Overview

• On April 17, 2020, we placed on CreditWatch negative our ratings on Mitchells & Butlers Finance's outstanding classes of notes.
• Following our full review, we have lowered our ratings on the class B1, B2, C1, C2, and D1 notes, and affirmed and removed from CreditWatch negative our ratings on the class A and AB notes. Our ratings on the class B1, B2, C1, C2, and D1 notes remain on CreditWatch negative.
• Mitchells & Butlers Finance is a corporate securitization of the U.K. operating business of the managed pub estate operator Mitchells & Butlers Retail. It originally closed in November 2003 and was subsequently tapped in September 2006.

LONDON (S&P Global Ratings) June 25, 2020--S&P Global Ratings today lowered its credit ratings on Mitchells & Butlers Finance PLC's class B1, B2, C1, C2, and D1 notes. At the same time, we have affirmed and removed from CreditWatch negative our ratings on the class A and AB notes. Our ratings on the class B1, B2, C1, C2, and class D1 notes remain on CreditWatch negative, reflecting the continuing significant uncertainty surrounding the timing and robustness of the COVID-19 recovery and their available liquidity.

On April 17, 2020, we placed on CreditWatch negative our ratings in this transaction to reflect the potential effect that the U.K. government's measures to contain the spread of COVID-19 could have on both the U.K economy and the restaurant and public houses (pub) sectors (see "34 Tranches On Seven U.K. Corporate Securitizations Placed On CreditWatch Negative Due To COVID-19 Uncertainty," and "European Corporate Securitizations: Assessing The Credit Effects Of COVID-19," published on March 26, 2020).

Transactions backed by operating cash flows from pub companies (pubcos) will be particularly hard hit by the mandatory restrictions imposed by the U.K. government, which prohibit dine-in business and only permit take-away sales and deliveries. For the managed-pub sector, it is likely that delivery will not grow meaningfully enough to offset the loss of revenue due to the cessation of dine-in. As a result, we expect a material reduction in turnover across the pubcos that we rate. For strictly wet-led (leased and tenanted) estates, the ability to generate revenue from delivery is generally very low and the loss of revenue can be expected to be nearly total while the government's restrictions are in place.

Mitchells & Butlers Finance is a corporate securitization of the U.K. operating business of the managed pub estate operator Mitchells & Butlers Retail Ltd. (Mitchells & Butlers Retail or the borrower). It originally closed in November 2003 and was subsequently tapped in September 2006. The borrower's ability to withstand the loss of turnover will come down to their current level of headroom over their financial covenants and readily available sources of liquidity.

The transaction features five classes of notes (A, AB, B, C, and D), the proceeds of which have been on-lent by Mitchells & Butlers Finance, the issuer, to Mitchells & Butlers Retail, via issuer-borrower loans. The operating cash flows generated by Mitchells & Butlers Retail are available to repay its borrowings from the issuer that, in turn, uses those proceeds to service the notes. Each class of notes is fully amortizing and our ratings address the timely payment of interest and principal due on the notes, excluding any subordinated step-up interest. In particular, our ratings do not consider the deferability of the class AB, B, C, and D notes..

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Business risk profile

We have applied our corporate securitization criteria as part of our rating analysis on the notes in this transaction. As part of our analysis, we assess whether the operating cash flows generated by the borrower are sufficient to make the payments required under the notes' loan agreements by using a debt service coverage ratio (DSCR) analysis under a base-case and a downside scenario. Our view of the borrowing group's potential to generate cash flows is informed by our base-case operating cash flow projection and our assessment of its business risk profile (BRP), which we derive using our corporate methodology (see "Corporate Methodology," published on Nov. 19, 2013).

We expect the COVID-19 pandemic will have a severe impact on the pub and casual dining industry in the U.K. and more generally on the broader macroeconomic environment over the course of calendar 2020 and, to a lower extent, 2021. We anticipate reduced consumer spending and confidence, muted inflation and potential for further weakening in the pound sterling as headwinds for pubs and restaurants over the next 12-18 months.

