Fitch Downgrades Delta Air Lines to 'B-' on Intense Revenue Pressure; Outlook Negative.
-- Issuer Default Rating (IDR) to 'B-' from 'B';
-- First-lien senior secured credit facilities to 'BB-/RR1' from 'BB/RR1';
-- Second-lien secured credit facility to 'B-/RR4' from 'B/RR4'.
-- IDR to 'B-' from 'B';
-- Secured bank credit facility to 'BB-/RR1' from 'BB/RR1'.
The ratings apply to $2.4 billion of funded secured debt at DAL and $904 million of outstanding credit facility borrowings at NWA. The Rating Outlook is Negative.
The downgrade of DAL's ratings reflects the continued erosion of the airline's near-term cash flow generation potential that has resulted from extremely weak business travel demand and large year-over-year declines in passenger revenue per available seat mile (RASM). Despite large 2009 cost savings driven by the sharp decline in jet fuel prices from last summer's peak, Fitch expects DAL to report another year of substantially negative free cash flow in 2009 as the airline struggles to adjust capacity to a diminished level of demand. While total unrestricted liquidity of more than $5 billion provides DAL with a bigger margin of safety than most of its legacy carrier competitors, the steady erosion of cash balances since last fall threatens DAL's ability to comfortably meet heavy fixed obligations without improved access to capital. With scheduled debt maturities of over $5 billion between now and the end of 2011, DAL's ability to maintain liquidity near current levels depends upon improved credit market openness and a stabilization of the industry operating environment in 2010.
The 'B-' IDR reflects DAL's weak near-term margin and cash flow outlook, the anticipated erosion of cash balances driven by weak operating results in the second half of 2009, and the carrier's extremely heavy lease-adjusted debt burden. Risk of default over the next year is mitigated by DAL's liquidity and cost advantages over its more vulnerable rivals--UAL, AMR and US Airways (all with IDRs of 'CCC' by Fitch). Fitch believes that a bankruptcy filing by any of those carriers, which could occur as early as the winter if operating trends fail to stabilize, would quickly result in further capacity rationalization and a stabilization of RASM trends for better-positioned carriers like DAL.
Steady progress toward complete integration of NWA into DAL has been made since the merger closed last October. Most of the key labor representation and seniority issues have been resolved, and DAL appears on track to meet its goal of receiving a single airline operating certificate from the FAA by early 2010. Cross-fleeting of DAL and NWA aircraft is now underway, and consolidation of airport facilities is nearing completion. Unfortunately, many of the projected revenue synergies offered by the creation of a truly global route network are being offset by the collapse of premium business travel demand and intense fare competition across the entire industry. This has forced DAL, as recently as early June, to announce more planned cuts in international capacity to minimize losses on under-performing routes. While the combined DAL-NWA network is probably best positioned to deliver a RASM premium to the industry once global economic recovery occurs, a continuation of substantial unit revenue declines could, in Fitch's view, drive full year 2009 negative free cash flow in excess of $400 million.
The revenue outlook has shown no signs of real improvement over the last few weeks, even as hopes for a slow economic recovery moving into 2010 have increased. For DAL, May monthly revenue trends appeared to weaken versus April, particularly in hard-hit international markets that had been at the center of DAL's network growth strategy since 2007. DAL noted that H1N1-related booking softness was apparent even outside of Mexican markets last month. Asian point of sale bookings in particular were affected, and DAL indicated that the H1N1 revenue impact could approach $250 million for the full year. This has eroded international RASM further and contributed to DAL's decision to pull more seats out of its international system this fall. The carrier now expects total system ASMs to be down about 10% in fourth quarter 2009 (4Q09). In light of the continued revenue softness, Fitch believes that full-year passenger RASM declines in the range of 10%-15% are now far more likely for DAL and the other legacy carriers with significant international and premium passenger exposure.
The big driver of negative RASM comparisons in the second quarter remains weak business bookings on high-fare trans-Atlantic and trans-Pacific routes. In order to offset the impact of poor front cabin loads, U.S. legacy carriers and foreign flag carriers have been engaged in aggressive fare discounting. Fitch expects this fare and unit revenue pressure to continue through the summer, dampening hopes of a free cash flow turnaround in the second half of the year. Recognizing the risk of widening losses in international markets after August, DAL's most recent capacity cut will seek to trim schedules in some of the underperforming international routes. On the cargo side, extreme revenue pressure linked to the global trade collapse led DAL to shut down the dedicated freighter operation inherited from NWA.
DAL's relative liquidity strength within the U.S. legacy carrier group has been pressured over the past year as a result of poor operating trends and the outflow of cash driven by the need to post fuel hedge margin collateral with hedging counterparties. While that liquidity effect is winding down as the out-of-the-money hedges roll off this year, DAL's total unrestricted liquidity position has worsened to the point where unrestricted cash, investments and revolver availability total less than 20% of annual revenues. On June 11, management indicated that Q2-ending liquidity will total $5.3 billion (including the undrawn $500 million NWA revolving credit facility). Given the carrier's heavy maturities over the next three years and the significant refinancing risk it faces in the still-constrained credit markets, Fitch regards a cash position of over $4.0 billion as critical for DAL as it faces negative free cash flow in the second half of the year and heavy scheduled debt maturities of over $2.9 billion in 2010.
