Fitch Affirms American at 'B+'; Outlook Stable

NEW YORK—(BUSINESS WIRE)—Fitch Ratings has affirmed the ratings for American Airlines Group Inc. at ‘B+’. The ratings also apply to American’s primary operating subsidiaries, American Airlines, Inc., US Airways Group, Inc. and US Airways, Inc. The Ratings Outlook is Stable.

Fitch has also affirmed the ratings on several American and US Airways EETCs as described at the end of this release.

The ratings are supported by the solid operating results American has posted since its merger with US Airways and concurrent emergence from bankruptcy a year ago. Over the past year American has expanded its operating margins, modestly improved unit revenues, and made significant progress towards integrating the two airlines. Fitch expects revenue and profitability to continue to improve in the near term based on sharply lower fuel costs, a solid domestic travel environment, and due to various strategic initiatives currently underway at American. The ratings are also supported by American’s sizeable liquidity balance, which includes $7.9 billion in cash and short-term investments and newly upsized revolver capacity of $1.8 billion.

The ‘B+’ rating also incorporates notable risks in American’s credit profile, including on-going integration-related risk, a significant debt balance, heavy upcoming capital requirements, and shareholder-directed cash deployment which was implemented sooner than expected. Other rating concerns include risks that are inherent to the airline industry including cyclicality, intense competition, and exposure to exogenous shocks (i.e. war, terrorism, epidemics, etc.).

KEY RATINGS DRIVERS:

Strong operating performance since the merger:

American has exhibited strong financial performance since its emergence from bankruptcy. That performance is notable as the company is still early in the integration process, and much of the expected revenue and cost synergies have yet to be realized. Fitch’s expectation for a relatively positive demand environment for 2015, and the minimal additional capacity planned by the combined company going forward, should lead to continued improvements in operating results in the near term. Margins are also likely to gain a sizeable tailwind if fuel prices remain at the lows seen in recent months.

Total operating revenue for the combined companies is up by 6.7% through the first nine months of the year. Meanwhile, EBITDAR margins have expanded by more than 200 basis points (bps) since year-end 2013 to 20.7%. Fitch expects margins to expand further in 2015, with potential for significant improvement based on lower fuel prices. Recent margin expansion is notable compared to American’s peers. Profitability has outpaced its competitor United, and has made significant strides towards closing the gap with Delta, which has been the clear leader among legacy carriers for several years. Importantly, American has been able to keep its operating costs in check during the integration process. Excluding special items, American’s mainline cost per available seat mile (CASM)-ex fuel is up by 2.4% through the first nine months of the year, well below its total revenue per available seat mile (RASM) increase of 4.3%.

Sharply Lower Fuel Costs:

Fitch notes that American has significant profitability and cash flow upside potential in 2015 if fuel prices remain near current levels. Fitch’s base case forecast incorporates fuel prices that are above current market rates; therefore, American has the potential to outperform if prices remain low. For reference, American burned roughly 3.3 billion gallons of fuel (mainline and regional) through the first nine months of the year. Given that jet fuel prices have recently fallen to below $2.30/gallon from $2.80-$3.00/gallon where they have hovered for the past two years, the magnitude of the cost savings could be significant.

Integration Risks Remain:

Fitch notes that American has made progress in its integration with US Airways since the merger closed in December 2013. However, significant technical challenges remain and will constitute risks in the near- to-intermediate term. Major hurdles still to come include the cross-over to a single reservation system (which is set for the second half of 2015), and reaching joint collective bargaining agreements with the various labor groups.

Improving Credit Metrics:

Fitch assigned the ‘B+’ rating upon American’s emergence from bankruptcy with the expectation that metrics would improve quickly from levels that were weak for the rating at the time. The company has lived up to those expectations thus far. Through the first nine months of the year, total adjusted debt/EBITDAR is down appreciably to 4.5x from 5.3x at year end. EBITDA/Interest has also improved to 5.6x from below 4x at year end. Fitch notes that leverage should improve in the coming year, though any improvements will come from growing EBITDAR and not through debt reduction. Heavy upcoming capital expenditures are likely to necessitate incremental borrowing over the intermediate term. That said, Fitch notes that American has made efforts to pay down some of its high yield debt, and to buy aircraft off of expensive lease contracts in 2014. New capital raised through debt transactions this year has been at attractive rates, which will have a positive impact on interest expenses going forward.

Heavy Capital Spending and Re-fleeting Efforts:

Using conservative fuel price assumptions, Fitch anticipates that American’s FCF could remain negative in 2015 in the range of $500 million-$750 million; there is significant upside potential to this estimate if fuel prices remain low. American is in the midst of a massive re-fleeting effort that will see deliveries of between 60 and 75 mainline aircraft per year through at least 2018. American estimates that total capital spending will be in the $5.5 billion range annually for the next several years. To put that number in context, United Airlines has a long-term annual capital spending target of roughly $3 billion and Delta’s goal is roughly $2 billion-$3 billion annually (both of which are similarly sized airlines in terms of revenue). Although Fitch expects American’s cash flow from operations to improve in coming years as profits increase, the company will likely have to rely on the debt markets to fund a portion of its upcoming deliveries.