We are therefore anticipating that Mitchells & Butlers Retail's, the borrower's, financial position will deteriorate over the course of the financial years ending in September 2020 (FY2020) and September 2021 (FY2021) compared with FY2019, driven by a sharp decline in earnings over the second half of FY2020 and, to a lesser degree, FY2021. That said, we continue to assess the borrower's BRP as fair, supported by the group's strong position as one of the top 3 pub operators in the U.K., its well invested estate, and the added flexibility of its cost structure due to high levels of real estate ownership. We believe that, together with the cash-preservation measures put in place over the lockdown period, the factors above will support Mitchells and Butlers Retail's longer-term recovery in earnings towards more sustainable levels.

Recent performance and events

• Reported revenue in FY2019 was £1.67 billion, which was slightly lower than our expectation of £1.68 billion, while reported earnings before interest taxes depreciation and amortization (EBITDA) was £367.4 million, which was in line with our expectations of £365.2 million.
• Mitchells & Butlers Retail operates in a highly competitive market, with sales volumes expected to grow only moderately due to exposure to discretionary consumer spending. Its strategy of conversion and remodeling underperforming pubs should help maintain market share.
• The ongoing investments in conversions and re-modelling within the existing estate lead to a relatively high capital expenditures (capex) spent in the near to medium term. In FY2019, the group's capex, excluding acquisitions, was £141 million (FY2018: £161 million).
• In FY2019, Mitchells & Butlers PLC completed 240 remodels and conversions (FY2018: 232), which means the company is on track to maintain the reduction in its investment cycle to 6-7 years from 11-12 years previously, which boosts the company's reported EBITDA. EBITDA return has been just under 21% on all capital projects and 34% on remodel spend.
• On June 12, 2020, Mitchells & Butlers Finance announced that it and the borrower agreed a number of amendments and waivers with its controlling creditor, Ambac Assurance UK Ltd. The changes include a temporary waiver of, and amendment to, the 30-day suspension of business provision; waivers of the six-month DSCR test through July 2021 and of the 12-month DSCR test through September 2021; a waiver of the requirement to appoint a financial adviser which would otherwise have arisen for the same period when full compliance with the DSCR test is waived; a reduction in the required amount of the minimum capex by the borrower through the end of FY2021 arising from temporary suspension of business; and a waiver of the failure by the borrower to pay the debt service required under the issuer/borrower facility agreement over the next three quarters, provided that the resulting liquidity shortfalls do not cause the issuer to make drawings of more than £100 million, in total, under the issuer's liquidity facility. Furthermore, those drawings must be fully repaid by the end of March 2021.

At this time, we view those waivers as tactical responses to the current liquidity pressures resulting from the mandatory closures under the U.K. government's response to the COVID-19 pandemic, rather than a reflection of a long-term deterioration of the creditworthiness of the borrower. That said, under our methodology we expect a borrower to make a broad range of covenants intended to ensure that cash is trapped and control is given to the noteholders before debt service under the notes is jeopardized. We will continue to monitor both the effect of these waivers and any long-term weakening of the creditor protections they provide to the noteholders, and may re-evaluate whether they result in any weakening of the creditor protections.

Rating Rationale

Mitchells & Butlers Finance's primary sources of funds for principal and interest payments on the outstanding notes are the loan interest and principal payments from the borrower, which are ultimately backed by future cash flows generated by the operating assets. Our ratings address the timely payment of interest and principal due on the notes.

In our view, the transaction's credit quality has declined due to health and safety fears related to COVID-19. We believe this will negatively affect the cash flows available to the issuer.

DSCR analysis

Our cash flow analysis serves to both assess whether cash flows will be sufficient to service debt through the transaction's life and to project minimum DSCRs in our base-case and downside scenarios.

In the face of the liquidity stress resulting from the COVID-19 pandemic on those sectors directly affected by the U.K. government's response, our current view is that the duration of the maximum liquidity stress will be contained within the second and third quarters of 2020 (calendar year) and be followed by a recovery period that may last through 2022. Importantly, it is our current view that the pandemic will not have a lasting effect on the industries and companies themselves, meaning that the long-term creditworthiness of the underlying companies will not fundamentally or materially deteriorate over the long term. Our downside analysis provides unique insight into a transaction's ability to withstand the liquidity stress precipitated by the closure of pubs in the U.K. Given those circumstances, the outcome of our downside analysis alone determines the resilience-adjusted anchor (see paragraph 46 of our criteria). As a result, our analysis begins with the construction of a base-case projection from which we derive a downside case. However, we have not determined our anchor, which does not reflect the liquidity support at the issuer level--which we see as a mitigating factor to the liquidity stress we expect to result from the U.K. government's response to the COVID-19 pandemic. Rather, we developed the downside scenario from the base case to assess whether the COVID-19 liquidity stress would have a negative effect on level of the resilience-adjusted anchor for each class of notes.

