British Airways debt now rated as ‘junk’ by all three major credit rating agencies

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Moody’s has joined fellow rating agencies Fitch and Standard & Poors in cutting British Airways debt to ‘junk’ status.

In early April, as we covered, Fitch cut the credit rating of British Airways plc from BBB- to BB+.  Whilst there was no press announcement, the IAG website here shows that S&P cut the debt of British Airways plc to BB – also ‘junk’ – on 20th May.

(For clarity, this downgrade is specifically for British Airways and not for its parent, International Consolidated Airlines Group.  This is because the debt which has been downgraded is ringfenced against the British Airways operation.)

You can see a summary of Fitch’s reasoning from early April here.

Moody’s has now followed.  Having S&P and Moody’s downgrade its debt is a headache for British Airways, because many investment funds are not allowed to hold debt which is rated as junk by two or more ratings agencies.

Moody’s has cut its BA rating from Baa3 to (ironically) Ba1.  The outlook is ‘negative’, meaning that the next move is more likely to be downwards than back up to investment grade.

A detailed summary of the Moody’s report on British Airways is here but you will need to register with the Moody’s website to read it.  Here are some key extracts:

British Airways parent has its debt rating cut to 'Junk' status

The rating was driven by, in their view:

The increasing duration and severity of the coronavirus outbreak

Moody’s expectation that the airline industry will remain deeply constrained in 2020 and 2021 and will not recover 2019 passenger volumes until 2023 at the earliest

Despite current substantial liquidity, risks that financial resources could be under pressure from further coronavirus outbreaks and extended restrictions on air travel

The likelihood that the company will incur substantially increased debt during the coronavirus pandemic, and faces challenges to recover its balance sheet in the next two to three years

The company’s strong market position, high profitability, strategic importance to the United Kingdom economy and expectation of its continuing industry leadership

The company said:

“Moody’s expects flight activity to resume over Q3 and Q4 of 2020, but remaining severely depressed, with domestic flights recovering earlier and a slower return for international and long haul flights. With around 80% of capacity outside Europe and a high exposure to business travel and premium leisure, Moody’s expects that as flights resume British Airways will see a slower recovery profile than the industry as a whole. The United Kingdom’s current plans to quarantine international air passengers arriving from outside Ireland are also likely to affect British Airways’ ability to resume meaningful volumes in 2020.”

and (bolding mine):

“The company also has substantial levels of unencumbered aircraft fleet and has the potential to monetise its air miles loyalty scheme which could be used to further enhance liquidity. Moody’s estimates that the company has liquidity to support around one year of groundings before additional funds are raised, although this remains subject to some uncertainty particularly in relation to the level of potential customer refunds for cancelled flights.”

and

“IAG has hedged around 90% of its expected fuel burn for 2020 and has reported a mark-to-market loss of around €1.5 billion which is expected to be incurred in cash during the year. Moody’s estimates that British Airways’ share of this cost in the range £600-700 million.”

and

“Moody’s expects that British Airways will incur substantial additional debt to support its liquidity and cash consumption during the coronavirus outbreak, and that cash generation is unlikely to be sufficient thereafter to restore balance sheet metrics by 2023.”

On the upside:

“At the same time the rating reflects Moody’s expectation that British Airways will remain a leading operator in the industry and that it is likely to gain market share and improve operational efficiencies after the crisis. This is supported by its position as the UK’s leading international scheduled airline, with a strong premium brand and competitive positions on key routes and airports including at London Heathrow Airport. It also reflects the company’s high operating margins, its extensive global network, further supported by its membership in the one-world alliance and its position within IAG, and its strategic importance to the UK’s economy and connectivity.”

Moody’s does not address the issues caused by the current British Airways order book, which had caused concern in the earlier Fitch report.  Last year, British Airways placed a firm order with Boeing for 18 x Boeing 777-9 aircraft (pictured above).  These have a list price – admittedly before a substantial discount which BA will have negotiated – of $442 million each.

As of February 2019, British Airways was also committed to 12 x Boeing 787s, four 777-300ERs and 18 x Airbus A350, albeit some of these are already delivered.

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Here's the full HFP index of articles for May 2020
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Comments

  1. @mkcol says:

    So how do they monetise the Avios programme?

