* Deal remains subject to funding, regulatory approval
* Virgin should be able to fund transaction - ratings agencies
* Velocity is Australia's 2nd largest airline loyalty programme (Adds S&P, Moody's comment)
By Jamie Freed and Niyati Shetty
Sept 16 (Reuters) - Virgin Australia Holdings Ltd VAH.AX on Monday said it entered an agreement to buy back the 35% of its Velocity frequent flyer programme that it does not already own for A$700 million ($481 million) from private-equity group Affinity Equity Partners.
Australia's second-largest airline said completion of the deal, which values the stake at more than twice the A$335 million price paid by Affinity in 2014, remained subject to funding and regulatory approval.
The purchase will give Virgin greater control over a division that generates positive cashflow at a time when new CEO Paul Scurrah is undertaking a turnaround plan after the carrier last month reported its seventh consecutive annual loss.
Credit ratings agencies Standard & Poor's (S&P) and Moody's said the airline, which lacks an investment grade rating, should be able to fund the deal.
"Even if you assume 100% debt, we still believe they have the balance sheet capacity to do the buy back," S&P analyst Graeme Ferguson said in a phone interview. "Having full control over the business strategy is certainly a positive."
The value of loyalty schemes lies in the steady income from banks, retailers and other partners who pay up front for points and then pass them on to customers who typically do not redeem them with airlines for many months.
Velocity is Australia's second-largest airline loyalty programme, behind that of rival Qantas Airways Ltd QAN.AX , with 9.8 million members as of June 30.
Velocity was a bright spot in Virgin's bleak annual results last month, with earnings before interest and tax from the division up 12% to A$122.2 million. Chitterer, a vice president at Moody's, said the Velocity purchase was credit positive for Virgin because it would diversify earnings away from the cyclical airline sector but the final impact on its rating would depend on the funding structure.
The carrier's share register is dominated by major strategic investors Singapore Airlines SIAL.SI , Etihad Airways, HNA Group HNAIRC.UL , Nanshan Group NANSH.UL and Richard Branson's Virgin Group that baulked at providing more capital since an equity raising in 2016, seven current and former Virgin managers have said.
Virgin Group on Monday declined to comment on whether it was willing to help fund the Velocity acquisition, while Singapore Airlines, Etihad, HNA and Nanshan did not respond immediately to requests for comment.
Exclusive talks between Virgin and Affinity were first reported by the Australian Financial Review on Sunday. representative from Affinity declined to comment. Virgin shares were flat in morning trading on Monday. ($1 = 1.4539 Australian dollars)