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Players Eye Buying American

DEC 9, 2011 7:27pm ET
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CHICAGO — With trading active on much of bankrupt American Airlines’ $3.2 billion of special facilities revenue bonds, some market participants are sounding a cautionary tone in assessing their value, as bargain hunters eye the airline’s discounted bonds secured by collateral.

Fort Worth-based AMR Corp., the parent of American, filed for federal Chapter 11 bankruptcy on Nov. 29 seeking to lower employee costs and pare its debt load as its competitors have done over the last decade.

The airline lists in its bankruptcy filings about $3.2 billion of special facilities revenue bonds in at least 19 transactions. The tax-exempt debt primarily funded projects at American’s hub airports and its maintenance facilities along with several other facilities.

American lumped more than $1.4 billion into the category of unsecured claims, meaning repayment is not backed by an asset, property or revenue stream. They carry only an airline guaranty of repayment. Payments on pre-petition claims are halted after a Chapter 11 filing. The bonds’ value has plummeted in recent trading activity.

The other more than $1.8 billion of bonds are secured by some form of revenue stream or asset such as a leasehold mortgage interest, lease or sublease agreement. While they have lost value, the market has taken a wider range of views on their value.

Some are trading at 80 cents on the dollar while others are closer to 50 cents or on par with their unsecured counterparts. The disparity shows how difficult it is to ascribe a value to the pledged collateral and that a “secured” claim doesn’t guarantee full compensation in bankruptcy.

“What happens in bankruptcy is unpredictable,” said analyst Matt Fabian, a managing director at Municipal Market Advisors. “You don’t know how the stakeholders will interact” as airports, the airline and bondholders are pitted against one another.

Holders of the unsecured bonds will have to await the company’s reorganization process to learn their recovery rate. In past airline bankruptcies, unsecured claims have paid as little as cents on the dollar to more than half of the principal owed.

The value for investors of so-called secured bonds is more complex. Some investors might recoup their full investment but the ultimate payout hinges on a number of factors such as whether the asset or revenue stream backing the bonds is challenged by American as bankrupt airlines have done in the past with mixed results.

Previous airline bankruptcies may provide some direction for distressed buyers weighing whether to buy, but market participants warn that each case takes its own track — influenced by the airline’s goals, the courts’ interpretation of applicable laws, and each bond structure’s own nuances.

“In these situations there is a need to do a careful analysis of the documents in relation to the bankruptcy,” said James Spiotto, a lawyer at Chapman and Cutler LLP who has worked on past airline bankruptcies and authored a 2007 case study on the outcome of United Airlines’ 2002 Chapter 11 on its special facilities revenue bonds. 

“I think people are in the process of looking into these transactions and determining what they have and what the structure is and how it works,” he said. “You have to assess each one separately.”

Richard Lehmann, publisher of Distressed Debt Securities Newsletter, put all of American’s special facilities revenue bonds in his latest count of municipal defaults after the bankruptcy filing, even those classified as secured bonds, some of which could ultimately retain their value. “It’s a function of what American will or won’t do” in rejecting or accepting leases or challenging repayment terms, he said.

The uncertainty offers “great opportunity to profit and great opportunity to lose” on trades, Lehmann added.

Before the filing of United’s parent UAL Corp., the market had typically viewed a leasehold mortgage or sublease as a solid security. But the United bankruptcies and those of Delta Air Lines and the former Northwest Airlines in 2005 debunked that notion.

When a leasehold mortgage is put up as collateral, a debtor can sometimes escape full repayment based on a determination by the courts of the property’s current value in the case of a maintenance base, for example. Any additional amounts owed on the mortgage are treated as an unsecured claim.

A leasehold mortgage with the bond trustee afforded rights to capture rents from the re-letting of the leased facilities — such as terminal gates — is considered one of the sturdiest collateral pledges and the reason why a good portion of American’s bonds for projects at John F. Kennedy International Airport have held on to their value in secondary trading.

If the debt service obligation is tied directly to a lease or sublease, a debtor can surrender the property that in turn can be re-let or it can assume its lease, in which case it must make good on all payments due.

Rejection damages are capped in bankruptcy. If gates are in demand at an airport, the re-let provision carries more traction. United challenged the status of its subleases tied to several financings, and in some cases succeeded in reducing their status to that of a loan or financing arrangement, rendering it an unsecured claim.

As its competitors’ past filings also did, American’s bankruptcy underscores the greater risks taken for the higher yields offered by airline’s tax-exempt borrowing for qualified airport projects compared to general airport revenue bonds used by airports to raise capital for more general projects.

