Fitch Ratings Calls Pilot's Demands 'Unsustainable'

(The following article originally appeared as a post on the Fitch Wire credit market commentary page. All opinions expressed are those of Fitch Ratings, which released the article to the general media.)

The absence of progress this week in contract talks between AMR Corp. management and the Allied Pilots Association (APA) raises the risk that American Airlines will be forced into a Chapter 11 bankruptcy filing. Fitch Ratings sees agreement on terms similar to those proposed by management as essential if the carrier is to move toward a sustainable operating profile in 2012 and beyond.

After five years of unsuccessful bargaining for new contracts, American's pilots appear committed to proposals that would drive AMR's unit labor costs still higher at a time when the airline's margin performance continues to lag significantly behind that of competing U.S. carriers such as United and Delta.

While AMR's liquidity position ($4.3 billion in unrestricted cash and investments at Sept. 30) is adequate to allow the company to avoid a bankruptcy filing in the short run, we regard the achievement of competitive pilot wage and benefit levels as key to American's long-term survival.

In addition to an unsustainable cost profile, AMR faces heavy debt maturities and cash pension funding requirements over coming years that necessitate the generation of positive free cash flow (FCF) and a gradual but consistent reduction in lease-adjusted debt. Another year of substantial operating losses would likely drive AMR's liquidity toward unmanageable levels, despite the carrier's success in accessing debt markets earlier this year and the potential for scheduled current maturities of $1.4 billion to be refinanced.

Although the industry revenue environment has remained healthy in the face of broader weakness in the global economy, persistent fuel cost pressure in 2011 and the labor cost gap have placed AMR in a fundamentally unsustainable financial position.

While management has repeatedly emphasized a desire to avoid an in-court restructuring, Chapter 11 would provide room for the carrier to transform its long-term operating profile. Restructuring steps would likely include a termination of defined benefit pension plans and a significant reduction in the size of American's uncompetitive MD-80 fleet through the rejection of certain aircraft obligations.

A downgrade in AMR's 'CCC' issuer default rating (IDR) to 'CC' or 'C' is likely in the event that a break down in labor negotiations signals a continuation of significantly negative FCF in 2012 and a likely re-assessment by management of the need to pursue a near-term reorganization in bankruptcy.

FMI: www.fitchratings.com