Fitch Ratings yesterday announced that it had downgraded Avianca Holdings’ Long-Term Foreign and Local Currency Issuer Default Rating (IDR) to ‘C from ‘CCC-‘. The ratings have been removed from Rating Watch Negative. This downgrade follows the announcement by Avianca that it has deferred payments on principal for certain loan obligations, in addition to lease agreements.

Fitch estimates that around $50 million of debt is overdue. Avianca has around $66 million of outstanding unsecured bonds coming due in May 2020.

Key Ratings Drivers

Coronavirus Covid-19 Lockdown: Avianca announced it has temporarily ceased to operate all regular passenger flight operations until at least April 12, 2020, following a Colombian government announcement closing Colombian airspace as of March 25, 2020. Seeking to preserve cash, Avianca announced the payment deferrals and a cut in all non-essential capital expenditures, and is working on agreements with its key suppliers, strategic lenders and others creditors to restructure its payments under the new cash flow scenario. Avianca has offered a voluntary unpaid leave program and around 14,000 employees have accepted this offer.

Debt Deferral: The announcement of loan payment deferrals indicates to Fitch that a default process has begun, which is commensurate with a ‘C’. This rating further reflects Fitch’s view that Avianca’s $66 million USD of outstanding unsecured bonds coming due in May 2020 will likely not be paid in a timely manner. Besides the loan obligations, the company has also announced leasing agreement deferrals, which have been common practice within the airline industry amid the current pandemic. As of Dec. 31, 2019, Avianca had $398 million in cash and $872 million of short-term obligations, $237 million of which is related to lease agreements.

Limited Access to Funding: Avianca has just emerged from a debt restructuring process in late December 2019, when it completed its 2023 secured bond exchange offer, and received $324 million of loans with United Airlines, Kingsland Holdings, and private investors. Fitch considers that Avianca has limited financial flexibility, with no availability of unencumbered assets that could be monetized.

Strong Regional Market Position: Avianca’s business model combines operations in Colombia, Central and South America, allowing it to rotate capacity according to market conditions. Its geographic diversification allowed the company to maintain consistently solid average load factors of 81% during 2015-2019. The company’s business diversification is viewed as adequate with international passengers, domestic passengers, cargo operations, and the loyalty program and other segments representing approximately 42%, 41%, 13%, and 4% of its total revenues. The announcement of a joint business agreement with United and Copa Airlines are still pending regulatory approvals and should only benefit Avianca’s competitive business position in the medium to long term.

Credit Linkages and Notes’ Guarantees Structure Incorporated: The ratings also reflect Avianca’s corporate structure and credit linkage with its subsidiaries, Aerovias del Continente Americano S.A. (Avianca) and Grupo Taca. Combined, these two operating companies represent the main source of cash flow generation for the holding company. The significant legal and operational linkages between the two operating companies are reflected in the existence of cross-guarantee and cross-default clauses relating to the financing of aircraft acquisitions for both companies.

Derivation Summary

Avianca’s ‘C’ rating reflects the announcement of deferred payments on certain long-term leases and deferred principal payments on certain loan obligations. In terms of business profile, the company has a good asset base and is relatively well positioned to regional peers based on its network, route diversification and important regional market positions. Nevertheless, these factors are tempered by the company’s higher gross adjusted leverage and refinancing risks, weaker liquidity and financial flexibility relative to peers.

Avianca’s rating is below its regional peers LATAM Airlines S.A. (LATAM, ‘B+’/RWN), AZUL S.A (AZUL, ‘B’/RWN) and GOL Linhas Aereas Inteligentes S.A. (GOL,’ B’/RWN). The ratings distinction among the three airlines reflects differences in the financial strategies, credit access, operational performance volatility and business diversification.

Fitch’s Key Assumptions Within Its Rating Case for the Issuer

The recovery analysis is based on a liquidation approach given the high value of its aircraft fleet, which positively compares to the going concern approach.

Fitch has assumed a 10% administrative claim.

Liquidation Approach:

The liquidation estimate reflects Fitch’s view of the value of aircraft and other assets that can be monetized in advance at a rate of 70%, 75% account receivables due to high percentage of credit card receivables and 50% inventories.
These assumptions result in a recovery rate for the unsecured bonds within the ‘RR6’ range, which generates a one-notch downgrade to the debt rating from the IDR. Nevertheless, considering the current debt deferral, it is commensurate with a ‘C’ rating level.

Rating sensitivities

Developments That May, Individually or Collectively, Lead to Positive Rating Action:

An upgrade of the ratings for Avianca would occur following the completion of its refinancing with creditors.

Developments That May, Individually or Collectively, Lead to Negative Rating Action

Avianca’s ratings will be downgraded to ‘RD’ if the company announces a debt restructuring (DDE), or to ‘D’, if the company formally files for bankruptcy protection.

Liquidity & debt structure

Limited Financial Flexibility: As of Dec. 31, 2019, Avianca had $398 million in cash and $872 million of short-term obligations, $237 million of which is related to lease agreements. Fitch estimates that around $50 million of debt is overdue. Avianca has around $66 million of outstanding unsecured bonds coming due in May 2020. Total adjusted debt was $4.9 billion at the end of 2019. Debt consists primarily of $1.8 billion of aircraft loans, $1.3 billion of corporate debt, $500 million of cross-border bonds and $1.2 billion of on balance-sheet lease obligations.

Best/Worst Case Rating Scenarios:

Ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings https://www.fitchratings.com/site/re/10111579.

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About the Author

Loren Moss is the founder and publisher of Finance Colombia. He has over 20 years of international business experience, including over a decade of experience in securities, insurance, and commercial real estate, at the institutional and international level.