That said, we performed the base-case analysis to assess whether, post-pandemic, the anchor would be adversely affected given the long-term prospects currently assumed under our base-case forecast (see "Comparable rating analysis").

Base-case forecast

We typically do not give credit to growth after the first two years, however in this review, we consider the growth period to continue through FY2023 in order to accommodate both the duration of the COVID-19 stress and the subsequent recovery.

Mitchells & Butlers Finance's earnings depend mostly on general economic activity and discretionary consumer demand. Given the lack of updated guidance from the current management team and the nature of the COVID-19 pandemic, our base-case assumptions remain very uncertain. As a result of the virus' steep escalation, we have revised our previous macroeconomic forecasts to reflect the likely contraction in global output and reduction of consumer spending.

After considering the likely effect of COVID-19, our current assumptions are:

• U.K. real GDP contracting by 6.5% in calendar year 2020 amid a COVID-19-induced slowdown, and rebounding by 6.0% in 2021. We assume real private consumption growth in the U.K. will also decline, especially in the first half of 2020, limiting demand for discretionary items.
• We anticipate revenues to sharply decline in FY2020, resulting from a prolonged lockdown period of about three months, which we anticipate to be followed by a period of severe restrictions on in-site capacity due to social distancing measures. We therefore anticipate FY2020 revenues to fall by over 30%.
• We anticipate topline to recover somewhat over the course of FY2021, although remaining well below FY2019 levels due to the weakened macroeconomic picture, as well as some level of social distancing measures until the COVID-19 pandemic is definitely resolved. Thereafter, we anticipate trading levels to recover towards FY2019 levels in FY2022.
• While the pandemic will represent a blow on Mitchells & Butlers Retail's topline, we anticipate the group to benefit from the comprehensive set of measures implemented by the U.K. government to alleviate the short-term effect on its cost structure. Having furloughed most of its staff and benefitting from a 12-month business rate holiday, coupled with the relatively low amount of rent costs (due to the high proportion of company-owned sites), we anticipate the borrower will control operating expenditures over the second half of FY2020. That said, we expect its EBITDA margins to be under pressure over the course of FY2020 and FY2021, as limited pub capacity and lower volumes could lead to weakened economies of scale.
• Due to the topline shortfall and deterioration on profitability margins, we anticipate Mitchells & Butlers Retail to report muted EBITDA in FY2020 and, to a lesser extent, FY2021. We anticipate reported margins to fall below 20% in FY2020, and somewhat recover towards 20% in FY2021.
• We also expect the borrower to reduce capex to about £70 million-£80 million in order to preserve cash. We anticipate more normalized capex levels over the course of FY2021 and thereafter, going back towards £100 million-£120 million on a capitalized basis.
• Weakened earnings and tax relief will likely result in reduced tax payments in FY2020 and FY2021.

Downside DSCR analysis

Our downside DSCR analysis tests whether the issuer-level structural enhancements improve the transaction's resilience under a moderate stress scenario. Mitchells & Butlers Retail falls within the pubs, restaurants, and retail industry. Considering U.K. pubs' historical performance during the financial crisis of 2007-2008, in our view, a 15% decline in EBITDA from our base case is appropriate for the managed pub subsector.

Our current expectations are that the COVID-19 liquidity stress will result in a reduction in EBITDA that is far greater than the 15% decline we would normally assume under our downside stress. Hence, our downside scenario comprises both our short- to medium-term EBITDA projections during the liquidity stress period and our long-term forecast, but with the level of ultimate recovery limited to 15% lower than what we would assume for a base-case forecast over the long-term. For example, our downside scenario forecast of EBITDA reflects our base-case assumptions for recovery into FY2021 until the level of EBITDA is within 85% of our projected long-term EBITDA.