“It comes down to the structure and what’s the legal significance, and if it’s a true lease structure, what’s the value of the lease to the airline,” Spiotto said.

THE BONDS

At the end of September, AMR’s debt obligations totaled $10.9 billion, including a mix of secured variable- and fixed-rate indebtedness, enhanced equipment trust certificates, special facility revenue bonds, various notes, a bank advance and purchase miles agreement.

 The carrier reports in its bankruptcy filings the issuance of special facilities revenue bonds primarily to purchase equipment and-or improve airport facilities that are leased or otherwise used by American.

The largest amount, about $632 million, listed in the unsecured category was issued for projects at Dallas-Fort Worth International Airport through the Dallas-Fort Worth Facilities Improvement Corp. They include $199.2 million of airport facility improvement bonds sold in 1999 and due in 2035 that paid a 6.375% rate, a $131.7 million issue of refunding bonds sold in 2007 and due in 2030 that paid a 5.50% rate, and a new-money issue for $126.2 million due in 2014 that paid a 6% rate.

A $103 million offering of Series A3 refunding bonds was sold in 2000 maturing in 2029 and paying a 9.125% rate. An A2 series for $65 million was also sold in 2000 that is due in 2015 and pays a 9% rate. A 2002 issue for $7.1 million due in 2026 paid a 8.25% rate.

Manufacturers and Traders Trust Co. is trustee on the bonds. A 2030 maturity on the $131.7 million issue dropped in value from 50 cents on the dollar in pre-filing November trading to 17 to 20 cents on the dollar last week.

Additional issues include $357.1 million of Alliance Airport Authority Inc. special facilities revenue refunding bonds sold in 2007 and due in 2029 that paid an interest rate of 5.2%. Another $49.5 million of bonds were sold in 1991 that were due Dec. 1 at an interest rate of 7%.

Because the bankruptcy filing came ahead of the due date, bondholders did not receive payment. Trading fell from 97 cents on the dollar in mid-November to 16 cents after the bankruptcy filing and was at 22 cents late last week.

Manufacturers and Traders Trust Co. is the trustee for both issues.

The outstanding issues also include $115.6 million of Puerto Rico Ports Authority Series A special revenue bonds borrowed for projects at Luis Munoz Marin International Airport in San Juan in 1996, which are due in 2026 and paid a 6.25% rate.

Another $39.7 million of special facilities revenue bonds series were sold in 1993 and are due in 2013 and paid an interest rate of 6.3%. Law Debenture Trust Co. of New York is the trustee on both issues.

A third issue was sold through the Puerto Rico Industrial Medical, Higher Education and Environmental Pollution Control Facilities Financing Authority as Series 1985 bonds for $36.2 million due in 2025 that paid an interest rate of 6.45%. U.S. Bank NA is the trustee.

Through Chicago, the airline sold $108.7 million of O’Hare International Airport special facility revenue refunding bonds in 2007 that mature in 2024 and paid a 5.50% rate. Bank of New York Mellon is the trustee.

An issue for $17.9 million of New Jersey Economic Development Authority bonds was sold in 1991 for projects at Newark Liberty International Airport. The bonds are due in 2031 and paid a rate of 7.1%. Bank of New York is trustee.

The airline listed among its debts another 11 bond issues. The bonds appear to fall into the category of a “secured” debt that is backed by either a leasehold mortgage or facilities sublease. 

The deals include $1.4 billion of special facilities revenue bonds issued for projects or to refund debt for projects at JFK issued through the New York City Industrial Development Authority.

The JFK transactions include a 2005 issue for $740.7 million, a 1994 issue for $83.1 million, a 1990 issue for $83.9 million, a 2002 issue for $120 million, and a 2002B series for $380 million.

The airline lists Bank of New York representing holders of $907.7 million of leasehold mortgage bonds issued for projects at JFK as among its five largest secured creditors.

A 2020 maturity from the $83.9 million 1990 issue was trading at just 21 to 22 cents on the dollar last week. A 2024 maturity from the $83.1 million 1994 issue dropped from 80 cents on the dollar in early November to between 20 cents and 22 cents last week.

Both sets of bonds are payable solely from and secured by a pledge of payments to be made pursuant to a lease agreement between the airline and agency, according to the offering statements.

A 2028 maturity from the $380 million 2002 issue dropped to 76 cents on the dollar after the filing and was at 88 cents last week. The bonds carry a sturdier leasehold mortgage with re-let rights as collateral.

