S&P Lowers Ratings on UAL Debt

The airline company is beset by ongoing losses and stalled labor negotiations

On Jan. 22, Standard & Poor's lowered its ratings on UAL Corp. and its principal subsidiary, United Air Lines Inc., reflecting substantial ongoing losses and lack of progress in crucial negotiations aimed at containing the airline's high labor costs. All ratings remain on CreditWatch with negative implications, where they were placed Sept. 13, 2001 (along with those of other rated U.S. airlines).

United and its mechanics union are locked in thus-far unsuccessful negotiations to reach a new contract, and over the weekend a Presidential Emergency Board issued recommendations that, while persuaded of the airline's difficult financial situation, would result in raising the mechanics' pay to levels comparable to those at American Airlines Inc. and Northwest Airlines Inc.

The negotiations highlight the conflict between the union's desire to match pay gains achieved by other United unions and by mechanics at other large U.S. airlines, and the company's ongoing efforts to secure pay and productivity concessions from labor in order to trim United's high operating cost structure in response to weak revenues. UAL and United were losing substantial amounts of money even prior to Sept. 11, 2001, due to industrywide revenue weakness and United's high operating costs ($678 million net loss during the first half of 2001), and recorded a further $1.16 billion net loss in the third quarter.

United was unable to reach agreement with its mechanics last year and President Bush appointed a Presidential Emergency Board (PEB) to head off a threatened strike in December. Under applicable labor law, if management and labor still cannot reach agreement, the PEB recommends a settlement that can then be imposed by Congress after 30 days. The PEB provided that recommendation on Jan. 19. It stated, "(United) persuasively asserts that, unless the economics of the industry improve beyond any reasonable expectation (existing cost-cutting) efforts are simply not enough, by themselves, to stave off reorganization under the bankruptcy laws at some future time," and that a "financial recovery plan" might well require employee concessions. Even so, the PEB asserted that "Any fair and reasonable (contract) agreement must provide for immediate and significant increases in compensation to bring the UAL mechanics and utility employees to their proper position in parity with the top of the industry."

The PEB did offer management some relief in suggesting that the pay raises be phased in over time and that United be allowed to defer payment for higher wages retroactive to July 2000, when the contract became amendable.

United and the mechanics union leadership had continued negotiations into the weekend, but remain far apart. The company's efforts to secure labor cost concessions are complicated by the situation facing the leadership of United's mechanics union: United's pilots received a substantial pay increase in 2000, mechanics at other large airlines (most recently at Northwest Airlines and American Airlines) have received substantial pay increases, and a rival union is attempting to take over representation of mechanics from the current union (the International Assn. of Machinists). Accordingly, it is difficult for the mechanics union leadership to recommend, or for its membership to accept, a contract that does not provide for substantial pay increases before any discussion of concessions begins.

The PEB's recommendations were consistent with the general approach of federal labor mediation—to encourage the two sides to reach their own agreement and, failing that, to look to settlements at comparable companies for guidance in recommending an outcome. Still, the PEB's action will likely force United, at least initially, to agree to substantial pay raises and then immediately enter into talks with all unions about securing concessions to improve the airline's financial situation. If the two sides do not reach agreement in 30 days, the mechanics could strike unless Congress imposes the PEB's recommendations. The threat of a strike will undermine United's already weak revenue generation, and an actual strike would be financially ruinous.

Any broader package of labor concessions would necessarily include United's pilots and probably its flight attendants. Reaching a contract settlement with the mechanics and then attempting to negotiate with several unions regarding concessions, even if successful, could take an extended period. UAL, meanwhile, would be incurring further, if declining, losses during this period, and the gradually improving airline industry environment may over time erode the sense of urgency to reduce labor costs. Given United's long history of difficult labor relations, it is also possible that attempts to secure pay and productivity concessions could be unsuccessful.

UAL will report its fourth-quarter 2001 financial results on Feb. 1, 2002, with a large loss expected. Still, as at other U.S. airlines, revenue is recovering gradually from its September 2001 low point, and cash is sufficient to avert any near-term liquidity concerns. UAL had $2.7 billion of cash at Sept. 30, 2001, and faced $969 million of debt and capital lease payments in the succeeding 12 months.

Ratings could be lowered further if a strike occurs or if it appears unlikely that United will be able to reach a reasonable settlement with its various unions.

From Standard & Poor's Credit Wire

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