Our downside DSCR analysis resulted in strong resilience scores for the class A, AB, and B notes, which are unchanged from our previous review (see "Transaction Update: Mitchells & Butlers Finance," published on Oct. 31, 2019). This reflects the headroom above a 1.80:1 DSCR threshold that is required under our criteria to achieve a strong resilience score after considering the level of liquidity support available to each class.

Both the class C and class D notes have limits on the amount of the liquidity facility they may utilize to cover liquidity shortfalls, and the limits vary over the transaction's life. Moreover, any more-senior classes may draw on those same amounts, which makes the exercise of determining the amount of the liquidity support available to the class C and D notes dynamic. We project that both the class C and D notes will experience interest shortfalls under our downside DSCR analysis, with the class C notes withstanding less than three years and the class D notes withstanding nearly seven years. The resulting resilience scores are vulnerable and weak for the class C notes and D notes, respectively, which are lower than the fair resilience score achieved by each class of notes in our prior review.

The inversion of the resilience scores for the class C and D notes is a direct result of the proportion of the liquidity facility amount available to each class of notes relative to the level of debt service to be covered. On a forward-looking 12-month basis, the class C notes initially have a coverage ratio of just over 2:1, based the liquidity facility's support alone, while the class D notes have a coverage of just under 7:1. As a result, the class C notes' resiliency to withstand the COVID-19 liquidity stress is, in our view, lower than the class D notes' ability.

Each class's resilience score corresponds to rating categories--excellent at 'AAA' through vulnerable at 'B' (see paragraph 46 of our criteria). Within each category, the recommended resilience-adjusted anchor reflect notching based on where the downside DSCR falls within a range (for the class A, AB, and B notes) or the length of time the notes will survive before we project shortfalls (for the class C and D notes). As a result, the resilience-adjusted anchors for the class A, AB, B, or D notes would not be adversely affected under our downside scenario, while the class C notes' resilience-adjusted anchor would be two notches lower, moving to 'b+' from 'bb'.

Liquidity facility adjustment

Given that we have given full credit to the liquidity facility amount available to each class of notes, a further one-notch increase to any of the resilience-adjusted anchors is not warranted.

Modifiers analysis

We applied a one-notch downward adjustment to the class D notes to reflect their subordination and weaker access to the security package compared to the class C notes.

Comparable rating analysis

As mentioned, we performed our base-case analysis to assess whether, post-COVID-19, the anchor would be adversely affected given the long-term prospects currently assumed in our base-case forecast.

As highlighted in our previous review, we could lower our ratings on the class B, C, or D notes if there were a deterioration in our assessment of the borrower's overall creditworthiness, which is a reflection of its financial and operational strength over the short-to-medium term, or if we thought Mitchells & Butlers Retail's liquidity position had weakened, for example, due to a material decline in cash flows, a tightening of covenant headroom, or reduced access to the overall group's committed liquidity facilities. Although we acknowledge that the broader Mitchell's & Butlers group has been able to secure additional liquidity, our assessment of the overall creditworthiness of the borrower has deteriorated, leading to a one-notch downgrade of the class B1, B2, C1, C2, and D1 notes.

Counterparty risk

We do not consider the liquidity facility and bank account agreements to be in line with our revised counterparty criteria due to the weakness of the contractual remedies provided in the documentation. Therefore, our ratings on the notes in this transaction are capped at the weakest issuer credit rating (ICR) among the bank account providers (Barclays Bank PLC and Santander UK PLC) and the liquidity facility providers (Lloyds Bank Corporate Markets PLC and HSBC Bank PLC).

The notes are supported by hedging agreements with NatWest Markets PLC (interest rate swaps for all the floating rate notes and cross-currency swap on the class A3N notes) and the London branch of Citibank N.A. (interest rate swaps on the class A4, AB, C2, and D1 notes). We assess the collateral framework as weak under our counterparty criteria, notably due to the length of the remedy period to begin collateral posting, while the replacement commitment is robust enough that we give credit to it. As the swaps in this transaction are collateralized, we consider the resolution counterparty rating (RCR) on the swap counterparty as the applicable counterparty rating.

This combination of factors results in a maximum supported rating on the notes at the level of the lowest applicable rating among the ICR on the account banks, the ICR on the liquidity facility providers (ICR), and the RCR on the swap counterparties. The current minimum applicable rating is at least equal to the ratings on the senior notes, so they do not currently constrain our ratings.

