations published in October 2000. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
In this approach, a sustainable annual free cash flow is derived over the medium to long term horizon of the transaction, and then multipliers are applied to such cash flows in order to reach the debt which could be issued at the targeted long-term rating level for the Notes. In addition, we look at various haircuts on the pub values and consider different levels of swap MtM. As such, Moody's analysis encompasses cash flow analysis and stress scenarios.
The updated assessment is a result of Moody's on-going surveillance of commercial mortgage backed securities (CMBS) transactions. Moody's prior assessment is summarised in a press release dated 5 April 2011. The last Performance Overview for the affected transactions were published on 19 June 2012.
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