Absent strong free cash flow, extensive capital markets activity will be required to refinance maturing obligations. One positive is the fact that all near-term aircraft orders have committed financing in place, and aircraft capital commitments in 2010 are relatively light. In addition, Continental's launch of a public enhanced equipment trust certificate (EETC) deal in early June bodes well for a revival of credit market access--at least for better-positioned airlines like DAL. With regard to 2010 maturities, the freeing-up of collateral backing the NWA bank credit facility and the 2001-1 EETC issue (both maturing next year) puts DAL in a relatively good position to successfully refinance those obligations.
Since DAL and NWA were the last major carriers to restructure in Chapter 11 this decade, they exited with a unit cost advantage over the other U.S. legacy carriers. This puts the merged carrier in a position to report somewhat better margins than UAL, AMR and US Airways--even as DAL struggles with a network strategy that is not delivering big revenue premiums to the rest of the industry. Merger-related savings are being realized this year as facilities are streamlined, capacity and headcount are reduced and aircraft are parked. For the full year, DAL expects non-fuel unit costs to rise by 4%-6%. Fitch expects unit cost inflation to moderate somewhat in 2010 and 2011 if capacity cuts abate in line with a modestly better operating environment. Fuel costs will be the biggest single contributor to cash flow this year, with fuel-related cash savings of over $5 billion expected based on the forward curve.
Like the other large U.S. airlines, DAL paid a steep price for aggressive fuel hedging undertaken in 2008 as energy prices soared before pulling back sharply. By 4Q08, after crude oil and jet fuel prices had dropped from their July highs, DAL began to unwind some of its remaining fuel hedge exposure. Even after the early termination of many fuel swaps, DAL was required under GAAP hedge accounting rules to recognize large losses in 4Q08 and 1Q09. This will continue over the next two quarters, and the company has indicated that it will likely book $500 million in hedge-related losses in the current quarter. From a cash standpoint, the key trend will be the working down of the fuel hedge collateral account to less than $100 million by the end of the June quarter. After the late 2008 fuel price collapse, DAL began layering on more protection for 2009. In order to reduce downside liquidity risk, the airline has used call options more extensively to hedge. DAL has approximately 52% of Q3 fuel consumption hedged. For Q4, hedges cover approximately 36% of projected consumption. Based on the forward curve, DAL's projected fuel price is $2.04 per gallon for Q2, $2.17 per gallon for Q3, and $2.05 per gallon for Q4. The narrowing jet fuel crack spread in the first half of this year has kept jet fuel prices from rising as much as gasoline and other refined products, limiting some of the damage of rising energy prices over the past several weeks.
Recovery expectations for the DAL first-lien revolver and term loan are superior to those of the second lien term loan. Recovery prospects for first-lien lenders are strong, reflecting the value of a collateral pool consisting of aircraft, engines, spare parts and other assets, as well as a tight covenant package protecting lenders via fixed charge coverage, minimum liquidity and collateral coverage tests. Similar covenants are included in NWA's secured bank credit facility, which is secured by NWA's Pacific route authorities. Taking into account the credit facilities, aircraft-backed EETC obligations and private mortgage agreements, DAL has few unencumbered assets remaining to support additional borrowing if liquidity needs grow.
With regard to covenant compliance, the most restrictive requirement is the quarterly EBITDAR fixed charge coverage test in DAL's bank credit facilities. As defined in the bank agreement, DAL must maintain a ratio of EBITDAR to fixed charges in excess of 1.2 times (x) on a twelve-month trailing basis. A similar covenant exists in the NWA credit facility. Compliance with a fixed charge ratio requirement of 1.0x for the preceding quarter only begins in the current quarter following a suspension of the test for four quarters after NWA's negotiation of a waiver in 2008. In subsequent quarters, the EBITDAR coverage test will be extended to a two-quarter period ending Sept. 30 and a three-quarter period ending Dec. 31.
A further downgrade of the IDR to 'CCC' could follow later this year or in 2010 if no signs of stabilization in the airline revenue environment appear, increasing the risk that DAL's total liquidity position could slip below $4.0 billion with forecasts of continuing negative free cash flow next year. Fitch believes that in such a scenario other more vulnerable carriers will file for bankruptcy before DAL would face imminent default risk. In the process, capacity rationalization would have the effect of stabilizing unit revenue, putting DAL in a better position to ride out the period of industry restructuring. A revision of the Outlook to Stable would likely occur if a stabilization in RASM and fuel trends, accompanied by modest global economic growth, occurs in 2010. A significant re-opening of aircraft-backed credit markets would also be regarded as a necessary condition for a return to a Stable Outlook.
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|Date:||Jun 25, 2009|
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