Fitch Affirms American Airlines IDR at 'BB-'; Outlook Stable

Fitch Ratings-Chicago-01 December 2017: Fitch Ratings has affirmed the Long-Term Issuer-Default Rating (IDR) for American Airlines Group Inc. (American, AAG) at 'BB-'. The ratings also apply to American's primary operating subsidiary, American Airlines, Inc. The Rating Outlook is Stable. Fitch has also taken various rating actions on American's EETCs as described at the end of this release.

The 'BB-' rating is supported by American's market position as the largest airline in the U.S., its dominant position in key hubs, and by the solid financial results that the company has produced since emerging from bankruptcy and merging with US Airways in December 2013. Credit metrics have been pressured this year by higher fuel and labor costs and by an intensely competitive environment that has kept a lid on unit revenue growth. Fitch expects American's leverage to end the year at around 4.8x up from 4.3x at year-end 2016, which we consider to be high for the rating. In addition, full-year margins are expected to decline by 300-500 bps, and FCF will be negative by around $1 billion. However, Fitch expects metrics to improve in 2018 and beyond as cost pressures ease, and capital spending moderates, bringing credit metrics to a level that are solidly supportive of the current rating.

KEY RATING DRIVERS

Healthy Profitability though Margins to Remain Below Peak: American is generating operating margins that are in line with its network-carrier peers and that remain well above levels of profitability that it generated prior to its emergence from bankruptcy, though profitability has declined materially from peak levels in 2015 and 2016. Fitch's base case forecast includes operating margins that remain near current levels. Although we believe that several of American's revenue initiatives (i.e. basic and premium economy, revenue management practices), have merit, we remain cautious about the broader unit revenue environment in the near term. For the LTM period ended Sept. 30, 2017 American generated an EBIT margin of 11.9%, which is down from 16.2% for the same period a year ago. American's peers experienced similar margin declines this year due to higher fuel prices, labor costs, and a highly competitive environment.

Unit Revenue Performance Above Industry Average: A combination of low fuel prices and intense competition led to weak unit revenues across the industry for the past two to three years. Although there has been some improvement in 2017, heavy competition with low-cost carriers and weakness in sections of Asia have prevented a more meaningful recovery. American has fared better than the industry average in part due to its exposure to Latin America, which has rebounded since Brazil has progressed through the worst of its recession. In contrast, both United and Delta have greater exposure to Asia, and United has experienced its own problems in domestic markets as it has grown more quickly than other carriers. Through the first nine months of the year, American's RASM grew by 3.3% compared to 1.7% at Delta and -0.3% at United.

Cost Pressures to ease in 2018: American absorbed significant cost increases over the course of 2015 and 2016 after achieving new contracts with its unions in late 2014/early 2015 and then granting mid-contract pay increases in 2017. The company is also dealing with added expenses related to the integration of US Airways. American's CASM -ex-fuel (cost per available seat mile) was up by 6.4% for the LTM ended Sept. 30, 2017 (per Fitch's calculations). American recently laid out a goal of achieving average CASM growth of below 2% from 2018-2020 excluding the impact of any potential new labor agreements, which Fitch views as achievable as it moves past the worst of its labor cost pressures, finalizes its integration efforts, and continues to upgauge its fleet.

Cash Deployment and Capital Structure Remain Key Rating Negatives: American continues to pursue a more aggressive financial policy than many of its peers, leading to above average leverage, and the possibility that credit metrics could deteriorate quickly in a downturn. Although share repurchases have slowed materially in 2017, the company continues to return significant amounts of cash to shareholders, while maintaining a sizeable debt load. Fitch expects that American's leverage will peak in 2017 and begin to decline thereafter as capital spending eases. Nevertheless, we expect American to maintain a more leveraged balance sheet than its peers for the foreseeable future. Fitch's concerns are partly offset by American's target of maintaining at least $7 billion in total liquidity including its $2.5 billion in revolver availability. Such a sizeable liquidity balance should allow the company to weather rough patches in the industry.

