Embattled BAA completed its long-delayed debt refinancing just before the global financial crash prompting BAA CEO Colin Matthews to proclaim: "This is the largest financing of its kind ever completed, and the fact that a landmark transaction of this size and complexity has been completed in challenging credit markets is a testament to the strength of the business and the confidence of the financial markets in BAA and its airports."

But, although the deal was structured to overcome a climate of tightening liquidity, rising margins and little or no bond appetite, no-one foresaw the financial markets storm that was coming. And long-term fallout from that storm could mean that BAA's expectation of achieving a long-term cost-saving via another refinancing once the bond markets reopen may be a lot further off than the sponsor and its parent, Ferrovial, anticipated at financial close.

The overall refinancing plan involves a £50 billion ($90.1 billion) multi-currency programme (BAA Funding) via which BAA has access to both the bank and bond markets. This has meant splitting BAA's assets into designated and non-designated airports, which are separately financed. The designated airports include Heathrow, Gatwick and Stansted and the non-designated airports are Edinburgh, Glasgow, Aberdeen and Southampton.

The program is designed to cope with the sale of one or more airports – as is now happening with Gatwick for which BAA wants £3 billion from a sale being handled by RBS and HSBC. A senior banker working in the deal says: "The structure provides certain leverage levels so that if any assets are disposed the proceeds to will go to pay the bank debt to provide enough liquidity to meet the covenants."

The debt facilities feature fixed and floating charges over all the assets and undertakings of the borrower group, as well as share pledges. Strict covenants governing leverage, interest coverage ratios, bond downgrades and capex give creditors additional protection, he says, as do restricted payments and, in the extreme, the ability to appoint an administrative receiver.

Caveats aside, the two-tier investment-grade structure does give BAA substantial flexibility and allows it to issue investment-grade paper at short notice as and when the bond market returns. In effect it is a secured corporate debt programme.

The original buyout debt is being refinanced via a £7.15 billion bank facility, for designated airports, and a £1.25 billion facility for non-designated airports. The new structure includes £4.5 billion of bonds (also issued to finance Ferrovial's original acquisition) migrated by BAA's long-term holders.

The £7.15 billion designated airports loan is divided into a £4.4 billion A-rated (Fitch) facility and a BBB-rated £2.75 billion working capital/capex tranche for new projects. The designated airports are being additionally funded with a £440 million loan from the EIB.

The non-designated airports are being refinanced via £1.25 billion of seven-year bank facilities – £1 billion of term loans and £255 million capex and working capital facilities. MLAs on these loans are Citigroup, Export Development Bank of Canada, HSH Nordbank, ICO, ING, La Caixa and RBS.

The £4.4 billion designated airports A-rated loan is the stopgap where a new bond issue, that subsequently proved untenable, should have been. The £4.4 billion loan is split into a £3.4 billion tranche A loan rated single-A minus and paying a margin of 175bp over Libor. The remaining £1 billion tranche B loan is rated triple-B and pays 225bp over Libor. Both loans have step-up margin levels dependent on the aggregate amount outstanding – but as they are both fully drawn down BAA is paying the highest margin level at launch. Given that the original bridge financing paid an initial margin of 100bp on the senior acquisition debt (with step-ups over time) and 400bp on the junior, the cost savings from the refinancing do not look good unless a bond take-out proves tenable in the short- rather than long-term.

The £4.5 billion existing bond migration to BAA Funding was dogged by regulatory uncertainty. Although the original timetable envisaged the deal being wrapped up before March 2008, existing bondholders were never going to get comfortable until the Civil Aviation Authority's position on BAA price controls was clear.

Following long negotiation between the liability management desks of Citi and RBS and the Association of British Insurers (and coupon pick-ups of 70 basis points for post-2002 bonds and 10bp for pre-2002 bonds), agreement was reached. The cost to the structure of getting the bondholders on side was £12 million to cover the early acceptance fee and £15 million for extra coupon payments.

The BAA mix of bank and bond funding presented significant difficulties because of the need to have separate floating charges over the bond and bank assets. Under the UK Enterprise Act, companies with more than £50 million of capital markets issuance are exempted from the abolition of administrative receivership. But bank debt is not exempt. The greater the bank debt in the structure, the greater the challenge for the arrangers. But in this case the likelihood of BAA, a regulated utility, being allowed to enter receivership is remote at worst.

Nevertheless, some analysts are still uncomfortable with the deal and continue to question how BAA will meet its debt payments – especially if it sells Gatwick, an airport that accounts for a big share of its revenues. According to one BAA analyst: "They will use the sale proceeds to pay down the bank loans – but I'm not sure they'll get their money back from the Gatwick sale. Gatwick has major capacity constrains and any buyer would have to be mad to pay a premium for that airport." Furthermore, he expects airlines to cut capacity by 20% in the coming months, shrinking BAA's EBITDA margins to 25% from 45%.

BAA Funding
Status: Financial close 20 August 2008
Description: Refinancing of BAA leveraged buyout by Ferrovial in 2006.
Sponsor: BAA/Ferrovial
Lead arrangers designated airports: Banco Santander, BBVA, BNP Paribas, Caja Madrid, Calyon, Citi, HSBC Bank, Royal Bank of Canada, RBS
Lead arrangers non-designated airports: Citigroup, Export Development Canada, HSH Nordbank, ICO, ING, La Caixa, RBS
Borrower legal counsel: Freshfields
Lender legal counsel: Clifford Chance