Fitch Places Bombardier on Rating Watch Negative.

NEW YORK -- Fitch Ratings has placed Bombardier's (BBD) and Bombardier Capital's (BC) ratings on Rating Watch Negative. Fitch currently rates BBD's and BC's senior unsecured debt and credit facilities 'BBB-', commercial paper programs 'F3', and BBD's preferred stock 'BB+'. Due to the existence of a support agreement and demonstrated support by the parent, BC's ratings are linked to those of BBD. These ratings cover approximately $6.1 billion of debt and preferred stock.

The Negative Rating Watch is based on significant uncertainties present in BBD's regional jet (RJ) operations and transportation unit (BT), as well as continuing weak operating margins. Fitch believes that it will be able to resolve the Negative Rating Watch in the next three to six months.

Fitch is concerned that further production rate reductions are possible in BBD's RJ operations due to low backlog levels (1.5 years worth of production), poor order visibility, and backlog risks related to the weak financial conditions of several large airline customers, including Delta Airlines, US Airways, United Airlines, and Independence Air. Delta is currently formulating a restructuring plan that could lead to a bankruptcy filing. Other concerns related to BBD's RJ operation include competitive pressures from Embraer's new 70-100 seat aircraft family, the cash requirements of a possible 100-seat aircraft program, and the weak aircraft financing market.

The fiscal 2006 (F2006) production rate that BBD announced last week for CRJ200's was already incorporated into Fitch's ratings, but Fitch had expected production of CRJ700's and CRJ900's to be higher. Further production rate reductions will not necessarily lead to negative rating actions, but will be evaluated on the basis of several factors including how BBD manages the reductions and the timing and magnitude of the reductions. RJ production reductions will also be evaluated in the context of BBD's overall business, given that business jet improvements and the BT restructuring could offset the impact of lower RJ deliveries.

Margin improvement continues to be a key credit issue for BBD's debt ratings. Margins at BT were 2.8% in the second quarter, and the company has estimated that margins will be approximately this level for the next six quarters. At Bombardier Aerospace (BA), margins were negative (-0.6%) for the second consecutive quarter, but improved sequentially. BA's margins continue to be pressured by sales incentives, foreign currency, increased depreciation and amortization related to new business jet programs, and higher interest expense allocation due to the debt issuance earlier this year. Given BBD's level of debt compared to revenues, relatively modest improvement in margins will drive noticeable improvement in credit protection measures. However, failure to improve margins or the discovery of additional problem contracts at BT will likely lead to a rating action.

Other general rating concerns include low free cash flow, the potential need for further restructuring actions, the uncertain timing of margin improvement, the impact of exchange rate fluctuations on financial results and planning, and the sizable pension deficit.

General factors supporting the ratings include BBD's liquidity position, the improvement in the business jet market, better-than-expected free cash flow in the first half of F2005, significant progress on the multi-year restructuring plan, leading market positions, the more conservative strategy at BC, the large backlog at BT, new senior management, and the cost cutting actions at both BA and BT.

BBD's liquidity remained strong at the end of the second quarter, with $2.2 billion of cash and $1.6 billion of credit facility availability. An additional $600 million is available under BC's credit facilities. Fitch notes that approximately $1.2 billion of the cash on hand at BBD is related to advances and subordinated loans extended by BC to the parent. Fitch expects BBD to pay down some of the advances in the third quarter so that BC can retire approximately $500 million of maturing debt. Fitch anticipates that some additional BC advances will be repaid in Q3 to fund increased assets, which declined temporarily last quarter due to seasonal factors. Fitch expects BBD to be cash positive in the second half and for the year despite likely increases in capital expenditures and restructuring outflows during the next two quarters.

BBD is seeing improved demand and better pricing for its business jets, consistent with industry-wide conditions. Orders were up significantly in the first half of the year, and deliveries will likely exceed the company's plan this year. The magnitude of the apparent recovery in BBD's business jet operations is greater than the expectations incorporated into Fitch's ratings of BBD, and the recovery could offset some of the risk related to BBD's RJ operation.