A 2025 maturity from the 2005 sale fell from 92 cents on the dollar prior to the bankruptcy to 76 cents after and has since risen to 88 cents.

The 2005 bonds are also secured by a leasehold mortgage and the trustee is afforded re-let rights. The structure was crafted with United’s lease challenges in mind.

The airline sold $237.6 million of facilities sublease revenue bonds for projects or to refund debt at Los Angeles International Airport through the Regional Airports Improvement Corp.

They include a terminal 4 refunding series in 2002 for $15.7 million, a 2002B series for $26.7 million, and a 2002C series for $195.2 million. Payments due under a sublease secure the bonds.

A 2024 maturity had dropped to 55 cents on the dollar in trading Thursday from 88 cents earlier in the week. Several market participants said that might signal that American skipped a Dec. 1 payment.

The airline issued $237.6 million for its maintenance base in Tulsa through the Tulsa Municipal Airport Trustees. The deals include a 1992 issue for $27.5 million, a 1995 series for $97.7 million, and a 2000 refunding series $112.4 million.

The offering statements note that the bonds are “payable from rents derived under a sublease.” A 2020 maturity from the $97.7 million 1995 deal was trading at 61 cents to 70 cents on the dollar last week.

The next hearing in the case being presided over by Judge Sean Lane in U.S. Bankruptcy Court for the Southern District of New York is Dec. 13.

Fitch Ratings in a recent report warned that unsecured creditors might recover less than 10 cents on the dollar. Under United’s reorganization plan, unsecured claimants were paid four to seven cents on the dollar in new United stock. Though the stock’s price fluctuated after its initial offering, it proved to be worth substantially more.

PAST BANKRUPTCIES

Investors learned the hard way that a “secured” classification early in a bankruptcy case is no guarantee the company won’t try to shed the debt.

United challenged repayment of $1.1 billion issued for projects at five airports, arguing that its lease agreements and cross-default mechanisms linking the airline’s use of the airport to bond repayment could not be enforced in bankruptcy.

Federal courts re-characterized United’s leases tied to $250 million of bonds at JFK, Los Angeles International and San Francisco International as a loan after a review of the economic substance of the leases.

The action rendered the debt unsecured. The courts upheld the lease status of United’s $250 million of debt for projects at Denver International Airport and investors continued to be paid.

The Denver lease was distinguished from the others by the fact that it was contained in one ground and facilities contract between the owners of the airport, the city and county, and the airline, and did not involve a lease-leaseback with other governmental bodies serving as the bond issuer.

The city also retained economic risk in the property at the conclusion of the lease, unlike at the other three airports where the bond issuer had no ownership interest.

In bankruptcy, appeals first go to the district court and then the appellate court. The Seventh Circuit Court of Appeals in Chicago relied heavily on Colorado law governing contracts in its decision on the Denver bonds.

Lease challenges are made more complex because they entail both the application of federal bankruptcy law, precedent set in appellate districts, and state laws governing leases. United emerged from bankruptcy in 2006.

In the case of United’s $600 million of special facilities revenue bonds at O’Hare, Chicago officials and the bond trustees believed that debt repayment was required under provisions of the airline’s use agreement at the airport that required bond repayment.

United argued that the cross-default provisions could not legally be enforced in bankruptcy. The trustees and United eventually settled the case in a deal that forgave $450 million of debt.

Bondholders were angered by Chicago’s position during the bankruptcy as they refused to enforce the cross-default mechanism on behalf of investors. “Investors simply cannot trust the airports to do the right thing for the bondholders,” Fabian said.

Holders of Delta Air Lines’ $414 million of tax-exempt debt issued for projects at Cincinnati-Northern Kentucky International Airport believed an airline “guaranty” of debt repayment unconditionally guaranteed repayment of the bonds regardless of whether the airline challenged its leases or rejected them.

Bondholders eventually settled for an unsecured claim of $260 million.

While the carriers’ bankruptcies of the last decade at first soured investor taste for special facilities debt, they also provided a reference in structuring future deals to better protect investors, as was the case with the JFK bonds in 2005.

That was not the case with American’s unsecured $108.7 million O’Hare refunding in 2007 that was snapped up by investors despite the risks.

The documents make clear that in the event of a bankruptcy the court could severely limit the worth of the company’s guaranty even if the facilities agreement was upheld as a lease.

“Irrespective of the treatment of the agreement and the guaranty in a bankruptcy proceeding with respect to the company or the guarantor, owners of the bonds would likely suffer a substantial loss with respect to their investment in the bonds,” according to the offering statement.

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