Fitch Ratings Downgrades Bombardier's Ratings to 'BB'.

NEW YORK -- Fitch Ratings has downgraded Bombardier Inc.'s (BBD) and Bombardier Capital Inc.'s (BC) senior unsecured debt and credit facilities to 'BB' from 'BBB-'and BBD's preferred stock to 'B+' from 'BB+'. Fitch has withdrawn the 'F3' commercial paper rating. The ratings have been removed from Rating Watch Negative, where they were placed on Oct. 12, 2004. The Rating Outlook is Negative. 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 downgrade reflects poor free cash flow performance due primarily to slowing growth at Bombardier Transportation (BT); weak operating margins; and continuing concerns regarding regional jet (RJ) backlog (1.5 years of production) and production rates. Free cash flow and margins are not expected to improve materially in the near term. The two notch downgrade also reflects concerns that renewed bank facilities in fiscal 2006 (F2006) may contain covenants or security provisions that could weaken the position of existing debt holders. While the Negative Outlook focuses on all of these issues, stabilization in BBD's operating performance could result in Fitch revisiting the Outlook in the near term.

Other general rating concerns include 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. Additional concerns related to the RJ operation include competitive pressures from Embraer, the cash requirements of a possible 100-seat aircraft program, the weak aircraft financing market, and poor order visibility.

Factors supporting the ratings include BBD's current liquidity position; the recovery in the business jet market, which could offset much of the decline in RJ production in F2006; and BBD's level of debt compared to revenues, which could allow modest improvement in margins to drive noticeable improvement in credit protection measures. Other issues supporting the ratings include significant progress on the multi-year restructuring plan, leading market positions in most segments, the more conservative strategy at BC, and the cost cutting actions at both Bombardier Aerospace (BA) and BT.

Cash flow deterioration in F2005 is the main driver of the ratings actions. Excluding BC, cash usage (cash from operations less capital expenditures) was $152 million in the fiscal third quarter, offsetting what had been better than expected cash usage in the first half. The primary cause of the lower cash generation was lower advance payments at BT, which resulted from slowing orders. The outlook for cash flow in F2006 is unclear, and Fitch believes that cash flow will likely be pressured due to continued uncertainty at BT, restructuring costs, and pension contributions. Fitch is also concerned with the potential cash flow impact of the C-Series regional jet, which the company could decide to develop starting in F2006.

BBD's liquidity (excluding BC) remained strong at the end of the third quarter, with $2 billion of cash and $2.2 billion of credit facility availability. An additional $600 million is available under a BC credit facility, although BBD has indicated that it will not renew this facility in F2006. Fitch notes that approximately $500 million of the cash on hand at BBD is related to advances extended by BC to the parent, and much of BBD's cash will be used to pay debt maturities at BC. BBD and BC have sufficient liquidity to meet cash obligations in the intermediate term. These obligations mostly consist of approximately $1 billion of debt maturities in the next five quarters, including $300 million of accelerated maturities resulting from rating triggers being breached. BBD (ex-BC) has $6.2 billion of credit facilities, with no borrowings outstanding, but with nearly $4 billion of issued letters of credit. Approximately $2 billion of BBD's credit facilities will mature in F2006, and renewal of these facilities could require additional covenants or security of some type. Fitch believes that BBD's solid liquidity position could be enhanced by selling non-core assets.

Growth at BT is slowing due to some contract deferrals in Europe, mainly Germany. BBD is now estimating transportation growth of 0%-2% compared to the previous 3%-5% expectation. There were no significant contract adjustments in the third quarter, and margins were in line with Fitch's expectations. BT's restructuring appears to be on track, and BT announced 2,200 additional employment reductions in response to the slowing market.

The RJ production rate reduction announced on Dec. 1 (F2006 production of 131 aircraft, down from the previous rate of 145) was expected, and Fitch believes that further cuts for F2006 are a possibility. 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.

BBD is seeing improved demand and better pricing for its business jets, consistent with industry-wide conditions. Orders were up significantly in the first nine months of the year (100 compared to 43). Because of higher projected F2006 business jet deliveries, Fitch estimates that Bombardier Aerospace could reduce RJ deliveries further and still deliver a total number of aircraft in F2006 that is comparable to total deliveries in F2005. As a result, Fitch's concerns related to BA deliveries are increasingly focused on the F2007 outlook.

Margin improvement continues to be a key credit issue for BBD's debt ratings. Margins at BT were 2.5% in the third quarter, and the company has estimated that margins will be around this level in the next few quarters. At BA, margins were slightly negative in the third quarter, but they improved sequentially. BA's margins continue to be pressured by increased depreciation & amortization related to new business jet programs, sales incentives, foreign currency, and higher interest expense allocation due to the debt issuance earlier this year. Failure to improve margins or the discovery of additional problem contracts at BT could lead to additional rating actions.