FCF to Improve as Capital Spending Moderates: Fitch expects lower capital spending to drive material improvements in FCF in the coming years. FCF is expected to rise to the low single digits as a percentage of revenue in 2018 and remain positive through the end of our forecast period. Capital spending has been particularly high in recent years, as American has gone through a major overhaul of its fleet. Capex topped $5.3 billion in 2014, $6 billion in 2015, and $5.7 billion in 2016. American has stated that total capex will be around $5.7 billion in 2017 and will decline fairly materially in 2018 as aircraft deliveries decline. American is scheduled to take delivery of only 22 aircraft in 2018, down from 73 in 2017. Deliveries will increase again in 2019 as the company begins to take more 737 MAXs and A320 NEOs, but capital spending should remain below peak levels seen in 2015 and 2016.

Higher expected FCF will be partially offset by more material pension funding. Required contributions to American's pension funds are governed by the Pension Protection Act of 2006, which expires at the end of 2017. American's plans were fully funded under the regulations laid out by the Pension Protection Act. American plans to contribute $780 million to its plan in 2018, following several years where payments were much less significant. As of year-end 2016, the company's pension plans were underfunded by $7.2 billion, equating to a 58% funded status.

EETC Rating Actions
Fitch has downgraded the American Airlines series 2015-1 class B pass through trust certificates to 'BBB-' from 'BBB'.

The downgrade reflects deterioration in the recovery prospects for this transaction caused by lower asset values for various aircraft in this pool. Declining values for 777-300ERs were the primary driver. The current rating for the B-tranche represents a three notch uplift (maximum for a 'BB' category issuer is four per Fitch's EETC criteria) from American's proposed IDR of 'BB-'. The three-notch uplift primarily reflects Fitch's view that the affirmation factor for this collateral pool remains high. Secondary factors for the B tranche rating include the presence of an 18-month liquidity facility and, as mentioned above, Fitch's view of recovery prospects in a stress scenario.

Fitch has affirmed the ratings on various other American Airlines EETCs as shown at the bottom of this release. Senior tranche affirmations are supported by levels of overcollateralization that continue to allow the transactions to pass Fitch's 'A' or 'AA' level stress scenarios, depending on the transaction. However, American Airlines' 2013-1 senior tranche may be in line for a future downgrade. Asset values for the collateral in that pool have declined, particularly for the 777-300ERs and 777-200ER, causing the senior tranche of that transaction to pass our 'A' level stress test with minimal headroom. Further value declines could lead to a downgrade into the 'BBB' category.

The affirmations of the subordinated tranches were based on the affirmation of American's corporate rating and on Fitch's unchanged opinion of the likelihood of affirmation for these pools of aircraft.

DERIVATION SUMMARY

American is rated lower than its major network competitors, Delta (BBB-/Stable) and United (BB/Stable), primarily due to the company's more aggressive financial policies. American's debt balance has increased substantially since its exit from bankruptcy and merger with US Airways in 2013 as it has spent heavily on renewing its fleet and on share repurchases. As such American's adjusted leverage metrics are at the high end of its peer group. The risk of maintaining a high debt balance is partially offset by American's substantial cash position. At Sept. 30, 2017 American had a cash balance of $5.8 billion compared to $4.3 billion and $2.4 billion at UAL and DAL, respectively. American's ratings are also supported by the breadth and depth of its route network, its position as the largest airline in the world (as measured by available seat miles) and by strong financial results since its merger with US Airways.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
--Capacity growth of 1% in 2017 followed by low single digit annual capacity growth thereafter;
--Continued moderate economic growth for the U.S. over the near-term, translating to stable demand for air travel;
--Jet fuel prices equating to around $55/barrel on average for 2017, increasing to around $65/barrel by 2020;
--Low single digit RASM growth in 2017 followed by modest annual growth thereafter;
--Unit cost growth beyond 2017 increasing at under 2% per year, in-line with the company's forecast;
--Annual share repurchases are assumed to be sized in such a way to keep liquidity above AAL's target of $7 billion.

RATING SENSITIVITIES

Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
--Adjusted debt/EBITDAR sustained below 4x;
--FFO fixed charge coverage sustained around 3x;
--Free cash flow generation above Fitch's base case expectations;
--Moderating policies toward financial leverage and shareholder-friendly cash deployment.

Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Adjusted debt/EBITDAR sustained above 4.5x;
--EBITDAR margins deteriorating into the low double-digit range;
--Shareholder-focused cash deployment at the expense of a healthy balance sheet ;
--Liquidity sustained below 15% of LTM revenue.

EETC Rating Sensitivities
Senior tranche ratings are primarily based on a top-down analysis based on the value of the collateral. Therefore, a negative rating action could be driven by an unexpected decline in collateral values.

Subordinated tranche ratings are based off of the underlying airline IDR. As such, Fitch might upgrade various B tranches by a notch if American were upgraded to 'BB'. However, the B tranches may not be downgraded if American were downgraded to 'B+', as Fitch's EETC criteria allows for a wider notching differential for 'BB' and 'B' category rated airlines. Subordinate tranche ratings are also impacted by recovery prospects. Class B certificates currently rated at 'BBB' could be downgraded to 'BBB-' should asset values decline by a greater degree than predicted in Fitch's models.

LIQUIDITY

American is an Active Debt Issuer:
As of Sept. 30, 2017, AAL with a total unrestricted cash and short-term investments balance of $5.8 billion plus $2.5 billion in undrawn revolver capacity, equal to 20% of LTM revenue. This is well above American's long-term minimum liquidity target of $7 billion, but the company aims to keep liquidity high due to its high leverage and current fleet renewal process. Fitch views American's liquidity along with expected generation of significant cash flow from operations to be more than adequate to cover upcoming obligations, including debt maturities of $2.6 billion in 2018 and $2.9 billion in 2019.

American is an active debt issuer having raised $2.6 billion of debt in the first nine months of 2017, including the issuance of two new EETCs and two subordinate tranches of debt on existing EETCs. American has also been very active in the capital markets with multiple repricing transactions. For example, in early November, the company reduced the interest rate on its 2016 December term loan from 250 bps above LIBOR to 200 bps. The company has completed the same repricing transaction with its three other term loans. For comparison, American's term loans were priced at 300 bps above LIBOR in 2014.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the corporate ratings for American Airlines as follows:

American Airlines Group Inc.
--Long-Term IDR at 'BB-';
--Senior unsecured notes at 'BB-'/'RR4'.

American Airlines, Inc.
--Long-Term IDR at 'BB-';
--Senior secured credit facilities at 'BB+'/'RR1'.;
--Series 2016 revenue bonds issued by the New York Transportation Development Corporation at 'BB'.

Fitch has affirmed American Airlines EETC Ratings as follows:

American Airlines 2017-2 pass-through trust:
--Series 2017-2 class AA certificates at 'AA';
--Series 2017-2 class A certificates at 'A';
--Series 2017-2 class B certificates at 'BBB'.

American Airlines 2017-1 pass-through trust:
--Series 2017-1 class AA certificates at 'AA';
--Series 2017-1 class A certificates at 'A';
--Series 2017-1 class B certificates at 'BBB'.

American Airlines Pass Through Trust Certificates, Series 2015-1
--Class A certificates at 'A'.

American Airlines Pass Through Trust Certificates, Series 2014-1
--Class A certificates at 'A';
--Class B certificates at 'BBB-'.

American Airlines Pass Through Trust Certificates, Series 2013-2
--Class A certificates at 'BBB';
--Class B certificates at 'BB+'.

American Airlines Pass Through Trust Certificates, Series 2013-1
--Class A certificates at 'A-';
--Class B certificates at 'BB+';
--Class C certificates at 'BB-'.

US Airways 2013-1 Pass Through Trust
--Class A certificates at 'A';
--Class B certificates at 'BBB-'.

US Airways 2012-2 Pass Through Trust
--Class A certificates at 'A';
--Class B certificates at 'BBB-';
--Class C certificates at 'BB-'.

US Airways 2012-1 Pass Through Trust
--Class A certificates at 'A';
--Class B certificates at 'BBB-'.

Fitch has also downgraded the following rating:

American Airlines Pass Through Trust Certificates, Series 2015-1
--Class B certificates to 'BBB-' from 'BBB'.