CHICAGO — Three months into its Chapter 11 bankruptcy, American Airlines Inc. has begun to show its hand to investors holding $3.2 billion of the carrier’s special facilities revenue bonds by making good — at least for now — on some debt-related payments while moving as expected to shed other obligations.

The airline’s intentions have become clearer from recent court and regulatory filings and trustee notices, while one analytic report this week has offered an assessment of the bonds’ standing based on the latest developments.

Still, bondholders’ ultimate recovery rates remain clouded as even in cases where the airline has made good on debt-related lease payments for bonds issued at facilities in Los Angeles, New York City and Tulsa, it has reserved the right to challenge the characterization of its lease agreements to shed the debt.

American’s position has prompted some trustees to withhold debt service payments given the uncertainty and the potential for a legal battle.

United Airlines employed that strategy with mixed results in its 2002 bankruptcy, rattling the special facilities market. The market had typically viewed a leasehold mortgage or sublease as a solid security, but United and later Delta Air Lines in its 2005 bankruptcy debunked that notion as some debt was rendered unsecured because the sublease terms too closely resembled those of a loan or financing arrangement.

Recent trading activity on American’s bonds has ranged from 20 cents to 89 cents on the dollar as investors attempt to assign a value to the bonds based on their status and pledged collateral.

American — whose parent, Fort Worth-based AMR Corp. filed for federal Chapter 11 on Nov. 29 — reported recently in its fiscal 2011 10K filing recapped details of its Feb. 1 announcement of a framework for a business plan aimed at restoring the restructured carrier to profitability.

“The chief components of this business plan include targets of an annual $2 billion in cost savings and $1 billion in revenue enhancement,” the filing reads. The case is being presided over by Judge Sean Lane in U.S. Bankruptcy Court for the Southern District of New York.

“We are in the process of renegotiating numerous agreements, including those relating to aircraft financings and other indebtedness and leases, to achieve cost savings we believe are necessary to our restructuring … as part of the process of renegotiating agreements, we may reject certain of those agreements in our Chapter 11 cases,” the filing stated.

Fueling Bondholder Jitters

The statement may serve to fuel bondholder jitters. “From this aim, it may be inferred that the company’s airport special facilities obligations would remain very much in the crosshairs,” according to  Bank of America Merrill Lynch’s municipal research group, led by John Hallacy, in the bank’s Global Research report released Monday.

The airline’s tax-exempt debt funded projects at its hub airports, maintenance bases and other facilities. Between $1.4 billion and $1.5 billion was lumped into the unsecured category, meaning the debt was not secured by an asset or lease, and carried only an airline guaranty of repayment.

The worth of those bonds depends on the airline’s reorganization plan and could range from pennies on the dollar to double-digit returns.

The other $1.7 billion to $1.8 billion of bonds are secured by some form of collateral or asset, such as a direct lease, a leasehold mortgage interest or a sublease.

The strength of the pledge varies based on the terms of the individual deals, and American has made good on some payments tied to its secured bonds while hedging its position by leaving open the option for a future challenge to the lease status.

When bond repayment is tied to a true lease, the petitioner must either accept the lease or reject it. If accepted, it needs to make good on all payments. If rejected, the property is surrendered. Bondholder claims would fall into the unsecured category and damages are capped. If the property can be relet, bondholders can possibly recoup their investment.

The airline’s tax-exempt debt that falls into the category of “secured” debt includes $1.2 billion of bonds issued for projects or to refund debt at John F. Kennedy International Airport through the New York City Industrial Development Authority.

The JFK transactions include a 2005 issue for $740.7 million, a 2002 issue for $120 million and a 2002B series for $380 million. All of the bonds carry a leasehold mortgage with re-let rights, provisions considered among the strongest forms of collateral in an airline bankruptcy. The bonds traded between 76 cents to 88 cents on the dollar after the bankruptcy filing and have traded at 89 cents to 94 cents on the dollar over the last month.

In a trustee notice, the Bank of New York Mellon reported that American had made the $49.5 million payment due Feb. 1 under its lease agreements while also preserving its ability to change course.

The payment “shall not be deemed an admission by American concerning the legal characterization or nature of American’s obligations, and American does not waive (and expressly reserves) its right to seek to recharacterize any or a portion of the obligations,” the notice reads.

BNY-Mellon said it believes that it could not use the payment to satisfy the Feb. 1 debt service payment because the rental payment was accompanied by the “reservation of rights.”

The trustee said it had intended to tap reserves but believes their use would violate bankruptcy rules. The trustee is attempting to obtain American’s agreement to use the reserve funds to make the Feb. 1 debt-service payment or to pay the trustee’s fees, expenses and other costs that could arise.

“In the event American does not so agree, BNYM is preparing a protective motion for relief from the automatic stay so that it can use the reserve funds,” the notice reads. An update is expected within 45 to 60 days.

The airline’s $237.6 million of facilities sublease revenue bonds issued for projects or to refund debt at Los Angeles International Airport through the Regional Airports Improvement Corp. also fall into the secured category. Payments due under a sublease secure the debt. The bonds traded between 55 cents to 88 cents on the dollar after the bankruptcy filing and last week were at 87 cents to 89 cents on the dollar.

In a December notice, bond trustee BNY-Mellon reported that American had made payments due under its sublease on Dec. 1, but it also reserved its right for a future challenge.

“It cannot be determined if American will continue to make payments under the sublease or take any action to recharacterize the sublease or recover any payments made pursuant to the sublease,” the notice read.

