Fitch Rates AMR Corp.'s Convertible Notes 'CCC+'.

Business Editors

CHICAGO--(BUSINESS WIRE)--Feb. 10, 2004

Fitch Ratings has assigned a 'CCC+' rating to the $300 million in senior unsecured convertible notes issued by AMR Corp. (AMR), the parent of American Airlines, Inc. (American). The notes, which are guaranteed by American, carry a coupon rate of 4.5% and mature in 2024. The Rating Outlook for AMR is Stable.

The convertible note rating reflects continuing concerns over very high debt levels relative to cash flow, the heavy fixed cash obligations faced by the company over the next three years, and a liquidity position that remains somewhat weak by industry standards. While the financial turnaround rolled out by American in the spring of 2003 is clearly paying off in terms of improved operating performance, the carrier remains exposed to a litany of risks that could put pressure on liquidity and slow the process of balance sheet repair in 2004. In particular, substantial debt and capital lease maturities (over $800 million this year and at least $1.5 billion in 2005) and required funding of defined benefit pension plans (about $600 million this year) will offset much of the improvement in cash flow from operations that AMR is positioned to report this year.

Improved liquidity and access to the capital markets are primary management objectives as the industry revenue environment continues to recover modestly. This has led the company to issue new debt, slowing the reduction in leverage that is the key to a reconstruction of the airline's balance sheet. Moreover, a total of 80 regional jets now on firm order must be financed over the next three years. This will impede the company's ability to de-lever even as it benefits from a much more competitive cost structure and a potential return to modest profitability in 2004.

Following three years of large operating losses and the 2001 acquisition of TWA, AMR's total consolidated balance sheet debt and capital lease obligations grew from $6.3 billion at the end of 2000 to $14 billion at the end of the third quarter of 2003. Most of the company's available unencumbered assets (including owned, Section 1110-eligible aircraft, engines and parts) have already been pledged as collateral in secured debt transactions. With the exception of American Eagle, AMR's regional airline unit, and a residual equity stake in online travel company Orbitz, most non-core assets have already been monetized. AMR's improved year-end 2003 cash balance ($2.6 billion in unrestricted cash and short-term investments as of Dec. 31) reflected the impact of last year's asset sales - including the sale of stakes in computer reservations company Worldspan, as well as online travel companies Orbitz and Hotwire. Together with $180 million in secured debt issued by American in January, the current $300 million convertible note offering should bolster the airline's cash balances at the end of the first quarter.

While AMR's balance sheet can be strengthened only incrementally this year, the airline's operating profile and cost structure have been transformed in a fundamental way over the past ten months. Indeed, lower labor costs established in the new set of collective bargaining agreements ratified by unionized employees last spring helped the carrier report a 12% year-over-year reduction in operating cost per available seat mile during the fourth quarter of 2003. With an estimated $1.8 billion in annual labor cost savings locked in, and over $2 billion more in annual savings related to strategic initiatives, American's unit costs are now at the low end of the U.S. network airline peer group. American reported the best operating margin among the major network carriers in the fourth quarter (2.5%, excluding special items). A pre-tax loss margin of 2% (excluding special items) in the fourth quarter was only marginally worse than Continental's adjusted pre-tax loss margin. This places American at the top of the network airline group in terms of profitability and operating cash flow generation, and clearly demonstrates the competitive impact of the labor and strategic cost-saving initiatives implemented in 2003.

American's unit revenue performance has shown signs of steady improvement in the months since air travel demand bottomed out in April of last year. For the fourth quarter, passenger revenue per available seat mile increased by 6% over the year-earlier period -- driven by a 3% increase in passenger yields. Domestic yields remain very weak in the face of large increases in scheduled capacity planned by the rapidly growing low-cost carriers. Even with a radically transformed cost structure, American faces stiff fare competition from low-cost rivals such as JetBlue, AirTran, Southwest and America West in city pair markets that have historically generated good yield characteristics. The start-up of transcontinental service by America West on routes between Los Angeles and San Francisco to New York and Boston represents a direct competitive threat to American in historically profitable markets. American's fare and promotion responses to low-cost carrier incursion in formerly strong markets will likely dilute yields somewhat in 2004. With total industry available seat mile capacity likely to grow by as much as 8% this year, prospects for significant improvements in unit revenue appear limited.

On the cost side, the primary risk relates to persistently high jet fuel prices and the inability of American and the other network carriers to effectively hedge against fuel price increases beyond the first quarter of this year. The company expects to pay an average of 91 cents per gallon for jet fuel in the first quarter, with only 21% of exposure hedged. All hedge positions after the end of the quarter have been unwound, and opportunities to layer on attractive hedges are limited in light of steadily high spot fuel prices. Today's OPEC announcement regarding reduced oil production quotas should keep pressure on jet fuel prices for the next several months. Based on recent fuel consumption patterns, AMR's quarterly pre-tax income would be changed by $7.2 million for each one-cent change in the spot price of jet fuel.

This rating was assigned by Fitch as a service to users of its ratings and is based on public information.