Airline Debt Takes Off as Passenger Traffic, Profits Rise
By Tim Catts and Mary Schlangenstein -
Oct 31, 2010 6:11 PM MT

Bonds of airlines are proving unbeatable two years after the industry struggled with record high fuel prices and an economy in freefall.

Borrowers from Dallas-based

Southwest Airlines Co., the world’s biggest discount carrier, to Australia’s Qantas Airways Ltd. led gains of 2.36 percent for the sector last month, topping the Bank of America Merrill Lynch Global Broad Market Corporate index, which was little changed. The increases pushed total returns this year to 15.4 percent, the best of the 17 industries making up the index.

Bondholders have more confidence airlines will have an easier time meeting debt payments as the International Monetary Fund in Washington forecasts the world economy will expand more than 4 percent next year, compared with the average of 3.69 percent from 2000 through 2008. The eight largest U.S. carriers are reporting quarterly profits for the first time since 2007 as the industry holds the line on adding seats.

“Performance has been incredible, and it really doesn’t have to be over,” said

William Hochmuth, an analyst at Minneapolis-based Thrivent Financial, which manages $67 billion. “The biggest thing that everyone was focused on in third- quarter earnings was the maintenance of capacity discipline and as long as we have that, there’s pricing power.”

‘Very Good Shape’
United Continental Holdings,

Delta Air Lines Inc. and AMR Corp.’s American Airlines said they plan to limit capacity increases to 3.5 percent or less next year. Profit at the eight biggest U.S. airlines was $2.44 billion in the third quarter, beating analysts’ average estimates. Average airfare per mile excluding taxes rose every month this year through August after falling in 2009, according to the Air Transport Association.

“The airlines have had very good financial results through the summer,” said

Roger King, a debt analyst at fixed-income research firm CreditSights LLC. “They have a lot of cash and they’ve been able to push out their debt maturities. So from a credit metrics standpoint they’re in very good shape.”

Elsewhere in credit markets, the extra yield investors demand to own company bonds rather than government debt worldwide narrowed for a fourth week, capping the biggest monthly drop since July. Global corporate bond issuance declined before

Federal Reserve policymakers meet this week amid speculation the central bank will announce another round of large-scale asset purchases, or quantitative easing. Leveraged loan prices rose, reaching the highest in almost six months.

Yield Spreads
Spreads on company bonds from the U.S. to Europe and Asia shrank 3 basis points last week to 164 basis points, or 1.64 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. That’s a decline of 9 basis points for the month. Average yields of 3.45 percent on Oct. 29 have slid from 4.4 on Dec. 31.

The cost of protecting corporate bonds from default in the U.S. and Europe fell for a second week. Credit-default swaps on the Markit CDX North America Investment Grade Index declined 1.9 basis points to 94.5 basis points, according to Markit Group Ltd. The index, which has dropped from 106.7 at the end of September, reached 92.5 on Oct. 26, the lowest since May 3.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 2.5 basis points for the week to 96.9. The Markit iTraxx Asia index of 50 investment- grade borrowers outside Japan rose 0.2 basis point for the week to 107.06, according to prices from data provider CMA. It fell 1 basis point to 107 as of 8:35 a.m. in Singapore today, Barclays Plc prices show.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Loans Soar
The

Standard & Poor’s/LSTA US Leveraged Loan 100 Index climbed 0.26 cent for the week to 91.34 cents on the dollar, the highest since May 6. Prices on the index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, climbed from 90.46 cents at the end of September.

Seven leveraged loan deals closed last week for $3 billion, bringing the total for the month to $15.3 billion, according to JPMorgan Chase & Co. Year-to-date volume stands at $114.1 billion, compared with $38 billion in all of last year.

In emerging markets, relative yields fell 11 basis points for the week to 242 basis points, according to JPMorgan index data. The index, which closed at 276 last month, touched 237 on Oct. 28, the narrowest level since April 20.



