OREANDA-NEWS. Fitch Ratings has affirmed Punch Tavern Finance B Limited's (Punch B) swap loan and senior debt (A3, A6 and A7 notes), as follows:

GBP49m floating-rate swap loan due 2019: affirmed at 'BB', Outlook Stable
GBP146.9m Class A3 fixed-rate notes due 2021: affirmed at 'B+'; Outlook Stable
GBP220m Class A6 fixed-rate notes due 2022: affirmed at 'B+'; Outlook Stable
GBP149.1m Class A7 fixed-rate notes due 2024: affirmed at 'B+'; Outlook Stable

The affirmation reflects that Punch B's operating performance is in line with Fitch's base case expectations. The Stable Outlooks reflect the expected continued stabilisation in transaction operating performance over the next two years.

In the year to March 2015 total EBITDA (excluding parent company support and redemption profits) declined by -6.2% to GBP76.1m compared to Fitch base case assumption of GBP74.6m EBITDA over the same period. The decline in EBITDA was driven by an 8.3% reduction in the number of pubs as primarily weaker pubs continued to be sold.

Positively, increased capital investments (enhancing the average quality of the pubs), the improving economic environment and the sale of non-core pubs with lower EBITDA resulted in an increase of EBITDA per pub by 3.0% in the year to March 2015 and by a compound annual growth rate (CAGR) of 2.0% over the past three years. Data availability at Punch B level is limited, but, reported like-for-like net income growth over the past two years at Punch Group plc level (2014, 2015: 1.3% and 0.3% respectively) indicates that the mechanical effect of disposals are not the only contributor to per pub EBITDA growth.

The gross EBITDA leverage for the swap loan and the class A notes reduced to 0.51x and 7.12x vs. 0.62x and 7.21x, respectively, at the restructuring in October 2014, primarily due to GBP0.3m of disposal proceeds being used to prepay the swap loan and retained cash used to repurchase and cancel GBP8.6m of the class A7 notes.

The new post restructuring coverage covenants are EBITDA DSCR rolling four quarters and free cash flow debt service coverage ratio (FCF DSCR) rolling four quarters. As of 7 March 2015, they were reported at 2.0x and 1.5x, respectively.

KEY RATING DRIVERS
Industry Profile - Midrange
The pub sector in the UK has a long history, but trading performance for some assets has shown significant weakness in the past, with the sector being in a structural decline for the past three decades due to demographics shifts, greater health awareness and the presence of a larger variety of competing offerings. Exposure to discretionary spending is high and revenues are inherently linked to the broader economic cycle. Competition is viewed as high, including off-trade alternatives, and barriers to entry are low, despite increasingly more demanding licensing laws and regulations. Despite the on-going contraction, Fitch views the eating- and drinking-out market as sustainable in the long term, supported by the strong pub culture in the UK.

Sub-key rating drivers (KRD): Operating environment: Weaker; Barriers to entry: Midrange; Sustainability: Midrange

Company Profile - Midrange
The Punch securitisations have underperformed comparable pub transactions during the past few years, partly due to weak operational performance of its pubs and an over-leveraged capital structure, requiring repeated financial support and covenant waivers to avoid a borrower event of default prior to their restructuring in October 2014.

EBITDA per pub has stabilised over the past two years mainly as a result of extensive disposals of weakly performing non-core pubs and increased investments in the core estate following years of capex underspend. The leased/tenanted business model makes it more challenging for the Punch group to adapt the growing eating-out market in the UK as it has reduced control over publicans' strategy and less cash to spend on capex due to performance decline.

Furthermore, limited visibility with respect to the tenants' profitability means that the sustainability of the cash flows generated by tenanted pubs is more difficult to estimate. The continued disposals of non-core pubs, combined with increased capex in the core estate, should result in an overall improved quality of the estate in the foreseeable future.

