MAY 12TH, 2017

Fitch Affirms Delta at 'BBB-'; Outlook Stable

Fitch Ratings-Chicago-11 May 2017: Fitch Ratings has affirmed Delta Air Lines’ (DAL) Long-Term Issuer Default Rating (IDR) at ‘BBB-’. Delta’s Seattle project bonds have also been affirmed at ‘BBB-’. Delta’s 2007-1 Class A certificates have been affirmed at ‘BBB+’. The Rating Outlook is Stable. A full list of rating actions is shown at the end of this release.

Delta’s investment-grade ratings reflect the material improvements in its credit profile in recent years as the company has paid down debt, improved profitability, and firmly established its ability to generate meaningful free cash flow (FCF). Importantly, Fitch believes that Delta will be able to maintain credit metrics supportive of an investment-grade rating even in a moderate to harsh economic downturn. The ratings also reflect concerns including Delta’s substantial annual cash needs for capital expenditures, dividends, and debt maturities. Concerns also include the typical operating leverage of an airline, which leads to noticeable financial sensitivity to economic conditions and input prices.

KEY RATING DRIVERS
Balance Sheet Supports the Ratings: Delta’s focus on maintaining a healthy balance sheet is supportive of its investment-grade rating. Fitch calculates Delta’s adjusted debt/EBITDAR at 2.2x as of March 31, 2017, which is up from 1.8x a year ago, but down from more than 9x at year-end 2009. Higher leverage is partially due to Delta’s decision to issue debt to fund its pension plan, which we view as credit neutral. Fitch expects Delta’s leverage to decline modestly through the forecast period, as debt reduction is partially offset by expected margin pressure stemming from higher fuel prices and wage inflation.

Rising Costs are Manageable: Delta’s pilot union recently ratified a new four-year contract that includes a 30% pay increase over the life of the deal. This comes on top of a 14.5% pay increase that Delta granted to non-pilot employees in September 2015. Although increasing pay rates will drive a significant increase in cost per available seat mile in 2017, Fitch believes that pressures can be partially offset by savings in other areas over the longer term. Items such as reduced reliance on 50-seat jets, increased worker productivity and maintenance savings may limit increases in CASM beyond 2017.

Near-term Margin Pressure: Higher wages and salaries, rising fuel costs, and a soft (but improving) unit revenue environment will contribute to lower operating margins in 2017 compared to the record levels generated in 2015 and 2016. Fitch’s conservative forecast incorporates only moderate unit revenue improvement in the coming years, and fuel prices rising towards $2/gallon by 2019, leading to operating margins that remain several hundred basis points below 2016 levels. Nevertheless, we expect these levels of profitability to support healthy FCF generation and stable or improving credit metrics.

FCF and Financial Flexibility: Fitch expects Delta Air Lines, Inc.‘s healthy operating profits and manageable upcoming capex will allow the company to produce sizable FCF for the near future. FCF is likely to decline somewhat from recent levels as Delta begins to pay a meaningful amount of cash taxes; nevertheless, FCF is expected to remain supportive of the rating. Fitch’s base forecast anticipates that FCF could reach $3 billion this year (excluding its $3.2 cash billion pension contribution) and could exceed $6 billion on a cumulative basis between 2017 and 2019. Delta spent $2.6 billion on share repurchases in 2016, which could be reduced if needed to maintain liquidity.

Returning Cash to Shareholders: Fitch does not expect shareholder-friendly actions to harm Delta’s credit profile in the near term, due to management’s continued public support for reducing net debt and contributing to pension plans. Although cash deployment to shareholders is expected to be sizable in the near future, it is expected to be more than offset by Delta’s strong cash flow. Concerns would be raised if any dividends or buybacks occurred at the expense of the balance sheet’s health or any necessary operational investment. Delta has spent more than $7 billion on share repurchases and dividends over the past three years.

Reduced Pension Risk: Delta has taken steps in recent years to address its outstanding pension obligations, including issuing $2 billion in unsecured bonds in the first quarter of 2017 to contribute to the pension plans. In total, Delta has contributed nearly $3.6 billion to its pension plan in 2017 (including $350 million in Delta stock). Though DAL’s pension obligations remain sizeable, contributions made this year effectively reduce required contributions to zero through 2020, creating some flexibility in the near term around uses for cash flow. Delta’s pension plans were underfunded by $10.6 billion at year-end 2016, down from $11.2 billion at year-end 2015.