The trustee said it would withhold debt service payments in part to preserve funds for potential litigation.

The airline’s $237.6 million issue for its maintenance base in Tulsa through the Tulsa Municipal Airport Trustees also holds secured status. The deals include a 1992 issue for $27.5 million, a 1995 series for $97.7 million and a 2000 series $112.4 million.

The bonds are “payable from rents derived under a sublease.” The bonds initially traded after the Chapter 11 filing at 61 cents to 70 cents on the dollar and traded more recently at 75 cents on the dollar.

Trustee BNY-Mellon reported in notices in a January notice that the airline has made payments due under its sublease agreements, again reserving its right to change course and seek a recharacterization of the lease agreements. The trustee said it would withhold debt service payments given the uncertain status.

Investors have ascribed less value to the Tulsa bonds than other secured American debt due in part to the risk that American might reject the lease and surrender the property.

“We do not have confidence this facility will go unscathed and in the event AMR rejects the lease we see difficulty in re-letting the facility,” Trident Municipal Research wrote in a report.

Conflicting Comments

Two issues that analysts have offered conflicting comments on regarding their secured or unsecured status are the NYCIDA’s $83.1 million issue from 1994 and $83.9 million from 1990. The 1994 bonds were trading at 21 to 22 cents on the dollar after the bankruptcy filing and through January. The 1990 bonds most recently traded last month at 20 cents to 27 cents on the dollar.

Unlike the more stringent lease provisions attached to the other secured NYCIDA debt, the 1990 and 1994 bonds are payable solely from and secured by a pledge of payments to be made pursuant to a lease agreement between the airline and the agency, according to the offering statements.

In a Feb. 1 notice informing holders of the 1994 issue that the airline did not make its scheduled rental payment linked to debt service, the trustee wrote that it was examining all options.

In a January notice on the 1990 bonds, the trustee bank reported that American had made a payment due under its lease, but American reserved the right to seek to recharacterize the debt, and as a result the trustee opted not to make a payment to bondholders pending more clarity on the carrier’s intentions.

Hallacy and his team hold a dim view of the recovery rate likely on American’s unsecured debt and warn the prospects for the $453 million of Tulsa bonds and the 1990 and 1994 NYCIDA bonds “are highly uncertain.”

Hallacy’s group offers a more heartening assessment for investors holding the 2002 and 2005 NYCIDA and LAX bonds. They believe those debts could be paid in full. The analysts don’t think American will move to recharacterize those bonds and risk losing the facilities that can be relet under the bond agreements.

“The possibility of the Port Authority of New York and New Jersey and the Los Angeles Department of Airports assuming control over American’s terminal space, in the event of default on the respective bonds, poses serious legal and operational risks to American which, in our view, would be too great to be tested among the myriad issues that the carrier is seeking to resolve in the course of its reorganization,” the report reads.

Unsecured Category

American Airlines has halted payments on those bonds it lumped into the category of unsecured, as required during bankruptcy proceedings. In the latest development on its unsecured bonds, American last week filed a motion to reject its facilities agreements at Dallas-Fort Worth International Airport and Alliance Airport tied to $632 million of DFW special facilities bonds and $407 million of Alliance debt. The motion is scheduled for the airline’s monthly omnibus hearing on March 22.

The DFW series issued through the Dallas-Fort Worth Facilities Improvement Corp. includes $199.2 million sold in 1999, a $131.7 million sold in 2007, a $126.2 million issue from 1995, a $103 million issue and a $65 million issue in 2000, and a 2002 issue for $7.1 million.

Manufacturers and Traders Trust Co. is trustee on the bonds and it has hired Drinker Biddle & Reath LLP to represent bondholders. The bonds traded at 24 cents on the dollar this week.

American also has $357.1 million of Alliance Airport Authority Inc. special facilities revenue refunding bonds from a 2007 issue and another $49.5 million of bonds from a 1991 sale tied to construction of its maintenance base in Fort Worth.

American disclosed in its Feb. 1 “framework” plan its intention to abandon the Alliance base. The bonds were trading at 25 cents on the dollar this week. Manufacturers and Traders is also trustee for the issues.

The airline’s other unsecured bonds include $115.6 million issued through the Puerto Rico Ports Authority for projects at Luis Munoz Marin International Airport in San Juan in 1996 and another $39.7 million from a 1993 issue. Law Debenture Trust Co. of New York is the trustee. The bonds have most recently traded at 27 cents on the dollar.

A third issue for $36.2 million was sold in 1985 through the Puerto Rico Industrial Medical, Higher Education and Environmental Pollution Control Facilities Financing Authority. U.S. Bank NA is the trustee. Bonds from that issue traded last month at 30 cents on the dollar. The airline did not make payments due Dec. 1 and the trustee in a notice filed last week said it had hired Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC.

Chicago sold $108.7 million of O’Hare International Airport special facility revenue refunding bonds in 2007 on American’s behalf. BNY-Mellon is the trustee. The Chicago bonds traded at 27 cents on the dollar last week. The trustee informed bondholders that American had did not make a scheduled December payment.

A $17.9 million issue was sold by the New Jersey Economic Development Authority for projects at Newark Liberty International Airport. BNY is trustee. The bonds traded last month at 26 cents on the dollar. The trustee notified bondholders in a December filing of American’s treatment of the bonds as unsecured. “So far, I haven’t seen many surprises with the case,” a bankruptcy attorney said.

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