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Delta's high price of survival

Old 04-13-2005, 11:13 AM
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Default Delta's high price of survival

Delta: The High Price of Survival

Provided By: The Atlanta Business Chronicle
Last Modified: 4/11/2005 10:42:30 AM

Delta Air Lines Inc.'s most high-profile lenders, General Electric Co. and American Express Co., are reaping a pretty penny on their $1.1 billion investment in the ailing carrier.

GE Commercial Finance and American Express are charging Delta as much as .9.8 percent and 11.5 percent on the various loans and credit lines they extended to Atlanta-based Delta (NYSE: DAL) last fall after the airline narrowly avoided a bankruptcy filing, according to new details on the loans revealed in Delta's recently filed annual report.

Most of Delta's other debt notes have interest rates closer to 7 percent and 8 percent.

The loans from GE and Amex include strict financial covenants that require the carrier to keep at least $1.1 billion in unrestricted funds at all times through October, and Delta also must meet certain pro forma earnings .figures for rolling 12-month periods.

Credit analysts call the terms of these loans "onerous," but they also note that Delta didn't have much leverage to negotiate better rates when the deals were struck last fall.

"The terms are onerous, but not surprising because these facilities were negotiated when Delta was on the edge of bankruptcy," said Philip Baggaley, airline credit risk .analyst and managing director for Standard & Poor's Ratings Services.

Delta currently has $21 billion in total debts and other obligations. The carrier has debt payments of $835 million due this year, with another $913 million in debt due in 2006. In 2007, debt payments balloon to $1.4 billion and they increase to $1.5 billion in 2008.

Attorney Bill Rochelle, a partner with New York law firm Fulbright & Jaworski LLP who specializes in airline bankruptcy cases, said the terms for the GE and Amex lending show just how risky of an investment Delta is considered. The loans call for Delta to pay interest rates as high as 6 percent and 7.75 percent over LIBOR, or the London Interbank Offered Rate (currently set at 3.8 percent).

That could mean an effective interest rate of 9.8 percent on the GE loans and 11.5 percent on the Amex deal. None of Delta's other debt notes carry an interest rate higher than 9.5 percent.

"The perception is that junk debt is getting more risky, especially in aviation, and when they made the loans back in November, there was no assurance Delta would stay out of bankruptcy," Rochelle said.

As Delta continues to burn through its remaining $1.8 billion in unrestricted cash to cover record fuel costs and implementation of its massive network overhaul called "Operation Clockwork," analysts say Delta may need to take on more of these types of loans bearing high interest rates.

Company officials recently warned in their annual report that they expect a "substantial net loss" in 2005 and that Delta's cash flows from operations "will not be sufficient to meet all of our liquidity needs" for the year.

Delta's auditor, Deloitte & Touche LLP, maintains a going concern about Delta's ability to stay in business.

"They may try to sell convertible [debt notes] or stock, but those would depend on earnings prospects and if they're burning through cash and may be headed for bankruptcy, it would be hard to sell those types of securities," Baggaley said. "So asset sales or secured lending seem to be the most likely avenues for some further liquidity."

Delta's only major remaining unencumbered assets are its connection carriers, Comair Inc. and Atlantic Southeast Airlines Inc.

Both are wholly owned subsidiaries that Delta bought five years ago for a combined $3 billion. However, Delta took a $1.9 billion write-down for the carriers in the fourth quarter to adjust their fair market value - a move widely viewed as preparing the carriers for a possible sale.

Delta CEO Jerry Grinstein has said publicly that Delta could still benefit from Comair and ASA without actually owning them, and an executive from SkyWest Inc. airline told investors in early March that his company had had some early talks with Delta about buying one or both of the regional carriers.

"They could try to monetize their regional airlines or it's possible [additional lending] will come from GE and Amex, but there's just no clear indication which way it will go," said Greg Clifton, airlines analyst and vice president at Moody's Investors Service. "[Delta management] has also said they will look at the options to either issue equity and/or further restructure their debt. But, what is the capital market's appetite for Delta stock right now?"

Analysts say fuel prices remain the biggest wild card on liquidity for Delta and several other struggling carriers.

Jet fuel costs about $1.40 per gallon right now, about 20 cents higher than Delta and many other carriers anticipated.
Because Delta uses 2.5 billion gallons per year, each 1-cent increase in jet fuel costs them $25 million. Last year, Delta spent $2.9 billion on fuel alone, nearly $1 billion more than it spent on fuel the previous year.

Several carriers including Delta have been able to raise ticket prices on .certain routes by $5 or $10 each way to offset fuel costs, and those hikes appear to be sticking. However, there have been no indications that fuel prices will come down anytime soon. Crude oil is at $56 per barrel right now, and has remained in the mid-$50s for several months.

Delta's financial picture will be clearer when the company reports its first-quarter results in a few weeks. Airlines typically burn through the most cash in the fourth and first quarters while travel demand slows during the winter months. The peak travel season during quarters two and three typically allows the .carriers to build up enough cash to get them through the next winter.

But if Delta ends the first quarter with too little cash and then fuel prices further erode cash throughout the summer, the carrier could face bankruptcy before next winter rolls around, Clifton said.

"The alarm could go off if Q1 is worse than we anticipate," he said. "We're going to know how bad this past winter was, and then we'll be scrutinizing Q2 and Q3 and if they don't build up enough cash over the summer then that's a red flag ... and they could be in a position where they may have to file bankruptcy."

Clifton added, however, that Delta's largest lenders, such as GE and Amex, have strong incentives to help the airline stay in business.

"GE and Amex have an interest in keeping these aircraft in the air and keeping Delta viable to the extent they can," Clifton said.

"They are making somewhat of a .premium on the loans because of the risk, and keeping the aircraft flying and hopefully allowing Delta enough time to see if they can hit their transformation plan."
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