London City Airport Transaction
The London City Airport financing last fall was the first use of “whole business” securitization to finance a project in the United Kingdom. The transaction structure is shown on the next page.
London City Airport opened in 1987 and operates as a premium city center airport for business travelers between London and other European city centers. The airport is operated by London City Airport Limited. In October 1995, the company came under the control of Irish businessman Dermot Desmond. Since that acquisition, the airport has experienced substantial growth becoming the seventh largest airport in the United Kingdom with 11 airlines operating scheduled routes to 23 European destinations. In 1998, the airport was granted planning consent to expand its plane movements by approximately 100% over 1998 approved levels.
London City Airport’s revenues are generated from aviation activities (72%) and commercial activities (28%). Aviation revenues are derived from the movement of aircraft passengers and cargo through the airport. The commercial income of the airport has traditionally consisted of duty-free sales, concessions, property rental income, ticketing and check-in desks and other non-core businesses associated with the operation of the airport. Additional revenues have also been generated from the provision of transportation to and from Liverpool Street station and Canary Wharf.
Funding — An issuer was formed in the Cayman Islands to issue £100 million in 7.886% secured notes due 2021 to investors. The notes were rated Baa2 by Moody’s, BBB by Standard & Poor’s and BBB+ by Fitch.
The issuer lent the proceeds from the notes to its wholly-owned subsidiary, London City Airport Limited, which operates the airport. This term loan was on substantially the same economic terms as the notes. The term loan was made under a loan agreement containing covenants typically found in corporate loans. The fact that the issuer and London City Airport are within the same group indicates that the prime motive for the deal was to raise attractive long-term finance via the capital markets rather than to achieve off-balance-sheet financing.
London City Airport Limited owns certain leasehold interests that comprise the airport. It holds those interests under a sublease from a UK company — called “Airport Holdco” in the chart — that is the parent of the issuer. Airport Holdco holds its interest in the property comprising the airport pursuant to a head lease from a Jersey company — called “Owner” in the chart — that is the ultimate owner of the property. All these key companies are ultimately controlled by Dermot Desmond through a common holding company incorporated in Jersey — called “Master Holdco” in the chart.
Security — The term loan agreement required London City Airport to grant a deed of fixed and floating charge over all its assets. The security was granted in favor of a security trustee. The security package includes a first priority security over all of London City Airport’s assets.
The documents subordinate rental payments by London City Airport to Airport Holdco to debt service payments on the notes issued by the issuer.
The issuer, in turn, granted to the security trustee for the noteholders, as security for the issuer’s obligations under the notes, first priority security over all its assets, including all its rights under the transaction documents, bank accounts and the issuer’s shares in London City Airport Limited.
Security arrangements are the cornerstone of “whole business” securitizations. Under English insolvency law, the security trustee may, on default by the issuer or London City Airport, appoint an administrative receiver over the assets of chargor companies. The receiver can continue to manage the businesses of such companies, collect revenues and repay capital markets indebtedness without the need for a disruptive asset sale by virtue of a default by a chargor company. In this sense, there is an analogy between “whole business” and conventional “true sale” securitizations: the underlying income-generating assets are capable of being controlled by the issuer’s creditors, notwithstanding default or insolvency of the issuer.
One unusual feature not commonly present in “true sale” securitizations is found in whole business securitizations: where a group company gives security for the benefit of a group company — Airport Holdco and Owner each granted, among other things, first ranking floating charges over all their property and assets and undertakings in favor of the security trustee — then section 245 of the Insolvency Act 1986 should be noted. This provides that a floating charge in favor of a connected person will be invalid within two years of the onset of insolvency, except to the extent of any value given on or after the creation of the charge by the chargee. Such invalidity risk was present in the London City Airport deal because the charges from Airport Holdco and Owner granted to the security trustee were done so by the trustee on behalf of the issuer. As these companies were connected to the issuer and neither received any consideration from the issuer, there was a risk that their floating charges would be invalid.
If the floating charges were subsequently enforced and deemed invalid, then the remaining security granted by Airport Holdco and Owner would still be valid (being the first ranking fixed security granted over their respective leasehold and freehold interests in the airport). However, under English law, it would not be possible for the security trustee to block the appointment of an administrator to Airport Holdco or Owner who could theoretically deal with the assets that are the subject of the fixed security in favor of the security trustee under the Insolvency Act, notwithstanding the trustee’s security interest.
In this transaction, the section 245 invalidity risk was overcome through contractual covenants under which Airport Holdco and Owner covenanted not to engage in any activity that is not incidental to owning its interest in the airport, have employees or premises other than the airport (save as permitted under the documentation), or incur financial indebtedness or make guarantees. These entities were, in substance, converted into special-purpose vehicles by virtue of covenant restrictions.
