New York, March 17, 2020 -- Moody's Investors Service ("Moody's") downgraded its senior unsecured debt ratings of Southwest Airlines Co. ("Southwest") to Baa1 from A3 and the ratings on its one enhanced equipment trust certificate financing, Series 2007-1, Class A to A2 from A1, and Class B to Baa2 from Baa1. All ratings are on review for further downgrade.
The rapid and widening spread of the coronavirus outbreak, the deteriorating global economic outlook, falling oil prices and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The passenger airline sector has been one of the sectors most significantly affected by the shock given its exposure to travel restrictions and sensitivity to consumer demand and sentiment. Southwest remains vulnerable to shifts in market sentiment in these unprecedented operating conditions and the company remains vulnerable to the outbreak continuing to spread. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. Today's actions reflect the impact on Southwest of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.
With the downgrades and further review, Moody's considers that the coronavirus will significantly curtail US domestic and global demand for air travel through at least June. For now, Moody's assumes a measured pace of recovery in demand commencing in the third quarter. Moody's anticipates that the accelerating incidence of the coronavirus across the US will lead to further capacity reductions across the industry and, potentially, a temporary restriction on passenger air services, both domestically and to and from additional foreign countries. Moody's current assumption is that domestic industry capacity in the US is cut by 50% in the second quarter and by 25% in the third quarter relative to the respective quarters in 2019. Moody's assumes Southwest's full year capacity would reduce by about 18%. However, there are high risks of more challenging downside scenarios and the severity and duration of the pandemic and travel restrictions are highly uncertain.
In its review, Moody's will consider (i) the sufficiency of the company's liquidity profile, which is substantial with about $6 billion of cash currently on hand; (ii) the company's ability to timely and, in what magnitude, aggressively reduce expenses and capital investments to reduce cash outflows as new booking levels recede; (iii) evolving market conditions, including demand patterns and additional capacity cuts; (iv) the potential for and types of support the US government might provide to US airlines; and (v) the potential for Southwest to timely restore key credit metrics following the coronavirus, which will require prioritization of debt reduction over share repurchases.
Southwest's liquidity is substantial with about $6 billion of cash on hand after recently paying 2019's profit sharing of more than $600 million. The $1 billion revolver is now drawn, and on March 12 the company arranged and drew a new $1 billion unsecured 364-day credit facility, increasing cash to the $6 billion level. The company has substantial unencumbered assets, including aircraft available for sale / leaseback transactions or to pledge as collateral for new credit facilities or capital markets transactions should this become necessary. A $500 million unsecured note is due in November 2020.
The Baa1 senior unsecured rating reflects Southwest's conservative capital structure, marked by debt-to-EBITDA of 0.9x at the end of 2019; its record of recurring free cash flow; strong liquidity; and its leading market position in the US domestic passenger airline industry. The grounding of the Boeing 737 MAX has delayed capital expenditures, contributing to the company holding more cash coming into 2020 relative to prior years.
The ratings could be downgraded if Moody's believes the impact of the coronavirus will lead to a steeper and longer decline in passenger demand than it anticipates at this time. A shutdown of US domestic airspace could lead to a downgrade, as would cash approaching $3.5 billion. Additional downward ratings pressure would result from (i) a longer-running decline in passenger bookings beyond the second quarter of 2020, or a slower pace of recovery as a result of the coronavirus outbreak, particularly if not matched by further additional sources of liquidity; (ii) greater liquidity pressure from an inability to remove costs and cut capital spending; and/or (iii) if there are clear expectations that Southwest will not be able to timely restore its financial profile once the virus recedes (for example, Reported Debt/Capital maintained near or above 40%, Debt-to-EBITDA above 3x, FFO + interest/interest below 8x, or Retained Cash Flow/Debt approaching 25%). Share repurchases ahead of repaying in full the 364-day term facility and the revolver could also pressure the ratings. There will be no upwards pressure on the rating until after passenger demand returns to pre-coronavirus levels and Southwest restores its debt-to-EBITDA to about 1x.
Changes in the EETC ratings can result from any combination of changes in the underlying credit quality or ratings of the company, Moody's opinion of the importance of the aircraft collateral to the operations, and/or its estimates of current and projected aircraft market values, which will affect estimates of loan-to-value.
The methodologies used in these ratings were Passenger Airline Industry published in April 2018 and Enhanced Equipment Trust and Equipment Trust Certificates published in July 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
Southwest Airlines Co., based in Dallas, Texas, is a leading low-cost airline in the United States. Southwest operates more than 4,000 flights daily during peak periods, serving 103 destinations across the United States and ten additional countries. Based on the most recent data from the US Department of Transportation, Southwest remains the nation's largest carrier in terms of originating domestic passengers boarded. The company reported revenue of $22.4 billion for 2019.
..Issuer: Southwest Airlines Co.
....Senior Secured Equipment Trust, Series 2007-1 Class A, Downgraded to A2 from A1; Placed Under Review for further Downgrade
....Senior Secured Equipment Trust, Series 2007-1 Class B, Downgraded to Baa2 from Baa1; Placed Under Review for further Downgrade
....Senior Unsecured Regular Bond/Debenture, Downgraded to Baa1 from A3; Placed Under Review for further Downgrade
....Senior Unsecured Shelf, Downgraded to (P)Baa1 from (P)A3; Placed Under Review for further Downgrade
..Issuer: Love Field Airport Modernization Corporation
....Senior Secured Revenue Bonds, Downgraded to Baa1 from A3; Placed Under Review for further Downgrade
..Issuer: Southwest Airlines Co.
....Outlook, Changed To Rating Under Review From Stable