Fitch Affirms Southwest Airlines' IDR at 'A'; Outlook Stable.

CHICAGO -- Fitch Ratings has affirmed the debt ratings of Southwest Airlines Co. as follows:

-- Issuer Default Rating (IDR) at 'A';

-- Senior Unsecured Debt at 'A';

-- Bank Credit Facility at 'A'.

In addition, Fitch assigns an 'A' rating to the $300 million of new senior unsecured notes maturing 2016.

The Rating Outlook for Southwest is Stable. The affirmation applies to approximately $1.7 billion of outstanding debt currently issued by the airline, including the new issuance.

Southwest's ratings reflect the low-fare carrier's demonstrated ability to consistently deliver industry-leading margins and sufficient levels of operating cash flow to meet heavy aircraft capital spending commitments without driving leverage higher. During a period of unprecedented turmoil in the U.S. airline industry over the past five years, Southwest has remained profitable in every quarter, growing available seat mile (ASM) capacity and domestic market share as many of its legacy airline competitors struggled for survival.

Southwest has de-levered its balance sheet somewhat in 2006, with the pay-down of approximately $600 million in aircraft-backed notes in November. That maturity has been partially refinanced with the issuance of $300 million of new notes this month. Following the issuance of the new notes, total debt outstanding at year-end 2006 will be approximately $1.7 billion, down from $2 billion at year-end 2005. Southwest maintains a strong liquidity position, with $2.3 billion of cash and short-term investments on the balance sheet at Sept. 30. In addition, the carrier has a $600 million undrawn bank credit facility, which matures in 2010.

Operating cash flow has been influenced materially by changes in the balance of counter-party fuel hedge deposits held by Southwest over the past two years, as the value of the airline's hedge position has changed. During the first nine months of 2006, Southwest's fuel hedge portfolio value decreased from $1.7 billion at year-end 2005 to $1.3 billion as of Sept. 30. Pulling out the $270 million reduction in counter-party fuel hedge deposits seen during the first nine months of this year, Southwest's net cash flow from operations totaled approximately $1.6 billion. Operating cash flow was driven not only by better operating results and the $442 million in net income through the third quarter, but also by the $319 million increase in the air traffic liability. This increase reflected the stronger revenue environment and solid booking levels moving into the fourth quarter.

A commitment to the management of fuel price risk through a multi-year fuel hedging program has contributed to Southwest's substantial unit cost advantage versus other U.S. carriers again in 2006, but diminished hedge protection in 2007 will pressure cost per available seat mile (CASM) comparisons next year in a high jet fuel price environment. To offset fuel pressure, Southwest has remained focused on the need to push non-fuel CASM levels lower. Non-fuel CASM declined by 0.6% year-over-year in the third quarter, helping to offset the impact of higher fuel prices. Continued success in this regard, particularly in light of the need to negotiate new labor contracts, will be critical if Southwest is to deliver stronger operating cash flow in 2007 and 2008.

A continuing focus on growth (7% ASM growth targeted for 2007) will keep capital spending levels high again next year. Southwest expects to take delivery of 37 Boeing 737-700 aircraft in 2007, and management has indicated that it may pursue more aircraft if additional growth opportunities arise. Following the Nov. 15, 2006 US Airways merger offer to Delta creditors, Southwest management signaled that it would look to acquire additional assets (perhaps including slots and gates at East Coast airports) if antitrust authorities force the sale of assets at airports where US Airways and Delta have extensive overlapping service.

The industry capacity outlook remains benign moving into 2007, reflecting the absence of big aircraft orders by the U.S. legacy carriers. Southwest appears optimistic about additional growth opportunities in light of the 37 new Boeing jets entering service next year. The ramp-up of new service at Washington-Dulles and Denver, recovery of operations in New Orleans and the pick-up in traffic resulting from the partial elimination of Wright Amendment restrictions at Dallas Love Field all point toward a healthy demand and fare picture, assuming modest U.S. economic growth over the next several quarters.

More cash has been directed toward share repurchases in 2006, and this activity can be expected to continue into next year if the operating environment remains strong. Prior to the Board's authorization of $400 million in additional share repurchases in November, Southwest had completed $600 million in buy-backs during 2006. Repurchases were offset in part by proceeds from employee stock option exercises, which totaled $226 million in the nine months through Sept. 30. A significant increase in share repurchase activity in 2007 could influence the airline's credit profile negatively--particularly if Southwest chooses to fund any additional share buy-backs by issuing new debt.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.