KEY ASSUMPTIONS
Fitch’s key assumptions within our rating case for the issuer include:
—Low single-digit annual capacity growth through the forecast period;
—Continued moderate economic growth in the U.S. over the near term, translating into stable demand for air travel;
—Jet fuel prices equating to roughly $55/barrel on average for 2017, increasing to around $70/barrel by the end of the forecast period;
—Flat-to-moderately positive RASM in 2017 followed by moderate growth thereafter.

RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
-Continued progress towards reducing underfunded pension balance;
—Sustained FCF margins in the mid
to high-single digits as a percentage of revenue;
—Expectations for sustained FFO fixed charge coverage ratio above 5x;
—Total adjusted debt/EBITDAR remaining below 2×.

Future actions that may individually or collectively lead to a negative rating action include:
—Increased operating costs, either fuel or non-fuel related, that are not adequately matched by higher ticket prices leading to substantially reduced operating margins;
—Total adjusted debt/EBITDAR remaining above 3x;
—A substantial increase in dividends or stock repurchases that comes at the expense of a healthy balance sheet;
—An unexpected and protracted drop in the demand for air travel.

LIQUIDITY
Delta ended the first quarter with $2.7 billion in cash and equivalents and $2.4 billion in undrawn revolver availability. Total liquidity was equal to 12.8% of LTM revenue. While some airline peers have a higher cash balance on a cash/revenue basis, Fitch considers DAL’s current liquidity balance to be more than adequate to fund near-term requirements, particularly since the company is consistently generating solid cash flow.

Maturities are manageable in the near term, until 2018 when Delta’s term loans mature. The company has roughly $1.1 billion and $2.3 billion in principal maturing in 2017 and in 2018 respectively, with sufficient cash on hand and cash flows to cover those obligations. Obligations for aircraft deliveries total $2.1 billion for the next nine months of 2017 and $3.1 billion in 2018. The company has stated that given sufficient operating cash generation they may pay for upcoming deliveries with cash, depending on the availability/attractiveness of other financing options at the time of delivery.

2007-1 EETC Ratings:
The ‘BBB+’ rating reflects a two-notch uplift from Delta’s IDR of ‘BBB-’. The two-notch uplift is based on a high affirmation factor (1 notch) and the presence of a liquidity facility (1 notch). The affirmation factor is supported by the relatively high proportion of Delta’s widebody fleet represented by this pool of aircraft, and by the desirability of the 737-800s contained in this collateral pool compared to some of the older narrow-bodies (MD-88s and MD-90s) that Delta operates. Seven of Delta’s eight 777-200ERs are included in this transaction, making affirmation in a bankruptcy scenario likely. The high affirmation factor is partially offset by newer, more efficient widebodies that will be coming in to Delta’s fleet over the next several years and by cross-default provisions in this transaction which are only effective upon final maturity, whereas most recent transactions include an immediate cross-default provision.

Note that Fitch is utilizing its bottom-up ratings approach for this transaction as opposed to the top-down approach that is generally used for EETC senior tranches. This approach follows Fitch’s EETC criteria which call for the bottom up approach if a transaction fails to pass at least a ‘BBB’ level stress test. The Delta 2007-1 class A certificates fail to pass Fitch’s ‘BBB’ stress test largely due to declining appraised values for the 777-200ERs in the portfolio.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following:

Delta Air Lines, Inc.
-Long-Term IDR at ’BBB‘;
—$450 million senior secured revolving credit facility due 2018 at ’BBB’;
-$1.5 billion senior secured revolving credit facility due 2020 at ‘BBB’;
-
$1.1 billion senior secured term loan B-1 due 2018 at ‘BBB’;
-$500 million secured term loan B due 2022 at ‘BBB’;
—Senior unsecured notes ’BBB
’.

Industrial Development Corporation (IDC) of the Port of Seattle special facilities revenue refunding bonds series 2012 (Delta Air Lines, Inc. Project):
-$66 million due April 1, 2030 at ’BBB’.

Delta Air Lines Pass Through Trust Certificates 2007-1:
—Class A Certificates at ‘BBB+’.