Rio Tinto Group, the world’s third-largest mining company, led $59.4 billion of corporate bond sales worldwide last week, down from $67.7 billion in the period ended Oct. 22, Bloomberg data show. Monthly sales of $273.5 billion compare with $376.5 billion in September and $282.3 billion in October 2009.

Rio Rallies
London-based Rio Tinto’s $1 billion of 3.5 percent notes due November 2020, issued Oct. 28 at 99.225 cents on the dollar, rose to 100.276 cents to yield 3.47 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Fixed-income investors will be watching as Fed policy makers meet Nov. 2-3 to discuss their plans for economic stimulus. The Fed has already cut interest rates almost to zero and bought $1.7 trillion of government and mortgage securities.

The meeting ends two days before the U.S. government may say that the

jobless rate probably held at 9.6 percent for a third month in October, according to the median of 61 estimates in a Bloomberg News survey. Payrolls likely rose by 60,000, the first gain since May.

Airline Rebound
Airlines’ performance for debt investors in October compares with a return of 0.08 percent for corporate bonds worldwide, based on Bank of America Merrill Lynch indexes. Their bonds gained 1.6 percent in September and 1.86 percent in August, versus market gains of 0.22 percent and 2.14 percent.

More than a dozen carriers collapsed in the first half of 2008 as they faced spiraling fuel costs and the worst economic crisis since the Great Depression. Seeking to slash expenses, carriers expanded efforts to charge for snacks and checked bags.

“Airlines are struggling for survival,”

Giovanni Bisignani, the chief executive officer of the International Air Transport Association, said in a speech in Istanbul in June 2008. That was a month before crude oil prices reached as high as $145.29 a barrel.

Airlines are poised to record their first positive fourth quarter in a decade, according to

Michael Derchin, a CRT Capital Group LLC analyst. Before this year’s third quarter, the last time all of the eight largest U.S. airlines were profitable was the same period of 2007.

United Leads Rally
Bonds from United Airlines were the best-performing last month in the Bank of America Merrill Lynch U.S. Corporates Transportation index, gaining 4.61 percent. United’s $500 million of 9.875 percent notes due August 2013 have climbed to 109.25 cents on the dollar from 99.25 cents on Jan. 13, Trace data show. United and Continental Airlines merged to become United Continental Holdings on Oct. 1.

Atlanta-based Delta’s bonds ranked second in the index, returning 3.06 percent in October.
The reduced supply of aircraft seats is aiding carriers as demand picks up from business travelers, who generally buy tickets closer to their departure dates and pay higher fares.
“In terms of absolute strength of revenue, we’ve achieved a level I think is sustainable at Southwest for at least in the near term,” said

Gary Kelly, CEO of Dallas-based Southwest. “I’d call that roughly 12 to 24 months. That’s under the assumption the economy doesn’t slip back into recession and travel demand continues to strengthen.”

Airline Default Swaps
Southwest’s bonds rose 1.1 percent in October, according to the Bank of America Merrill Lynch index data. Qantas’s U.S. dollar-denominated bonds returned 0.76 percent. The Sydney-based carrier’s $513.6 million of notes maturing in April 2016 rose 0.98 cent to 110.78 cents in October, Trace data show.

Credit default-swap spreads on North American airlines fell to an average 650 to 700 basis points from 900 to 1,000 basis points in June, Bloomberg analyst

George Ferguson wrote in an Oct. 25 report.

Contracts on Delta, the world’s second-biggest carrier, tumbled to the lowest in almost three years on Oct. 29. The contracts declined to 570.7 basis points, from 725 at the end of September, CMA prices show.

S&P increased its outlook on Delta, from negative to stable on Oct. 21. “Continued strong earnings, coupled with debt reduction” could lead to an upgrade, S&P said. Delta cut its debt by $750 million in the quarter, it said in a statement.

To contact the reporters on this story:

Tim Catts in New York at tcatts1@bloomberg.net; Mary Schlangenstein in Dallas at maryc.s@bloomberg.net
To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Ed Dufner at edufner@bloomberg.net