Outlook

Over the next 12 to 24 months, we expect that Mitchells & Butlers Retail's operating performance will remain under pressure against a backdrop the current economic shock stemming from the COVID-19 pandemic and the U.K. government's response. As we receive more issuer-specific and industry-level data, and learn more about what actions issuers will be taking to mitigate the impact on turnover, we will assess the transaction to determine whether rating actions are warranted.

Downside scenario

We may consider lowering our ratings on the class A and AB notes if their minimum projected DSCRs in our downside scenario have a material-adverse effect on each class' resilience-adjusted anchor.

We could also lower our ratings on the class B, C, or D notes if there were a further deterioration in our assessment of the borrower's overall creditworthiness, which is a reflection of its financial and operational strength over the short-to-medium term. This could be brought about if we thought Mitchells & Butlers Retail's liquidity position had weakened, for example, due to a material decline in cash flows, a tightening of covenant headroom, or reduced access to the overall group's committed liquidity facilities.

Upside scenario

Due to the current economic situation, we do not anticipate raising our assessment of Mitchells & Butlers Retail's BRP within the next two years.

CreditWatch resolutions

As we develop better clarity on the expected size and duration of reductions in the transaction's securitized net cash flows, we will evaluate whether adjustments to our base-case and downside projections are appropriate. Changes in our projections could adversely affect our DSCR estimates, which, in turn, could put pressure on our ratings on the notes. If longer-term effects emerge that reshape the economy or industry, we may revise our assessment of a company's BRP, which could also result in rating changes. We expect to resolve the CreditWatch placements within the next 90 days when we have a clearer guidance on the overall effect on each company's liquidity during the shutdown, our evolving view of the severity and duration of the COVID-19 driven stress, the prospects for recovery, and the long-term effects on the U.K economy and the pub industry.

Environmental, social, and governance (ESG) factors relevant to the rating action

• Health and safety.

Related Criteria

• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Structured Finance | ABS: Global Methodology And Assumptions For Corporate Securitizations, June 22, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Criteria - Structured Finance - General: Global Framework For Cash Flow Analysis Of Structured Finance Securities, Oct. 9, 2014
• Criteria | Structured Finance | General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• General Criteria: Methodology Applied To Bank Branch-Supported Transactions, Oct. 14, 2013
• Criteria | Structured Finance | General: Global Derivative Agreement Criteria, June 24, 2013
• Criteria | Structured Finance | General: Criteria Methodology Applied To Fees, Expenses, And Indemnifications, July 12, 2012
• General Criteria: Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012
• General Criteria: Methodology: Credit Stability Criteria, May 3, 2010
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Related Research

• European Economic Snapshots: Large Risks To Growth Ahead, May 5, 2020
• Credit Conditions Europe: The Lowdown On Lockdowns, April 27, 2020
• Europe Braces For A Deeper Recession In 2020, April 20, 2020
• 34 Tranches On Seven U.K. Corporate Securitizations Placed On CreditWatch Negative Due To COVID-19 Uncertainty, April 17, 2020
• Credit Conditions Europe: Europe Goes Into Lockdown, April 1, 2020
• European ABS And RMBS: Assessing The Credit Effects Of COVID-19, March 30, 2020
• Coronavirus Impact: Key Takeaways From Our Articles, March 27, 2020
• European Corporate Securitizations: Assessing The Credit Effects Of COVID-19, March 26, 2020
• COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• Assessing The Coronavirus-Related Damage To The Global Economy And Credit Quality, March 24, 2020
• Coronavirus Dramatically Increases Risk For Already Stressed Retail And Restaurant Sectors, March 20, 2020
• COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
• Disorderly Appreciation Of The Euro Might Inflict Longer-Lasting Economic Harm Than COVID-19, March 13, 2019
• The Coronavirus Will Shave 50 Basis Points Off Eurozone Growth, March 4, 2020
• Global Credit Conditions: COVID-19's Darkening Shadow, March 3, 2020
• Transaction Update: Mitchells & Butlers Finance, Oct. 31, 2019
• Mitchells & Butlers Finance's U.K. Corporate Securitization Senior And Mezzanine Notes Ratings Affirmed Following Review, Aug. 1, 2019
• Standard & Poor's Cash Flow Evaluator-Engine, June 21, 2019
• Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016
• European Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016