Sub-KRDs: Financial performance: Weaker; Company operations: Midrange; Transparency: Weaker; Dependence on operator: Midrange; Asset quality: Weaker

Debt Structure - Midrange (swap loan)/ Midrange (class A)
The swap loan benefits from a favourable repayment profile with a combination of front-loaded scheduled amortisation and a cash sweep mechanism. The assessment is however limited to Midrange as Fitch views the probability of default of the swap loan and the class A to be much closer aligned than in other tranched UK whole business securitisations. Unusually for UK whole business securitisations, only the most junior class B3 notes can defer interest payments. Consequently, failure to pay interest and scheduled amortisation (or final principal) on the class A notes would result in an issuer event of default due to the class A notes' non-deferability.

The interest rate exposure of the floating-rate swap loan is deemed immaterial given its small size and quick repayment.

The Weaker debt profile assessment for the class A notes reflects the partially amortising and the large bullet maturities in 2021, 2022 and 2024, which cannot be met out of excess cash flows in Fitch's base case, requiring either a debt refinancing or significant disposals of core pubs.

The security package remains largely unchanged for the rated debt instruments. Operational and financial covenants are satisfactory, although Fitch notes the exclusion of the bullet repayments for the purpose of calculating the FCF DSCR as well as the possibility of preventing a covenant breach through the availability of disposal proceeds as part of the FCF definition. Fitch considers the inclusion of a leverage covenant mitigates this relative weakness. A reduced liquidity facility is structured to cover 18 months of peak debt service. However, this is effectively only interest payments and scheduled principal (excluding final bullets).

Sub-KRDs: Debt profile: Midrange (swap loan)/Weaker (class A); Security package: Stronger; Structural features: Midrange

PEER ANALYSIS
Given the unusual debt profile with cash sweeps/traps as well as the refinance risk that no other WBS deal faces (except Arqiva's junior tranche), the leverage metrics and deleveraging profile become more relevant for the ratings. Punch's current leverage looks quite low in comparison with peer transactions. However, there is a significant amount of uncertainty in relation to deleveraging (given that, unlike for peers transactions, it relies on disposal proceeds) in addition to significant refinancing risk, which constrains the ratings.

RATING SENSITIVITIES
The ratings could change if the operating performance falls materially above or below Fitch's base case. Negative rating action would be likely if disposal proceeds were insufficient to reduce leverage via prepayments leading to a deterioration of long-term leverage expectations. Furthermore, the anticipation of a failure to refinance maturing debt tranches would lead to negative rating action.

TRANSACTION PERFORMANCE
The forecast FCF DSCR of the swap loan appears high with annual coverage in Fitch's base case at above 6x in the four years to the swap loan's repayment. However, the more relevant metric to reflect the close alignment of the probability of default of the swap loan with that of the class A notes would be an average coverage around 1.4x until 2020 in relation to the combined debt service of the swap loan and class A notes.

Fitch forecasts FCF DSCRs (the smaller of the average and the median) to be around 1.19x in relation to the class A notes calculated over a hypothetical 25-year period. Our FCF DSCR calculation is different to the calculation as per the bond documentation. As the class A notes are not expected to fully amortise out of operating cash flow by their respective legal maturities, Fitch calculated a synthetic debt service based on a 25-year annuity-debt profile. At each interest payment date the annuity is updated to reflect the then current debt outstanding and the remaining years left (until year 25) to better compare FCF DSCRs with that of typical fully amortising pub securitisations.

Fitch expects senior leverage to decline close to 6x prior to the final maturity of the class A3 notes in 2021. In practise, leverage will depend on the availability of disposal proceeds from the sale of non-core pubs, which are inherently uncertain and have therefore not incorporated into the Fitch base case. As a result, in Fitch's base case the class A3, A6 and A7 notes would require refinancing of approximately GBP60m, GBP190m and GBP87m at their respective bullet maturities in 2021, 2022 and 2023. Notably even considering disposals of non-core pubs per management projections a refinancing or repayment through proceeds from disposal of core pubs would still be required.

SUMMARY OF CREDIT
Punch B is a whole business securitisation of tenanted pubs located across the UK owned by Punch Tavern Plc (the group). As of March 2015, the transaction consisted of 1,131 pubs in the core estate and 353 pubs in the non-core estate. Besides Punch B the group's financing structure consists of a second securitisation, Punch Taverns A Ltd (Punch A).