S&P Cuts Delta Rating to CC

The downgrade doesn't mean a bankruptcy filing is more likely, because a successful debt-exchange offer could still avert that

By Philip Baggaley, CFA

On Sept. 16, Standard & Poor's Ratings Services lowered selected ratings on Delta Air Lines (DAL ), including lowering the corporate credit rating to CC from CCC. The rating action reflects a high likelihood that, with the launch of an exchange offer that would pay less than face value to holders of Delta unsecured bonds and certain junior classes of enhanced equipment trust certificates, Standard & Poor's shortly will lower the company's corporate credit rating either to SD (selective default), if the exchange offer is successful, or to D if the offer fails and Delta files for bankruptcy.

The rating change does not indicate a heightened risk of a bankruptcy filing, as a successful exchange offer (which would require fulfillment of other conditions) could avert such an outcome. Accordingly, Standard & Poor's affirmed ratings on securities that are not part of the exchange offer.

Delta proposes to offer up to $680 million of new secured notes to holders of $2.2 billion of unsecured bonds (an additional $1.5 billion of senior unsecured bonds aren't included) and $471 million in three junior classes of enhanced equipment trust certificates (EETCs). The new secured notes would consist of three classes that have an equal claim on the same collateral pool, but have different coupons and maturities. The new notes would be offered to existing bondholders, grouped by the maturity of the securities that they hold currently, at various exchange ratios.


  Collateral backing the new notes consists of 87 aircraft (MD88, MD90-30, B757-200, and B767-300), mostly delivered in the early 1990s, plus some flight simulators. The appraised current market value of the collateral is about $1.3 billion, and the initial loan-to-value if all notes are issued of about 52% (55% against the aircraft collateral only).

Numerous conditions are attached to completion of a successful exchange offer, including minimum issuance of $612 million new notes and conclusion of a cost-saving contract with Delta's pilots' union. Delta has not requested credit ratings on the exchange notes. If the offer were fully subscribed by each group of bondholders, Delta would reduce its total debt by about $875 million, exchanging $680 million of new notes for about $1.56 billion of existing bonds and certificates.

The exchange offer, which will be open until Oct. 14, 2004, is intended to advance Delta's overall restructuring plan, which seeks to combine cost cuts (an additional $2.7 billion of annual cash savings by 2006, including $1 billion being sought from pilots), enhanced customer service, debt reduction, and widespread network changes (including the closure of Delta's hub at Dallas-Fort Worth International Airport).


  The pilots' union has offered concessions it values at about $700 million, while management is seeking a minimum of $1 billion of savings, which would include changes to the pilots' pension plan. Management has indicated that it will consider granting profit-sharing and/or an equity stake in the company in return.

The proposed exchange offer, although it does not materially reduce Delta's overall $20 billion of debt and leases, would lighten near-term debt maturities and help persuade pilots that management is seeking sacrifices from a range of stakeholders, not just labor. A near-term bankruptcy threat, caused by the potential early retirement by Oct. 1, 2004, of senior pilots concerned about their pensions, which could cause operational disruption and loss of revenues, is the subject of negotiations between the pilots' union and management, separately and in advance of an overall contract agreement.

Delta's liquidity, previously substantial, is dwindling rapidly, with $2 billion of unrestricted cash at June 30, 2004, down from $2.7 billion at Dec. 31, 2003. The company indicated that it expects its cash position to decline at a similar rate during the second half of the year, which would imply yearend cash of $1.3 billion. Although this amount in itself would not necessarily trigger a bankruptcy filing, expectations of further cash losses during the seasonally weak first quarter might persuade Delta to file for Chapter 11 unless it secures the labor concession it is seeking.


 Debt maturities for the remainder of 2004, based on the most recent available information, total about $410 million ($290 million in the third quarter and $120 million in the fourth quarter), with a further $1.2 billion due in 2005. Delta expects to fund an additional $50 million into pensions during 2004, after having contributed most of its required amounts earlier in the year. It also forecasts $370 million of capital expenditures for the third quarter of 2004, of which $210 million is for regional jets (a "substantial" portion of which will be financed under existing commitments).

Delta has no availability under credit lines, other than commitments to finance upcoming regional jet deliveries. These commitments do not have covenants that Delta is in danger of violating.

The outlook is negative. Ratings will be lowered to D upon a bankruptcy filing or to SD upon a distressed debt exchange, such as that proposed Sept. 15, 2004. A new corporate credit rating would be assigned after completion of such an exchange.

Ratings Lowered    
Rated Entity/Rating Category To From
Delta Air Lines Inc.    
Corporate credit rating CC CCC
Senior unsecured bonds* C CC
Equipment trust certificates    
Series 2000-1, Class C CCC- CCC
Series 2001-1, Class C CCC- CCC
Series 2002-1, Class C CCC- CCC
Ratings Affirmed    
Delta Air Lines Inc.    
Senior secured debt**   CCC
Senior unsecured debt    
8.125% notes due 2039   CC
7.77% notes due 2005   CC
8% sr conv notes due 2023   CC
2.875% sr conv notes due 2024   CC
Senior unsecured airport revenue bonds   CC
Equipment trust certificates and pass through certificates***    

*Excepting senior unsecured bonds listed as affirmed and unsecured airport revenue bonds.

**Secured airport revenue bonds.

***Excepting the issues noted as downgraded.

Baggaley is a credit analyst following the airline industry for Standard & Poor's Ratings Services

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