UAL Debt Pricing May Indicate Liquidity Fears

Bond investors are demanding a high yield to take on even the secured debt of United Airlines parent UAL, as declining travel demand continues to hurt revenues and raises the risk its liquidity could come under stress.

United Airlines on Friday sold USD$175 million in senior notes backed by its US aircraft spare parts. The notes were priced at 90 cents on the dollar.

"The pricing indicates lack of investor interest and management desperation," CreditSights analysts said in a report on Monday.

"Whether it was due to banker exuberance or company desperation is unclear, but this type of issuance is frequently just a few steps from the grave. It signifies that sources of liquidity are up against a limit while investors have yet to perceive any rising tide of seasonal demand," they said.

UAL denies that the pricing of the debt sale was out of line with general market conditions.

"The transaction was oversubscribed with terms that reflect the transaction structure, the nature of the collateral used and the tight credit market," said a UAL spokesperson.

The sale "will further boost our liquidity as we continue to take the right actions in response to the difficult environment, adjusting capacity and reducing our cost structure," she added. "We continue to take actions to raise liquidity, having raised more than USD$500 million in the first quarter alone."

LIQUIDITY CONCERNS

Concerns that UAL's liquidity could come under pressure have increased as the outlook for travel demand remains bleak and the risk of a renewed surge in fuel prices remains a risk.

Fitch Ratings this month cut UAL's issuer credit rating two notches to CCC, eight steps below investment grade and a deeply speculative grade.

United could report substantially negative free cash flow for the final three quarters of 2009, and the airline has USD$655 million of debt and capital leases maturing in the last three quarters of the year, Fitch said.

"Even if revenue trends stabilize late in the year, the airline faces over USD$1 billion in scheduled debt and capital lease principal payments next year, raising the probability of a deepening liquidity crisis," Fitch added.

Management has indicated that an estimated USD$1.7 billion in remaining unencumbered assets could be used to improve liquidity in the future, though much of these assets are older aircraft and engines that may not be easily magnetized, Fitch said.

"United may have difficulty raising a large amount of new capital over the near term as credit market conditions remain very tight," Fitch said.

Meanwhile the ability of bondholders to obtain the parts backing the recent debt sale in the event of bankruptcy may be challenged, CreditSights said.

"The history of aircraft parts collateral in bankruptcy has been spotty," and bondholders in a past case involving the now-defunct TWA airline were wiped out when a bankruptcy judge did not want to deal with commingled inventory, the analysts said.

"Given the inherent limitations of spare parts collateral, bondholders are betting their principal investment that the issuer will not default over the next three years. That does not seem to be a good bet right now," CreditSights said.