S&P Downgrades Five Big U.S. Airlines

The rating agency cites a disappointing revenue outlook and concerns over continued long-term risks

On June 28, 2002, Standard & Poor's said it lowered its corporate credit ratings and other ratings on five large U.S. airlines, due to a disappointing revenue outlook and concerns over continued long-term risks relating to airport security, rising low-fare competition, increased use of discounted tickets by business travelers, and limited flexibility to reduce labor costs.

The debt ratings for each company's securities were lowered one notch in all cases, excepting bond-insured obligations. Following the downgrades, the ratings of AMR Corp. (and subsidiary American Airlines Inc.) and Delta Air Lines Inc. were removed from CreditWatch, and a negative outlook assigned; while the CreditWatch status of UAL Corp. (and subsidiary United Air Lines Inc.) was revised to developing from negative, reflecting a range of potential rating outcomes as United pursues labor cost concessions and a federal loan guaranty. The outlooks of Northwest Airlines Corp. (and subsidiary Northwest Airlines Inc.) and of Continental Airlines Inc. remain negative after their downgrades.

"The pace and strength of the revenue recovery for large U.S. airlines has weakened, prolonging losses and further eroding their weakened balance sheets," said Standard & Poor's credit analyst Philip Baggaley. Although revenue measures are improving on a year-over-year basis, the industry was already deteriorating in early 2001, making the comparisons easier as the year proceeds. Compared against 2000, the last relatively healthy year for the industry, passenger revenue per available seat mile reported by the Air Transport Association in May 2002 was 16.8% lower than levels of two years earlier, versus only 9.6% lower in January.

Business traffic and ticket pricing remain soft, reflecting not only a cyclical downturn, but also an acceleration of existing trends unfavorable to the large hub-and-spoke carriers, in particular growing low-cost competition and increasingly widespread use of information technology to search for low fares. Increased inconvenience and costs imposed by security measures have added a further disincentive to air travel, especially on short flights.

As a result, and despite stringent cost-cutting efforts, second-quarter and full-year 2002 earnings expectations for the large airlines have slipped in recent months. Lowering the largest single expense, labor costs, requires negotiations with unions in most cases, and these have proven difficult so far, where attempted, despite the industry's clear financial distress. Some large airlines have weathered the crisis relatively better than others, as a comparison of the pre-September 11, 2001, corporate credit ratings with current, revised ratings indicates: the cumulative downgrade for Northwest Airlines Corp. is one notch (to double-'B'-minus from double-'B'), for Continental Airlines Inc. and Delta Air Lines Inc. two notches (to single-'B'-plus from double-'B', and to double-'B' from triple-'B'-minus, respectively), for AMR Corp. three notches (to double-'B'-minus from triple-'B'-minus), and for UAL Corp. four notches (to single-'B' from double-'B'-plus).

All of these companies have sufficient liquidity to survive under the currently foreseen outlook, but all will have accumulated substantial debt and leases to fund losses, debt payments, and capital expenditures through this downturn, burdening their financial profile going forward. Debt and leases as a percentage of revenues is already above peak levels of the early 1990s, after the last industry downturn, and will mount further through at least 2002 before stabilizing at high levels.

From Standard & Poor's CreditWire

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