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Rating Action:

MOODY'S DOWNGRADES DEBT RATINGS OF CONTINENTAL AIRLINES, INC (SENIOR IMPLIED TO B2 from B1)

21 Dec 2001
MOODY'S DOWNGRADES DEBT RATINGS OF CONTINENTAL AIRLINES, INC (SENIOR IMPLIED TO B2 from B1)

Approximately $16.3 Billion of Debt Securities Affected.

New York, December 21, 2001 -- Moody's Investors Service downgraded the debt rating of Continental Airlines, Inc. ("Continental"), senior implied to B2 from B1. The rating outlook is negative. The rating action completes the review of Continental's ratings that began after the terrorist attacks of September 11th.

The ratings reflect the more difficult business environment facing Continental due to the weak economy, potential weakness in the Houston market stemming from energy concerns, and the specific effects on the airline industry of the September 11 terrorist attacks. While Continental's operating performance exceeded that of many industry peers during the third quarter of 2001, the intermediate term outlook for the company's earnings and debt protective measures has deteriorated. Moreover, cash losses since September 11 have eroded Continental's financial profile. These concerns are balanced against the company's lower than average cost structure, the effectiveness of its aggressive cost cutting efforts and its well established position in certain markets. The rating agency also noted that the airline industry is fragile and highly vulnerable to shock risk. The negative rating outlook considers the risk that in the current environment any adverse development, that might otherwise have been easily tolerated, could have more devastating implications for a carrier.

Ratings affected are:

Senior Implied Rating to B2 from B1

Debt Shelf: Senior Unsecured to (P)B3 from (P)B2, Subordinated to (P)Caa2 from (P) Caa1, Equipment Trust Certificates Shelf to (P)Ba3 from (P)Ba2

Senior Unsecured IRB to B3 from B2

Preferred Stock to Ca from Caa1

Enhanced Equipment Trust Certificates - All Enhanced Equipment Trust Certificates and Equipment Trust Certificates have been downgraded by one ratings notch. Ratings range from Baa1 (down from A3) to B1 (down from Ba3).

Following the events of September 11, passenger load factors for all major airlines fell sharply, resulting in significant excess capacity and lower potential yields (revenue per passenger seat mile). Many carriers announced significant capacity reductions and grounded certain older aircraft in their fleets. While load factors have recovered to a fair degree, they are based on a lower capacity level, and the absolute number of passengers carried remains depressed. Continental, with the youngest aircraft fleet in the US industry, has cut capacity similar to many of its competitors, but has maintained load factors somewhat better than its peers. Moody's anticipates that Continental's load factors will show further recovery during 2002, particularly if an improved economic outlook enhances normal seasonal strength in the second and third quarters. However, due to the company's exposure to the Houston market, the pace of Continental's improvement could lag the industry if further weakness is seen in the energy industry. Moody's also noted that much of the passenger traffic recovery has been stimulated with fare sales and yields remain depressed on a year over year basis. Continental's business traffic, which provides higher yields and has been a key part of its recent success, remains at levels well below those seen a year ago.

Continental has benefitted from a cost structure that is lower than many of its major competitors. This stems in part from lower absolute labor costs due to greater work rule flexibility under its labor contracts with pilots, flight attendants, and other workers, and was a factor in the company's ability to report a modest profit for the first half of 2001 when other carriers were experiencing sizable losses. During the past year many airlines have negotiated new labor contracts which included sharply higher labor costs, and during the next several years Continental will need to renegotiate its contracts. Moody's believes that Continental's cost benefit relative to peers may narrow as a result of future labor negotiations, although the magnitude of change may be constrained by the new economic realities facing the industry. Moody's also noted that Continental has benefited from relatively low fuel costs. While no near term increase in fuel costs is expected, the company has no hedging in place and a lack of future hedging could leave the company less well positioned to absorb fuel cost increases, although fuel price increases may well be beneficial for the Houston market and certain of Continental's business.

Since September 11, Continental has reduced its capacity by approximately 18% (as measured by available seat miles), reduced headcount by about 8,500 people, and has taken other cost reduction and cash conservation actions. The company has also benefitted from $213 million in grants from the Airline Stabilization Board, of which $154 million (after-tax) was recognized as income and enabled the company to report a net profit of $3 million for the third quarter. Despite these actions, the company's earnings outlook has weakened when compared to the first three quarters of 2001, and Moody's anticipates that Continental will show sizable losses for the fourth quarter of 2001. The company anticipates that the full benefit of its restructuring actions coupled with further improvement in travel demand will enable it to return to profitability by the second quarter of 2002. Nevertheless, Moody's believes that industry conditions remain uncertain and that Continental could continue to experience losses well into 2002, and that it could be some time before financial returns and credit metrics return to adequate levels.

Continental currently maintains approximately $1.1 billion of balance sheet liquidity. This amount is, on a size adjusted basis, somewhat less than its peers. Debt and capital lease maturities are about $350 million over the coming year and the company has successfully reduced or extended most of the major near term calls on cash, particularly equipment purchases. One material call on cash will be the payment of excise taxes on tickets, which have been deferred following the September 11 events, but will be payable in January 2002. The company has indicated that all future aircraft deliveries have committed financing arrangements. While these actions help to reduce near term cash demands, Moody's noted that any delay in recovery of operating performance would put additional stress on the company's cash position. With virtually all of its major aircraft pledged to existing debt holders, Continental has, compared to its peers, less financial flexibility. However, the rating agency noted Continental's ability and willingness to place $175 million of equity during the fourth quarter. Moreover, the company has the potential to seek further assistance in the form of government guaranteed loans under the airline stabilization program.

Looking forward, Moody's believes that there are three principal risks which will affect Continental's ability to rebuild its revenue base: 1) recovery of the US economy from current depressed levels, specifically improved employment levels which will stimulate higher yielding business travel, 2) rebuilding passenger confidence in the safety and efficiency of the domestic airline system, and 3) constraint on the part of all airlines in adding capacity back into the system. The US economy remains in recession and an upturn may not materialize until well into 2002. The airline industry traditionally lags developments in the broader economy, suggesting a more protracted period of weakness for airlines. Because approximately half of the reduction in airline capacity in the United States is as a result of lower utilization than permanent grounding of aircraft, Moody's is concerned that underutilized capacity can be easily and quickly reintroduced into the system at the first sign of strengthening demand. This could temper the financial benefit of any recovery in industry fundamentals. Finally, passenger sentiment remains highly sensitive to safe and efficient functioning of the airline system, and any adverse events could prompt a further reduction in load factors. While the current ratings anticipate a marked recovery in cash flow by the second quarter of 2002, the negative rating outlook considers the many uncertainties affecting the industry and Continental's ability to rebuild its revenue and cash flow base.

Continental Airlines, Inc. is headquartered in, Houston, TX.

New York
Michael J. Mulvaney
Managing Director
Corporate Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Richard Bittenbender
VP - Senior Credit Officer
Corporate Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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