efinancial news, 7/25/01

The development of the now legendary ratings-sensitive coupon payment in potentially tricky bond sales has taken yet another twist as British Airways (BA), the UK quoted airline, prepares to use a new version of the model on its forthcoming bond issue.

The British Airways bond, BA's first foray into the debt markets for more than 10 years, will pay an extra 25 basis points in the form of coupon payments if either Moody's or Standard & Poor's downgrades the borrower's credit rating. This is the first time a bond deal for an airline has contained language of this sort.
Standard & Poor's, which currently rates BA's debt BBB+, needs only to downgrade the company's rating by one notch to BBB in order for the step-ups to kick in. Moody's, on the other hand, will have to lower BA's debt by two notches, from A3 to Baa2, in order for the extra payment to be triggered.

A further one-notch downgrade by either of the rating agencies will result in another 25 basis point coupon increase, although subsequent upgrades by the agencies will cancel the extra payouts.

The step up in coupon repayments is not dependent on both agencies moving in tandem. The higher coupon will be triggered if one agency downgrades BA, but will stay at the same level if the other agency follows. Other deals with step-up clauses have required that both agencies downgrade the borrower for the extra payments to take effect, but this has met with resistance from investors.

One observer not involved in the BA deal said: "This sort of language is becoming increasingly complex. First, the issue was whether there were going to be ratings-linked coupons at all. Now, the question is on what terms."

Observers said the BA bond structure took investor-friendly bond language such as this into a new sector, although they pointed out that airlines are not regular visitors to the bond markets and the move to link coupon payments to ratings was most likely a credit-specific, rather than sector-wide issue.

Coupon step-ups have become commonplace in the telecom sector, as debt laden European operators battle to hold on to their credit ratings and offer bond investors extra protection in the event of being hit by a downgrade.

They are also becoming a more regular fixture on bond issues for water companies, with Southern Power, Wessex Water and Northumbrian Water all including similar terms on their bonds (all Northumbrian Water's deal was pulled before launch).

Barclays Capital and UBS Warburg are running the books on the £200m (€325m) BA bond sale, which is expected to price later this week.