As a consequence, it was considered unlikely by the rating agencies that an administration order would be made because an order may only be made if its purpose is for the survival of the relevant company as a going concern, or on the basis that administration would achieve a better realization of assets than would a winding-up. If the companies were one-asset companies with no real “going concern” business, then this test was not likely to be met and, in any event, even if an administrator were appointed, it was considered that the court would permit the security trustee to enforce its security over the real property interests mortgaged to it.
Credit enhancement — Credit enhancement was provided for in the securitization in two ways. First, London City Airport Limited deposited £5 million from the term loan into a cash reserve account for application against amounts due to the issuer under the term in order to remedy any breach of financial covenants. Second, there was over collateralization represented by the market value of the airport — appraised to be £165 million — relative to the amount of the term loan.
Liquidity enhancement — Liquidity enhancement had to be provided by a bank having a particular rating for its debt. Allied Irish Banks, plc agreed to lend £7 million to the issuer to meet the issuer’s payment obligations falling due on each interest payment date under the notes to the extent that the issuer received insufficient funds from London City Airport under the term loan. As is common with liquidity facilities, the term was 364 days renewable annually.
In addition, London City Airport was granted by Allied Irish Banks, plc a revolving credit facility in a maximum principal amount of £7 million for its general corporate purposes for a term of seven years. The additional facility is a working capital facility intended to ensure that third-party creditors are not able to petition London City Airport into a voluntary winding up.
Revenue administration — As with true sale securitizations, the administration of the revenues of the operating business is left with the key operating company to avoid business disruption. Thus, London City Airport Limited is required to act as “cash manager” under a cash management agreement and provide to the issuer and the security trustee notification and reporting services and cash management services in relation to monies standing from time to time in the issuer’s bank accounts. A bank account agreement was also entered into among London City Airport Limited, the bank and the security trustee regulating the manner in which London City Airport was to operate its bank accounts.
An unusual feature of the security arrangements in this transaction was that London City Airport did not grant any fixed security interest over its material contracts generating revenue in excess of £100,000 per annum. This is because some of the material contracts were non-assignable without the consent of the other contracting parties and, in any event, many of the contracts could terminate at any time. However, a fixed charge over all receivables payable under such contracts was sought to be taken by the security trustee. Covenants were imposed on London City Airport Limited to ensure that future material contracts did not contain a prohibition on charging unless to do so could reasonably be expected to have a material adverse effect on London City Airport.
The rating agencies considered a number of business risks before granting their rating.
Permits — London City Airport’s operating license from the Civil Aviation Authority, whose issuance and renewal was based mainly on considerations of safety, was considered together with planning consents — relating to noise, air quality, transport and landscaping — and rules pertaining to regulation of airport fees and charges.
Recent regulations — As the airport was mainly a business travelers’ airport, revenue derived from lost duty-free sales as a result of recent European Union regulations was not considered to be significant. The European “Ground Handling Directive,” which requires airports with large passenger volumes to subject their baggage handling services to competitive tender, was considered not to have a material adverse effect on London City Airport’s ability to meet its obligations under the term loan.
Airline industry risks — The business travelers’ focus of the airport supported the conclusion that revenues for the airport were likely to remain strong even if general economic conditions deteriorated or there was a downturn in the airline industry or if low-cost carriers continued to have success in attracting largely non-business passengers. It was noted also by the rating agencies that transport links for the airport are currently being improved which would also make it more convenient for business travelers to reach the airport.
Increased competition from other airports in the southeast of England was considered by the rating agencies, although this was thought unlikely to have a material adverse effect on London City Airport. Likewise, capacity constraints at some larger European destinations may affect decisions by airlines using London City Airport to maintain or grow existing services provided by regional jets or turboprop aircraft (which operate from London City Airport owing to the size of its runway and other technical factors).
Aircraft accident risk was also considered. The agencies noted that the airport adheres to Civil Aviation Administration standards in the UK, and the airport has not only a very good operational safety record but also a comprehensive insurance program (including business disruption insurance).
Contracts used by airlines operating at London City Airport can be terminated on immediate notice without additional liability. While any termination could have a material adverse effect on the airport, particularly if significant airlines or routes are affected, history indicates that the effects of any such termination may be mitigated over time by replacement airlines or routes. The risk of termination is mitigated by two considerations. First, if an airline wanted to move to another London airport, it would face capacity constraints. Second, the cost of an incumbent airline switching airports may be high.
Environmental risks — The rating agencies also investigated possible environmental concerns, including potential areas of subsurface contamination. However, site consultants concluded that such risks remained low in this instance. London City Airport Limited had to make representations and warranties about compliance with environmental laws. Title to the airport was investigated and the property was valued at £165 million. It was noted that the airport is a highly specialized asset for which there is not a ready market in a default scenario. London City Airport is required to maintain insurance on the airport at replacement value naming the security trustee as a co-insured. Reports covering insurance, environmental issues and valuation issues were called for by the security trustee.
— Denis Petkovic, in London