Although American’s sizeable capital spending will pressure FCF, Fitch notes that the re-fleeting efforts are necessary, and will offer lower unit costs going forward as the company begins to replace its older, inefficient aircraft. Most notably, on the narrowbody side, the company’s fleet of MD-80s, which have an average age of 22 years, will begin to be replaced by modern 737NGs and Airbus A320s. In addition to being significantly more fuel efficient, and more reliable (reducing maintenance costs and operational delays/cancellations), the newer narrowbodies will feature more seats than the existing MD-80s, providing better unit cost performance. For instance AMR’s 737-800s will typically seat 160 (once reconfigured from their previous 150-seat layout) as compared to 135 on the standard MD-80. On the widebody side, American is scheduled to take 42 787s which will provide highly efficient replacement flying for some of American’s older 767s. American also continues to take 777-300ERs which are key to its international operations.

American also stands to benefit from the introduction of larger regional jets (RJs). The company will take 90 76-seat RJs between 2014 and 2017 (30 CRJ-900s and 60 Embraer 175s). Larger RJs are not only more efficient from a unit cost perspective, but they are preferable for travellers. Airlines report that customers will actively avoid booking a ticket on a smaller RJ if a comparable flight is available on a larger plane. Replacing the smaller RJs helps to retain those customers.

Returning Cash to Shareholders

Aside from heavy capital expenditures, a portion of American’s cash flow in the coming years will be directed back to shareholders. American initiated a dividend and share repurchase program earlier this year. The share repurchase program was initially sized at $1 billion, to be completed by the end of 2015. A dividend of $0.10/share represents an annual payout of roughly $280 million. The dividend is American’s first since 1980. These shareholder-friendly actions are more aggressive than Fitch initially anticipated at the close of the merger a year ago, given that American remains in the early stages of its integration, and given that it maintains a sizeable sum of debt. While payments to shareholders are not expected to drive a negative rating action, directing cash to shareholders rather than paying down debt creates a potential delay of further credit improvement. These risks are partially mitigated by American’s large cash balance and improving operating performance.

Solid Liquidity:

American’s sizeable liquidity balance is supportive of the ratings. As of Sept. 30, 2014 American Airlines had a cash balance of $1.18 billion, short-term investments of $6.7 billion. In addition, in October 2014, American upsized its existing revolving credit facility by $800 million and now has access to $1.8 billion in committed revolving credit facilities. Total available liquidity including the company’s undrawn revolver is equivalent to 24% of LTM revenue. AAL’s cash balance is partially offset by the $721 million held in Venezuelan Bolivars. Fitch views American’s current level of liquidity as being more than sufficient for day-to-day operations, and to manage through an expensive merger integration. However, incremental borrowing will be required to fund upcoming capital expenditures.

Recovery Ratings:

The notching for American’s secured debt reflects Fitch’s recovery expectations under a scenario in which distressed enterprise value is allocated to the various debt classes. Senior debt which is secured both by aircraft and non-aircraft collateral (including slots, gates, routes, ground equipment, etc.) is expected to receive substantial recovery (91%-100%, implying a Recovery Rating of ‘RR1’) in a default scenario. Senior unsecured notes are expected to exhibit average recovery prospects of between 31%-50%, equal to a rating of ‘RR4’. Therefore the senior unsecured debt is rated equal to the airline IDR. However, Fitch notes that unsecured recovery ratings are highly sensitive to model inputs, since unsecured debt makes up a relatively small portion of the capital structure, and is subordinate to a sizeable amount of secured debt.

RATING SENSITIVITIES

Positive Rating Sensitivities include:

- Adjusted leverage moving towards 4x;

- FCF to improve from current negative levels;

- Further evidence that the merger integration is progressing smoothly, e.g. completion of the move to a single reservations system;

- Clarity around outstanding joint collective bargaining agreements and their impacts on unit costs.

A negative rating action is not anticipated at this time. However, Fitch could consider revising the ratings downward if the company were to experience significant/sustained integration-related difficulties. The ratings could also be pressured by an unexpected demand shock that materially impacts operating results.

EETC Ratings:

Fitch Ratings has also affirmed the ratings for multiple American Airlines backed EETCs concurrent with its review and affirmation of American’s Issuer Default Rating (IDR). The rating affirmations cover American Airlines Pass-Through Trust Series 2013-1, 2013-2, and 2014-1 and US Airways Pass-Through Trusts Series 2012-1, 2012-2, and 2013-1.

Senior EETC Tranche Ratings:

Fitch’s senior EETC tranche ratings are primarily based on a top-down analysis of the level of overcollateralization featured in the transaction. Collateral values are updated regularly based on the current appraised values. Fitch notes that aircraft values have largely performed in line with agency expectations over the past year. Exceptions include some softness in current model 777 values after the launch of the 777x and softness in A320-200 values following a shift in preference to the larger A330-300 and due to the announcement of the A330neo program. The ratings also incorporate the structural benefits of section 1110 of the bankruptcy code and the presence of an 18-month liquidity facility.