    • Journeying John says:

      Excessive taxes and surcharges at redemption, restricting availability of reward flights…
      Sound familiar?

      • mark2 says:

        The taxes are fixed by governments and fees by airports etc. Only the surcharges are fixed by the airline.

      • Jonathan says:

        They want people to redeem as it converts a liability on the balance sheet to income. The fees & surcharges also bring in cash so they’ve got no interest in cutting off this income stream if there are empty seats to fill. As others have said before, you devalue your loyalty scheme when times are good rather than the other way round.

        • Steve says:

          Semantics I appreciate but frequent flyer scheme, not loyalty. There is no loyalty on either side of these programmes.

          • Nick_C says:

            FF Scheme? Not for me. 650,000 Avios in the last three years, but none earned from flying!

        • the_real_a says:

          But there isn’t a liability on balance sheet – liability is managed by a contractual obligation to 2 seats on every future flight. Gift cards and hotel redemption’s can be stopped with a days notice and are funded by points generation activities. i.e. cash flow.

    • It’s an asset

      They could sell the avios program or I would assume raise funds against it.

      They could also, a la Hilton and Marriott, sell a large quantity to eg Amex for cash

      • Doug M says:

        Isn’t it in reality an asset with a huge liability? Also, given the Air Canada example who’d think buying a loyalty scheme was a good idea.

        • Genghis says:

          Yes and no I guess. The avios always belong to AGL. So whilst for accounting there’s a liability of deferred revenue, IAG could in theory decide to scrap the scheme, unwind the liability and in the process destroy all customer loyalty.

      • Incorrect. Loyalty programs are always a liability to the Issuing corporate. They can raise cash by selling points, which brings in liquidity, but cannot recognise income until the points expire or are redeemed. Points outstanding will be shown as a liability on the balance sheet.
        To give a fair accounting comparison, its a bit like provision for warranty expenses. Companies allocate funds for possible warranty claims in the future, this sits on liability side of balance sheet and is used when the claims come in or is taken back to P&L if there are no claims.

        • the_real_a says:

          You have to submit this to the “so what” test. If you can devalue the liability to near zero on the simple sign off of a board meeting then is it a liability in the common sense meaning of the word? The real liability is any guarantees issued with financial penalty clauses – such as those you might add to bulk buying £1bn of points to AMEX.

    • It makes £200m profit per year ….

      Now, the history of selling loyalty programmes is shockingly bad, with Air Canada Aeroplan the key disaster. Given that BA is untrustworthy there is even less chance of it getting away.

      What Air Canada did was sell Aeroplan with a 20 (?) year guaranteed contract. When this period was getting near the end, Air Canada announced it was starting a brand new scheme which it would own and dumping the old programme. This meant the old programme had no value and Air Canada bought it back for virtually nothing. Clever stuff but no-one will get away with it again.

      • On the legal side of clever/fraud!

        Morally fraud.

        I’ve always considered good business to be when both sides are happy regardless of contractual small print.

        • Doug M says:

          Not sure I agree. That may be true if you had a 20 years plan to do that. But isn’t it more likely as management changes someone new revisited it and thought, why not? They’ve had 20 years we owe them nothing.
          If the buyer priced up the value any way other than the locked in period they were pretty gullible.

  2. NigelthePensioner says:

    The fuel burn will have been vastly over estimated! Isnt it a price they hedge and not a volume?

    • They hedge a percentage of their expected volume, which it turns out is a) significantly higher than their actual burn and b) costly since the oil market tanked

      • Mr(s) Entitled says:

        Swings and round abouts. All hedging done now may prove to be very profitable in the future.

        In many cases, despite what your star traders says, you are simply getting market returns over the long run but with a medium term lag.

        • In what way? Unless they are cavalier they won’t hedge until a customer books a ticket, in which case the best they can hope for is to cover the cost of fuel at today’s prices.

    • Doug M says:

      Wouldn’t the hedge have to be both a volume and a price?

    • Lady London says:

      TBH that fuel hedging loss didn’t look like they got it too wrong. The result looks quite low on the volumes of fuel they would normally be using.

      • TGLoyalty says:

        It’s only been 2 months might as well quadruple that as the fuel price won’t recover anytime soon.

        • Lady London says:

          Hum. Good point.

        • Will be offset by new hedges put on at the low prices.