Fitch’s stress case uses a top-down approach assuming a rejection of the entire pool of aircraft in a severe global aviation downturn. The stress scenario incorporates a full draw on the liquidity facility, an assumed 5% repossession/remarketing cost, and various stresses to the value of the collateral.

Collateral pools for the US Airways transactions are similar, consisting of newer vintage A321-200s and in the case of US Airways 2012-2 and 2013-1, Airbus A330-200s. Fitch considers both types to be low Tier 1 or high Tier 2 aircraft. As such, stress rates of 25-30% were applied in the ‘A’ level stress test, representing the higher end of the Tier 1 stress range. Stress tests for the two 2012 vintage deals produce maximum loan-to-values (LTVs) in the low 90% range, while the 2013-1 transaction has a maximum stress LTV in the high 80% range. These results suggest a full recovery for the certificate holders. Importantly, recovery would be expected prior to the expiration of the 18-month liquidity facility thus avoiding a potential event of default.

American Airlines 2013-1 features a mixed collateral pool of newer delivery 777-300ERs, and 2000-2001 vintage 737-800s and one 777-200ER. Fitch considers the 777-300ER to be a Tier 1 aircraft. While the 737-800s are one of the most liquid aircraft types available, Fitch applies a Tier 2 stress rate to the 737s in this transaction due to their age. The 777-200ERs are considered to be a Tier 2 aircraft. Fitch’s ‘A’ level stress test produces a maximum LTV of 98.7% through the life of the transaction, supporting the ‘A-’ rating.

American Airlines 2013-2 features a mix of 737-800s, 757-200s, 777-200ERs, and one 767- 300ER, most of which are 1999-2001 vintage. Stress rates applied to the pool are generally in the Tier 2 range due to the relative age of the aircraft. Fitch’s ‘BBB’ level stress scenario produces a maximum LTV of 98.5% through the life of the deal, supporting the ‘BBB+’ rating.

American Airlines 2014-1 includes 17 newer vintage aircraft including five Boeing 777- 300ERs, seven Airbus A321-200s, and five A319-100s. Fitch classifies the 777-300ER as Tier 1 collateral while the A321s and A319s are considered low Tier 1/high Tier 2 collateral. All three types are considered strategically important to AAL’s fleet. The 777-300ERs in this pool receive a 25% haircut representing the middle of Fitch’s Tier 1 stress range of 20%-30%. The 25% stress rate reflects that the 300ER is a high-quality aircraft while incorporating the historical volatility of widebody planes. Both the A319s and A321s receive 30% value stresses reflecting Fitch’s view of these aircraft as borderline Tier 1/2. These assumptions produce a maximum stress LTV of 89%, supporting the ‘A’ rating.

Subordinate EETC Tranche Ratings:

The B and C tranche ratings are notched from the ‘B+’ IDR of the underlying airline. The ‘BB+’ rating for the B tranches reflects a moderate-to-high affirmation factor (2 notches) and the presence of an 18-month liquidity facility (1 notch). In the case of American Airlines 2014-1 the ‘BBB-’ reflects a high affirmation factor (3 notches) and the presence of a liquidity facility (1 notch). The ‘B+’ rating for the C tranches reflects a high affirmation factor (+2 notches) and low recovery expectations (-2 notches).

Fitch has affirmed the following ratings:

American Airlines Group Inc.

—IDR ‘B+’.

—Senior Unsecured Notes at ‘B+/RR4’

American Airlines, Inc.

—IDR at ‘B+’;

—Senior secured credit facility at ‘BB+/RR1’;

US Airways Group, Inc.

—IDR at ‘B+’;

—Senior Unsecured Notes at ‘B+/RR4’.

US Airways, Inc.

—IDR at ‘B+’;

—Senior secured credit facility at ‘BB+/RR1’.

American Airlines Pass Through Trust Certificates, Series 2013-1

-Class A Certificates at ’A’

—Class B Certificates at ‘BB+’

—Class C Certificates at ‘B+’

American Airlines Pass Through Trust Certificates, Series 2013-2

—Class A Certificates at ‘BBB+’

—Class B Certificates at ‘BB+’

—Class C Certificates at ‘B+’

American Airlines Pass Through Trust Certificates, Series 2014-1

—Class A Certificates at ‘A’

-Class B Certificates at ’BBB’

US Airways Pass Through Trust Certificates, Series 2012-1

-Class A Certificates at ’A’

—Class B Certificates at ‘BB+’

—Class C Certificates at ‘B+’

US Airways Pass Through Trust Certificates, Series 2012-2

-Class A Certificates at ’A’

—Class B Certificates at ‘BB+’

—Class C Certificates at ‘B+’

US Airways Pass Through Trust Certificates, Series 2013-1

-Class A Certificates at ’A’

—Class B Certificates at ‘BB+’

Additional information is available on www.fitchratings.com

Applicable Criteria and Related Research:

—‘Rating Aircraft Enhanced Equipment Trust Certificates’ (Sept. 12, 2013);

—‘Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers’ (Nov. 18, 2014)

Applicable Criteria and Related Research:

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813588

Rating Aircraft Enhanced Equipment Trust Certificates

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=717763

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=945055