          • TGLoyalty says:

            I can’t imagine theres a market for hedges at this low a price. Lower than BA’s original position perhaps but not low enough they won’t be losing money for a while.

          • lets use Brent Crude as a proxy for aviation fuel.
            Current price is $27
            Future price for Mar 21 is $41

            It’s the $41 plus a bit (roughly) price you would hedge now for deliveries in Mar 2021.
            What if things haven’t improved by then ?
            More fuel hedge losses would likely result.

            I think Singapore airlines have hedged more than 1/2 their volume (at about $60 Brent crude) for the next 4 YEARS.
            This to me seems extraordinarily reckless – it may pay off but it’s effectively gambling.

            If you want to play the markets join a hedge fund not an airline.

        • Derivatives losses don’t work that way. All outstanding positions are marked to latest price in the market.

          • Sure – but no doubt BA/IAG are using the bits of IFRS so as to ensure the entire negative MTM is not hitting the P+L yet.

          • The “hedge accounting” bits of IFRS. Sorry, forgot two words.

      • IAG said they had hedged 90% if 2020’s anticipated volume.
        The £1.2bn hit (fuel and currency) already taken is towards the full year cost with the best information they had at the time.
        Full year cost for fuel hedging likely to be £2.3 – £3.0 billion, but won’t be 4 times the Q1 unless something extraordinary happens.

        • Lady London says:

          On that basis doesn’t look too bad a job was done? BA owning half of the loss?

  3. Oskar says:

    Let’s hypothetically say I own IAG stock.
    Given that this downgrade happened after markets closed here on Friday… Some questions in case there are knowledgeable folks here:
    1. Is there an after hours / weekend trading market for IAG stock with publicly available data? Is trading still happening somewhere, and can I see what’s happening with the price?
    2. If I call my broker and tell them to place an order onto the order book before markets open in London Monday, let’s say 15% below the Friday close price, how do I tell them “but if trading starts even below that, I’ll take whatever price you give me”?
    3. Am I right that all the slow-moving US pension funds that need to shed IAG now that it’s mostly made up of junk BA will only be able to trade on this once their business hours begin, so later on Monday?

    • It actually happened on Thursday. We held the article back.

      • Oskar says:

        Ah, right. That probably contributed to the ~10% fall after Thursday.

    • Pat the Postie says:

      I don’t believe that the LSE has publicly available early and after hours like the US stock market.

      Most stock brokers would allow you to place a limit order so if you wanted to sell at a minimum price, alternatively you can sell at the market rate which would be whatever price it is at the time.

      Personally if I had IAG stock, I would wait to see the reaction next week as it may have less effect than expected if people had assumed it was junk to begin with.

    • The downgrades were pretty much expected and the prices were more or less ‘baked in’. It’d be a brave soul to think airline debt wouldn’t be downgraded in this catastrophic situation.
      Also the share price is only affected to the extent the company becomes unable to raise new funds and it really needs liquidity. On the other hand, the bond prices might see price action as funds (that can only hold IG debt) sell the bonds.

      • Sanders says:

        Yep, there is no point panic selling.

        I am quite sure a lot of panic selling went on in March before any type of recovery

      • And if you were BA/IAG if the debt trades down materially you might well consider undertaking some form of liability management exercise to acquire some of that formerly IG, now junk debt at a price below par (perhaps using the proceeds of some soft state loans to do so…)

        • Lady London says:

          If I was BA I would want the bad news to stay for a while. After all, they’ve got to seize an opportunity to get rid of 12-18,000 employees, and get to zero base bufget for large groupa of employees that remain. Good news right now wouldn’t help.

    • mr_jetlag says:

      I wouldn’t expect a huge share price hit from this downgrade. Most of the ratings agencies couldn’t properly respond in 2007/8 and are lagging massively behind again. If anything this could increase secondary market interest in the debt from eg credit hedge funds who expect a recovery from IAG.

  4. I hear BA will pull out from LGW completely and move everything to LHR.

    • They can’t. Unless the airline is going to be permanently 25% smaller than it was in January 2020 there are not enough Heathrow slots.

  5. Why the negative focus on BA? BA/IAG is not the only airline that’s been downgraded, and they’re pretty much all on negative outlook.

    • Because we’re a UK focussed site and most of our stuff is about BA!

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